Is Gold Running Out of Steam?

  • Jeff Clark
  • Senior Metals Analyst
  • January 18, 2013
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Let's ask an honest question. Shouldn't the gold price be higher?

The Fed announces that it will be buying $85 billion a month of government debt and other paper – and gold drops? Similarly, Japan elects a new government that has said it intends to print aggressively in 2013, and gold goes nowhere. The fiscal cliff did little to move the price. All this occurs amidst a zero-interest-rate world and a debt pile that continues to grow every day.

Even though gold logged an annual gain for the twelfth consecutive year, it's up only single digits for the past two years: 8.3% in 2012, and just 8.9% in 2011. It was also outperformed by the S&P 500 last year – the first time that's happened since 2004. A lack of steam certainly seems to be an appropriate metaphor.

It appears that gold is no longer responding to what are clearly positive catalysts like it has in the past. It's traded below its all-time high of $1,921 for over 15 months now. Heck, the price returned to its prior highs within 17 months during the 2008 market meltdown; it doesn't feel like we'll reach $1,900 by March 2013.

Has investor fatigue set in? Could those who have been claiming gold is in a bubble – gulp– be right? Many of us expected to see a modern-day gold rush before this bull market concluded – is that out of the picture now?

If so, our bull market is small compared to most others in modern history.


Over the past 40+ years, our bull market would be among the smallest. Based strictly on percentages, ours doesn't appear to be over.

Bull markets historically tend to end in a climactic blow-off top. For example, gold rose 120% in 1979. Our best year was 32% in 2007. Hardly meteoric, and contrary to how the typical bull market culminates.

This audience hardly needs a reminder of why investors should own gold. But the questions about its lag are real. For the next few issues of SmartMetals™ Investor, we'll explore what we see as the future drivers of the gold price. Regardless of what has driven gold higher in the past, what are the catalysts that will push it higher going forward? And what's the likelihood of those drivers actually coming to pass? It will be a fun – and important – series.

What seems apparent, at least for now, is that a "new" catalyst might be necessary for gold to return to record highs. The 65% jump in the money supply, the Federal Reserve's $2-trillion binge buy of US Treasury bonds and mortgage-backed securities, the trillions that have been added to the federal government's debt in just the last four years, the failure to cut government spending – all are scary issues, but investors have been buying gold for those reasons for a few years now. The smart investor realizes that the consequences of these actions have not fully materialized, and indeed that the worst is yet to come.

However, the trader in the commodity pits in New York might need to see a new threat to the Fed's strategy before he's compelled to bid on the yellow metal again. The average retail investor may not enter the market until he sees a significant jump in inflation. Institutional investors might want to see the new Basel III Accord. A black swan swimming nearby might need to bite before the public is scared into the precious-metals market.

So what's it going to take to move gold to $2,000 and beyond? Any of the catalysts we list below – or, perhaps frighteningly so, more than one. What we think you'll see is that not only is the gold bull market not over, it's more important than ever to make sure you have meaningful exposure.

Here's what we think will drive gold higher over the next few years, which we'll be covering in depth in future letters…

An adverse monetary event. Add up all worldwide household, corporate, and government liabilities and you reach a whopping $200 trillion. The stability of the global financial system is highly questionable, and the concern is that confidence in its long-term strength could deteriorate and metastasize into something ugly. Gold is a direct hedge against an unexpected or severe impact, and buying en masse would be a very natural reaction.

Continuation of global negative real rates – even if rates rise. A number of analysts project that the Fed is likely to keep rates near zero through 2018. But even if interest rates begin to rise before then, the gold bull market will continue if the real rate (nominal 10-year Treasury rate minus headline CPI) remains negative. And this is highly likely because escaping high rates of inflation is going to be a very difficult thing to do. So if interest rates climb to, say, 10%, but inflation is 12%, rates are still negative – and still gold positive. The longer this environment continues, the longer gold is supported.

Loss of confidence in the US dollar. In the long term, the dollar must move lower. How can we be so sure? History has shown that the #1 cause of hyperinflation is large and prolonged government deficits. Trillion-dollar deficits seem almost certain in Obama's second term – and they could be higher if the next recession is deep. An even greater concern is if foreigners begin dumping dollars if, in their view, those dollars are getting debased too much. The point here is that as the value of money decreases, so does the dollar, and gold will be an automatic refuge as that process gains momentum.

High Inflation. It's clear that government leaders will continue to allow their currencies to devalue through inflation, so that the fixed value of their massive debt loads can be paid back in less valuable currency. Make no mistake, this story is going to end with very high levels of inflation, and only the number of chapters it will have before we get there is unknown. Generally speaking, the higher inflation goes, the higher gold goes. By the way, don't wait for the CPI to move higher to buy your gold; precious metals often move in anticipation of higher inflation.

An announcement from China about its gold reserves. Another potential catalyst we're watching for is an announcement by China, probably within the next year or two, that it has acquired a large amount of gold in its official Reserve position. This would validate gold as the foundation of the international monetary system and we believe, send the price to the mid four-figure range very quickly.

Growing supply/demand concerns. Production from gold mining operations hasn't increased materially since 2000, yet the price is up 500%+. A rising metals price hasn't been sufficient to increase supply, which is what would normally occur. Meanwhile, demand for bullion continues climbing – the US Mint just reported, for example, that it sold 50,000 ounces of gold on the very first day of 2013, and another 7,000 on the second business day, nearly matching the entire amount sold in December and almost half of January 2012. If supply remains stagnant and demand grows dramatically – especially if it were to occur abruptly – the price would be forced up by an order of magnitude.

A black-swan event. Geopolitical conflict, unexpected bad news on the economy, Greece or another of the PIGS defaulting, some type of bond event out of Japan… any of these could materialize overnight and catapult gold higher. You can probably think of more unexpected events that would catch investors off guard and send them scrambling to the safe haven of gold.

These are just some of the matches that could light a fire under the gold price. In the big picture, though, the #1 reason to hold bullion is because the current path of currency devaluation – and the high likelihood that it will continue and even accelerate – will make our dollars increasingly worth less and less. It's not about another Lehman Brothers going belly up, or hyperinflation occurring in some far-off land, or Iran launching a bomb at Israel (or vice versa), or even if the gold price is somehow being managed. Gold is about protecting your purchasing power… it's about preserving the standard of living for you and your loved ones.

Once you internalize that and come to realize that throughout history precious metals have been money more often than not, how much to own becomes easier to answer.

Despite the price lag, gold remains a must-own asset. And the lack of steam, sooner or later, will reverse course and perhaps even turn into a powder keg. Buy accordingly.


Jeff Clark is editor of BIG GOLD, and a regular contributor to the Hard Assets Alliance.

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