Gold Will Continue To Glitter

Includes: GLD
by: Disruptive Investor

Gold has corrected by nearly 14% from its 2011 peak and is currently trading at $1,643. The precious metal has been in a long-term bull market for the last 10 years. In this article, I discuss the reasons why gold will continue to trend up in the next decade as well.

I decided to touch on this topic now as I feel that the current correction in gold is a good opportunity for long-term investors to buy more of the precious metal. I am not suggesting that the gold correction is over. It is difficult to predict the bottom for any asset class for the near or long term. I just want to bring forward some compelling data that convince me the gold bull run is far from over.

At the onset, I would like to clear up any doubts related to the belief that gold might be in a bubble stage. Whenever any asset class is in a bubble stage, it is characterized by significant flow of money in the asset class along with huge amount of holdings and interest in the asset class. This is not true in the case of gold. The bubble fear might be true in the case of government securities.

The chart below from an Economics and Finance Fanatic article on gold and the Treasury bubble gives the outstanding amounts of marketable potentially safe assets in trillions of U.S. dollars.

Click to enlarge all images.Potentially safe marketable securities

Very clearly, the holdings of gold as a potentially safe asset is just 11% compared to the holdings of government securities, which is well over 50%. Therefore, there is no indication of any bubble in the precious metal. As mentioned above, there is surely a bubble in the governments bond market.

Readers might argue that not being in a bubble does not mean that the asset class will give excellent returns in the long term. An asset class can be unattractive for many other reasons. Therefore, my next objective is to explain why gold will give above-normal returns in the long term. The reason has been discussed several times in the past. I would like to talk about it, along with providing a chart that shows the consequences of easy monetary policies.

Before that, it is important to note and understand that the economic and financial problems in the eurozone and the U.S. will be a prolonged one. The eurozone economic activity has been dipping, and several countries might witness another bout of recession. This will necessitate more quantitative easing than austerity measures.

At the same time, the economic scenario in the U.S. remains fragile with weak job market and economic activity. I would not go by the 8.1% unemployment numbers to think that there is a recovery in the economy. The number of people in the labor force has been shrinking and that contributes to the lower unemployment rate.

All of these items point to one major outcome: More quantitative easing by the government. As such, the balance sheet of the government will expand and so will the monetary base, which has already been surging.

The chart below, from another article on the Economics and Finance Fanatic website, gives the relation between gold prices and the U.S. adjusted monetary base.

Very clearly, gold prices have surged in the recent past with the surge in monetary base. Therefore, as long as governments continue to print money, gold will trend up.

As mentioned before, the problems in the Western world will remain prolonged. Therefore, the quantitative easing and the surge in gold prices will also remain prolonged. These factors make a strong case for investment in gold. Furthermore, as central banks look to diversify their reserve holdings, gold is one of the best currency choices (as a store of value). Therefore, from a demand perspective, things are expected to remain robust.

In conclusion, I would look at accumulating gold at current levels and adding gold to my portfolio on a further correction as well. If the economic scenario in the U.S. worsens the dollar will strengthen in the near term, leading to some additional correction in gold. However, a subsequent quantitative easing will lead to a renewed rally in the precious metal.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I hold physical gold and gold ETFs in my long-term portfolio