Gold Prices May Be Falling but Not Forever

NEW YORK (TheStreet) -- Professional commodity traders know when a solid trend is in place; the biggest move is usually the last. It's during this last move, also known as capitulation, is when the largest gains are made. Understanding why will help you profit while the mob panics.

In 2001, I started procuring Eagles, Maple Leaf and Krugerrand gold coins on EBay (EBAY). My goal was to buy one per month when I could win an auction or "buy it now" for under $300 each, including shipping. Eagles and Maple Leafs were hard to get as they trade for a premium over Krugerrands, but over time I managed to buy a few. I also started buying American Eagle silver coins.

I wasn't as much bullish on gold as I was non-bearish. After experiencing the gold bubble and subsequent pop in 1980, I was well aware of the potential but I thought they would make a suitable investment for my sons.

I had no idea, at the time, that World Gold Trust Services were creating a new financial ETF product called SPDR Gold Shares (GLD) that could create never-before seen gold demand. Following SPDR Gold Shares' success, the silver iShares Silver Trust (SLV) began trading. In hindsight, it's obvious that as soon as a catalyst lit the fuse, the gold and silver ETFs would help propel the metals to levels never seen before. The ETFs made it easy for anyone with an equity account to gain exposure in commodities. Since most retail investors are long only, it leaves only one direction: up (once the launch sequence is initiated).

Therein lies the problem, most retail traders limit their thinking to long only. Even with reverse/short "bear" products available including the Power Shares DB Gold Short ETN (DGZ), that eliminates "supposedly unlimited risk"* of shorting, the average investor condemns their portfolio to considering only half the strategies available.

Unless you believe that gold (or any other security) will only appreciate higher and never fall in price, that's a concession of self-limiting your profit potential. Failing to consider the bear thesis, by definition, also means you're not fully examining why, or what your counter-party is convinced of. Never forget that when you buy a dip, there is always someone on the other side selling with the same level of conviction that selling is the correct decision.


Investors not on the lookout for every opportunity, including shorting, missed out in May 2012. That's when I wrote about how to profit from falling gold. GLD fell about 40 points since. DGZ increased 40%, Blue Nile  (NILE) increased 50%, Signet Jewelers (SIG) increased over 60%, and Zale (ZLC) increased 500%. You can receive my real time trading ideas with actual entry and exit prices at Real Money Pro.

Investors should understand that as gold prices fall, production levels may increase, not decrease (at least in the interim). I know it sounds counter-intuitive, but I will explain. Think of cash as the life-blood of companies. If a company's cash is drained past a certain point, vital organs begin to shut down -- creating inefficiencies and a domino effect -- until the company dies.

For example, if a worker's paycheck bounces or cannot even be made, workers stop showing up. Gold then can't be mined -- instigating further cash flow issues and causing diesel suppliers to cut off fuel supplies until they are paid. And it just becomes a vicious cycle. One method to prevent a liquidity crisis is to sell more gold, not less. Leaving companies with high fixed costs, plus falling profits and margins, give little choice but to mine and sell as quickly as possible.

What's in any given miner's best interest is collectively detrimental for participants, not unlike the plight of the commons was to farmers, or OPEC members exceeding quotas because of falling prices.

We can see the impact on share prices of Goldcorp (GG), Barrick Gold (ABX), Newmont Mining (NEM), Kinross Gold (KGC). Some of the larger companies may not make it through to the other side, many of the smaller, higher cost of production companies won't. Absent a clear and compelling black swan event, you should anticipate continued challenges for miners and an accelerating decline for gold and silver in the short term.

Longer term, the price of gold will bottom and weaker miners will stop production, then the supply-demand equilibrium will happen again. But leave with this thought -- the short-term usually lasts a lot longer and travels much further than expected. In other words, when it comes to buying a falling market, it's not the early bird that gets the worm, but rather the late mouse that gets the cheese.

Don't be in a hurry to buy gold dips, and don't even consider a miner that isn't profitable at this level. I'm actively watching to become a gold bull again, but we're not there just yet.

At the time of publication, Weinstein had no positions in securities mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.