The gold rally has years to run
The price of gold today is irrelevant.
Or so said Tocqueville Gold Fund boss John Hathaway in a recent podcast.
Hathaway’s point was simple. There are big things coming for the price of gold in the next couple of years. So gold being a few bucks either side of US$1,300 doesn’t matter.
What does matter, is where the price of the metal is going.
Today, I hand you over to Jim Rickards. He lays out where he sees the price of gold heading.
And if Jim is right, the gold bull run is really only beginning…
Until next time,
The Gold Rally
Has Years to Run
Jim Rickards, Strategist
Gold has staged a strong rally in the past five months.
From US$1,185 per ounce on 26 September 2018, to $US1,330 per ounce on 21 Feb 2019, gold has surged by over 12%.
While this is encouraging to gold investors, it shows that this rally is just part of a much larger bull market in gold that has years to run.
As explained below, there is still time to join the rally.
Your strategist in a gold mine near Johannesburg, South Africa. Mining output from South Africa has dwindled in recent years due to a combination of mine depletion and labour problems. Global gold production has plateaued at about 4,300 tons per year since 2010. Some analysts suggest ‘peak gold’ means that output will remain flat for the foreseeable future.
Halving the money supply
This latest gold rally is the result of a confluence of short-term and long-term factors that are impacting the price of gold at the same time.
The long-term factors are explained in detail below.
Among the short-term factors, none is more important than the Federal Reserve.
Since 2015, the Fed has been raising interest rates in 0.25% increments four times per year with occasional pauses in the rate hikes to take account of disinflation, disorderly markets or slower job growth.
These rate hikes started out slowly (one hike in 2015 and one in 2016), but the tempo has increased since then (a total of seven rate hikes in 2017 and 2018).
The lower limit of the fed funds target moved from 0% to 2.25% between 2015 and 2019.
In addition to the rate hikes, the Fed has been reducing the money supply since October 2017 in an effort to ‘normalise’ its balance sheet.
The original intention was to reduce the balance sheet money supply from US$4.4 trillion to about US$2.5 trillion by 2020.
The current tempo in this balance sheet reduction is US$600 billion per year.
That’s how much money is being burned by Fed Chair Jay Powell and his colleagues.
Analysts estimate that the impact of this money supply reduction is equivalent to an additional 1% per year in rate hikes.
The combination of nominal rate hikes and balance sheet reduction represents a monetary tightening equivalent to 2% per year in rate hikes working off a very low base.
Nothing like this has been attempted in the history of the Federal Reserve since it was created in 1913.
Gold defies market
Normally, rate hikes are a strong head wind for gold prices. Gold competes with short-term US treasury notes and bank deposits for safe haven capital flight and investor allocations.
Gold has no yield, so as US treasury yields increase (when the Fed raises rates), gold looks less attractive.
A case could be made that gold should have fallen from US$1,200 per ounce to US$1,000 per ounce or lower in the face of higher rates.
Instead the opposite happened; gold rallied.
There were three reasons for this.
The first is that physical supply flatlined.
The second is that physical gold demand increased, mainly due to large-scale bullion buying by Russia and China.
The third is that astute investors could see that Fed tightening was overdone and the economy was bordering on recession.
This meant the Fed would have to reverse course and resort to monetary ease.
That would be the signal for higher inflation and much higher gold prices. That’s exactly what happened.
Gold bull markets last for years
The Fed pivot occurred in stages between late December 2018 and mid-February 2019.
On 3 October 2018, Fed Chair Jay Powell gave a speech in which he said, ‘We’re a long way from neutral now…’.
That was a clear signal the Fed intended to keep raising rates.
Stock markets promptly tanked and entered full bear market territory by Christmas Eve.
After Christmas, the Fed realised its blunder and switched to easing in the form of a pause in rate hikes.
Jay Powell used the word ‘patient’ on 4 January 2019. Patient is Fed-speak for ‘no rate hikes until further notice’. A March 2019 rate hike is now off the table.
Then the Fed let it be known they would likely discontinue their balance sheet reductions by the end of 2019.
This added to the notion that the Fed was in full-scale easing mode as a form of damage control in the face of economic slowing.
The trifecta of flat output of gold, strong demand for gold and monetary ease was enough to set the gold market on fire.
After the brutal bear market that began in 2011, how sustainable is this new rally?
Why should gold investors be encouraged now after years of disappointment?
The single most important factor in the forecast is that a new multiyear bull market in gold has just begun, and there is ample time to invest in gold and enjoy the greatest gains in the years to come.
The long-term price chart below helps to put the bull and bear gold markets in historical perspective.
The importance of the 50% retracement
The time series begins in 1970 just before Nixon closed the gold window (15 August 1971), which ended the Bretton Woods system.
At that time, gold had a fixed price of US$35.00 per ounce under the Bretton Woods gold standard (1944–73).
Gold’s first bull market ran from August 1971 to January 1980, during which time the gold price increased from US$35.00 per ounce to US$800.00 per ounce, a gain of over 2,100%.
A bear market began in January 1980, which lasted until June 1999, at which point gold bottomed at $260 per ounce, a 67% crash.
However, this bear market played out over 20 years.
Most of the decline occurred by June 1982 when gold hit US$310.00 per ounce (61% decline from the peak).
During the remaining 17-year period, gold traded in a US$225-per-ounce range between a high of US$485 per ounce (December 1987) to US$260 per ounce.
This was not really a bear market so much as a shadow gold standard operated by Alan Greenspan known as the Great Moderation.
Gold prices over five decades
Source: Fast Markets, ICE Benchmark; Thomason Reuters; World Gold Council
A new bull market began in June 1999 and lasted until August 2011 when gold briefly traded at US$1,900 per ounce.
That second bull market ran for just over 12 years and produced gains of over 730%.
A second bear market began in August 2011 and lasted until December 2015 when the price of gold bottomed at US$1,050 per ounce, a 45% drop over 52 months.
However, if one uses the June 1999 low of US$260 per ounce as a baseline for the second bull market, the US$1,050 low in 2015 represents a 52% retracement of the gains in the second bull market (1999–2011).
That’s highly significant because commodities don’t rally from base levels to peak levels without a 50% retracement along the way.
The expected peak level for gold is US$10,000 per ounce (the minimum nondeflationary price needed to support global money supplies on a gold standard) or higher.
The projected rally from US$260 per ounce to US$10,000 per ounce needed a material 50% retracement to hurt sentiment and flush gold from weak hands to strong.
The retracement lays a new foundation in which sentiment is at its worst.
At that point, gold is set for the final push to a permanently higher level.
The best is yet to come
The combination of a 50% retracement and an interim low (US$1,050) both occurring in December 2015, has now established a new baseline from which to measure the ultimate bull market.
Gold has rallied over 25% in the early stages of this new bull market, from US$1,050 to US$1,330 per ounce.
That performance is entirely typical of long-term bull markets, which start slowly (in order to overcome negative sentiment) and then gather momentum as confidence increases.
In the 1999–2011 bull market, it took gold over three years to achieve a 25% gain off the US$260 per ounce low in 1999.
However, gains continued and accelerated from there.
The greatest gains were in the final years of the bull market from January 2009 to August 2011, when gold gained 220% in 30 months.
The new bull market in gold (the third bull in the past 45 years) has just started.
Based on the prior two bull markets, the new bull should run until 2025 or later and should achieve prices of US$15,000 per ounce or higher.
In short, investors who did not jump into gold at US$1,050 per ounce have not missed the boat.
Based on past bull market behaviour going back to 1971, there’s still time to join the rally.
The greatest gains could be yet to come.
All the best,