11 years of the gold bull market have already passed and currently gold is trading near $1600/oz. After creating a top above $1900 in September, 2011 gold retraced nearly 20 percent from the top before bottomed twice in the month of May, 2012 at the same price we saw in December, 2011. Is gold still a good long term investment?
Technically speaking, $1500 will act as an important support level - and if gold breaks decisively below that level, a lot of autopilot trades would kick in to put further pressure on gold. I don't rule out that possibility. If $1500 breaks on the downside and price of gold falls another 200 to 300 points to trade near $1200, I would still consider that as a correction in a secular bull market. In any bull market a 30 to 40 percent correction is quite normal and such deep corrections offer an excellent entry point for long term investors.
Fundamental Analysis: Secular Gold Bull Market Intact
Fundamentally, the proposition that gold bull market is nearing end is very hard to justify. Let me elaborate:
Sovereign money printing for funding growth: According to an S&P report, the bank loan and debt capital markets will need to finance an estimated $43 trillion to $46 trillion wall of corporate borrowings between 2012 and 2016 in the US, the eurozone, the UK, China, and Japan (including both rated and unrated debt, and excluding securitized loans). This amount comprises outstanding debt of $30 trillion that will require refinancing, plus $13 trillion to $16 trillion in incremental commercial debt financing over the next five years that is estimated companies will need to spur growth. (Source: Standard & Poor's)
The authors of the S&P report clearly stated that without the availability of the "new money", sovereign growth outlook for the foreseeable future remains very bleak. An extremely low growth for the corporate world is estimated without printing the money stated above.
As money printing continues, inflationary pressure will exist. How would it be possible not to treat gold as real money and what else can be considered as real money apart from the yellow metal, the only commodity with an inherent anti-inflationary property?
Interest rates at historic lows with an all-time high sovereign debt: Interest rates are actually yielding negative returns in real terms for sovereign bond holders. If central banks allow interest rates to go up even a little bit, that will have devastating impact on the economies worldwide and governments will face tremendous pressure to meet their obligations.
Unless and until sovereign bond holders are able to capture a positive yield there is nothing to lose for holding gold.
Bear Case Arguments
Let's now focus on the bear case scenario for gold, and examine if that's actually possible.
US will adopt a modernized version gold standard for USD: Some of the most vocal gold bears predict that the United States will adopt a new modified form of a gold standard within the next five years - and warn investors to be "extremely careful" about putting money in gold because there's a lot of future devaluation priced into the current price of gold.
It is of course possible for the US to adopt a new gold standard very soon. It is also a fact that US national debt has passed the $13 trillion mark. Returning to a gold standard in any form will not help in getting rid of the huge national debt. The consensus view is if the US went back to a 100% reserve gold standard today, the equilibrium gold price should be at least of $5,000/oz.
Demand for gold will be decreasing in India and China: Gold bears argue that as the growth outlook of emerging markets like China and India is not as bright as predicted a few years ago, gold prices will not sustain at higher levels, especially because the two countries mentioned above are currently the top gold consuming countries in the world.
Worldwide demand for gold was down about 5% during the first quarter of 2012 compared with the first quarter of 2011, mainly due to import duty in India and higher gold prices. Demand for gold in China was up 10% as the country is now emerging as the largest consumer of gold, leaving India behind. China's import of gold from Hong Kong this year is at record high levels. Gold is essentially an anti-inflation play. Central banks are buying aggressively on every dip in gold prices. During the first quarter of 2012, central banks continued to add to their gold holdings in order to diversify their reserves. Central banks' gold purchases continued in April as well. Russia, Mexico, Kazakhstan, Turkey and Philippines have been the main purchasers this year. (Source: World Gold Council)
Central banks are doing so because they are left with no alternatives apart from printing money. In this way many central banks around the world are devaluing their national currency, and they just can't afford not buying gold to counteract the exercise of weakening their national currency.
What's the Potential Upside of Gold Price?
Being a non-productive asset, the intrinsic value of gold is very difficult to find out. Using the M3 money supply yield method we can roughly estimate what the current price of gold should be if we were to revert back to the gold standard. The consensus estimate is reverting back to a gold standard today would require a minimum gold price of $5,000/oz.
As a long term investor, one should buy gold either in physical form or gold ETFs like GLD (NYSEARCA:GLD) or IAU (NYSEARCA:IAU) in small quantities on every dip in gold prices with an eye to accumulating aggressively in deflationary twists.