Is It Time To Buy Gold?
It seems like a year ago...wait, it was a year ago that we wrote in our weekly missive that gold had peaked after a parabolic spike stating: "Should I Buy Gold Now? In a one word answer...Are you kidding me – Gold has never been this overbought before and if you ever want to be the poster child of buying at the top – this is it.
Okay, not really a one word answer but here is my point. Gold is currently in what is known as a 'Parabolic Spike'. These do not end well typically as it represents a 'panic' buying spree. Therefore, if you currently OWN gold I would recommend beginning to take some profits in it."
Then in March, as the media began predicting the end of gold as an asset class I wrote "Death of the Gold Bull Market" updating our August analysis where in we discussed a 12-month consolidation process for gold before the next move higher. Well, here we are today with gold attempting to move higher after a long and drawn out 12-month consolidation process - is it time to "buy?"
The first chart shows our weekly "buy" and "sell" signals. During the last recession gold had experienced a very similar parabolic price spike going into the first quarter of 2008. This spike in gold prices resolved itself over the remainder of the 2008 with a correction of 30% during the financial crisis. That consolidation process then gave way to the next major leg of the secular gold bull market. That surge was fueled by fears of hyperinflation due to successive rounds of liquidity injections by the Fed and soaring national debt levels.
In June of 2011 gold again went into a parabolic price spike over concerns about the debt ceiling and a potential U.S. debt default. While an actual default on U.S. debt was never actually a concern, as witnessed by the sharp drop in 10-year interest rates at the time, the fears of such an event sent gold prices spiraling higher (along with underground bunker, gun, ammo and dried food sales.) The chart shows our August prediction of the consolidation process as of last August (dashed green line) with the actual performance of gold to date. While we were early on our expectation of an upturn in gold prices this summer the process has played out fairly close to our original estimations.
With gold prices now turning up from a long consolidation process the issue now becomes what may be the drivers of the next leg of the secular gold bull market. Since gold is a "fear" trade we have to look at what can potentially go wrong for the markets in the coming months ahead. The reason is that for gold to get a substantial lift from current levels we need two things to occur: severe economic concerns and stimulative government interventions. These two events will fan the fears of "economic doomsday" and "hyperinflation." While the reality is that neither of those events will occur for a variety of reasons, primarily because we are a soverign currency issuer, it is the "fear" of those events that drive the price of gold higher.
Catalysts For The Next Gold Surge
The following are the catalysts that could certainly send investors scurrying back into gold.
Draghi Fails To "Do Whatever Is Necessary" - While talk is cheap and has calmed the markets so far there is likely to be some major stumbling blocks in the weeks and months ahead for the ECB and Mario Draghi to "cash the check his mouth has written" over the last two months. As we have discussed previously in much more detail - Germany is the paymaster in Europe and with a large majority of the German population against further bailouts, and Merkel up for re-election next year, it is likely that the things will not work out for Draghi as hoped. This will lead to a resurgence of the Eurocrisis, promptly to be followed by more talk and rhetoric, which will lead to concerns about a financial crisis spreading through the financial system.
Beneficiary: Gold, U.S. Dollar and Treasuries.
Stock Market Declines By 20%
When stock market participants realize that no further stimulative action is coming in the near term the markets are likely to be disappointed which could lead to a deeper correction. Bob Junjuah recently wrote specifically about the likelyhood of this event stating: "I now think the correct thing to do – as I also said in April and June – is to prepare for a serious risk-off phase between August and November...over the August to November period I am looking for the S&P500 to trade off down from around 1400...by 20% to 25%...to trade at or below the lows of 2011."
A sharp decline in equities is likely to money into gold as a "safe haven" against a stock market catastrophe. While this will likely not be the case it is important to remember that investors react emotionally to events and extrapolate events to excessive degrees. The push into gold as a "hedge" against a market decline will boost the metals asset price higher.
Beneficiary: Gold, U.S. Treasuries and Dollar
Economy Slows To Near Recession
The fear of a recessionary economy, or worse, is a "gold bugs" best friend. There have been plenty of stories about how the economy is going to ultimately collapse and the dollar will fall to zero because of the rising debt and deficit spending of the government. While economic growth is most definitely impacted by the high debts - the "End of America" is not coming anytime soon.
However, as stated above, it is the "fear" of these events that drive individuals into buying gold as a hedge against the demise of the economy and the collapse of the U.S. currency. Should the economy began to show severe signs of stress then gold will, as stated previously, be the hedge against economic ruin.
There is one event that is coming in the near future that is likely to fuel the same type of speculative spike in gold as we saw during the summer of 2011 during the debt ceiling debate. That is the potential for a similar fight over the upcoming "fiscal cliff" as all of the Bush-era tax cuts, Obama tax cuts and the new ObamaCare taxes all collide at one time. The debates over what to extend, what not to extend or what to implement could very well find an already divided Congress and Senate back at war with each other over these issues pushing fears of a severe economic recession soaring.
Beneficiary: Gold, U.S. Treasuries and Dollar
Fed Acts With Further Stimulus
The markets have been anticipating further Federal Reserve intervention since the end of 2011. With each piece of bad economic news, or market hiccup, calls for further Quantitative Easing have rung through the halls of the media. Quantitative easing is inflationary by its very nature as the liquidity injected into the system flows directly into the most highly liquid and levered assets - commodity and stock futures. These price increases in everything from oil to corn press consumers with higher prices at home.
Federal Reserve intervention programs drive not only commodity prices higher but also the fears of hyperinflation. As liquidity is pumped into the system - gold rises in price as a hedge against the inflationary pressures. The U.S. dollar has been weaker during these periods.
Beneficiary: Gold and U.S. Treasuries. Short U.S. Dollar
Time to buy gold now?
The question of whether to buy gold now, or wait, is based on what your expectations are for the events listed above. Gold has recently ticked up after a long consolidation. This is very slimilar to the more substantial correction seen during the financial crisis. The chart shows the percent of deviation in gold from its average price. With the percentage deviation now turning positive - the risk/reward opportunity appears to be favorable.
Your personal outlook for the economy, the markets and further Fed interventions are the determining factors as to whether you should be considering adding gold to your portfolio. If stocks continue to rally then gold is likely to underperform as money moves from "safe haven" holdings to take on more risk. If you believe the economy is on the mend and will get stronger in the future - then gold will tumble sharply for the same reasons.
If you feel, as I do, that there are no clear cut answers - then holding a small position of gold, overweight fixed income, and defensive on equity risk certainly will protect your retirement savings from sudden and unexpected downturns. Of course, if the economy really does collapse and there is an outbreak of Zombies then it really won't matter any way.