Hypothesis: The 7% compound increase in gold price for the past 50 years reflects the corresponding increase in money supply above GDP and devaluation of currencies.
I have chronicled the last 3 articles about the US stock peaks and gold on September 15, October 3, and December 8. The demise of stocks as opposed to gold's ascent during the entire period is an indication that the entire fiat system is under stress, because of record-high asset prices and unprecedented total debts within the system.
This article intends to highlight gold during times of fear. I use a series of diagrams and charts to reveal the merits of gold within the complex basket of global financial assets. As the best alternative of money outside the fiat system, physical gold has no counter-party risk. As signs of bankruptcies and bank failures spread around the world, gold will be the ideal choice to preserve one's wealth. While the fiat currencies are faith-based that fade, gold is forever solid.
The illustrations are labeled by Paul Wong or PKW with data sources stated.
Gold vs. Fiat Monetary System 2008-2020
The diagram is a view to relate gold to the fiat monetary system, as expressed by the Exter's Pyramid, and the effects of asset price inflation due to quantitative easing by the central banks in increasing base money supply from 2008 to 2018. Since last February, price deflation in many assets, including US stocks finally happened due to mostly the effects of central bank's quantitative tightening, which is still ongoing. As such, prices on real estates, stocks and bonds likely will descend further into bear markets.
In contrast, gold may be the asset of choice for appreciation potential in the next two years with little downside risk, because the last major bottom was in place in February 2016. If QE, quantitative easing, resumes again to suppress rising interest rates, gold prices will bounce upward, as shown in the 50-year gold price diagram below.
Many emerging central banks increased their gold holdings as reserves in 2018, replacing other reserve currencies. The moves validate gold's status as the ultimate risk-off asset, not subject to counter-party risk and shifts in political policies. This sentiment change of some central banks is noteworthy for the investors.
Dollar Value Analysis of Gold
The US Dollar Index (NYSEARCA:UUP) is a measure of the value of the US dollar relative to a basket of foreign currencies. The dollar value of an asset is simply the product of the asset with UUP (UUP*Asset or $Asset).
The following chart shows the inverse relationship between dollar index (UUP) and gold (GLD), in light blue and gold color. Gold has accelerated upward since the Democrats became the majority in Congress after the mid-term election in November. The low of $1,160 held in last August to enable gold to stay above the 5% uptrend since 2016. The 2 times inverse relationship with the dollar index is quite clear as shown. A repeat of gold price mounting to the 2016 high of $1,376 before July is within reach.
Gold market is global. The following updated chart is used to track the trends of the dollar, gold and dollar gold (UUP*GLD). Dollar gold in brown has performed better than gold since October, showing the superior real value of gold during times of global financial asset decline.
Debt and Interest Rates
Rising interest rates as represented by the 30-month LIBOR chart below are wrecking global financial markets of bonds and stocks. The rising rates are the direct results of liquidity contractions initiated by central banks especially the Fed. If interest rates surge further, another stock correction will follow. Deleveraging, reduction of debt, and credit, most likely will accelerate forward throughout 2019 to drive the stock and bond markets even lower.
Long-Term Treasuries vs. Gold
The chart below illustrates the relationship among long-term bonds in green, US dollar and gold. As the long-term-bonds trend down after a 35-year bull market, gold is more attractive in preserving capital as it resumes the 7% growth rate since 2016.
The 42-month chart below tracks the performance of the Dollar Index in light blue, gold and the dollar S&P 500 (UUP * SPY or $SPY) in beige. $SPY shows the real or global valuation of the US stock market which generally behaves inversely with gold.
Lately, gold is keeping up with the rise of USD, indicating that fear is permeating among investors primarily due to the instability caused by the record global debt levels.
Gold After Rate Hike
The 42-month chart below shows gold in gold color usually performs well after each rate hike. With the Fed signaling a pause in raising interest rates for at least the next 2 months, as evidenced by the weakness in the dollar lately, the setup is bullish for gold.
The recent wave of mergers and acquisition among the majors is hugely positive for the long-term profitability of the mining industry. All the commodity industries such as oil and including the miners have been suffering with too much competition due to low interest rates and easy credits for the past 10 years. Finally, we are witnessing the beginning of self-discipline by the mining industry leaders to lower unit cost simply through the process of economy of scale by mergers. Reducing production growth by focusing on only the high margin projects will help profits also. Yes, profitability is the only thing that matters for capitals. Other industries like oil need to notice and join this new movement of mergers to secure a better future for all. The coming or ongoing global bear markets provide a timely window of opportunity to take bold actions to reduce competitors.
The rise in gold price is amplifying the performance of the miners since mid-September. Because the miners had declined to an extremely low level for the past two years, the upside is large for the next 6 months if gold continues the upward path. Silver miners lagged gold miners until the middle of November but have been catching up fast. The upside potential is much bigger than gold miners if silver ascends further.
Silver and Silver Miners
Silver had been following gold lower for the past 2 years until August 16, 2018, when both hit bottom. Dollar silver or $SLV in light green, which is the real or global value of silver, is higher than silver because of the strength of the dollar. The outlook of silver appears to be good following gold upward.
The chart above show the relationship of S&P 500 or SPY in orange, with silver (SLV) in silver color and the silver miners (SIL) in blue. In comparing the performance of SPY with SLV and SIL, SPY/SLV in purple and SPY/SIL in gray, the relative performance of the curves fell because of the stronger performance of both silver and the miners since October 2018, when the stock market drops.
The list of global asset deflation since February 2018 is complete with the fall of the US stock market. Most likely, the confirmation of the completion only marks the early stage of the bear market ahead. The next nine months will be challenging for stocks and bonds.
Fortunately, gold is likely to be the prime exception as discussed above. With the combination of the Fed pause in rate hikes, a weakening dollar, an uptick of volatility in the stock market and favorable seasonality till mid-March, these are the factors that will push gold higher for the next 3 months.
(For discussion purpose only, not intended for any investment advice).
Disclosure: I am/we are long GDX, SIL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.