Gold Should Take a Breather

Source: http://www.flickr.com/photos/tao_zhyn/

At the beginning of the year I wrote an article in which I argued that investors should purchase gold regardless of the momentum-driven bearish hype and the ubiquitous belief that the price of gold is going to continue to fall. Since then the price of gold is up from about $1,200 per ounce to $1,280 per ounce, or over 6 percent. This may not seem like a lot, but annualized this would put gold higher by a whopping 75 percent for the year.

While I believe that the price of gold is ultimately going to much higher levels, I think investors need to wait a little in order to buy again.

The negativity has largely remained in gold among larger analysts, and this gives me reason to be bullish as a contrarian. For instance, Goldman Sachs’s Jeffrey Currie told CNBC that gold will continue to fall. He has a price target of $1,050 per ounce. Bank of America Merrill Lynch believes that the price will fall as well, to $1,150 per ounce.

This is the sort of negativity that we see toward the end of bear markets, just like we see unbridled enthusiasm toward the end of bull markets. Recall that in 2011 Goldman Sachs was actually bullish on the price of gold.

With sentiments reversed I am far more optimistic that we have seen the bottom in the gold price, or that we are very close.

However, there has been a significant amount of enthusiasm for the yellow metal over the past several weeks, and I think this enthusiasm needs to taper off a bit before prudent investors continue buying. This enthusiasm has been most prominent in the shares of the mining companies, and specifically the shares of the smaller — aka “junior” — mining companies.

Since the beginning of the year, the Market Vectors Gold Miner ETF (NYSEARCA:GDX) is up 16 percent, whereas the Dow Jones Industrial Average is down nearly 5 percent. The Market Vectors Junior Gold Miner ETF (NYSEARCA:GDXJ) is up nearly 29 percent for the year. If this latter trend continues for the remainder of the year we are looking at a nearly 1,000 percent annualized return! As much as I want to see my gold mining stocks rise 1,000 percent, I am realistic and I don’t believe that this is going to happen.

Ultimately I think we can see some resistance around the $1,300-per-ounce level as short sellers attempt to defend their positions and as some disgruntled longer-term holders see this as an opportunity to unload their positions.  However, if there is any price weakness, it should be temporary.

Gold still offers incredible value given the recent rise in the money supply as well as the very real yet presently latent possibility that we will see economic chaos in the not-too-distant future. These will be catalysts for the gold price longer term, although they are not reasons for investors to ignore the “buy low, sell high” rule or to chase momentum. Negativity will always come back into the market, and that is when prudent investors buy.

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