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Just
a few weeks ago, gold and silver prices were soaring, almost beyond
belief. A growing chorus of investors, analysts, and financial
journalists opined that the “bubble” in precious metals prices
would soon pop - and many predicted an imminent long-term bear market was
just around the corner.
And,
when precious metals prices tumbled - gold from its all-time intraday high of
$1,576.50 on May 1st to an intraday low of $1,463.20 just four
days later and silver from $49.59 on April 28th to $32.44 a couple
of weeks later - pundits were quick to declare that the bubble burst . . .
and many pronounced that the bull market in these metals was over, done,
kaput, much like the end of the world that was also predicted around the same
time and similarly garnered much media attention.
As
gold and silver rocketed higher in March and April, I warned that prices were
rising too far, to fast . . . and chances of an imminent correction were also
rising day by day.
So
it came as no surprise when gold and silver prices shifted into reverse - but
I never doubted that this was anything more than a healthy correction in a
long-term bull market, a bull market that had years to go and would
ultimately carry gold and silver prices to multiples of their recent highs.
Although
gold’s recent correction generated much media attention, from peak to
trough it amounted to less than ten percent. Early in my career as an
economist and precious metals analyst, in the midst of a major long-term bull
market, I saw the yellow metal retreat some 50 percent from over $200 an
ounce in 1974 to near $100 in 1975. I also remember what
followed: Gold rose by more than 700 percent to a long-term cyclical
peak of $875 in January 1980.
Silver’s
recent correction, about 35 percent from its April high to its May low point,
attracted even more attention because the preceding advance had been so
meteoric. But, like gold, silver saw a number of short-term corrections
in the midst of the great 1970s bull market, the biggest fall amounting to
more than 60 percent.
What’s a Bubble?
A
“speculative bubble” or “financial mania” is
generally defined as a rapid run-up or spike in the price of an asset or
asset class (equities, bonds, commodities, real estate, or even tulips, for
example) caused by excessive or exaggerated expectations of future price
appreciation, appreciation unrelated to market fundamentals, realistic trends
in supply and demand, or “intrinsic” value. Bubbles are
driven by emotion, fear of “missing the boat” as an asset
appreciates, and they are generally characterized by a high volume of trading
and public participation.
By
this definition, the recent rise in gold and silver prices was hardly a
bubble. While speculative demand by “momentum” traders in
futures markets contributed to the rapid ascent (just as selling by the same
traders contributed to the subsequent swift decline), these speculators are
hardly irrational players driven by emotion. Quite the opposite, they
take long and short positions based on trading algorithms or years of
experience watching markets rise and fall.
Instead,
the long-term bull market in these precious metals has been, and will
continue to be, driven by rock-solid long-run fundamentals including macroeconomic,
geopolitical, and demographic trends, as well as each metal’s own
supply/demand situation and outlook - all of which suggest gold and silver
prices have a long way to go.
This
is not to say we won’t see future price volatility in gold - and, even
more so, in silver - with price swings that again attract attention, leading
some to predict that sharp corrections are the start of a long-term bear
market rather than a great buying opportunity like we saw in recent weeks
when gold neared $1470 or silver traded under $34 an ounce.
Monetary Assets
Importantly,
both gold and silver are monetary assets, a characteristic not shared by
equities, bonds, commodities, or real estate. As monetary assets, they
are bought by a growing number of investors and savers who hold and hoard
these metals, not only for profit when prices rise, but also, or even more
so, as lasting stores of value in lieu of U.S. dollars, euros, Japanese yen,
Chinese yuan, Indian rupees or whatever currency circulates in their home countries.
Even central banks are again buying gold as a monetary asset and store of
value rather than acquiring and holding more depreciating foreign-currency
assets.
Many
of those in China, India, and other Asian nations who buy gold or silver as
monetary assets, have contributed to higher prices for these metals - but
they are not acting irrationally or emotionally. Instead, as their
household incomes rise, they are following the long historical and cultural
traditions of their ancestors who over the millennia have held and hoarded
these metals as lasting stores of value.
Even
in the United States and Western Europe, many are buying gold and silver, not
for fear of “missing the boat” and losing the opportunity for
quick profit on a rising asset. Instead, they are reacting to the
current economic and political environment that on both sides of the
Atlantic, and environment that has a growing number of investors and savers
worried misguided government actions and policies are threatening their
future economic security and wellbeing.
There
is no simple answer or single reason why gold and silver have been moving
from strength to strength for more than a decade - irrespective of the
occasional price setbacks or corrections that have led some would-be
Jeremiahs to foresee the death of gold and silver as worthy investment and
savings assets.
Bullish Building Blocks
Over
the past many years here on NicholsOnGold,
in many public speeches, articles, and client presentations, I have discussed
at length some of the building blocks underpinning the long-run bull market
for gold and silver - but for readers worried that the world of precious
metals, as we know it, is facing an early demise here are the highlights of the
bullish case for gold and silver:
- Current and
prospective U.S. monetary and fiscal policies promise further erosion in
the U.S. dollar overseas, an acceleration in consumer price inflation at
home, and growing demand for gold as a hedge asset. Even with the end of
quantitative easing next month, the Fed will feel compelled by
persistently sluggish business conditions and high unemployment to keep
real inflation-adjusted interest rates low or negative and the economy awash
in liquidity. Moreover, despite all the rhetoric from both political
parties, Americans will not soon agree to take the tough steps necessary
to rein in the Federal budget and shrink the country’s immense
Federal debt.
- Inflation is
not only a U.S. disease. It is accelerating virtually everywhere -
China, India, Europe, America, Africa and the Middle East - thanks to
many years of easy money policies worldwide, high and rising oil prices
(in part, a consequence of political unrest and uncertainties in some of
the oil-exporting countries) and, for a variety of reasons, rising
agricultural and industrial commodity prices.
- Fear of
sovereign-debt defaults and bank failures in one or more of
Europe’s “periphery” economies is also prompting many
investors and fund managers to buy gold as the preeminent safe-haven
asset. These periphery countries - including Greece, Portugal, Spain,
and Ireland - continue to pursue self-defeating fiscal policies. Despite
tax increases and deep spending cuts, their debt ratings are falling and
the cost of refinancing sovereign debt is increasingly prohibitive.
Moreover, the stronger “core” countries - led by Germany and
France - are increasingly reluctant to bail out their southern
neighbors. As a result, the viability of Europe’s common currency,
the euro, is increasingly doubtful - and a break-up of the
single-currency system would send gold and silver prices sharply higher.
- Political
turmoil across North Africa and the Middle East is prompting an increase
in world gold demand - both as a reflection of heightened geopolitical
uncertainties and in response to higher oil prices. Civil war in Libya
continues and protests are raging in Syria, Bahrain and Yemen. No one
knows where this “Arab Spring” will stop, which country may
be next, and what the long-term consequences will be for political
stability within these countries and throughout the region, or for
future world oil supplies and prices.
- The growing
affluence of the emerging-economy nations, especially the two
big-population countries, China and India, has already had - and will
continue to have - a profound influence on the world gold and silver
markets with rising long-term demand and prices of these metals.
China’s already huge and growing appetite for gold - both jewelry
and investment - will continue in tandem with economic growth, rising
personal incomes, worrisome inflation expectations, and pro-gold
government policies. Long-term gold demand from India and other
traditional Asian gold markets is also rising, reflecting (as in China)
growth in personal incomes and wealth, worrisome inflation, and the
development of new gold investment vehicles and distribution channels.
- Increasing
central-bank interest in gold will continue to underpin the yellow
metal’s price -as countries (such as China, Russia, and some of
the OPEC nations) under-weighted in gold and over-weighted in U.S.
dollar reserves seek the diversification offered by gold. Mexico
purchased more than 93 tons earlier this year, joining a long list of
countries that have increased gold holdings in the past couple of years.
In addition to China, Russia, India, Saudi Arabia, and Mexico - all big
buyers - the list of central banks that have increased gold reserves in
the last couple of years includes Thailand, the Philippines, Sri Lanka,
Mauritius, Kazakhstan, Venezuela, Bolivia, Peru and probably others that
have bought gold surreptitiously and choose not to report an increase in
their official gold holdings.
- A growing
recognition and appreciation of precious metals, both gold and silver,
as a legitimate investment class is prompting greater participation from
both retail and institutional investors in the United States and Europe.
At the same time, the development of new products and channels of
distribution - especially the growing popularity of gold and silver
exchange-traded funds - makes gold and silver more convenient, more
attractive, and more accessible to more investors around the world. It
is especially noteworthy to see the entry of a number of leading hedge
funds, pensions, endowments and insurance companies - some as short-term
traders but many as long-term investors with a time horizon often of
many years or decades.
- As demand
continues to grow, I expect no more than marginal growth in world
gold-mine production for at least the next five years. Moreover, some of
the biggest gold-mining nations, like China and Russia, are increasingly
absorbing more of their own production for domestic jewelry consumption,
investment, and additions to central bank reserves.
Together
these bullish factors are responsible for a growing gap between new mine
supply and aggregate demand - a gap that can be closed only by much higher
prices in the years ahead. Call it a “bubble” if you will -
but gold and silver prices are heading higher, much higher, in the months and
years ahead.
Jeffrey Nichols
NicholsonGold.com
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