Explanations for this gold selloff abound everywhere and nearly all of them
are inane and incorrect. The silliest among all the reasons offered for the
current bear market in gold is that Bernanke has recently morphed into a form
of Paul Volker; even though he has maintained the Fed's zero percent interest
rate policy and massive money printing continues unabated. His policies have,
and will continue to significantly weaken the intrinsic value of the dollar--so
you can just summarily dismiss that reason. Another vacuous reason to explain
the drop of the gold price is that the U.S. is eventually headed towards a
trade surplus. This is because some predict our energy independence in the
next ten years, causing the dollar to soar sometime in the future. But the
dollar fell from 83 to 82 on the DXY during the month of April, which coincided
with the selloff in gold, so that can't be the reason either. In addition,
our National Debt should be near $30 trillion in 10 years; and that would far
outweigh any benefit for the dollar that would be gained from a potential trade
surplus.
To understand the real reason behind gold's selloff, investors first need
to acknowledge that it's not just gold coming under pressure. Industrial and
growth stocks are plummeting across the board. For example, Caterpillar (CAT)
is down 20% in the last 30 days, base-metal commodities are headed into bear
market territory and copper is down 15% since February and is now trading at
a over a 52-week low. Oil is also dropping sharply of late, falling down to
$86 per barrel from the mid-90's a few week ago. Also, the recent stock market
rally has been very narrowly based. Those equities that have been working are
defensive in nature like healthcare and consumer staples...that is not representative
of a healthy market. What gold is really telling us is that the global economy
is on very thin ice.
So it comes down to this; investors should not make the same mistake they
did during the fall of 2008, namely, ignoring the deflationary forces that
are at work in certain parts of the world. Commodity bear markets aren't good
for earnings if they are representative of a worldwide economic collapse. Going
long equities in September of 2008 because oil was headed from $147, to $33
a barrel wasn't a very good idea. To be clear, I'm not claiming that this is
at all the case today. Indeed, Japan and the U.S. are well on the way towards
reaching their inflation targets. But investors should be aware that the European
economy may be facing a long drawn out battle with deflation. It should be
noted that deflation is a necessary circumstance when rebalancing an economy
from the ravages of inflation; but in the short term is very negative for stocks.
Global GDP will be weak and this will put downward pressure on stocks and commodities
that are pegged to growth. However, central banks that are pursuing inflation
targets should help boost precious metal prices as they guarantee a stagflationary
environment in those economies.
The truth is that deflationary forces are currently very strong in Europe
and, to a lesser degree, in China. This week, the IMF lowered the projection
for global GDP and reduced its Eurozone GDP forecast, saying it would fall
by 0.3% in 2013. Meanwhile, European car sales are approaching a 20-year low;
registrations fell 10% in March to 1.35 million vehicles, the 18th consecutive
monthly decline.
Major global economies and markets have become bifurcated between those that
are aggressively seeking inflation and those that are embracing austerity and
deflation. Japan and the U.S. are printing money at record paces, while Europe's
monetary base is static. This makes investing extremely difficult at this time.
Investors must be very selective in which country they place funds and be careful
to avoid the trap of believing growth will accelerate later in 2013. That is
why it is imperative to hold a portfolio that is diversified among countries
that are pursuing inflation targets and avoid being over-exposed in sectors
of the market that rely on growth.
The bottom line is the selloff in gold bullion is almost over and the vicious
bear market in mining shares is soon coming to an end. Those countries that
have adopted inflation targets will keep printing until they are achieved and
those that have yet to state they are officially pursuing inflation goals should
soon (but foolishly) join in the fight. Once all major economies are once again
in sync with inflation as their goal, the investment climate will become clearer.
In the meantime investors need to buckle their seatbelts because--as I have
warned many times in the past--major global economies will be whipsawed between
inflation and deflation until they finally crash due to bond market meltdowns.
