Let me start by saying that I’m not a gold bug. I don’t own any physical. In the event of a global mega-disaster I don’t want gold. The fiat system is unsustainable on current trends, but debt limits in the major developed nations are further out, circa 2030, so those buying gold as protection against its collapse are too early, in my view. Investment and central bank demand are the growth areas for gold, and I expect them to reverse once a new secular growth cycle emerges and dividend-less gold suddenly doesn’t look very appealing.
All that said, gold has been a source of great profits since I started trading, because of its enduring secular bull since 2000, and I am overweight precious metals currently, anticipating that the biggest gains are yet to come in an imminent finale. By solar cycles, the peak should be 2013, and thereafter I don’t want any gold in my portfolio – not until the next secular commodities bull in the 2030s. In short, I believe there is a final gold mania just ahead, which is a terrific opportunity for a trader to make big, fast profits, and yet, I don’t want to get stuck with gold so want to ensure I sell out before the peak. Therefore, I have a full long position in precious metals already, frontrunning what I believe to be a final mania (if you subscribe to the general ideas of Kondratieff, then this is a K-winter in which gold is the leading asset).
But might I be wrong? It is a tricky one to call, as it isn’t clear cut, particularly with gold currently in a down trend some way off its peak. It reminds me of the condundrum regarding equities in the second half of 2011. It was a tough call that needed repeated assessment. So here we go again…
As things stand, gold’s secular bull remains in an orderly uptrend, although it is currently beneath the 200MA, which has largely supported the bull to date. There have been notable spikes on the way since 2000, but nothing resembling historical manias. If I had to pick out a few analysts who I respect and trust, then Marc Faber remains a gold bull, Zeal LLC maintain we are still in a gold secular bull, Chris Puplava is bullish on gold to retake $1900. The alternative is that precious metals peaked in 2011 and the batton has already been passed to equities.
The major central bank policies of negligible interest rates and stimulus make for asset bubbles, hence since the secular stocks bear began in 2000 we have seen bubbles in real estate, oil, cotton, and even equities in 2007. Until their policies change more bubble-blowing is likely, and with money finally flowing out of treasuries, the likelihood of bubbles has risen again. But will equities be the main beneficiary, with their low historic valuations and good dividends, will real estate, now that it is back at historically reasonable levels, or will commodities, and if so, some or all commodities?
Let’s start with real interest rates. Negative real interest rates are typically bullish for gold. The below chart shows that certain key countries have negative real rates but the trend is currently up as money exits safe havens and inflation has eased a little following 2011’s deflationary episode.
However, with a tentative economic recovery and large debt obligations, central banks and goverments need to keep rates down. Of course, their actions and policies over the last decade have made it clear that they will and can do this, particularly if inflation is not too pressing. Real interest rates are likely to stay supportive of gold into 2013, particularly as inflation should rear again, due to oil.
Oil inventories remain above historic average levels currently, however the recent push up in the price partly reflects the worsening situation in emergency stocks, as shown:
This is total OECD fallback stocks. Note that the dip in these stocks early in 2011 corresponded to the oil price accelerating in that period, only for the Euro-debt deflationary episode to deflate it for a while. But now stocks are decreasing again and the crude oil price is back over $100.
Below the global demand-supply situation. The forecast is for demand to increase later this year, which means supplies will have to increase again, if the price isn’t going to run away.
But now look at global production – it has been flat the last few years, with new supply coming on stream only covering old supply ending. Although it appears from the above chart that oil supply has been rising along with demand, it partly reflects drawdown on emergency stocks.
In short, the situation for oil is tight, and a geo-political supply disruption would rapidly see price escalation. As we head into the solar maximum of 2013, increasing sunspots have historically corresponded to protest, revolution and war (such as last year’s Arab uprisings), due to increased human excitability. I believe there is a distinct possibility that we could see something that threatens supply, and potentially mirrors the 1970s:
Source: Now And Futures
Now let’s look at gold supply and demand:
Source: Morgan Stanley
Essentially, investor and central bank demand are expected to reverse as of 2015. The price is expected to be supported into 2013/2014. What might change this? Emerging central banks are switching some reserves out of diluted major currencies to gold. It is unlikely by next year that the US, UK, Japan and Eurozone will have reversed their policies to non-dilutory. Investor demand could potentially reverse if the oil price declines and economic growth continues to pick up, making equities yet more attractive. However, stronger economic growth and oil price declines are an unlikely combination.
Balance sheets of the 5 main central banks continue to grow, and as a proxy for gold now make gold appear underpriced.
Source: PFS Group
Food prices also appear to be a proxy for gold. Broadly speaking the current outlook for food prices is supported by tight supplies and increasing demand but dampened by record plantings. With trends in natural disasters still on the rise, and particulary strong in 2011, there are potential threats to the plantings and harvests, but where and on what foodstuff is hard to predict. I therefore remain exposed to agri as a whole.
Source: Casey Research
If all non-gold reserves were covered by gold then the price would be close to $10,000. As can be seen, during the last secular stocks bull of the 90s, the gap in this measure didn’t inspire it to close. Whether it could do now, in a secular gold finale, remains to be seen.
Source: Casey Research
Gold in relation to the money supply reveals we are some way from gold’s last secular peak.
Source: Casey Research
CPI inflation-adjusted gold paints a different picture, that we have aleady reached 1980’s heights.
Source: Measuring Worth
However, the same model using Shadowstats undoctored inflation data shows a very meagre gold run to date.
However, there is nothing to say gold ought to replicate the final height of the last gold bull. For that, we might do better looking at gold’s relative value to other assets. The Dow-gold ratio, shown in my earlier posts of this week, reveals an unclear picture. Having bottomed so far around 6, it lies beneath the long term trend line, but some way from the 1-2 reached in the last gold bull. Having begun its secular bull from a ratio of around 40, gold’s relative value has moved a long way. So we might conclude that gold is relatively expensive to stocks historically, but could potentially move more extreme yet, doubling or tripling in relative value.
We see a similar picture in gold’s relative value to real estate. Both US and UK shown.
Again, gold is historically expensive compared to real estate, but could yet become more extreme, perhaps doubling again.
Lastly, here is an overlay of the current gold bull on the last. There are some technical similarities, and the finale would be achieved by 2013, in line with my expectations. The top would be circa $6k. Again, there is no requirement for gold to replicate the last gold bull’s ferocity, but drawing in the potential to hit absolute extremes in relative value versus stocks and real estate, something of that size would fit.
Source: Now And Futures
OK, let me sum up. The balance of evidence supports further rises for gold into 2013. Demand and supply, the oil/inflation situation, real interest rates and government balance sheet. As per my post of yesterday, gold and gold stocks are currently at overbearish extremes, suggesting a rally will occur soon, supported by gold seasonals the next 2 months. The technical shaping of that rally should give further clues as to whether my favoured scenario is correct. Developments in agri and oil and economic data will also help to bolster the one scenario or the other. For now, I sit on my full set of precious metals longs. If gold was to drop out of its current consolidation to the downside, then it would make the overbearish/oversold indicators yet more extreme, and therefore a mean reversion rally as a minimum. Furthermore, historical rhymes suggest that we should get a rally here even if it made its secular top last year. So, I expect a period of rally, and then we can reassess again.