Overbought Gold

It’s no secret that the global economy is in trouble, that governments everywhere are enacting massive stimulus plans for their economies, and that such massive stimuli often result in high inflation.

Put differently, there looks to be a global currency devaluation underway, where the value of all fiat currencies becomes questionable. They’ll fluctuate relative to each other, but with much more pretty paper on the planet, the absolute value of money is heading down.

Eastern Europe is on the verge of a collapse far worse than the orderly declines we’ve seen in the U.S., Japan, the U.K., and China. If it crumbles, it will take parts of Western Europe with it.

Japan, as I noted last week, is in trouble as exports dropped 45% last quarter, factories scaled back production, and employees are now working part-time jobs at ramen shops to make up for lost income.

The U.S. has dropped interest rates to zero and is now involved in quantitative easing, soon to be joined by the Euro zone via the ECB and England via the BOE. The U.K. might even opt into the euro, which would devalue the pound.

Russia borrowed $25 billion — for state-owned oil company Rosneft and state-owned pipeline company Tansneft — from China in exchange for oil.

Yes, it seems everywhere we turn we see a world hell-bent on devaluing the worth of fiat currency. Every country wants its money to offer the cheapest relative valuation.

The traditional way to protect against deteriorating money value is to own gold. Governments can’t make more of it, so it retains its value even as currencies come and go, rise and fall. The classic example is that you can buy a suit of men’s clothing today for the same amount of gold it would have cost you 2,000 years ago. Thanks to the ancients being wise enough to make money from precious metals, you could in fact use a Roman aureus made of gold today. It would provide an interesting moment at the Macy’s cash register, to be sure, and would require conversion somewhere first, but in the end you’d be able to use it. Try using a U.S. dollar in 4009.

That’s why gold has always been and will always be a way to protect purchasing power over time.

It’s also the reason its price has risen in the past several months as government activity exploded. The gold Spider (GLD) rose 40% from $70 on Nov. 12 to $97.80 on Friday. The leveraged approach via PowerShares Gold 2x (DGP) gained 88%.

With a current RSI of 71, however, GLD is almost certainly going to pull back before moving on to new highs. Therefore, even if gold has long-term appeal, the right position in the short term is making money on the downside.

That’s what we’re doing here at The Kelly Letter, though not the way you might expect. Turns out another famous commodity tracks gold, but with more volatility. It’s even more overbought than gold and I expect it to settle back even farther.

It’s the downside of that commodity that we’re betting on this morning.

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