Gold's Bull Run Has Not Yet Begun

by: Ben Kramer-Miller


The gold price is up substantially over the first part of the 21st century.

Yet by several measures it is cheaper than it was in 1999.

Gold market commentators grossly misunderstand the market as it relates to interest rates, even if they are bullish.

For all intents and purposes gold's bull market has yet to begin, although fundamentals are improving.


The gold market (NYSEARCA:GLD) has been one of the best performing in the 21st century, having outperformed broader stock market indexes and several commodities. It hit its low of $255/oz. in the summer of 1999 and it trades at just over $1,200/oz. today for a gain of 375%.

While this certainly looks like a bull market I would argue that we have, in fact, not yet begun to see a bull market in gold from a couple of critical standpoints:

  • Valuation: Gold is cheaper today, or as cheap as it was, based on key metrics than it was in 1999.
  • Gold's rise has coincided with a fall in yields, which is anathema to a gold bull market.

1--Gold's Valuation

In spite of the substantial rise in the gold price that we've seen over recent years this price increase doesn't reflect the incredible amount of money creation we have seen. There is a reason for this which I will get to later in this article.

Gold's price in Dollars should, over the long term, reflect the Dollar's purchasing power, which is in part correlated to the supply of Dollars. As the supply of Dollars rises it is intuitive that these Dollars should buy fewer goods, ceteris paribus. The idea here is that Dollars are valuable only insofar as they can be exchanged for other goods, and that an increase in their supply should lead to a decline in their relative value.

Meanwhile, while gold has industrial value its primary function is in its exchange value. Gold has a relatively stable supply and it possesses several qualities that make it suitable (not ideal) as a long-term store of value, including scarcity, fungibility and physical stability.

Gold's price increase has not reflected this rise in Dollars unless you use specific measurements of the money supply and measure from the bottom in the gold price.

Let's look at a couple of money supply measurements relative to the gold supply to get an idea. The first is the monetary base, which is essentially the Fed's balance sheet before the money supply is increased through fractional reserve banking. The following chart shows the value of US gold reserves relative to the monetary base, and as you can see this figure is not just below its 1999 figure but it is at its lowest point on the chart, which starts at the creation of the Federal Reserve.

(Source: Strategic Gold)

Note that while the gold price has risen nearly 50% from its 1980 peak nominally by this metric it is down nearly 95% and would have to exceed an incredible $20,000/oz. to reflect the 1980 high.

Of course the monetary base doesn't reflect the money supply as it exists for practical purposes since money is borrowed into existence via fractional reserve banking, and the assets that we consider "money" or "cash" include things such as bank deposits, CDs, money markets, and other assets.

A measure of America's gold relative to the value of these assets is arguably a greater measure of the public's confidence in these kinds of assets, and for this reason gold analyst James Turk created the Fear Index. The Fear Index measures the value of America's gold relative to the M3 money supply, which takes all of these forms of "cash" into consideration. The idea here is that as the Fear Index approaches 1 (100%) the public's confidence in paper assets falls to 0, as it collectively "demands" 100% convertibility of its "cash" into the gold held by the US Government.

The Fed stopped reporting M3 money supply so it is difficult to get an accurate read on this index, but assuming John Williams of ShadowStats is correct the figure is ~$16 trillion vs. America's 287.5 million ounces of gold worth ~$350 billion. This puts the Fear Index at just under 2.2%, which, as you can see by the following chart, reflects very little fear, and only slightly more fear than what we saw near the market's trough.

By both of these metrics it is evident that the gold price has hardly responded to the incredible amount of Fed stimulus we've seen in the 21st century, especially since 2008.

Finally in this section it is worth pointing out the fact that the marginal cost of production has risen along with the gold price. Above-ground inventories of gold far exceed those of other commodities relative to consumption since gold is hoarded, and this might make this metric less useful than it would be for, say, copper. But it is worth noting the fact that the gold price has risen while the cost of extracting it has, more or less, kept pace. The following data shows the cost of mining gold in Australia.

The rise can reflect all sorts of things from waste to low-grade gold production in the face of rising price, but what is clear here is that the business of gold mining has not improved with the gold price, and gold has effectively kept up with the marginal cost of production. We can see this in the lousy performance of numerous gold miners since the beginning of the century such as Barrick (NYSE:ABX), AngloGold Ashanti (NYSE:AU), and Gold Fields (NYSE:GFI).

While none of these is an ideal data point together they indicate that the rise in the gold price over the past 15 years has effectively been illusory.

Gold and Interest Rates

The above valuation metrics are far from perfect, although they do show pretty clearly that the gold market has not exhibited strength or bullish price action despite market enthusiasm going into the financial crisis and after the $1,000/oz. level was broken in 2009. The clearest piece of evidence that gold is not in a bull market, and is arguably in a bear market, is the strength in the bond market and the fact that interest rates are so low and have yet to move higher in spite of the fact that the bond market is grossly oversupplied. The bubble in bonds and in interest bearing assets is so egregious that in Europe there are several bond markets that have entered negative interest rate territory.

This brings up a crucial misunderstanding that investors have when it comes to the gold market, namely that falling interest rates are good for the gold price and that the fact that we haven't seen the gold price rise in the face of quantitative easing is evidence that the gold market is overvalued. It would follow from this that the gold price will fall dramatically once the Fed begins to hike interest rates.

This is, in fact, quite the opposite of how the gold market works vis-a-vis the bond market, and as we will see I think one of the primary bullish catalysts for the gold market will be a Federal Reserve rate hike.

The misunderstanding is that as interest rates fall gold should rise because bonds and interest-bearing assets (e.g. dividend paying stocks) are yielding less. The stable-valued asset with no yield becomes more attractive as the assets with a yield become less attractive by comparison in that the yield comes down.

While this is true falling rates will not send the gold price higher. A good analogy is that falling rates give the gold market potential energy whereas it needs kinetic energy to actually rise. So as rates remain low investors seek out yield in bonds and bond-like assets (e.g. dividend paying stocks) even while the money supply increases. Gold will move higher only once these yielding assets start to lose their attractiveness, and this only happens once rates rise.

From the time that the gold price was allowed to float freely in 1971 until ZIRP came into effect there has been a relatively strong correlation between the Feds benchmark rate and the gold price--as interest rates rose so did the gold price.

(Source: Yours Truly via

This correlation is far stronger than any of the more common ones postulated by gold market prognosticators from the CPI, unofficial measures of the CPI, the DXY, the money supply, debt outstanding...etc. Furthermore gold bulls are anxiously awaiting a further round of quantitative easing, and they are operating under the assumption that this will increase the money supply which will force money into the gold market. But until the bond bubble bursts or until the Fed raises rates (the two aren't necessarily mutually exclusive) low interest rates will continue to make interest-bearing assets relatively attractive. By extension gold will continue to fall, at least in terms of various measures of the money supply, and it will probably continue to underperform stock and bond markets.

Gold Market Catalysts

Given the massive amount of money creation we've seen in the past several years, and given the fact that interest rates are at historically low levels that make lending money unappealing for virtually anybody not doing so for political reasons, gold is an incredibly attractive asset with catalysts in its future that will stun even the yellow metal's most ardent bulls. But the status quo is not an environment in which gold will shine.

As interest rates remain low stocks and bonds with higher yields are relatively attractive, and any additional money creation we see will, more likely than not, flock to these assets. After all if money markets and other zero-duration cash-accounts have no yield (or negative yields!) then those in search of income are forced into long-term bonds, high yield bonds, and stocks with steady cash-flows trading with 20-30X PE ratios, which by comparison are extremely attractive. But at the same time the low interest rate environment is what makes these assets so attractive.

So I think a significant catalyst for gold in the near future could be a Fed rate hike, although given the incredible global USD-denominated debt load and the concomitant cost of servicing this debt in a "normal" interest rate environment I am extremely skeptical that we will see this. That's bad news for gold, at least in the near-term. In the long-term low interest rates and continued inflation in interest-bearing assets all provide additional potential energy for the gold market, and the disparity between gold's fundamental valuation and its low market valuation will widen.

But whether the Fed or the market forces interest rates higher eventually this has to happen. When it does correlated assets such as bonds and "stable" dividend paying stocks will see their primary catalyst dissipate. The money creation that the gold bulls had expected to go into gold will finally enter the market, and so will begin the gold bull market that I am expecting.

While I am fairly confident in this outcome I am not really certain about the timing. After all the bond bull market has been ongoing for ~35 years, and there have been prognosticators calling the market a bubble for years now. The bubble can certainly continue for another year or two, or even five. It could also burst tomorrow.

With that in mind I think investors would be wise to participate in this bubble with at least some of their assets, so long as they are fully aware of the fact that this is a trade that can backfire. If you choose to do so take necessary precautions by taking profits, using stop orders and options, and preparing yourself for the inevitable gold bull market. Companies with strong, stable cash-flows and long histories of dividend payouts that are growing even slightly are relatively inexpensive assuming this scenario continues, even if they trade at, say, 18-25X earnings.

Meanwhile gold should continue to underperform, although the rise in the money supply could put upward pressure on the gold market in nominal terms, as it has since 1999. Gold miners that have low production costs and sustainable organic growth that is nurtured by strong management teams should also perform very well. Those looking at such investments should consider stocks on this list that I put together at the end of 2014.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.