A Few Words of Optimism for Gold Investors

November 10 2014

Earlier this year, I warned that gold prices would drop, when I wrote that the rise in gold prices did not indicate the end of the correction, and that we might see a move back to its recent bottom, or possibly an even lower bottom. As of this moment, gold is trading at €925 per troy ounce, well over €50 above its low of December 2013. In sum, gold trades at well over 5% above its bottom

A Few Words of Optimism for Gold Investors

Earlier this year, I warned that gold prices would drop, when I wrote that the rise in gold prices did not indicate the end of the correction, and that we might see a move back to its recent bottom, or possibly an even lower bottom. As of this moment, gold is trading at €925 per troy ounce, well over €50 above its low of December 2013. In sum, gold trades at well over 5% above its bottom achieved past December. What can we expect to happen next?

In the 1970’s, the Correction Was Worse

Also during the 1970’s — when gold prices increased for many subsequent years — gold prices experienced a correction. Between 1974 and 1976, the price of gold decreased in a way comparable to today. Also comparable was the news coverage (that is; a negative outlook on gold, and an economy allegedly recovering).

At that time, the correction amounted to 50%. Gold prices dropped from $200 per troy ounce to $100. This was notthe end for gold, considering that after this correction its price rose from $100 to $850 — an eight-fold increase.

A 50% decrease at this point in time, would imply a gold price below $1,000 per troy ounce — about €800 per troy ounce. However, this time there is a strong case against expecting a 50% price decline.

The Big Difference between the 1970’s and Now

Of course, a lot has changed since the 1970’s. China is no longer considered the ugly duckling, but is an economic powerhouse. If we consider the world’s largest banks, then we find no less than four Chinese banks ranking among the top 10. In fact, the world’s largest bank is China’s ICBC with total assets of $3,200 billion.

And there are major implications.

Nowadays, a large share of the gold demand originates from China.

And what are the Chinese doing now that the gold price is decreasing again? Indeed, they buy more. China’s gold demand was remarkably strong during the past week. Recently, its demand increased to 60 tons) per week; a 100% increase in China’s demand compared to earlier this year (source: Koos Jansen). And then we still need to account for the gold purchases by China’s central bank!

Such a factor ensures a price bottom for gold that did not exist during the 1970’s.

Analysts from Standard Chartered expect gold not to drop below $1,100 this time around, considering China’s gold demand.

Is it therefore a good idea to sell now in order to buy back later, thus speculating on a further price decrease? I don’t think it is.

What Has Changed Since the Past Bottom?

Since the December 2013 low, worldwide government debt has only further increased. This is the reason for me to give gold an important role in any investment portfolio. Since January 1, 2014:

  • the Japanese national debt increased by about 1,000 billion (an increase of over 9%)
  • the U.S. national debt increased by about 400 billion
  • the British national debt increased by about 300 billion

Is it the right moment to sell gold? My answer to this question is an unequivocal “no”.

Debt Makes Fragile

Debt makes “fragile”, that is, it restricts one’s maneuvering space in case of emergencies. Only one unexpected event is needed for the house of cards to collapse.

Consider the banks. After publishing the results of the stress test, the ECB stated that possible write-offs may become as high as €136 billion. Nonetheless, according to very same analysis, it turns out that the sum of “non-performing loans” amounts to €879 billion.

Europeans banks can hardly withstand much more.

For instance, suppose something comparable to 2008 happens. Will European governments be able to provide large sums of state support as they did before? Can European governments afford to nationalize banks and assume all (future) losses just as last time?

The answer is no. Given the current debts levels, the vast majority of governments cannot afford such intervention. Debt makes fragile and since the 2008 bailouts, debt levels in the Western world have become so high that policy makers can only wish for a miracle.

The Reasons for Investing in Gold Are Unchanged

The motives for investing in gold have not changed. The easy money policy of central bank has caused a monetary illusion — a growth of nominal GDP, a mere achievement by the printing press.

However, this monetary illusion will not last forever. Worse still, this illusion with prove to be rather short-lived than longer.

Precious metals were not the only assets to see prices decline recently. All commodity prices declined, which is a clear signal of economic weakness and stagnation. The recovery is primarily impaired — not stimulated — by the easy money policy. It only serves to camouflage the structural problems faced by the developed economies and with the end of QE, the moment of truth regarding the alleged economic recovery is approaching rapidly. In my view, we absolutely want to own gold in anticipation of a price increase.

A Few Words of Optimism

Regardless of whether or not gold drops by another 10%, it makes sense to own gold. And to repeat myself: given the current price, it is wise to consider buying (additional) gold. Buy low and sell high, should be one’s maxim, not the reverse.

Over 80% of all investors underperform the market. Make sure you will not unwittingly among them by buying high and selling low by acting emotionally and following negative headlines.

Remember that price declines as seen this and last week are often immediately followed by a big rebound — a price recovery. Legendary investor Sir John Templeton always adhered to this wisdom, and profited correspondingly. In his own words: “The right time to buy is always at the point of maximum despondency.”

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