The title of the article is a bit deceiving because since we use the word "bubble", it suggests that gold's price is in a bubble and is apt to burst in the future - which we currently do not think is the case. In fact the only reason why we chose this title is because we wanted to respond to an article that a financial blogger, Mr. John Maxfield, wrote titled creatively enough 2 Reasons the Gold Bubble Burst in 2013 - we thought we would raise the stakes a bit and choose three reasons why gold certainly did not burst in 2013.
We will not go into the details of Mr. Maxwell's argument (investors should read the article for those details) but in summary, his two reasons why the gold bubble burst in 2013 are as follows:
1. Speculators sold their ETF gold stakes in massive amounts
2. The picture for interest rates changed dramatically as the Federal Reserve tapers its quantitative easing
So now let's give our three reasons why the gold bull market didn't end in 2013 - two of them will be counter-arguments to Mr. Maxwell, while the third will be our anteing up of the stakes (we have more reasons to be bullish on gold, but we'll keep those cards close to our vest).
Speculators Abandoned Gold in 2013
The first point is simply that speculators abandoned their gold stakes in large amounts by liquidating their positions in the gold ETFs. Mr. Maxwell states the following:
"The fact that speculators were behind the drop -- as evidenced by the cited "large-scale outflows from ETFs" -- is borne out in the numbers. In 2012, ETFs were net buyers of gold, purchasing an estimated 279.1 tons of the precious metal. In 2013, they transformed into net sellers, offloading a staggering 880.8 tons onto the market."
He's absolutely right that speculators sold their gold stakes to the tune of almost 900 tonnes, and if we add the fact that they were net buyers of almost 300 tonnes in 2012, that means speculators changed their position by a net of almost 1300 tonnes - or half of world's annual mine supply.
But we would pose the following question to Mr. Maxwell - if the speculators have sold their gold, then who is left to sell gold in 2014?
Intelligent investors need to remember that despite this massive 900 tonnes of ETF gold that was offloaded into the markets, we weren't awash in gold that was forced onto our desks to be used as door stops and paper weights, but instead it was melted down in Switzerland and much of it was shipped to China. After all, for every seller of gold, there was another buyer of it - without 900 tonnes of speculative selling who is exactly going to satisfy these 900 tonnes of buyers?
The fact that the speculators abandoned gold in 2013 (and many went short gold) is actually a very bullish sign because it means that this source of weak-handed supply is no longer available to the market. Those who bought gold in 2013 are a much stronger variety of investors that are not looking to sell gold back onto the market for a mere 10-15% profit - they are either looking for much higher gold prices or are simply accumulating gold as a store of value.
The Picture for Interest Rates Changed Dramatically
The author's second point is that the picture for interest rates changed as the Fed began tapering its quantitative easing program. He states:
"Beyond profit-taking, the outlook for interest rates changed dramatically in 2013, with analysts and commentators predicting the Federal Reserve would begin reversing course on its third round of quantitative easing. And because real gold prices and real interest rates are inversely correlated -- when real interest rates are low, real gold prices are high -- it seems reasonable to conclude that this served as the ignition switch."
The key wording here is "real interest rates" - a much more complex topic than meets the eye. First, rising interest rates do NOT mean that real rates are rising; which is a common mistake in the financial blogosphere. The author is assuming that if interest rates rise, then that means real rates will rise, which is absolutely not the case and there are plenty of current day and historical examples (we're seeing it in Argentina, Turkey, and Brazil to name a few).
Real rates are based on the difference between the interest rate and the inflation rate, and if inflation is rising faster than interest rates are rising, then you have real rates drop even as interest rates rise. So to make this point the author would have to make the case that the Fed is raising interest rates faster than the inflation rate is rising - which cannot be assumed.
In fact our view is that if the Fed aggressively raised interest rates to the point where they outpaced inflation (i.e. real rates rose), then it would cause significant damage to the financial markets as companies would have trouble refinancing at much higher interest rates (remember they hold more debt now than ever before). Even the US Federal government would be hard-pressed to find the financing for the extra $170 billion per year that each 1 percent rise in interest rates would mean - in a rising real interest rate environment, this extra $170 billion could not be printed away and would have to be found with real cuts elsewhere.
The scenario for this chaotic financial environment where the Fed aggressively raises interest rates is one that investors would absolutely want the protection of gold. Remember gold does best not in inflationary or deflationary environments, but in chaotic environments where risk runs wild and policy makers have no clue what to do.
Gold, the Bubble that Peaked - Just Like in 2008
The author starts his article with the following ominous chart that seems to back his argument in graphical terms.
In fact, if we take a look at a chart of gold (represented by GLD) from 2008, we get almost an exact replica of the chart that the author used to represent the gold "bubble".
We could actually do the same thing in a 2006 chart, but I think the point is made. Many commentators have been pointing out this same gold bubble since gold breached the $400 price level. The cries of "bubble, bubble!" get louder when the gold price rises or falls by a large amount - but they have been dead wrong then and we think they are dead wrong now.
Conclusion for Investors
Gold may have a bubble stage yet before this bull market is over, but we believe it has much more upside before investors should sell. The fundamentals are still very strong for gold and the financial system is nowhere near fixed or normal.
So we will happily accumulate more gold as the same people who have called the gold bubble for the last 10 years make their arguments, and we believe that investors should continue to buy physical gold and the gold ETFs (SPDR Gold Shares, PHYS, CEF). For investors looking for higher leverage to the gold price, they may want to consider miners such as Goldcorp (GG), Agnico-Eagle (AEM), Newmont (NEM), or even some of the explorers and silver miners such as First Majestic (AG).
We have yet to hear a strong argument why gold is truly in a bubble or why the fundamentals for gold are weak - that's why we continue growing our position as we believe gold will climb this wall of worry to new all-time highs. Gold is an insurance policy that we believe all investors should hold if they believe there is a chance that policy makers could get something wrong - we believe that likelihood is quite high.