With fiscal and monetary policy in the U.S. still loose, why has gold been a poor investment for over a year?
We see the effects of inflation everywhere. Home prices are rising and bidding wars are spreading. The average price of gasoline in 2012 was the highest ever. Gasoline recently hit its highest price ever for the date. Food costs creep up regardless of whether the underlying commodities are rising or falling on the futures market. Stock prices keep moving up, in part to discount all the money the Fed is creating and is expected to create. Yet money market and bank rates remain close to or at zero, "discounting" price stability-- which few expect.
This scenario "should" be accompanied by bullish action for gold.
Why instead has gold started going nowhere since the summer of 2011?
My guess is simply that gold got ahead of itself then, and now has "rested" enough to be ready to join the inflationary procession. Gold's bandwagon screeched to a halt in late summer 2011 after an excessive price run-up that year from $1324 on Jan. 24 to $1895 in early September ended. It was brought to an end in part when the global economic slowdown (which the U.S. largely avoided) introduced disinflationary price pressures and in part by the surprising refusal of the Fed to begin QE 3. Both those factors have now reversed, with global growth ex-Europe picking up and the Fed finally QE-ing again, but GLD continues to stagnate.
This presents an interesting investment opportunity.
Given that there are risks to the downside and traders may want to use stops, this article focuses on the SPDR Gold Trust ETF (GLD, which is the best-known "paper gold" listed investment vehicle in the U.S. markets) rather than physical gold. By doing so, I am not endorsing GLD as a "good" way to own gold. I am very well aware of all the arguments against "paper gold" in general and GLD in specific. Nonetheless, it is the most liquid paper gold investment there is, and I am personally comfortable trading in it, though I do not consider it to be a secure long-term store of value.
Also, bull markets in gold tend to be associated with even stronger bull markets in silver. Over long periods of time, they tend to move together. Since this article is aimed at both traders and long-term investors (who may wish to purchase or continue to hold physical metal rather than a stock or ETF), for simplicity this article focuses on gold/GLD; but silver/SLV is omnipresent in spirit.
There are three themes that all suggest an upward bias to the price of gold in the months ahead, and perhaps the years ahead.
First, there is the message of the price movements that are reflected in the charts. Technicals absent context are useless at best.
Gold has recently been through a testing period following a series of strong bull moves. The price of gold, which I shall simply call "gold," began a 20-year consolidation beginning in 1980. This was associated with repeated periods of prudent Fed policy, and then was triumphantly accompanied by the move to a balanced budget in the mid-to-late 1990s and into 2001. Then, the combination of the 2001 recession and the aftermath of the 9/11/01 terrorist attacks led to a turn in both fiscal and monetary policy from restraint to "stimulation," also called inflation. With varying degrees of enthusiasm, this inflationary/stimulative bias has remained the bias of both the Federal government and the Federal Reserve ever since. Long gone from the media is the cheerleading accompanying balanced Federal budgets.
The gold charts reflect this. After a determined multi-year run beginning in 2001, gold broke through its 1980 high of around $875/ounce, peaking near $1000 in 2008. It briefly collapsed in the liquidity crisis post-Lehman, but quickly rebounded as investors saw that the Fed was going to print money as part of the response to the crisis and that very large fiscal deficits were planned.
The fall 2008 collapse in gold's price created a spike bottom at $700, which merely briefly matched a spike peak from 2006-- a bullish sign of support. This interpretation was validated in 2009, when widespread bearish sentiment on gold that $1000 was going to be the top was accompanied by gold breaking through that "barrier" with force, never looking back. After further price rises, gold got ahead of itself in the summer of 2011. The precipitants were excessive fear of the U.S. government defaulting during the debt limit negotiations, and the downgrades of the government's ratings by several U.S. and international rating agencies. All of a sudden, from obscurity so far as the American public was concerned not long before, at least one poll showed that gold was considered the best investment possible, better than stocks, bonds or real estate. Gold had arrived. It bubbled up to $1900/oz and then sold off about 20%- a similar amount as the S&P's brief collapse in the summer of 2011 on an intra-day basis.
Gold then entered a high-level consolidation. The bull market gains have basically held. Gold's average price in 2011 was $1571, and was somewhat higher in 2012 (I saw the precise data somewhere on the 'Net recently but cannot find it now; a visual inspection of GLD shows that to be true. One should add about 2% to the price of GLD to get the price of gold.)
The highest average price of gold for an entire calendar year was 2012. But few know that, and that is unequivocally bullish in my view. (Data is through 2011 from the Nat'l Mining Ass'n.)
GLD is up about 20% from two years ago. This is several points better than the S&P 500 ETF, the SPY. How many people realize that fact? GLD is only down about 3% from one year ago, when it set yet another record high for February prices.
Yet the momentum players are piling into stocks, while gold, the stronger performer for the past 10 years except for the past 12 months, has been forgotten.
This is a bullish set-up for GLD.
Second, measured sentiment is quite negative, at least in the U.S.. Here is Fred Hickey from Barron's Roundtable, speaking on Jan. 14:
Hickey: I am recommending gold, as I have done for many years. I will continue to do so until the gold price hits the blow-off stage, which is nowhere in sight. I am excited about gold because sentiment is so negative. Gold could have a sharp rally at any time. The Hulbert Gold Newsletter Sentiment Index went deeply negative last week, indicating that gold-newsletter writers are recommending net short positions. When that happens, gold almost always rallies. The daily sentiment index for gold is at a 12-year low. Short positions by large speculators have doubled in the past few months. Sales of American Eagle coins hit a five-year low in 2012. Yet, the environment for gold couldn't be better. We talked today about massive money-printing by all the major central banks. Real interest rates are negative. These are the best possible conditions for a gold rally.
One can look no further than to observe the trading volume of GLD, and its more volatile relative SLV, over the past 5 years, to agree that the hot money has moved on. That's good for the bulls, in that fresh firepower could come in on a breakout, say above $1800.
Third, a number of fundamentals are positive for gold/GLD.
Gold is similar to the way the NASDAQ once was, where from its bottom in 1974, the total return from almost all leading stocks was understood to come from price appreciation rather than dividends. Gold is, in a sense, a zero-coupon "bond" that never matures. In an inflationary world with positive nominal interest rates, it is expected to rise in price over time, just as the general price level is expected to rise.
Most countries are now committed not to an "Austerian" approach to economics, but rather to "reflation," which is a nice term for inflation.
In general, the authorities, both fiscal and monetary, are taking the standard way out of credit crises: they are printing money, and they will never tell you the extent to which they think they need to print.
There may or may not truly be currency "wars" going on now, but certainly governments have been devaluing against gold for some time now.
The above point is in my opinion the single most important fundamental. The authorities intend to inflate the prior financial mess away, with as much real growth as possible assisting up the process; but the authorities know that they can be certain of the printing press, while the real economy is more difficult to speed up.
Gold is a store of wealth that is accepted by all governments and all major monetary bodies (in this regard, silver cannot compete). Every major country counts gold amongst its monetary reserves. So do the European Central Bank and the International Monetary Fund. Central banks globally have become net accumulators of gold for at least the past two years, exchanging dollars, euros or local currency for this metal that costs money to store. Gold is the only physical commodity that does not trade on banks' commodities desks. Instead, it trades on currency desks.
Gold (and thus GLD) indeed has fundamentals, and they are monetary.
Gold has tended to track the level of real interest rates, including short rates but also including long rates. Over many years, gold has tended to remain unchanged when the short-term rate is about 2% greater than the CPI. Short rates are about 4% below the CPI.
Gold, and GLD since its 2004 introduction, has also tended to track the aggregate Federal debt level, including all intergovernmental transfers (i.e. Social Security Trust Fund holdings of Treasuries are included).
The above correlations, while they may not hold in the future, are bullish.
There are different sorts of fundamentals. China has become the world's largest producer of gold and unlike the way it treats textiles and iPhones, it forbids the export of gold. In fact, it imports large quantities of gold, for individual accumulation and, it is thought, for central bank reserves as well. Russia also produces large quantities of gold and exports none of it. Thus they are treating the "barbarous relic" of Keynes (and Buffett) the way the United States treats important military secrets: not for export. The Chinese have always played things for the long term. Whatever they do not wish to sell, Western investors may want to give a second look at.
Finally, the world appears to have reached a form of "peak gold." Even at 2011-12 record price, gold mining companies cannot get a profits streak going. Earnings estimates for Q4 2012 and especially for FY 2013 have been dropping for the "Big 3" of Newmont (NEM), Barrick (ABX) and Goldcorp (GG) for some time. NEM is back where it was in October 2003, before GLD was even created and gold was a small fraction of its current price. Yet no major company can easily expand production, much less really goose profits. A year ago, Standard Chartered estimated that in order to achieve a business-standard internal rate of return (IRR), gold would have to be trading around $2000/ounce.
So even though mining only adds a modest amount of gold to the huge above-grounds stores, it cannot be ignored completely; the rapidly-rising cost of getting gold out of the ground helps put a longer-term floor under the price of gold and therefore under the price of GLD.
Cautionary points: All the above are "known knowns." Mr. Market may ignore them.
In addition, gold functions as a reserve currency that is not tied to debt issuance by a government, but it does compete with or supplement the major global currencies. Thus its expected return may be similar to the long-term nominal return from U.S. bonds, for example. Perhaps in 30 years, people will determine that the current yield on zero-coupon Treasuries, which are similar to gold in that they pay no interest, was actually fair in relation to realized inflation. In that regard, who knows what price target one should have for gold on this multi-decade consideration, which one would then discount back to today and the near-term future?
In other words, GLD may have good reasons as to why it could or should be a good investment choice now, but it simply may not be one.
A final caution: Just as dividend payments by a corporation result in an immediate subtraction from the stock price, GLD has (modest) operating expenses. If the price of gold bullion is unchanged one year from now, the price of GLD will tend to be about a half a percent lower, and this negative compounding effect will persist year after year as a drag on performance of this asset.
Summary: The above makes the bull case that GLD may be a good investment for traders (though not for day traders) as well as for investors. U.S. investors are gloomy about gold's prospective price performance even though it has outperformed the SPY on a 2-year basis; the Fed is aggressive; and very large Federal deficits are continuing, at least as of today. Central banks have ended a long period of selling gold and have begun accumulating it. The effects of the financial crisis of 2008 continue and have led to quantitative easing, aka money-printing, by the Fed. Also, gold miners are not minting money, as would be the case if gold were over-priced in relation to costs of production. Thus there is no danger of bullion stores above-ground exploding to the upside.
I believe that there are good reasons to have a bullish bias toward GLD, both from a trading perspective and as a hedge against fixed-income portfolios declining in value should inflation accelerate.