Gold remains
deeply out of favor thanks to global central banks? extreme money
printing. This fueled a global stock-market levitation that has
temporarily short-circuited normal market cycles, leaving investors
infatuated with stocks to the exclusion of prudent portfolio
diversification. This has left them radically underinvested in
gold, which sets the stage for massive mean-reversion buying when
they inevitably return.
Portfolio
diversification is an absolutely essential tool for investment risk
management. This simple and powerful wisdom is ancient, as a
three-millennia-old quote from the Israeli king Solomon reveals. He
advised, ?Invest in seven ventures, yes, in eight; you do not know
what disaster may come upon the land.? Indeed history has proven
countless times that putting all one?s eggs in one basket is
foolish.
And that doesn?t
just mean diversifying portfolios across individual stocks, but
entire asset classes. The vast majority of stocks are highly
correlated with each other, and the general stock markets. So when
the next major selloff inescapably arrives, individual stocks are
all going to spiral lower together. While owning different stocks
mitigates individual-company risks, it has very little
diversification value in major selloffs.
So throughout the
dozens of centuries since the super-wise Solomon opined on portfolio
diversification, the truly smart investors have diversified across
asset classes. While they owned stocks or whatever the equivalent
ownership stake in businesses was in their time, they also owned the
local bond equivalent, real estate, and precious metals.
Because of its unique behavior, gold is the most important
diversifier of all.
Stocks are highly
correlated with each other, and the stock markets as a whole are
highly correlated with the broader economy. And so are bonds and
real estate. So when the market cycles inexorably turn and a new
bear market begins, these portfolio mainstays all drop together.
The precious metals are the only major asset class with a strong
inverse correlation to stock markets, they thrive when stocks
are weak.
Prudent investors
have always understood gold?s indispensable roll in portfolio
diversification. The best financial advisors throughout history
have recommended all investors have 5% to 20% of their portfolios in
gold. It is the ultimate portfolio insurance, tending to rally
dramatically when everything else sells off. But thanks to the
extreme central-bank distortion in the stock markets today, gold has
been left for dead.
Stock markets
normally meander in
endless
bull-bear cycles, driven by valuations. But in early 2013, the
Fed?s unprecedented open-ended
third
quantitative-easing campaign started short circuiting them. The
Fed was aggressively conjuring money out of thin air to buy bonds.
And Fed officials kept on hinting that they would ramp up these debt
monetizations if the stock markets fell materially, greatly altering
psychology.
Normally investors
are wary of periodic healthy selloffs that rebalance sentiment, and
act accordingly. But with the Fed effectively backstopping stock
markets, this prudence vanished. Every selloff since early 2013 was
quickly nipped in the bud. Buy-the-dippers rapidly flooded back in,
usually on direct Fed-official jawboning. Eventually, investors
started believing that serious stock selloffs can?t happen
anymore.
So they forgot
about prudent portfolio diversification, and moved all their capital
into that stocks basket. They bought into the Fed-fostered fantasy
that the stock markets were essentially riskless as long as Fed
policy remained super-accommodative. So they abandoned gold,
leading to today?s situation of radical underinvestment in this
essential negatively-correlated portfolio asset class. This extreme
anomaly won?t last.
American investors
have probably never been close to even having 5% of their portfolios
in gold, the lower end of the historical best practice. But we can
still approximate how much their gold exposure has plunged in these
recent Fed-distorted years. This is evident through comparing two
key metrics, the capital invested in the GLD gold ETF and the
collective market capitalization of the elite S&P 500 companies.
GLD is the world?s
dominant gold ETF, and acts as a conduit for the vast pools of
stock-market capital to flow into and out of physical gold bullion.
It is the cheapest, easiest, and fastest way for stock investors to
get gold exposure in their portfolios. And of course the S&P 500
(SPX) is the flagship benchmark US stock index, containing the
biggest and best US companies. The contrast between the two is
illuminating.
This week, the
gold bullion held by GLD on behalf of its shareholders was worth
$27.1b. Meanwhile the total market cap of all SPX companies was
$19,729.8b. Run these numbers, and it suggests American stock
investors? total portfolio exposure to gold is just 0.14%.
That?s far too trivial to offer any portfolio diversification at
all. And such radical gold underinvestment is very atypical, even
in the gold-agnostic US.
Back in December
2012 just before the Fed?s incredibly-manipulative QE3 campaign
kicked into full gear, GLD?s holdings were worth $74.1b. That
worked out to 0.56% of the SPX components? market cap. While still
low, that was a whopping 4.1x higher than today?s anomalous levels.
And back in August 2011 the last time gold was really in favor, this
GLD-holdings/SPX-market-cap ratio climbed to 0.79%.
So even in recent
history, relative gold investment as a percentage of stock
investors? portfolios was 5.8x higher than today?s levels!
This reveals how extreme today?s gold underinvestment by American
stock investors is. Their portfolio gold exposure today via GLD is
only around 1/6th of peak levels relative to stocks, and about 1/3rd
of absolute levels in terms of capital invested in GLD. This is
super-bullish for gold!
At some point soon
here, these central-bank-levitated world stock markets are going to
roll over hard. History is crystal-clear in proving that
central-bank money printing can only amplify and stretch
market cycles, it can never nullify them. And as investors face the
first major
stock-market selloff since way back in late 2011, they are going
to scramble to buy gold. It will be rallying strongly while
everything else is falling.
As the vast pools
of stock capital start migrating back into GLD, it will be forced to
shunt these inflows directly into physical gold bullion. GLD acts
as a conduit for stock-market capital to flow into and out of
physical gold. That?s the only way GLD can maintain its mission of
tracking the gold price. Since the supply and demand for GLD shares
is independent of gold?s own, GLD?s managers have to actually buy
and sell gold.
When GLD shares
are being bought faster than gold itself is being bought, this ETF?s
price threatens to decouple to the upside and fail to mirror gold.
So GLD?s managers must offset this differential buying pressure by
issuing sufficient new shares to satisfy this excess demand. The
capital raised is then used to buy physical gold bullion held
in vaults for GLD?s shareholders. Stock capital flows into gold via
GLD.
But capital
pipelines work both ways. When investors sell GLD shares faster
than gold is being sold, its price will disconnect to the downside.
GLD?s managers have to buy back enough shares to sop up this excess
supply. They raise the necessary capital to do so by selling some
of GLD?s holdings of gold bullion. So stock capital also flows out
of gold through GLD, which is what has happened in recent years.
Since the dawn of
full-strength QE3 in early 2013, investors have wholesale abandoned
gold in favor of Fed-levitated stock markets. This chart shows the
quarterly changes in GLD?s holdings, reflecting the massive
outflows of stock investors? capital from gold. This extreme
selling peaked in Q2?13, when GLD?s holdings plummeted by 251.8
metric tons as investors fled. That drove gold?s worst quarterly
loss in 93 years!
Overall between
December 2012 and GLD?s recent extreme 6.3-year holdings low in
January 2015, investors dumped so many GLD shares that it was forced
to liquidate 648.5t of gold! That works out to about 25.9t of gold
per month. These epic outflows were so great that they overwhelmed
normal gold investment demand, forcing gold?s price sharply lower.
Gold was above $1700 right as GLD?s epic selloff started!
Gold investors
need to realize how incredibly important stock-market capital
flows have become for prevailing gold prices. The amount of
capital invested in the stock markets is enormous, dwarfing gold.
So when stock investors are buying or selling gold in a big way via
GLD, the resulting capital shunted into or out of physical gold
bullion has a dominating price impact. This is readily evident in
this chart.
Note how closely
the red gold price correlates with the blue GLD bullion holdings in
recent years. Gold could only rally significantly after GLD?s
holdings stabilized and started rising again. This proved true in
Q3?13, Q1?14, Q2?14, and Q1?15. Whenever GLD?s holdings were
falling, indicating differential selling pressure on GLD shares,
gold slid in unison. The additional gold supply spewed by GLD came
too fast to absorb.
So if you want to
know which way gold is likely heading next, look to GLD.
When stock investors have high gold exposure via this ETF, that
indicates that gold is likely in favor and in danger of topping.
And when they have low gold exposure like today, gold is out of
favor and likely bottoming. So the best time to invest in gold is
when GLD?s holdings are low, since stock investors have little
portfolio-diversifying gold.
And that describes
today?s conditions perfectly, as the radical gold underinvestment
has manifested in GLD. Thanks to the euphoric global stock markets
in recent months, and investors? irrational belief that central
banks have miraculously eradicated stock-market cycles, GLD?s
holdings have slumped considerably. This week they were just 0.7%
above their extreme early-January-2015 low, which is intriguing
technically.
GLD?s holdings
look to be carving a massive double bottom. Even though gold
was weak while central-bank-goosed stock markets surged to record
highs as 2014 ended, GLD?s holdings stopped falling. That strongly
suggests stock investors reached selling exhaustion on gold.
All of them susceptible to being scared into selling low had already
done so, leaving only buyers. This next chart zooms in on that
bottoming.
As gold fell
deeply out of favor in early January 2015, bearish commentary
abounded. Everyone, even most of the long-time gold bulls, was
forecasting major new lows soon. Sentiment was overwhelmingly
pessimistic, with all hope seeming lost for gold. Yet the darkest,
most-out-of-favor
times are right when markets are ripe for sharp reversals. And
that?s exactly what happened in GLD as investors flooded back in.
As gold itself
started surging higher on
heavy buying
by American futures speculators, stock investors quickly pounced on
this momentum and aggressively bought GLD shares. Their serious
differential buying pressure catapulted GLD?s holdings higher as its
managers shunted all those excess capital inflows into physical gold
bullion. So January enjoyed GLD?s best monthly holdings build since
November 2011!
And with GLD?s
holdings once again slumping back down near those same early-January
levels that marked a selling-exhaustion bottoming, another sharp
reversal is likely imminent. Some catalyst is nearing that is going
to reignite stock investors? demand for gold. I suspect it will be
a sustained and decisive selloff in these
wildly-overextended and
overvalued
US stock markets, which is long overdue.
While the Fed
hasn?t started unwinding any of the past 6.5 years? extreme
bond buying yet, it is rapidly nearing the end of its
zero-interest-rate policy launched in December 2008. This will
begin the Fed?s first rate-hike cycle in 9 years. Higher
interest rates are very damaging to overvalued stock markets, and
this coming rate-hike cycle is exceptionally risky. The Fed has
never before normalized out of zero rates!
As the resulting
adverse stock-market reactions and sheer uncertainty mount, stock
investors are going to remember that ancient wisdom of prudent
portfolio diversification. They are going to try and mitigate the
growing losses in their stock-heavy portfolios by shifting some
capital back into GLD. And since the gold market is so small
relative to the stock markets, it won?t take much capital inflows to
catapult gold higher.
Once this whole
mean-reversion process gets decisively underway for the stock
markets and gold, it isn?t likely to stop until it has fully run its
course. That means investors have a long ways to go to return their
gold portfolio allocations to more reasonable levels. While
gold-skeptic American stock investors will probably never get to 5%
of their portfolios allocated to gold, they will go far higher than
today?s dismal 0.14%.
Remember that
GLD?s holdings have been up to 6x higher in recent years
relative to the S&P 500 components? collective market
capitalization. I have no doubt we will see those 0.79% levels
again in the coming years. GLD?s holdings will almost certainly
exceed 1% of the SPX?s market cap the next time gold really returns
to favor. But to be super-conservative, let?s just assume this
allocation grows 3x to 0.42%.
It will probably
at least take a full-blown correction approaching 20% in the S&P 500
to drive stock investors? demand for portfolio-diversifying gold via
GLD that high. It?s been far too long since hyper-complacent stock
markets have seen one thanks to the Fed?s gross distortions. That
would drag the S&P 500?s market cap back down to $15,905.8b.
Multiplying that by 0.42% gold exposure via GLD is very bullish for
gold.
This yields GLD?s
holdings climbing back up to $66.8b. That is nearly 2.5x more
capital invested in GLD than today?s levels! And as the sharp gold
rallies in recent years partially fueled by GLD buying proved, that
would really light a fire under gold. Assuming gold was about 25%
higher than today near $1500, still way below its pre-QE3 2012
average around $1675, would yield GLD holdings back up near 1385
tonnes.
That is nearly
double today?s levels, yet still barely above December 2012?s
record of 1353.3t. And even if an SPX correction is not sufficient
to drive this, even if it takes an overdue 50% bear market, so much
GLD buying will massively boost the gold price. Stock bear markets
take about a couple of years to unfold. And even at that pace, this
mean reversion higher of GLD?s holdings works out to 28.1t of new
monthly buying.
According to the
World Gold Council, in all of 2014 global gold investment demand
averaged 68.4t a month. So American stock investors ending their
radical gold underinvestment and returning to GLD could boost this
on the order of 40% for a long time. And that doesn?t
include the big
coming buying from American futures speculators, another large
pool of capital with an outsized influence on gold price levels.
So as today?s
radical gold underinvestment as manifested in GLD?s holdings
inevitably reverses and mean reverts back to normal levels, gold
investment demand is going to soar. This will naturally power
gold?s price much higher, unleashing gold?s first major upleg of
this post-QE era. And the Fed?s coming rate hikes are nothing to
fear, as gold
actually thrives in rising-rate and high-rate environments!
While gold and GLD
will enjoy great gains as stock investors inevitably return, they
will be dwarfed by those in the left-for-dead gold miners? stocks.
Late last year they were battered down to
fundamentally-absurd levels relative to the gold price which
drives their profits. So they are poised to rally dramatically as
soon as gold turns around, with the greatest potential gains by far
of any sector in all the stock markets.
At Zeal we?ve been
aggressively buying the best of these beaten-down gold and silver
stocks in recent months, as have been recommended in our acclaimed
weekly and
monthly
subscription newsletters for contrarians. They draw on our
exceptional market experience, knowledge, and wisdom forged over
decades to explain what?s going on in the markets, why, and how to
trade them with specific stocks.
Subscribe today,
as we?re currently running a popular 33%-off
Contrarian Extinction Sale!
The bottom line is
American stock investors are radically underinvested in gold, as
evidenced by GLD?s low gold-bullion holdings. This is a result of
the Fed?s artificially-levitated stock markets of recent years,
which duped investors into forgoing prudent portfolio
diversification. As the stock markets roll over, gold is going to
return to favor in a big way. It is the only major asset class
strongly inversely correlated with stocks.
As these lofty
stock markets sell off, stock investors will flock back to GLD. All
their differential buying pressure will force this ETF?s managers to
shunt great amounts of capital directly into physical gold bullion.
That will really accelerate gold?s coming upleg, triggering even
more GLD buying. Investors who buy in ahead of this coming major
mean reversion in gold investment demand stand to make fortunes.
|