Gold has certainly taken a beating in recent days, giving up all of the gains attained during the Cyprus crisis — and down nearly 20 percent from its all-time high back in September 2011.
And, now having suffered two consecutive quarterly declines for the first time since early 2001, some analysts and investors are abandoning the yellow metal, proclaiming that gold’s decade-long bull market has run its course.
I’m no “gold bug” – but I couldn’t disagree more . . . based on solid reasoning and objective analysis.
Short-Term Shock Therapy
What the gold market needs to move higher is a good dose of Zoloft or perhaps, even more extreme, a high-voltage jolt of electroshock therapy to jog the metal’s price out of its current state of depression.
Perhaps this will come from across the Atlantic – where recessions are worsening, social discord is on the rise, and the euro appears vulnerable to further capital flight.
Maybe, unpredictably, it will come from some geopolitical upset – on the Korean Peninsula or in the Middle East.
Or, possibly, it will come from Washington’s inability to deal with its mountain of debt, lack of fiscal restraint, or the insidious and still barely apparent effects of sequestration on economic activity and employment.
More likely, the jolt needed to set gold firmly on its long-term upward trajectory will come from a renewed recognition by the Fed and the financial markets that still more monetary accommodation is needed to prevent the economy from stalling. That’s what fueled the September 2011 run to record high gold prices . . . and this may be what does it again.
For now, gold’s short-term prospects remain uncertain. We could very easily see a further retreat, possibly to $1520 or even lower . . . but much of the recent selling is also price-sensitive — coming from gold ETFs and “paper gold” products in futures and other derivative markets — and will diminish quickly if prices dip much lower and traders begin to bet on the long side of the market.
Meanwhile, physical demand – from emerging-economy central banks and the private sectors in China and other Asian markets – remains strong and can be expected to strengthen further if prices continue their retreat. As in the past, price-elastic physical demand will provide some downside insurance.
Gold’s short-term direction may depend largely upon the flow of outside news and black swan events, those surprises that seem to come out of the blue, rather than the internal fundamentals of the gold market. Indeed, there is no telling whether the next move will be up or down.
Long-Term Forces
What I can say, however, is that the long-term bull market remains intact . . . and there will be sizable rewards for those with patience who stay the course.
I can also tell you that central bank reserve managers are not worried their gold assets will depreciate. Indeed, they continue to buy more. But many are worried about the prospective depreciation in the value of their U.S. dollar holdings and view gold as a legitimate monetary asset, diversifier, and insurance policy.
So what are the factors and forces likely to push gold prices higher?
- First, the U.S. economy is doing worse than generally perceived — and thanks to recession in Europe, sequestration in America, and an enfeebled consumer on both sides of the Atlantic we are heading into economic doldrums or worse, a full-blown recession later this year. Anyone who thinks the U.S. economy is really in a sustainable recovery is just kidding themselves. ??As a consequence, the Fed will have no choice but to speed up its money-printing machine, even as inflation expectations begin rising. Remember it was the successive waves of quantitative easing that juiced gold up to its record high of $1,924 in September 2011. The adoption of still-more aggressive monetary easing by the Fed later this year or in 2014 will again set gold on fire. Other major central banks will be under pressure to reflate along with the U.S. — and some, like the Bank of Japan — are already greasing their printing presses.
- Second, the European economy — and the euro-zone monetary system — is under tremendous strain with the stronger economies increasingly unwilling to continue bailing out the weaker economies for whom there is no room for more forced austerity. Cyprus was just a warm-up of what’s to come. And, next time, it will be a big economy like Spain or Italy that goes belly up, triggering flight from the euro into both the U.S. dollar and gold.
- Third, whatever may come, China’s appetite for gold will remain firm as the domestic market continues to mature. The introduction of new products and channels of distribution (like ETFs) will increase the efficiency of the domestic gold market . . . and increase private household demand. In fact, valuing private-sector gold holdings as a national resource, the Chinese government will continue to support and encourage private gold ownership — and the associated demand will continue to support the price of gold in the world market.
- Fourth, emerging-economy central banks will continue to accumulate gold, especially at times of price weakness when their purchases are least visible. For some, it is merely a desire to diversify reserve assets and gradually wean themselves from over-relience on the U.S. dollar and the euro, which has now been totally discredited as a reliable reserve currency. ??But for China and Russia — the two central banks with the most aggressive gold-accumulation programs — increasing their gold holdings is undoubtedly part of grander plans to have the yuan and the ruble attain reserve-currency status.
- Fifth, there has been a little recognized structural shift in the world gold market. Many of the “new” buyers of gold in recent years are accumulating gold, not as an ordinary investment to be sold at higher prices for a trading profit, but as a long-term store of wealth to be passed down to the next generation. ??This is true across Greater China where the emerging middle class has more money than ever before and has a cultural affinity and emotional attachment to the precious metal. It is true for the American and European high net worth families and the retail buyer of gold-bullion coins. And, it is true for many central bank buyers — not just China and Russia, but Mexico, South Korea, Kazakhstan, and many others — who are accumulating gold not as an investment, per se, but as a national legacy for generations to come.
Bidding Wars Ahead
Most of this newly acquired gold is in extremely “strong hands” and will not come back to the market except at much higher prices. As a consequence, the available supply of gold in the marketplace to satisfy future demand — what I call “free float” — is shrinking . . . and future buyers will be forced to bid up prices to higher and higher levels in order to satisfy their hunger to own more.
Jeffrey Nichols is Managing Director of American Precious Metals Advisors consultancy group and serves as Senior Economic Advisor to Rosland Capital LLC.
He has been a leading precious metals economist for over three decades. His clients have included central banks, mining companies, national mints, investment funds, trading firms, jewelry manufacturers and others with an interest in precious metals markets.
In addition to publishing his views online at www.NicholsOnGold.com, Nichols tweets regularly @NicholsOnGold
