The price of gold – in terms of U.S. dollars – has certainly struggled since 2011. The price is currently under $1,200. Just when it shows signs of a promising run above $1,200, it falls back down.
Mining stocks have been even worse. They have been beaten down quite a bit over the last several years. It seems that almost nobody wants to touch them at this point.
A recent article at Forbes discusses the weakness in gold and why it should crash another 40% or more, which would send the metal down to $700 per ounce.
The author lists five reasons on why the gold price should fall further from its 2011 highs. However, I can take these five reasons and just as easily say that they are valid reasons for expecting a higher gold price in the future.
Five Reasons: Bullish or Bearish?
The first reason is: “Financial apocalypse and bubbles appear to be the new normal, making investors numb to uncertainty and indifferent to safe havens.”
It is certainly true that, in the past, uncertainty has generally been favorable towards gold. But just because investors have seemingly become numb to it, does not mean that gold will stay out of favor forever.
Uncertainty has driven many investors into cash and bonds, which are yielding almost nothing. We even saw negative interest rates on bonds in some European countries.
But what if cash and bonds fall out of favor? What if we see defaults on bonds for some European countries aside from Greece? What if price inflation picks up and people no longer view cash as safe? Where will they turn?
I don’t think investors have become numb to uncertainty and indifferent to safe havens so much as they are seeking liquidity. In many ways, some investors are seeking safety more than ever now. They just don’t know where to turn.
We could easily see investors turn back to gold for safety reasons.
The second reason is: “The stronger the U.S. dollar, the lower the prices for dollar-denominated commodities like gold.”
Again, it is true that a strong dollar is bearish for the gold price (in dollar terms).
But when you consider that the U.S. dollar has been incredibly strong against the other major currencies, it is amazing that the U.S. dollar price of gold has held up so well.
And while the euro and yen do not look very good at this point, there are many other currencies out there, even if not as major. There is nothing telling us that the U.S. dollar has to remain strong for several more years. If the dollar gives back some of its gains against other currencies, this will be a reason to see a higher price of gold.
The third reason is: “Inflation hasn’t reared its ugly head despite money printing galore.”
Again, I generally agree with the statement. Despite monetary inflation, we have not seen high price inflation. We have seen asset price inflation, but not high price inflation for many consumer goods.
This is basically due to two factors. First, much of the increase in the money supply has gone into excess reserves with the banks. Without the banks lending out the new money, this keeps it from multiplying through fractional reserve lending.
The other factor is velocity, or the demand for money. As stated above, people are seeking to hold cash for some liquidity. There is still some fear in the U.S. economy left over from 2008, and people are still not spending as much as they could.
But price inflation could still yet appear. In addition, we have to consider that real interest rates are essentially negative. If investors and savers do not fear price inflation, or at least fear it less than a possible recession, then gold may stay out of favor. However, things can change quickly with just a small jump in price inflation.
The fourth reason is: “The bigger worry is deflation rearing its ugly head.”
Any deflation we see is likely to be temporary. The Federal Reserve, or any other central bank, can always create positive price inflation by increasing the money supply at a greater rate. Ben Bernanke has stated this.
Again, this could be just as much a reason to think gold will eventually go higher. Let’s say we do see price deflation. This probably means a recession, or worse. This may in fact be temporarily bad for gold investors.
But what will end up happening? Do you think the Fed will sit on its hands? The response would likely be more monetary inflation. We will probably see QE4, and each QE seems to get bigger and longer than the last. Any threat of deflation just means a bigger threat of Fed money creation.
The fifth reason is: “Demand from China – gold’s No. 1 customer – is getting dull.”
I do agree that the threat of a Chinese recession could mean less demand coming from the world’s largest country. As in any recession, there will probably be a high demand for liquidity.
But long term, Chinese demand for gold is a reason to be bullish. If stocks and real estate fall out of favor, then perhaps more Chinese investors will turn to gold.
And we already know that the Chinese central bank has been building up its gold reserves. While it is showing few signs of dumping U.S. Treasuries, the Chinese central bank is still looking for diversification, which includes increasing its gold holdings.
Conclusion
It is possible that we have not seen the end of the downturn in gold (in terms of U.S. dollars). But all of the reasons offered for a lower price of gold are also reasons we will ultimately see a higher price.
The best time to buy any asset for investment is usually when it is completely out of favor. This is good news for those looking to diversify by buying gold.
