Has Gold Hit a Bottom?

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A commodity-trader friend of mine uses a colorful bit of slang to describe his behavior (and that of his trader brethren) whenever a large hedge fund finds itself trapped in a big wrong-way bet on the markets…

He calls it “circling the whale.”

According to my friend, the wooden-ship whalers of the 18th and 19th centuries — having sunk an iron harpoon into some unfortunate sperm whale — didn’t move in for the kill immediately. They knew it was in trouble — better to do nothing, lie back and wait for the inevitable.

I think the sharp decline in gold prices in recent days may have a lot less to do with last week’s employment report, and a lot more to do with gold traders “circling the whale” — Venezuela and its hoard of central bank bullion.

Bonfire of Bolivars

Bob Dylan once wrote that “When you ain’t got nothin’ — you got nothin’ to lose.” Well, Bob Dylan hasn’t been to Venezuela lately.

Try feeding your family on a “nothin’” currency like the bolivar when the estimated annual inflation rate is somewhere around 700% a year, according to private analysts such as Johns Hopkins’ Steve Hanke. I say “estimated” because the government of Victor Maduro stopped releasing inflation data many months ago, for obvious reasons.

The government also heavily subsidizes gasoline and food for its people. Plus there are sizable bond payments to international creditors.

So international reserves are already dropping fast — from $22 billion in January this year, according to data from Venezuela’s central bank, to $18 billion in May, to new record lows of $14.8 billion at the start of November.

Here’s where the “circling the whale” part comes in…

According to published reports, Venezuela has about $12 billion in bond payments due in 2016.

It could cover those payments out of the $14.8 billion that it still has in reserves right now. But here’s the twist: Only $3 billion of those reserves are liquid. The rest?

It’s all gold bullion, Venezuela’s crown jewels.

Gold and Falling Pianos

Think of Venezuela as a hedge fund, in need of cash and sitting on a gigantic “long” position that’s worth less and less by the month. Traders can see this gold “whale” is in trouble, so they hang back and let it thrash. Why try to catch the proverbial falling knife (or gold piano)? And, of course, the price of gold drops even further.

And since I was the one who said two weeks ago that he believed gold had “well and truly bottomed,” I’ll add that we don’t know the timing of these gold sales. By the time the data is released by Venezuela’s central bank, it’s already many months old.

With that in mind, the worst of Venezuela’s latest “gold dump” might already be over or close to it.

For instance, the World Gold Council’s data from late last year showed Venezuela with 367 tons of gold reserves (down from a peak of almost 373 tons in 2011). By the start of this year, that figure was reported down to 361 tons.

So how much more gold has Venezuela sold in all the months since?

We don’t know for sure, but Bloomberg recently reported the value of Venezuela’s gold reserves at $11.8 billion, based on the latest data from Venezuela’s central bank. And the bank’s “latest data” is from May of this year.

How much gold does that dollar figure represent?

If we use $1,266 an ounce — the average London Fix price for gold in 2014 — then, as of May, the central bank retained around 290 tons of gold in its vaults, by my guesstimate. Which would mean the bank sold down its gold holdings by as much as 70 tons by that time, worth nearly $3 billion.

And perhaps not coincidentally, Bloomberg’s story on Venezuela’s gold sales came out on October 28. That’s the same day that gold briefly popped through its 200-day moving average at $1,180 an ounce before plummeting below $1,100 in seven days’ time.

This is the sort of activity — the wholesale dumping of a big position by a “market whale” at low prices — that’s seen at the bottom of markets.

All we have to do is point to the United Kingdom, which dumped half its gold reserves between 1999 and 2002, with gold at its lowest prices in 20 years. And what happened afterward? Gold went on to quintuple in value to the 2011 peak.

A Great Time of Buy Cheap

As 2015 winds down to a close, we are faced with a Fed trapped in a great interest-rate conundrum, and we are seeing the early seeds of inflation starting to sprout. The U.S. is still growing its debt hoard at an astounding rate and the government has shown little to no interest in paying it down.

All of which makes this a great time (and likely one of the last) to buy gold, peace of mind and a little insurance on your other assets at these great prices. When the world is in turmoil, gold remains one of the last great stores of value.

And buying that insurance cheap against a rainy day is never a bad idea.

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JL Yastine
Editorial Director, The Sovereign Society