The New Bull Market in Gold

Lots of gold coins

It was ‘risk-on’ all around in global trade overnight. The major US indices were up nearly 1% on —get this — news of a cease-fire in Ukraine! Ignore the fact that markets never sold off on the escalating violence in the first place! But it sure makes for a good headline.

More than likely, everything rallied because poor US retail sales held out the hope that the US Federal Reserve will hold off on interest rate rises. The eternal guessing game of will they or won’t they, and more importantly, when, continues.

That’s good news for Aussie stocks, with the local market up strongly today. It reverses yesterday’s dose of reality where bad news on the employment front saw stocks sell off.

But the ‘good news’ for our rentier economy is that poor employment data for December means the RBA could cut rates again in March. Yay! The dollar copped it, falling more than 0.5% against the greenback straight after the news. It bounced back overnight though and is now around 77.3 US cents.

The unemployment rate jumped to 6.4%, the highest level since 2002. In seasonally adjusted terms, full time employment fell 28,100 in December.

Record low interest rates haven’t propped up the employment market, but that hasn’t stopped calls for further cuts from the RBA to ‘do something’ about the unemployment situation.

How lower interest rates are going to find jobs for thousands of engineering and construction workers is anyone’s guess. These are the biggest risk areas for job losses when the construction phase of many of the LNG plants winds down this year. They could retrain as baristas or real estate agents but that’s not exactly great for the economy.

It doesn’t matter though, does it? When there’s only one tool in the box, you’re going to use it. But as I wrote yesterday, it’s going to cause all sorts of trouble in the long run.

I also mentioned yesterday that the biggest threat to Australia from the ongoing euro crisis was a higher cost of funding for our banks. Soon after, I saw a headline on that suggested there are risks elsewhere too.

‘Big Banks lose crucial funding source’, the headline read. But it had nothing to do with Europe.

‘A $US90 billion funding line for Australian banks in the United States is beginning to close due to tough new financial crisis-inspired regulations, forcing local lenders to hunt for short-term money in more expensive funding markets.

‘The biggest US prime money market fund operator, Fidelity Investments, announced last week that three of its mutual funds will stop investing in bank paper and instead only buy government securities.

‘US money market funds, including Fidelity, Vanguard, BNY Mellon and State Street, are major investors in short term Australian bank paper with maturities of up to 12 months.

‘Australian banks had at least $US90.7 billion of short term debt issued to taxable US money funds as of January 31, according to Crane Data.’

Here’s how it works. US investors who don’t like the sound of 0% in a bank account put their cash in a money market fund. These funds invest in highly liquid short term securities, including Aussie bank paper.

Not any more though. Banks will have to look elsewhere, and chances are the cost of funds will be higher than a US money market fund.

Still, the banks won’t be too concerned. There is still plenty of liquidity around. But it is a gentle reminder of Australia’s reliance on foreign capital. The banking sector holds around $750 billion of foreign debt on its balance sheet, with short term funding accounting for just under half that amount.

Last year’s Murray Inquiry recognised the risk of this reliance on offshore funding and made recommendations to strengthen the banks’ balance sheets.
So far, none of these recommendations has been implemented, and with the government a bit of a basket case right now, none will be implemented for a while.

All it will take is an external shock of some kind and it doesn’t matter how far the RBA cuts the cash rate…if foreign capital reassess risk and stops flowing here, even just a bit, the cost of credit to the household sector will rise.

In such an environment, you’ll want to have a bit of financial insurance. In my view, gold is the best policy.

Speaking of gold, the divergence of opinions of some of the editors here at Port Phillip Publishing has caused confusion. Don’t be confused though; this is just how an independent publishing company works.

We publish ideas, not a company line.

Recently, I wrote a bullish article on gold here in The Daily Reckoning. A day later, we published an article by Diggers and Drillers editor Jason Stevenson, who is bearish on gold.

In short, Jason believes the US dollar bull market will knock gold down. But he’s talking about gold in predominately US dollar terms.

My bullishness on gold stems from looking at it from an Aussie dollar perspective. On that front, it’s hard to argue against the bullish case. I’ll show you what I mean by that in a moment.

But first, I do agree with Jason about the US dollar bull market. I’ve written about that in the DR before. A strong US dollar will make it challenging for gold to resume its bull market in US dollar terms.

The wildcard is what’s happening in the Eurozone. If discussions over Greek debt break down and Greece leaves the euro, capital will flee the European periphery into the US dollar AND gold. This would see gold in US dollar terms rise at the same time as the dollar rose against other fiat currencies.

There ARE headwinds for US dollar gold. I acknowledge that. But we’re deep into an historic monetary experiment and things are starting to turn ugly. There’s no reason why gold and the greenback can’t rally together.

But in Aussie dollar terms, it looks like the long bear market may be coming to an end. This is not just my opinion. In a market as opaque and as large and complex as gold, opinion is worthless.

You have to look at the price action to see whether the market endorses your idea. That’s why I’ve asked my mate, Quant Trader Jason McIntosh, to help out with the Sound Money. Sound Investments. report. Jason is an expert in identifying trends and trend changes. His analysis lets me know if my investment ideas are good or rubbish.

In the case of gold, we’ve been watching the sector closely for months. Aussie dollar gold recently broke out of a long term trading range and in many cases, Aussie dollar gold stocks have too. Newcrest Mining [ASX:NCM] for example has increased a whopping 64% since bottoming in November last year.

We could be wrong of course, but the early indications are that this is not just another bear market rally, of which there have been a few for gold stocks in recent years. Many stocks are showing signs of starting a new long term uptrend. It’s early days, but the signs are good.

Perhaps the best indication for the bullish thesis for Aussie dollar gold is in the chart below. I put this in my update this week to give subscribers further evidence of the bull market resumption thesis.

It shows a VERY long term chart — Aussie dollar gold over the past 20 years, on a monthly time scale. As you can see, gold has spent the past three years in a consolidation pattern, marked by the triangle shape.

These shapes are very common, and when there’s a definitive break out of the range, it tends to confirm the resumption of the dominant trend — in this case, a bullish one.

Keep in mind this is a monthly chart, so don’t expect the gold price to keep rising right away. More than likely, you’ll see a correction after such a strong breakout. In fact, we’re probably in the early stages of one now.

But if the breakout pattern holds, then in the years to come you can expect to see Aussie dollar gold making new highs.

By Greg Canavan, The Daily Reckoning

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Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.

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