Why I've Turned Bullish On Gold

Includes: GLD
by: Paul Nathan

Let me say from the outset that I'm no Perma-Bull when it comes to gold and precious metal stocks. I sold out 100% of my position in the spring of 2011, and in fact shorted gold at $1900, this after having been in it from 2001. As an investor in gold and precious metal stocks since the last bull market of the 70s, I've been in and out of precious metal stocks many times. Even though I've been bearish for the last two years, I think an opportunity looms.

Gold, silver and most commodities peaked in 2011 and have been falling ever since. At that time we entered a period where a disinflationary/recessionary bias entered the system, not just for the US, but the world at large. Actual deflation showed up in various economies, and recession or at least slowing growth rates became prevalent in most countries. It is no wonder that commodities in general began to fall. I think that is all about to change, but not at first -- it will happen at last.

We have probably peaked at 4.1% GDP in the third quarter, and chances are good that the next two quarters will be trending lower. The first quarter should be very challenging. But the year as a whole should be the highest growth year since the recession ended. Conversely, at a .09% inflation rate year-over-year, the odds of a continued fall in inflation are low from here. After all, how much lower can the Fed allow the rate to fall? Bernanke at his news conference said that they are more than a bit concerned with the falling inflation rate and will do whatever is necessary to combat it if it should continue. So the tendency will be to fight any trend toward lower growth and lower inflation.

My view is that the Fed will be confronted with both during the first quarter of the year and that they will be forced to change their tapering policy to a policy of reflation, or at the very least, put their tapering plans on hold. I wouldn't be surprised to see them eliminate or reduce the interest rate charged to banks on excess reserves to try and fight the drag on the economy in the next several months. A major correction in the stock market could hurry this decision.

But let's assume I'm wrong and falling growth and anemic inflation is not an issue in the 1st quarter, and that instead, we have a progressively better year in 2014. That case, the bullish case, is actually very persuasive and even more bullish for resource stocks in general and precious metal stocks in particular. It projects continued growth in GDP and a rising inflation rate.

Recently we have seen the development of a new energy boom, perhaps the most important boom in a generation. We are actually on our way to energy independence and making such cartels as OPEC, irrelevant. IHS, an energy group, is estimating by the end of next year, rail capacity could be enough to handle 700,000 barrels of crude per day, compared to 150,000 today. We are about to become net exporters of oil and gas to the world while importing less. This one industry will be instrumental in raising exports and increasing the GDP in 2014 and into the future.

Add to that a very robust housing recovery that looks to have legs and good car sales continuing in an industry that will also add to our exports next year, especially if world growth kicks in. It is possible that 2014 will bring the first synchronized international recovery in a very long time. All nations hitting on all cylinders will add to world demand for commodities.

The rising stock market, along with rising home prices, have led to a rise in individual net worth which just hit all-time highs this month. Corporate profits are at historic highs as a percentage of GDP, and disinflation has helped consumers make ends meet in a tight money and tight credit environment. Over the last five years, consumers have paid down debt and are in better shape than in decades. If it weren't for the confusion and uncertainty this nation faces due to counter-productive government policies, we would be experiencing robust growth today and probably for years to come.

So, if I'm wrong in the short term, and no meaningful deceleration occurs in the first quarter, I think I will be right in the long term where the economy moves higher from here with inflation also moving higher. After all, most of the world has been in a recession or declining growth for years now. This has led to unusually low demand. It can't last forever, and in fact there are signs already of a turn.

Either way, with or without a slowdown and some possible nasty problems in the first quarter, I think the days of disinflation and actual deflation are numbered. Whether sooner or later, I see growth higher from here after years of stagnation, gaining momentum in the second half of the year, and building momentum from there.

It's for this reason that I am predicting a turn in gold, silver, and most commodity prices in 2014.

Where gold has been discounting disinflation and possible deflation since October of 2011 and has been falling, I think it will begin to discount 2 to 4% inflation rates over the next year or two. Whether through a return to easier money by the Fed to prevent deflation, or just plain higher world growth and demand for commodities as inflation finally moves higher rather than lower, I think 2014 will be a year of higher commodity prices. Once inflation stops falling, the discounting process of falling commodities will also end. Instead of commodities discounting weakening world demand, they will begin discounting strengthening world demand, and higher prices will result.

The CRB, which fell from 370 in 2011 to a recent low of near 270 should bounce above the 300 level at the minimum and run higher. Gold and silver should put in a similar performance. If both GDP and inflation rise or are even firm from here, gold should move up, and we should see higher demand for resources and resource stocks in general.

And that I think will be the trade of the year.

It will be in this environment that we could see the beginning of the normalization of long term interest rates, money supply growth, increased velocity of money, and a rise in commodity prices in general. By the end of the year, I expect things to be much different than the first part of the year, with inflation trending higher along with higher long term interest rates as the markets discount 2, 3, and 4% inflation rates and higher world growth rates to come.

The prospect of higher interest rates, higher inflation rates, and higher gold prices, will be distinctly different from the previous period of lower interest rates, lower inflation rates, and lower gold prices. The former signals reflationary growth while the latter signals a deflationary/recessionary bias in the system. The year 2014 I believe will mark the beginning of this multi-year reversal in trend.

The one mistake I think most forecasters are making when it comes to gold is they assume that an era of prosperity will lead to lower gold prices because that's what happened for 20 years after Reagan took office. But this is a different set of fundamentals. Then interest rates fell along with gold due to falling inflation. In the years ahead, I think interest rates and gold will both rise due to rising inflation and increased growth and demand for resources.

The most profitable scenario for those who are invested in gold, silver, and resource companies, is not the doom and gloom scenario of implosion and collapse, but the world growth scenario where a growing world middle class accumulates wealth and demands more resources. If America can increase its growth rate, along with China and Japan, and if Europe can pull itself out of recession, 2014 will begin the long process of healing, growing, and creating wealth again. With that process comes demand for goods, demand for commodities, and demand for diversification of investment and savings.

In light of the possibility of such a scenario, good resource companies that have been crushed and sell today for fire sale prices, should be a good investment for those looking out over the new era we hopefully are about to enter.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.