Investing to Wealth

A few weeks back we looked at the precious metal sector because the Rydex traders had suddenly dropped their enchantment with the gold sector in response to the small weakness in gold and gold stocks. Usually when these myopic traders hop off a sector with such alacrity we have the makings of a good contrarian signal.

Since then both gold and gold stocks, as measured by the AMEX Gold Bugs index (HUI), have struggled and are trading right about where they were when I first wrote about this. The Gold Bugs index is right at its 200 day moving average and seems to have put in a double bottom (in the daily chart). So here’s an overview of various gold sentiment measures to get a better handle on where things stand now.

First off, let’s revisit the Rydex traders and see just how this recent rout compares to previous market corrections. The chart below shows both the NAV (blue - right scale) and the total assets (grey - left scale):

In January 2010 with more than $285 million in assets, the Rydex Precious Metals fund was king of the hill, at least within the Rydex fund family, having attracted 30% of total Rydex sector assets. By early February it had fallen to just over $100 million representing only 14% of assets. Right now it stands at $116 million.

This is similar to the recent correction in July 2009 when the Gold Bugs index (HUI) fell 25% last summer. Then, as now, assets in the Rydex Precious Metals fund fell to around $100 million. And the sector started its next rally, rising 70% by early December 2009. This was the time when I was very negative on the sector and cautioning that everyone had piled in making gold a very crowded trade.

Another similar characteristic between last summer’s correction and now is the K-Ratio. But a major difference is that whereas then prices were above their 200 day moving average, now they are struggling to stay above it.

Daily Sentiment Index
According to Elliott Wave, the 10 day moving average of the Daily Sentiment Index has fallen to just 20.1%. By the way, if you’re not familiar with the DSI or are curious why a 10 day moving average, check out: An Overview of the Daily Sentiment Index.

This decline is even more dramatic than the collapse in the Rydex sentiment gauge since the DSI has fallen below its levels last seen in November 2008. As you’ll recall this was during the worst of the bear market and the gold sector did little to offer any protection as it fell hard itself. But Elliott Wave doesn’t believe that we’re going to see a rally of the magnitude that followed that significant low. They are rather bearish long term on gold and believe that at best it will be able to reach its last swing high around $1200.

Man with the Golden Touch
While the so called ‘dumb money’ or retail traders have been totally routed and demoralized, savvy Wall Street players are continuing to build a sizable position in gold. John Paulson, the famous hedge fund manager who correctly identified and profited from the financial crisis by shorting financial and subprime mortgages, decided that the next major opportunity is in gold.

His conviction is so firm that he wasn’t just happy scooping up exposure to gold for his existing hedge fund but set launched a new one specifically for this purpose on January 1st 2010. He contributed $250 million of his own money to seed the fund but surprisingly, he’s been unable to get many others interested. Right now he’s reported to have only attracted $90 million of outside capital. Given his cache on Wall Street, this is puzzling.

The fund itself seems to be off to a good start according to a recent WSJ article. While the sector is off about 25% for the year Paulson’s fund is only down about 10% for the year (so far). While some attribute Paulson’s failure in attracting funds to the existing exposure in his prior hedge fund (around 10%), I think it also speaks about the wider gold sentiment among institutional investors. But in the end, it may be a bit early to judge Paulson’s fund raising capabilities because he also encountered and overcame skepticism and a cold reception when he first started to build up a short position in subprime mortgages back in 2006.

Popular Media
There has been growing attention paid to gold in the mainstream media lately. Among the strangest is Glenn Beck who shills for a certain gold company that is only happy to sell gold coins at an astronomical markup. Any attempt I might make at trying to parse this ridiculous man and his behavior would pale in comparison to the treatment he received from the Daily Show. If you’re in Canada, go here to see the clip.

Then there is this recent Esquire magazine article about the “every man’s” hedge fund Superfund which is offering a gold fund (Superfund Gold) denominated not in dollars but in gold.

As Felix reminds us, Ken Kurson, the author of that article, has been an almost perfect contrarian indicator. In 2006 he was advising Esquire readers to invest in credit default swaps. In 2005 he believed that American automakers were a buy. And in 2005 he said that he was short Apple (AAPL) at $65. At this rate Ken might replace Cramer as my human contrarian index of choice.

Remember, it is always more palatable for the mainstream media to sell you something that has a convincing story and a short term history of success. Jumping on the bandwagon of an asset class that has been the winner for the past few years is the most lucrative and populist thing to do. But from a contrarian perspective, when everyone has accepted that gold can only go up, it is time to seriously rethink that thesis.