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Gold's On a Wild Bull Run - For Seven Good Reasons
In case anyone hasn't noticed, the gold and precious metals market has been on fire for the better part of this year. As of this writing, gold has just finished the third quarter with a better than 6% gain. And the spot price of gold is within striking distance of the "magic" $500 number. A number, by the way, not seen since the infamous stock market crash of 1987... So what's at the heart of this phenomenal strength in gold? The answers are really not that surprising, when one considers the seven factors that are driving the gold price skyward. #1: Supply and Demand Fundamentals The fundamentals for gold are very favorable. In 2004, for example, global mine production of new gold decreased by more than 5%. That is the largest decrease in more than 60 years. Concurrently, gold demand rose by more than 7%. This surge was fueled by a (significant) 12% rise in demand from China, and about 10% each from India and the Middle East. Most notably, the gold market has finally witnessed real increases in individual global investment demand. It appears that Western investors have finally started to heed the warning signs that were so abundant about the U.S. dollar and the U.S. real estate market (not to mention those relating to the shaky foundations of the U.S. equity markets). Gold, which had been all but orphaned for two decades, is making a very real comeback. Ask precious metals dealers around the country, and their story will have a common theme: The telephones are in meltdown mode. #2: The Huge Increases in Debt Over the past five years, the level of trade and government debt has soared. The debt now exceeds the combined accumulated debt of the previous 220 years of American history. America now holds more than $2 trillion in consumer debt, and a whopping $6.2 trillion in mortgage debt. The average family's disposable income is now more than entirely consumed by fixed payments and debt payments. By year-end 2004, the U.S. government's outstanding debt stood at US$7.6 trillion, accounting for 67.3% of its GDP, a figure that exceeds internationally accepted safety limits. In 2001, when the new administration was sworn in, the U.S. was enjoying a surplus of $127 billion. Tax cuts, the recent economic slump, the market downturn, and the war being waged on terror have abruptly turned that surplus into a $459 billion deficit, almost 4% of GDP. Yet, massive amounts of consumer debt are continuing to pile up, against a backdrop of a lack of spending discipline and an absence of household savings. The twin deficits cannot be sustained penalty-free forever. The dollar will have to fall farther, relative to other currencies (which will make imports more expensive to the U.S. consumer) to correct these imbalances. The recent Katrina energy shock and related reconstruction spending frenzy will undoubtedly accelerate the arrival of the day of reckoning for the dollar. These concerns may already be visible in a plunge in consumer confidence to a nearly two-year low of 86.6 in September. This was the biggest monthly drop since October 1990, after Iraq invaded Kuwait and before the first U.S.-Iraq war. #3: Growing Uncertainty About the Dollar Uncertainty in the financial markets about the future fate of the dollar is growing. The current weakness of the dollar may simply be a reflection of trade flows or, perhaps, that of a (much more worrisome) systemic loss of confidence. Adding to these uncertainties are the apparent beginnings of the unraveling of the U.S. real estate bubble, the continuing erosion of consumer confidence levels, Alan Greenspan's imminent departure from the Fed, and the continuing large-scale costs of the wars being fought in faraway lands. #4: A Gold Bull Spreading to Other Currencies Rising gold prices are spreading to currencies other than just the dollar - a sure sign of a bona fide bull market. Over the summer, an important bullish signal was given when gold broke through resistance in euros at the 350 figure. In effect, this breakout puts gold on course toward being de-coupled from the dollar and other currencies, and roaring ahead on its own. This is the stage of the market that really attracts formerly reluctant investors. They become convinced that the train is departing, that they must dump their "frothy" (to use Mr. Greenspans's words) real estate, their unsustainable P/E ratio stocks, their inflation-prone paper dollars, and load up on one real asset: gold bullion. #5: Rising Retail Investment Factor The rising retail investment demand has a significant impact on the price of gold. Until recently, the aggregate consumption by investors around the globe was a measly 300 tons per annum. The launch of the much-vaunted gold ETF did not manage to create the anticipated demand. Yes, tonnage consumption rose, but it was at the expense of cannibalizing gold coin sales. The real swing factor in gold-oriented interest has come from the man in the street, (the streets of Shanghai, and Mumbai, and finally Peoria). #6: Increasing Investor Interest in Gold Ownership When investors get interested in owning gold and reallocate even a small (10%) portion of their portfolio to it, the global supply cannot meet the new incremental demand. Funny thing is, gold's demand curve is actually inverted, meaning that the higher the price of gold, the more investors start desiring it. The ensuing snowball effect drives gold higher and higher. People say that there is no rush quite as crazy as a gold rush. #7: Price and Expenditure Shocks Price and expenditure shocks continue to buffet the already fragile U.S. economy. The double-whammy of Katrina and Rita are estimated to require upwards of $300 billion (a third of a trillion) dollars in government expenditures and insurer claims. Even a healthy economy would have trouble sustaining such external shocks. But now, add in the energy situation in which the numbers present a very dim outlook. Oil inventories are at a 20-year low. Global supply is 2 million barrels short of daily demand. No wonder Sen. Schumer was recently quoted as saying: "We have now reached the point where rising oil prices are no longer a nuisance but a crisis for our economy." Now factor in the monthly $6 billion spent on the wars in Iraq and Afghanistan and the picture turns a shade darker. Taking just these two unforeseen and one "planned-for" expenditure events into consideration, it is easy to see why many analysts and investors have concerns about inflation. May the Bull Be With Us... The one factor to remember about gold right now is that we're in a secular bull market. The price of gold has been on a steady rise since January 2001, and with the reasons listed above, it's expected to continue for quite some time. Owning gold is a great dollar hedge and wealth preservation technique. That's because gold represents perhaps the only investment of pure value. That is, physical gold is never dependent on the creditworthiness or honesty of a company or government. There could well be bumps along this wild coaster ride over the next few years. Gold may actually fall from time to time, and fall sharply. However, such corrections are not signals of the end of the bull market. They are, just as the word implies, corrections in an overall trend that remains intact. I'm looking forward to a wildly profitable ride.
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Wealth Protection Advisory Panelist Michael Checkan is
President of Asset Strategies International, Inc. (