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Since long, I’ve wanted to do a write up on the long term bull case for gold and gold stocks and what I believe could be the culmination of all other present financial bubbles into a final mega bubble of gold (that has not even started).
There are so many gems like DRM, BDR, RRL, TGZ, etc among others which are ridiculously undervalued and have massive potential for the future.
I’ll try to present my best understanding below.
1) GLD hammering - Main cause for start of bear market
I’ll have to explain the reasons for the fall in gold to explain the situation better. The first is GLD hammering
Despite the many positives for gold which I will explain later, gold has not played along and the main reasons for this over the last 2 years was the hammering of GLD and talks of tighter monetary policy.
The hammering / raid of GLD around April 2013 is already over. It most probably cannot be hammered to that extent again. Hence, gold has held between 1180 and 1380 for much of the last 2 years, once the hammering was done. Any attempts to take gold below 1180 were met with massive rises, soon thereafter.
2) Talks of tighter monetary policy – Main cause for continuation of bear market
The second reason for the fall over the last 2 years was talks of tighter monetary policy
Let us look at 2013 and 2014 falls in gold which all seem related to FED policy.
2013 June – First talk of possibly tapering QE – This smashed gold, equities, emerging markets, etc. But by July, all was forgotten and gold soared
2013 Nov – First possibility of tapering QE actually starting – Gold was smashed. In Dec, tapering was actually announced, and gold bears proclaimed the end of gold. Effect on gold was muted and gold soared over the next few months (Jan onwards) to a high of around 1380 in Feb-March
2014 Oct - Nov – End of QE – Epic smash of gold. The world looked like it was going to end for gold and yet, in hindsight, gold bulls possibly had the opportunity of a lifetime.
What gold did in Jan was even more remarkable as it rose along with the USD rather than in the opposite direction. Gold’s rise here in Jan was unique as a currency and safe haven, and not as a commodity.
So, really, it has just been a sentiment game of gold vs USD for much of the past 2 years. This has been the heart of the bear market.
Favourables like low AUD, low BRL, improved cost controls of goldies, etc. is being ignored. Potential rate hike could be the last part of the sentiment game. There is no denying that gold sentiment could be dampened to some extent this year, till this game plays out to completion.
As can be seen clearly, gold took a hammering each time there was even a rumour of tighter monetary Fed policy. Strengthening USD means other currencies and commodities are weaker.
To conclude, much of gold’s fall over the last 2 years has simply been the understanding that Fed will tighten monetary policy. I’ll explain next what I feel might happen in alternate scenarios, and why that could be bullish for gold.
3) What if Fed tightens monetary policy - this could be the start of the end game
Tighter monetary policy could happen to some extent with a token rate hike. That will cause too much chaos in all markets (gold could be hit to some extent) and the Fed will have to quickly change course and reduce rates again.
Almost all major economies are involved in a full scale currency war in 2015. US seems to be the sole exception and hence, the USD was strengthening (till recently). Despite the dramatic rise of USD, gold has held quite well, unlike commodities which have been crushed as they followed the inverse relation (iron is the best example - of course iron has other factors, but strengthening USD contributed to its fall).
Scenario 1 – US raises rates – Markets collapse, risk taking ends, USD strengthens, US back in recession, commodities crushed, gold hit due to strengthening USD. However, gold hit would be offset to some extent due to gold's rise as safe haven due to chaos. Several bubbles will burst in the time to come, and investors will eventually rush to gold
Scenario 2 – US changes course, ends talk of rate rises and actually goes on to launch more QE to counter the hit to economy – Markets realize that much of what happened over last 2 years was all talk, that there is no real recovery and all recovery was a bubble that will eventually burst. USD will start to fall, gold will rise due to inverse correlation to USD, gold will rise as safe haven, gold will rise as currency as people realize that gold and not USD is the cleanest shirt in the laundry, and gold will rise as central banks rush to convert their expensive USD into dirt cheap gold.
I tried to give an overview of 3 major points above. I’ll now move on to individual points. Some of the points might already be covered in above overview but could offer a good idea of individual dynamics
4) Gold’s basic inverse relation to USD
As explained above, gold often moves in the opposite direction to USD. Recent rise in gold is largely due to fall in dollar index
5) Composition of US dollar index and gold as one of the best currencies
US Dollar index or DXY itself is a byproduct of Eur (57.6% weight), Yen (13.6% weight), GBP (11.9% weight), CAD, SEK and CHF. Eur and Yen have themselves gone down due to massive QE there itself. Thus the massive strength of the dollar index over the last year had little to do with a strengthening US economy but rather with currency debasement by other countries. Hence expressing gold in USD terms or in terms of any single currency does not make sense. It might look like gold was badly hit but in reality gold was one of the best performing currencies after the USD, as it rose last year in most currencies. Once gold is decoupled from USD, rise could be massive as it shines as a currency
6) Will QE4 happen
Further QE on the part of US will cause depreciation in USD and corresponding rise of gold.
US Fed rates are at an artificial low. If and When US Fed starts to raise rates (as they have been suggesting for sometime that they will do), IMHO, it is the beginning of the end, although it might take time to play out, and won't happen in a straight line. If I remember right, the immediate years preceding the GFC were met with a series of interest rate rises which finally pricked the housing bubble.
But I doubt that the Fed will allow it to go without a fight. IMHO, rising rates (if it happens) will cause financial panic and collapse of markets, and Fed will be forced to go for another round(/s) of QE till it is simply ineffective as larger and larger doses of QE drugs are needed. But when that happens, then markets will be finally convinced that US cannot survive without QE, and all talks of monetary tightening over last 2 years were just talk. The impact could be a hard hit on the USD, and automatically rising US interest rates, which will again hit the markets as rising interest rates pricks bubbles.
QE4 should thus lead to falling USD and corresponding rising gold
7) Continually rising Interest rates will prick bubbles
As explained above, a scenario of continuing rising interest rates will prick bubbles leading to rise of gold as safe haven
8) Currency printing by all banks cannot possibly end well
At its simplest, gold is a currency and has been one all through history. Massive money printing by all major central banks – Fed, ECB, BOJ, etc. should lead to gold being considered the cleanest shirt in the laundry over time. Gold is pure money as against all other fiat currencies
9) Assets will eventually move from existing bubbles into a final bubble of gold
IMHO, everything that has happened (so called recovery) over the last couple of years is due to central bank intervention, and easy monetary policy. Investors are forced to speculate due to artificially suppressed rates.
I'm bearish on global markets because IMHO, current global equity market valuations are an illusion built on easy monetary policy. There are several potential global bubbles and risks IMHO - possible shale bubble, global property bubble, tech bubble, start up bubble, education bubble, overall broader equity bubbles, emerging market bubbles, bond bubble, junk bond bubble, USD bubble, geopolitical risks, derivatives bubble, potential future currency crises (due to currency wars), etc. just to name a few which are all fuelled by ZIRP/ easy monetary policy / QE.
When these bubbles burst, people will move to the one asset that has not formed a bubble – gold
10) Could we be headed on road to GFC type crisis
IMHO, there are already plenty of signs of global overvaluation – collapse of Baltic dry index, commodities crushed due to lower demand, high margin debt, disconnect of equity prices with global GDP, limited stock market corrections since many years, disconnect with earnings, massively rising US debt and USD still king, overall irrational exuberance and optimism despite job losses and weak global economy, etc. So, theoretically judgment day should already be here.
Everyone knows that gold is one of ultimate safe havens when some major event materialises
11) Gold does well in extremes and one is quite likely
Over long term, the only asset I like is gold/gold stocks as gold does well in extremes - depression (1930s), stagflation (late 1970s), hyperinflation (Self explanatory as gold is mainly considered hedge against inflation and automatically rises with currency collapse), etc.
There are several alternate scenarios that can play out in the coming years including extreme depression (if central banks refuse to act in the event of chaos or have no impact anymore due to increasing doses of QE and easy monetary policy), stagflation (I feel that just continuing on the current path will lead to this due to a combination of artificially rising property price and job losses), hyper inflation (massive central bank intervention to the point that money becomes truly worthless - we are getting there gradually), and some combination of all of them. It is a sorry state of affairs that the only relevant thing right now for markets worldwide is central bank policy and what the Fed/ECB etc will do.
12) Sovereign risk is the next major risk
We keep having a series of bigger and bigger bailouts. Close to the start of the millennium, Long-Term Capital Management had to be bailed out by some of the biggest banks on Wall Street to avoid a contagion risk. The next time around (GFC), the banks themselves had to bailed out by central banks like US Fed. This time around, it might be countries itself going insolvent and bailout might have to come from IMF.
Greece is the best example of a potential major black swan
13) “Bail in” fears could lead to demand for gold
There are fears being expressed that in the next crisis, there won’t be a bail out of the banks but a "bail in" like what happen to Cyprus depositors some years back who lost a large portion of their deposits to save the banks. If this does materialize, then the smart money would probably be moving their funds into gold far earlier
14) Russia buying gold
Russia has obvious reasons to diversify away from the USD. Needless to say, a lot of their reserves have been moving away from USD to gold, and would be expected to continue to do so
15) Worsening geopolitics could increase demand for gold
The geopolitical situation continues to deteriorate the world over. Other countries too would in such a scenario choose to diversify their reverses away from those of just a few currencies like USD, EUR, etc. Gold is the safest choice
16) BRICS alliance and Bricso could lead to increased demand for gold
People for years have been talking of a more formal BRICS alliance and this has already become a reality. They have already formed a New Development bank that could rival IMF in the time to come. Needless to say that with the major countries in them having a strong preference for gold, gold reserves should form some major part of their reserves in the time to come
Some even suggest that they could launch a join currency ‘Bricso’ in the time to come. Much speculation has already become reality; so we never know
17) US debt probably cannot be repaid without debasing currency
US debt has simply been rising indiscriminately over the years. It is highly unlikely that the debt will be paid without causing some heightened inflation/hyperinflation to debase the currency so that the perceived amount of debt appears smaller. This has already been happening to some extent where the public is already desensitized to trillion dollar quantitative easings. To pay off debt, the US actually has an incentive to debase the currency which should lead to higher gold
18) New reserve currency and historical importance of gold
USD has been one of the main reserve currencies for some time. Considering the US debt situation, it is highly likely that this will change over time. Ideally, the countries with least third party risk and less exposure to other currencies should do well – i.e. those who hold the most gold. There is a quote that who holds the gold, makes the rules. Historically, change of major reserve currency is not really new and has happened many times, with the USD replacing the UK pound a century back
19) Does a major country want 1180 to be the base
1180 has been a major support with double, triple, quadruple and more bottoms. It is almost as if a deep pocketed investor (or country?) wants 1180 to be the base, which might be the case if they already hold a huge amount of gold, want to keep buying but want gold to maintain its reputation for solidity . Time will tell
20) Price already close to AISC (all in sustaining costs) since long
Price of gold has been been close to AISC for all companies. Companies like BHP and RIO have been comfortable in the iron fall. Countries like Saudi are very comfortable in the oil fall.
But no major gold company has been comfortable with the gold fall with gold price close to cost of production for all of them.
A good example is NCM which was decimated from a high of around 42 some years back to a low of around 7 in the panic of Dec 2013. This was an absolute hammering of the Aussie market leader. NCM has recovered somewhat due to a great turnaround in controlling costs, etc. but at around 14, is still much lower than the highs, and also historical valuations. Check international giants like NEM, Barrick, etc. and they are close to 20/30 year lows and this is a nightmare taking into account historical valuations. All this cannot continue indefinitely
21) Cashless society and negative interest rates will boost gold
There are increasing talks of a cashless society, negative interest rates, etc. Whether or not the cashless society talks materializes or not, negative interest rates could become (already the case in some countries) the next step of easy monetary policy intended to cause artificial inflation. Needless to say that if it becomes a reality, the very rich would have huge incentive to shift their bank reserves into hard assets like gold. Even the middle class would have the same incentive as no one would want to pay interest just for someone else to hold their own assets on their behalf. If negative interest rates take over, then issues of cost of holding gold (by losing interest) are also irrelevant
22) Currency wars and move to gold for wealth preservation
Currency wars have been intensifying since Jan 2015. The very rich have huge incentive to diversity their wealth into gold to preserve its value to protect their wealth from currency debasement.
23) Currency wars and move to gold by central banks
Central banks themselves have incentive to move their reserves into gold to protect the value of reserves
24) Currency crisis and role of gold for stability
IMHO, the heart of the next major crisis will be a currency crisis caused by currency wars of extremes in currency printing and an approach of currency debasement. Gold is the only currency that can give the aura of stability to currencies if and when that happens
25) No third party risk with gold
Gold unlike other currencies has no third party risk. Gold cannot default. If we do head into a currency crisis, then gold should be the biggest beneficiary not just as a safe haven but as a currency itself.
26) Role of IMF special drawing rights (SDR’s) in next crisis and China’s inclusion in SDR
Some experts believe that IMF SDR’s will have a major role in the next crisis as a currency of sorts. The SDR basket currently includes USD, Yen, pounds and EUR. It is apparently not a question of if but when the yuan will be included. China’s preference for gold could give further solidity. Some experts have been speculating that China has been increasing gold holdings in preparation for this and will finally announce its holding around the time of inclusion in the SDR
27) Gold pricing shift to East
Gold pricing is slowly moving to China as China steps up to have a greater say. As of right now, gold seems to follow an inverse relation to USD, but this could change in the time to come when pricing in yuan becomes more common, and huge physical demand for gold in China impacts the price on a daily basis.
28) Possible Huge Chinese holding
China has not updated its official holding and people have been speculating that the real holding is massive. Needless to say when they announce it and if true, it could cause a huge rush for gold
29) Chinese and Indian demand
Chinese and Indian demand is not just on central bank level but on an individual citizen basis where gold is valued and respected a lot as a store of wealth. Demand continues to be high
30) Easing of Indian gold controls
One big factor over the last 2 years which has suppressed the price of gold is Indian controls on import (like dramatically raising import duty) to control their trade deficit. Indian economy has continued strengthening in last 2 years and if they completely end the controls, it could give gold a boost. They did partially ease the controls few months back relating to rules for compulsory re-export of a portion of gold import
31) Fall of the petrodollar
Several factors like collapsing oil prices, oil surplus, oil denominated in other currencies besides USD, etc. could lead to far less petrodollar recycling back into USD, and consequent fall of USD which is good for gold in longer run
32) Increase in money supply and velocity of money to eventually cause US inflation
US money supply has massively increased. Fed balance sheet has moved by several multiples over the last couple of years. Technically, this should lead to increasing inflation but that can only happen if velocity of money (how fast money moves through the economy) increases. Inflation over the last couple of years has soared in many parts of the worlds as easy money created by the US could have moved into riskier assets in developing countries. If and when a crisis happens globally, and risk aversion starts, then this easy money could come back to the US eventually rapidly increasing the velocity of money, causing inflation and lead to a much stronger gold in USD terms.
33) Negative GOFO and gold backwardation implying strong urgent preference for physical gold
Over the last couple of years we have periodically had negative GOFO (Gold forward offered rate) implying that it costs banks more to borrow gold than USD and gold backwardation implying that gold for immediate physical delivery is costlier than price of future delivery. All this does not make sense as it implies ignoring of cost of holding gold. To a certain extent, this could be because of ZIRP and negative interest rates but that itself does not make sense that we are talking of how negative interest rates has becomes the norm. Negative GOFO and backwardation could thus imply a strong preference for physical gold and urgent need for physical gold which illustrates that the fall in last 2 years was fall not in physical but in paper gold.
34) Ratio of Gold stocks to gold one of worst ever and suggests possible near to end of bear market
While gold has been hit, gold stocks have been absolutely hammered with one of the worst ratios to gold, in history. Bull markets often resume after complete capitulation and severe bear markets and this is as severe as one has ever been where the last gold bull has probably capitulated. Gold could be forming a massive base for much higher levels.
35) Physical demand good
Most of the fall in gold over last 2 years has been due to hammering of paper gold. Real physical demand is still intact. Gold could really soar once physical gold decouples from paper gold.
36) Repatriation of gold from US by many countries
US was holding gold on behalf of many countries since the past few decades. Many of them are all suddenly demanding repatriation of their physical gold holdings, in the recent past suggesting that something very major could be due in the coming years. Time will tell.
37) Conclusion
All of the above is only a theory and IMHO only. Making guaranteed predictions in gold is a recipe for pain. But all the fundamentals that contributed to gold’s rise in last decade are not only intact but have only strengthened for gold and gold should ideally, cross 2000, if not much, much more in the time to come, as countries continue their currency wars with larger doses of QE.
Much of the above might not happen in a straight line, but could realistically happen over time. Much of what I have mentioned has already existed since the past few years and hence the bear market makes little sense and we should have been in a massive bull market; so I’m definitely not making any predictions or suggesting dates for events to materialize but merely pointing out my humble opinions on the fundamentals. Definitely all IMHO, DYOR and all that stuff
Short term volatility could cause pain (or great opportunities) for traders but long term investors could have great opportunities for 10 or 20 baggers, in time. My biggest disappointment would not be losing out an opportunity to buy at the best possible time (1180, 1200, .....who knows), but rather, not holding on to my goldies till the eventual rise to 2000 and beyond. As such, there could always be better opportunities to buy, but from a longer term perspective, now is as good a time as any. I’d rather buy now than wait for a confirmation as gold goes over 1500 and then start buying, only to see another hit to gold back to 1350. There is no perfect time.
I’ll end with a quote which has been attributed to JP Morgan 100 years back – Money is gold, and nothing else
Cheers 
