Barrick Gold Corporation (USA) (ABX), Goldcorp Inc. (USA) (GG): Time To Short Gold

I was wrong, I admit it. A while ago I wrote a post about how central bank demand would push gold higher. Instead, lower CPI numbers and other factors have pushed gold prices below $1,400 and caused numerous investment banks to revise their estimates downward. Credit Suisse sees gold heading to $1,100 an ounce by the end of the year, due to decelerating inflation and the global economy returning to normalcy. One thing I would like to point out is the historical correlation between the S&P 500 and gold.

The past 2 decades

Over the past 20 years gold has risen by 300%, while the S&P 500 is up 360%, which is a fairly close correlation. This would lead you to believe that as the S&P 500 goes up, so should gold, something that has made SPDR Gold Shares (NYSEMKT:GLD) investors very happy. But most of these gains have come in the past decade.

This century

Gold prices have done amazingly well in the early 2000’s, rallying from $290 to a high of $1,900. As of right now gold prices are up roughly 500% this century.  In the same time period the S&P 500 is up roughly 15%. This is clearly a deviation from the historical average.

One thing I found interesting is that Barrick Gold Corporation (USA) (NYSE:ABX) is trading at the same level it was in 2001, even though gold prices have moved 500% higher. I wouldn’t buy Barrick Gold Corporation (USA) (NYSE:ABX) though, as uber-gold bull John Paulson has completely sold out of his $32 million stake in Barrick, and gold prices look like they are going to keep falling. Barrick hasn’t followed the gold rally since the recession, and will only fall as gold, which is most of its production, falls.

Why gold prices will fall

If you look at the Reagan recovery from 1980 to the end of 1984, the price of gold went from $840 down to $320 as the S&P 500 went from 110 to 170. This is very relevant to today because the economy Reagan inherited faced similar problems, such as the Savings and Loan Crisis, Stagflation Crisis, and high unemployment, as the one Obama did.

During the Reagan recovery GDP growth was above 4%, the unemployment rate fell from its 10.8% (December 1982) peak to 7.3% (January 1985), and the markets rallied. While the economy healed and starting booming, markets rallied and gold fell.

The same thing happened during the tech boom with Bill Clinton in 1995-1999, when unemployment fell, GDP growth was strong, and the markets rallied. The S&P 500, was up 210% while gold prices fell 23%.

This is important because if the US economy is about to get better and post stronger growth and we see the unemployment rate fall to 6% in the next few years, then gold prices should fall as the markets keep rallying. We have seen US macro data get better and markets rally, but we haven’t seen a large decline in gold prices, which historically should have happened.

How to benefit

I would recommend staying far away from anything that is betting on gold going up, from anything like an ETF to a major gold producer like Barrick Gold Corporation (USA) (NYSE:ABX) or Goldcorp Inc. (USA) (NYSE:GG). Even if gold prices don’t plummet to $1,100, they will fall somewhat from the $1,400 level.

Goldcorp Inc. (USA) (NYSE:GG) produced 2.39 million ounces of gold in 2012, and sees the cost of producing an ounce going up while the price of gold goes down. This will crimp margins and make Goldcorp Inc. (USA) (NYSE:GG)’s earnings decline, even if they do boost gold production to 2.5 million ounces in 2013.

Barrick Gold Corporation (USA) (NYSE:ABX) is the world’s largest gold producer, producing 7.4 million ounces of gold in 2012. They too will have to deal with rising costs at their mines and declining gold prices, making their earnings fall. That’s why I’m staying away from these producers for now–the risk reward doesn’t pan out in my favor.

ProShares UltraShort Gold is an ETF that returns 2x the inverse of gold. In other words, you can short sell gold with an ETF. This is a much easier way that using puts or short selling. You could also short sell SPDR Gold (which is currently 8% shorted) or buy ProShares calls or SPDR Gold puts.

Short selling either the commodity itself or having an ETF do it for you is the best way to go, because gold producers didn’t rally nearly as much as gold did, so you wouldn’t make as much if gold fell. You want your bet to be based on gold prices and not have to deal with share buybacks or special dividends cutting into your gains.

Final Thoughts

If history is any indicator, gold prices are heavily overbought and will come down by at least a few hundred dollars as 2013 comes to an end. Global GDP is picking up, the US is rebounding, and China is still growing at around 7.5%.

Without a crisis to push gold up, a stronger dollar (which has gone up as gold has rallied since 2008) and history will pull prices back down. You should stay away from gold producers, because even if their stocks don’t plummet, they sure won’t rally with the market. Also, if you want to benefit from historical trends, either through puts, short selling or an ETF, bet against gold.

The article Time To Short Gold originally appeared on Fool.com and is written by Callum Turcan.

Callum is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

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