Why We Urged Investors to Buy Gold? — Gold Always Wins

Why We Urged Investors to Buy Gold? — Gold Always Wins

Gold is getting bashed, there’s no doubt about it.

Not all is doom and gloom. Some perspective is needed.

In the past 12 months, gold is up about 1%. That’s nothing to write home about, but up is up.

If we go back to the beginning of the current bull market on 16 December 2015 (when gold bottomed at US$1,050 per ounce), gold is up 61% even at today’s beaten down price.

That bottom was put in on the exact day that the Fed started their ‘lift-off’ in interest rates after seven years stuck at zero. We urged investors to buy gold then. Those who listened are still sitting on huge gains even after the latest drawdown.

Savvy investors know gold is volatile. They keep their eye on the long-term trends and long-term drivers of the gold price…

We’ve walked this path

We’ve been here before.

Gold fell 17% from 5 August 2016 to 1 December 2016. It fell 8.1% from 8 September 2017 to 13 December 2017.

It fell 12.5% from 6 March 2020 to 19 March 2020 during the pandemic panic. After every one of these falls, gold rallied back and maintained a trend line of higher highs, finally reaching the US$2,000 per ounce threshold in August 2020.

Volatility and dips come with the territory. If that’s not your cup of tea, perhaps gold is not the right asset class for you.

Still, sophisticated investors don’t sweat the dips. They see the occasional drawdowns as a great entry point and buying opportunity. So do I.

The important questions for gold investors are: Is this just a dip or the start of a new bear market? And, what’s driving the dip; when can we expect a turnaround? We address both questions by looking at the mainstream scenario and explain why it’s wrong and how the turnaround will emerge.

Here’s the mainstream scenario: Conventional wisdom is that the US and global economies are making a strong comeback from the pandemic. China is growing quickly, US unemployment is dropping, the virus is fading and the lockdowns are ending.

This would be a recipe for strong growth and higher interest rates by itself.

Now, the Congress and White House are about to pass a US$3 trillion COVID relief bill, which has little to do with COVID and everything to do with the Democratic goodie bag of spending for favoured interests including teachers, municipal workers, federal workers, community organisers, and money for programs such as the Kennedy Center, the National Endowment for the Arts and a US$140 million ‘tunnel of love’ infrastructure project near Nancy Pelosi’s district.

(Ed Note: The tunnel project was struck from the bill by the Senate Parliamentarian at the last minute, but Pelosi is sure to try again.)

The market view is this additional US$3 trillion of spending, on top of the US$6 trillion of deficit spending already approved for fiscal 2020 and fiscal 2021, and another US$4 trillion deficit spending package expected later this year, is more that the COVID situation requires and more than the economy can absorb without inflation.

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Don’t sweat the dips

Therefore, inflation expectations have risen sharply. And, along with inflation expectations, the yield-to-maturity on the benchmark 10-year US Treasury note has spiked.

The yield on the 10-year has risen from 0.917% on 4 January, to 1.316% on 6 February, to 1.573% on 4 March. Those rate hikes might not sound like much, but it’s an earthquake in the note market.

As rates go up, bond prices go down and the size of the capital loss per basis point of rate gains is larger when rates are low; (that’s a bit of bond math called ‘convexity’. Painful but true).

If you compare the rate hikes to the decline in gold prices, there is a high degree of correlation. As rates go up, gold goes down.

It’s that simple.

More deficit spending stokes the flames of inflation expectations, which leads to higher rates and lower gold prices. When those fundamental trends are combined with leverage, algo trading and momentum, it’s like throwing gasoline on an open flame. Gold investors are getting burned.

What’s flawed in this scenario? The short answer is: everything.

You can’t argue with the facts — rates are going up and gold is going down. But, the assumptions behind these trends are flawed. That means the trends will inevitably reverse, probably sharply.

US economy not as strong as headlines make out

Again, perspective helps.

The economy is not nearly as strong as the headlines and Wall Street cheerleaders would have you believe. Unemployment rates are coming down not because of strong job creation, but because able-bodied prime age workers are dropping out of the workforce.

The decline in the labour force participation rate is what’s behind a lower unemployment rate because the drop-out workers are not counted as ‘unemployed’.

If they were, the real unemployment rate would be about 11%, a rate associated with depressions.

Retail sales are being pumped-up by Treasury cheques handed out by Congress. What happens when those cheques stop? Real estate losses are being held down by rent moratoria and antieviction decrees. What happens when the rent is finally due? Student loan defaults are on hold because a grace period on repayment has been extended. What happens when the grace period is over?

The real story is that the economy is weak, but the weakness is being papered-over by handouts, grace periods and repayment standstills. When those handouts stop, growth will slow sharply and deflation or disinflation will reappear. Higher interest rates are anticipating inflation, but the inflation is a mirage. Gas at the pump and housing prices are going up. Almost everything else from tuition to healthcare to clothing is going down.

What comes next? The realisation that we’re not reinflating will take time to sink in.

It will emerge from the data over the next six months. Congress will put a halt to multitrillion deficit spending packages, despite the wishful thinking of Democrats that the country is ready for US$4 trillion. By mid-to-late 2021, the music will stop, the economy will slow, interest rates will resume their long-term downtrend and gold prices will soar.

What if I’m wrong? That would be good news for gold also.

The worst situation for gold is the one we have now where rates are going up, but there’s no actual inflation. If I’m right about inflation, then rates will come back down and gold will rally.

But, if inflation actually does appear, guess what?

Gold will go up because it always does in inflation. Gold wins either way.

All the best,

Jim Rickards Signature

Jim Rickards,
Strategist, The Daily Reckoning Australia

PS: Did it cross your mind to invest in gold ahead of further interest rate cuts? Download your free report now.