Gold: The Correction Is Finally Over

Summary

• The correction in gold has been ongoing for about four months now.
• In fact, during this time frame gold had declined by as much as 15% from peak to trough.
• However, despite the drop, the intermediate and long-term backdrop remains extremely favorable for the precious metal.
• Additionally, price action in gold miners is suggesting a bottom in the GSM (gold, silver, and miners) market is likely in.
• Gold is likely headed substantially higher.
• This idea was discussed in more depth with members of my private investing community, Albright Investment Group . Get started today »

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The "gold trade" has essentially been left for dead in recent months. The correction that began in early August had shaved as much as 15% off gold's top, toppling the precious metal from an ATH (all-time high) of roughly $2,080 all the way down to the $1,765 level.

Source: StockCharts.com

So, What's The Problem With Gold Lately?

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Aside from the technical factors that illustrate gold got massively overbought back in early August, it seems that every time some news regarding a COVID-19 vaccine comes out gold gets pummeled.

In fact, if we take a closer look at the gold chart, we can see that gold looked like it was forming a double bottom around the $1,850 support level. Gold began to make a strong comeback, and right around crucial resistance at roughly $1,960 news about the Pfizer (PFE) coronavirus vaccine came out.

Well, we see what happened immediately after this piece of news came out. Gold plummeted by about $100 in one day. Shortly following this meltdown, Moderna (MRNA) brought forth more promising data regarding its vaccine designed to prevent COVID-19. So, gold took another leg lower, eventually breaking through $1,800 support.

What Do COVID-19 Vaccines have to do with Gold?

It appears that many investors are looking at gold as a "fear trade." However, gold is not a trade, gold is an investment. Regardless of when the coronavirus vaccines get introduced in mass quantities around the globe, the economy is not getting back to the "old normal" in my view.

Here's What the New Normal May Look Like

• Continued easy monetary policy from major central banks around the globe, including the Fed.
• Substantial fiscal stimuli packages around the world (from countries that can afford it).
• Perpetually increasing debt burdens on already heavily indebted developed economies.
• Extremely low rates for longer. In fact, near zero or negative rates may become the norm going forward.
• Substantially higher inflation going forward.

With more than $27 trillion in national debt and a total debt to GDP ratio of nearly 144%, the Fed essentially cannot afford to raise rates. The national debt is mostly comprised of five-, 10-, and 30-year government Treasuries. Therefore, the U.S. needs to continuously make servicing payments on these debt obligations. A good benchmark to use for these servicing payments is the 10-year Treasury yield, which is around 0.86% right now.

This equates to around $232 billion in servicing payments alone, given that the 10-year Treasury remains around this level over a one-year time frame. Now, it's important to point out that the national debt has ballooned by roughly 35% in fewer than three years. Furthermore, the actual, current Federal budget deficit is at around $4.2 trillion. Thus, we can extrapolate that the national debt will continue to rise indefinitely, and the U.S. simply cannot afford to pay interest at a rate it did just a couple of years ago.

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Just think about it. If the U.S. 10-year Treasury ever goes back up to 2.5%-3.5%, it would infer a debt servicing payment of $675 - $945 billion per year. Now, this is considering the current debt load of $27 trillion which is perpetually increasing. Therefore, I believe it's unrealistic to believe that the Fed will ever be able to lift its benchmark rate far above zero, because if it did the debt could spiral out of control.

What Does Spiraling Out of Control National Debt Mean?

It essentially means one of three things in my view. Either the Fed will need to "print" an enormous amount of money to inflate the debt away, or the U.S. will be forced to default on its bond obligations. Scenario one seems far likelier, as a default by the U.S. government would create unprecedented panic and loss of confidence in the dollar. However, there's a third scenario, and that's to bring rates into negative territory. I know the Fed is not talking about this now, but it will likely need to implement this strategy eventually to deal with the debt issue.

Under any scenario, gold is likely to go much higher going forward

• Scenario one: An enormous increase in the monetary base, which could lead to hyper inflation.
• Scenario two: A catastrophic default which could lead to devaluation of the dollar and to loss of confidence in the U.S. monetary system.
• Scenario three: Perpetual zero or negative rates, which could lead to a continuously extremely low growth environment coupled with higher inflation, or a prolonged stagflationiory atmosphere.

While the third scenario seems like the "best" of the three, zero or negative rates make gold extremely attractive relative to other "safe-haven" assets. There's also likely going to be substantial inflation with zero or perhaps even negative benchmark/certain Treasuries. Furthermore, scenario three is unlikely to occur in the near future, and any scenario will likely lead to plenty of inflation going forward.

In my view, defaulting is out of the question, but the Fed will likely inflate (implement scenario one) before eventually pivoting toward scenario three. Therefore, intermediate and longer-term gold is likely headed much higher regardless of vaccines and any other transitory variables that cause temporary market gyrations in the gold market.

What the Gold Miners are Telling Us

Often times, before we see a bottom in the gold market gold miners begin to illustrate positive price action. So, let us look at some gold mining ETFs.

VanEck Gold Miners ETF (GDX)

After about a 28% "correction" GDX looks like it formed a base around the $33 level. Moreover, we saw a bounce off 30 RSI (relative strength index), implying severe oversold conditions were present in the gold mining market. Also, we see the full stochastic moving higher now, implying a shift toward a more positive momentum flow.

VanEck Vectors Junior Gold Miners ETF (GDXJ)

We see a similar image in junior gold miners, which appear to be basing around 200-day moving average support.

SPDR Gold Shares (GLD)

GLD got extremely oversold in recent sessions, touching up on critical support at around $165. Moreover, we saw the RSI fall to a remarkably low 26 level, even lower than in the mid-March meltdown, illustrating extremely oversold technical conditions.

The Bottom Line

Gold and the GSM sector in general is starting to look extremely attractive again. We saw a substantial correction of roughly 15% in gold, a healthy, natural phenomenon in a bull market. Now gold appears to be stabilizing and is likely getting ready to move higher again. We see this from the technicals in gold, as well as a turnaround in gold mining stocks.

Furthermore, the long-term image has not changed for gold, and the backdrop remains extremely favorable in the intermediate and long term. I expect inflation to pick up in 2021. Higher inflation coupled with an expanding monetary base is a perfect recipe for higher gold prices. Therefore, I expect gold to achieve a price of roughly $2,500 by year-end 2021, and about $3,500 by year-end 2022.

Analyst’s Disclosure: I am/we are long GDX GDXJ PFE. 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.

This article expresses solely my opinions, is produced for informational purposes only and is not a recommendation to buy or sell any securities. Please always conduct your own research before making any investment decisions.