Three Warnings Signs for Gold Bugs

Many investors today are still fearful about the economy and that another global recession could be just around the corner.

For example, the other day an elderly gentleman told me he’s worried that hyperinflation of the U.S. dollar is likely imminent. He also said he’s afraid that stocks are set up for a massive correction any day now.

As a result, he confidently stated he wouldn’t touch equities and he’s piling his money into gold instead.

I like gold. But it seemed odd this man would make such a drastic move with his money because he really doesn’t know what’s going to happen in the future any more than I do.

In fact, I have heard this doomsday story about the economy for well over two years now and have yet to see things fall apart.

Yes, we did experience a major recession in 2008 and it did ruin people’s lives.

There are also a number of major concerns, such as our government’s soaring debt, the unemployment rate, and Europe, which must still be addressed before we’re out of the woods completely.

But investors completely ignoring the stock market and buying gold in droves today could really be the ones setting themselves up for disaster.

Because while it’s a good thing to own some gold in your portfolio, going all-in on any investment is really just as risky as putting all your money in one stock.

It’s an investment based on emotion, not strategy.

In fact, when comparing gold prices to other commodities, the world’s most popular precious metal actually seems overpriced at current levels.

And you may be surprised just how detached gold prices when compared to other commodities according to one indicator.

By As Much As 74%

The Thomson Reuters Equal Weight Continuous Commodity Index (CCI) is often considered a key indicator of how commodity prices stack up against each other.

It’s an index on the ICE Futures Exchange that consists of 17 commodity futures, which are continuously rebalanced.

According to InsiderMonkey.com, historically, the price ratio of gold to the CCI has averaged 1.66. Today that ratio is about 2.89.

In other words, when measuring gold to other commodities, it’s overvalued by as much as 74%.

Now, I wouldn’t expect gold prices to plummet that much anytime soon.

But these days, gold bugs do have a couple of red flags to be aware of.

1. Global demand for gold has fallen consistently for the past four quarters straight. And the drop can mainly be pinned on India and China, which account for about 44% of global gold demand. According to MetalMiner, India’s gold demand is down 13% from the first quarter, and 38% year over year. Meanwhile, China cut its demand back by an incredible 43% from the first quarter. If demand for gold continues to fall, supply will increase, bringing gold prices down further as a result.
2. The U.S. housing market is making a comeback. The Los Angeles Times just reported, for the first time in about two years, all 20 major metro areas tracked by the S&P/Case Shiller Index are up. This signals housing prices have likely found a bottom, which many economists said would be the turning point for the U.S. economy. Plus, it gives the Fed incentive not to provide anymore stimulus to the economy, which also would drag gold prices down.
3. Rising Interest Rates. Although the Fed has vowed to keep rates low through 2014, that doesn’t mean they have to. And typically the price of gold is negatively correlated with interest rates. When rates finally do rise you may see something similar to what happened in the early 1980’s when the price of gold collapsed. Think about it, who would want to be earning next to nothing holding a hunk of metal once bank accounts begin paying decent interest again?

It’s not all bad news for gold though. As Matthew Carr has written about in the past, we’re about to enter the bullish season for gold prices.

The end of fall is known for being a time gold prices typically head higher. Coincidentally, it’s also right around the Diwali wedding season in India which should provide gold with a slight boost on its own. Chinese holidays also boost demand during this time of the year.

But before you go piling all of your cash into gold like the man I spoke with last week, just realize the future of gold prices may not be as shiny as the metal appears.

Good Investing,

Mike

P.S. Earlier this year, Alexander Green provided seven reasons why he felt holding more than 5% of your assets in gold was a gamble. He also predicted gold was unlikely to go much higher. Even with its recent rally, gold is still only about 2% higher than when Alex wrote his article.

To see Alex’s full essay on why gold is far from a sure thing, click here.

Founded in 1999, the goal of Investment U is to give you impartial, no-nonsense investment advice and investment research on how to build long-lasting wealth.

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