Gold bugs' arguments sometimes involve disingenuous logic

By Mark Hulbert, MarketWatch
Last update: 11:24 p.m. EDT Sept. 9, 2008

ANNANDALE, Va. (MarketWatch) -- I received a phone call Tuesday, in the wake of yet another session in which gold bullion was falling, this time to its lowest level this year.

Who, the caller wanted to know, were some of the gold bugs who were persisting in recommending gold bullion, despite a two-month decline that so far has taken more than $200 off the price of an ounce of the yellow metal?

This question got me thinking about what makes a gold-oriented adviser a genuine "gold bug"?

It can't be because he has continued to be bullish on gold in the face of the decline, I realized. After all, there are plenty of stock-market timers who have remained bullish in the face of the market's recent decline, and yet I've never heard them referred to as "stock bugs."
The best answer I could come up with is that a gold bug is someone who will remain bullish on gold, come what may. Perhaps the paradigmatic illustration of this attitude came from a newsletter editor I tracked in the early 1980s, who no longer publishes a newsletter and who I therefore will not mention to spare him any additional ignominy. When asked why gold had continued to fall, despite persistent predictions that it would rise, this editor said that it was the market, not he, that had been wrong.

By this logic, of course, an adviser can avoid ever admitting he made a mistake, no matter how much money he has lost for his clients. He definitely qualified as a "gold bug."

With this in mind, I reviewed which of today's gold-oriented newsletters are edited by advisers who come closest to my definition of a "gold bug."

Several themes emerged that became telltale signs of at least gold-bug-like tendencies. One is the notion that gold's fluctuations don't really matter, since we ought to be investing in it as a long-term hedge against currency devaluation. A prominent exponent of this point of view is Richard Russell, editor of Dow Theory Letters, though he is by no means the only adviser to put forth the argument. Another is Jim Dines, editor of The Dines Letter, who calls himself the "original gold bug."
The reason this argument strikes me as evidence of gold-bug tendencies is not that I think it is wrong, but in the way that many advisers use it: The argument is far more often trotted out after gold has declined than after it has risen. When gold is shooting up in price, in contrast, we are more likely to read boasts about how much money is being made by clients who paid attention to the letters' advice and bought gold.
This argument about gold therefore takes on a "Heads I win, tails you lose" quality. In my opinion, if you're looking for an adviser who will tell you when to get in and out of gold, then that adviser should be judged according to whether he was correctly anticipated the rallies and declines. It's unfair of him to try to wriggle out from underneath an incorrectly bullish forecast by saying that fluctuations don't really matter.

Another theme that also betrays gold-bug like tendencies is the notion that a conspiracy is keeping gold's price artificially low. Once again, I don't necessarily disagree with that. But, in my opinion, it should not be used as an excuse for an incorrect forecast.

What I am looking for in an adviser, and what I presume most investors are too, is someone who can accurately and objectively assess the world as it is and, after taking all relevant factors into account, make a profitable forecast about what is going to happen. Part of that world is the possible existence of conspiracies, including governments and central banks that might want gold to decline.

Consider, for illustration, an adviser who focuses on the Chinese stock market. We all know that the market there is not entirely free, diverging in several significant respects from the pure free-enterprise model we learned in Economics 101. Any adviser worth his salt better take this into account; it would be disingenuous in the extreme for him to excuse a losing recommendation by explaining that the Chinese economy is not entirely free.

One editor who frequently argues that the government is keeping gold's price down is Howard Ruff, editor of the Ruff Times. Ruff became famous in the 1970s for recommending gold at a time when the financial establishment pooh-poohed it, and he wrote several best-selling books on the subject.

In his latest issue, dated Aug. 22, on which day the spot gold futures contract closed at $828 an ounce, Ruff wrote that he saw "no need to change" his strong recommendation to buy gold. Downturns like the one that was already well underway when he wrote that issue "are the result of government manipulation," he wrote, "and will be short-lived at best."

Ruff acknowledged that some will find his advice "hard to take." But, he said, his bullishness on gold "is my view; right or wrong I'm stuck with it."

I suspect that it's because of strongly-held beliefs such as these that are in part keeping the Hulbert Gold Newsletter Sentiment Index (HGNSI) at abnormally high levels. That index reflects the average recommended gold-market exposure among a subset of gold-timing newsletters tracked by the Hulbert Financial Digest.

In recent weeks I have written several columns wondering what it would take for the editor of the average gold-timing newsletter to give up believing that gold was in a bull market. And it would appear that we still don't know.

That's because the HGNSI didn't budge at all on Tuesday, despite bullion's fall, remaining at 27.9%. To put that level in perspective, it is higher than where it stood in early August, when bullion was trading above $900 per ounce.

From a contrarian perspective, the bottom of gold's decline will come when enough of the gold timers throw in the towel. Ironically, from that perspective, the gold bugs' bullish persistence is extending the agony and postponing that eventual bottom.

Mark Hulbert is the founder of Hulbert Financial Digest in Annandale, Va. He has been tracking the advice of more than 160 financial newsletters since 1980.