Just Another 20-Year Bear Market For Gold?

Includes: GLD
by: SomaBull

With the weakness in the sector last fall, many wondered if gold was about to fall back to the $1,100 range, or worse, hit triple digits.

At the end of the day, fundamentals rule and the fundamentals for the gold sector are resoundingly better than they were 20-30 years ago.

If investors revisit this sector in a few years' time, they will have a sinking feeling again, but it will be one of regret for renouncing the sector.

The 70s were an amazing time for gold and the mining stocks, as they went on a mega bull run and generated astronomical returns while the stock market floundered. However, by 1980, the price of gold peaked at over $800 per ounce and then entered a 20-year bear market.

From 2001-2011, gold went ballistic again, going from $250 per ounce to a peak price of $1,900 by the late summer of 2011. Most investors know what happened since then - gold collapsed and has spent the last 5 years in the $1,200-$1,300 range (with a brief dip to $1,050-$1,100 back in 2015).

With the weakness in the sector last fall, many wondered if gold was about to fall back to $1,100, or worse, hit triple digits.

In fact, several months ago, I was receiving many emails from subscribers and followers, asking me if this might be a repeat of 1980-2000, which would make this only year 7 of a 20-year bear market.

Just the thought of that! What an incredibly sinking feeling for whatever bulls that remained at the time. There seemed to be a real fear of this possibility.

I can unequivocally say that the SPDR Gold Trust ETF (GLD) isn't in the third or fourth inning of a two-decade-long bear market. What took place in the 1980s and 1990s was a completely different environment.

One of the biggest differences between then and now is the massive increase in gold supply that occurred from 1980-1990. During that time period, worldwide gold production increased from about 1,220 tons to roughly 2,200 tons. There were significant discoveries in Nevada and Australia as many elephant-size gold deposits were found. Also, the advancement and widespread use of heap leaching allowed uneconomical deposits to become economical. By 2000, the annual gold supply had more than doubled (112%) compared to where it was in 1980. Now compare that to the 22% increase in global gold production that has taken place over the last 18 years.

(Source: SomaBull)

More importantly, the current price environment is restricting supply gains in the sector and hindering exploration and development. There is always a lag when it comes to the timing of impact, but most of the senior producers will see a contraction of supply over the next 3-5 years.

Take for instance Newmont Mining (NEM). Even if they get all of their projects online between now and 2025, they will still see a 5-10% drop in production. That's the best-case scenario. No wonder they felt the need to go out and buy Goldcorp (GG). The senior producers have turned to acquisitions in order to increase production.

(Source: Newmont)

If the price of gold were to stagnate around current levels for the foreseeable future, or worse, drop to $1,000 or below for an extended period of time, annual mine supply will definitely be contracting rapidly by 2020-2022.

If you look at the gold production graph above, anytime supply had contracted over a period of years, gold had already entered a major bull cycle. The market forces higher prices to fix the imbalances.

Some will try and make the argument that supply is still increasing so that could be construed as bearish for the sector. After all, mine production was just over 2,700 tons in 2010 and today it's 3,100-3,200 tons. But that's just "mine" supply. If we look at the other major component of supply (recycled gold), then the picture changes drastically as recycled gold has dropped by 500 tons since 2010.

(Source: WGC)

That cancels out all of the gains in mine supply. When you take that into consideration, total supply since 2010 is actually flat.

(Source: WGC)

The other side to the gold price equation is money supply, the ultimate driver of the metal. From 1980 to 1990, M2 in the U.S. doubled. But then from 1990-1995, the money supply flattened out and there was only a 45% increase in M2 from 1990-2000. Compare that to the 80% growth in M2 over the last 10 years.

(Source: FRED)

Growth in M2 also needs to be taken into consideration when discussing mine supply. Even if the supply of gold keeps rising over the next several years, the pace of money supply growth is at silly levels (trillions of Euros, Yen, Dollars, etc. are being added to the system each year) and far outpacing mine supply growth. I'm not talking about just on a one-for-one basis either, rather I'm referring to how much of this new money would be historically allocated to gold only.

The significant hedging that was being done by the large gold producers in the 1990s also weighed on the gold price. Today, barely any gold companies are hedging production, and that's unlikely to change given the disastrous results from the previous attempt.

I also wanted to add that the USD rose sharply during the late stages of gold's previous bear market, but a rising dollar is more of a headwind that just slows down gold's ascent. It won't ultimately stop gold from reaching its true potential.

At the end of the day, fundamentals rule and the fundamentals for the gold sector are resoundingly better than they were 20-30 years ago. Which is why I don't see a 20-year bear (with still 13 years to go) in the cards.

I'm a value investor. I'm looking for undervalued and overvalued markets, sectors, and stocks and then positioning myself accordingly.

Whether it's the housing bubble in 2005, the housing crash lows in 2010-2011, the financial crisis lows in early 2009, the gold bottom in 2015/early 2016, the bitcoin top in late 2017, the Nvidia (NASDAQ:NVDA) bubble top in 2018, etc., I have successfully identified markets, sectors and stocks that have wildly diverged from their historical mean averages and then profited heavily from playing many of these divergences.

I remember in 2005 when the housing bubble was in full swing, valuations were insane and it was clear it wasn't sustainable. I didn't know where the exact top would be, but I knew it was close in time (1-2 years).

In early 2009, I believed that the financial crisis had reached its nadir, as you had quality companies (i.e. major players in the tech industry) trading at or below cash value. Those valuations weren't sustainable.

In January 2016, the valuations of gold and silver stocks weren't sustainable either, as many were actually trading well below book value and some even below cash value.

I have spoken a few times about bitcoin and how it was a just a massive bubble like the Nasdaq was in 2000. Over a year ago, I cringed when I read stories about people piling into these cryptocurrencies as it was clearly going to end badly. Why? You just had to look at the chart of bitcoin; a classic bubble if I have ever seen one. Even though my top call wasn't based on valuation this time, it was still an easy top to spot given the chart pattern.

The same goes for Nvidia. I posted this back in 2017:

I look at Nvidia, a company that is now worth just over $100 billion, and can't help but be reminded of valuations circa 1999.

(Source: StockCharts.com)

I wasn't trying to top call NVDA, as I didn't know exactly where it would peak. But it was plainly evident that it was a bubble and would soon burst.

This is an updated chart of NVDA. Many will still hold out hope that NVDA will come back, just like they did with bitcoin after it had peaked and had a similar crash last year. But it's likely that the NVDA bubble will continue to deflate, as it has a lot of air left in it.

(Source: StockCharts.com)

The point is, valuations in stocks and sectors can reach extreme highs and lows. It's very easy to spot these peaks and valleys — if things make absolutely zero sense, then you have probably reached a major top or bottom (or are at least close to it).

I believe what was taking place in the gold sector last fall was not unlike the Nasdaq in 2002, general equities in 2009 and housing in 2010-2011. In other words, I don't believe I'm wrong on any of this; gold will NOT defy logic and remain in a bear market for the next 3, 5, 10, or 13 years.

Valuations are still well below the historical mean for the sector and fundamentals just don't support that outlook.

It appears as though the market has already turned. Since the fall, the gold sector has been on a tear, particularly many of the higher quality mining stocks like Barrick Gold (GOLD).

(Source: YCharts)

A few final thoughts.

Those that bought a house in 2005 at nosebleed levels probably felt like a genius for the next year or so as prices kept going up. Those that bought bitcoin at $10,000-$15,000 in late 2017 likely felt the same as the price went to $19,000 a few weeks later.

But ask anybody that purchased a home in 2005, or NVDA in 2018, or bitcoin in late 2017 (or anytime last year for that matter), how they feel about those purchases now.

Nobody expected the good times to end.

The same thing occurs near major lows. Investors might sell near the bottom, see things continue to decline, give a sigh of relief that they sold, and then swear off that stock or sector.

Those that renounced gold stocks last summer likely experienced these types of emotions as the sector dropped hard over the following months. However, many miners have already recouped those losses (and then some) and appear poised for significant gains. The same can't be said for these stocks or sectors that have seen their bubbles pop (I'm talking about you NVDA).

If investors revisit this sector in a few years time, they will have a sinking feeling again... but it will be one of regret for renouncing the sector as valuations will be much higher than where they are now.

It's a classic trap, I have seen it so many times.

Disclosure: I am/we are long GOLD. 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.