Saw this catchy headline at MarketWatch this morning: "Gold Crashes and Is Now Tarnished for Good." Wow. "For good"? That's a long time. Let's dive a little deeper. First, a little history. Gold bullion mounted an impressive 10-year bull run from 2001-2011, moving from below $300/oz to a high around $1,900. Since then, as the chart below from Monex Precious Metals shows, it's been a slow downward drift. Currently trading in the low $1,200s, gold has given up about 40% of its 10-year gains. Looking at the chart, optimists might say the metal is forming a triple bottom with good support at the $1,200 level. Pessimists don't expect the current level to hold. The writer of the MarketWatch article is clearly in the pessimists camp. What are his reasons?
The dollar is strong: The U.S. Federal Reserve has been telegraphing its moves for some time, and last week reiterated that October will bring about the end of its bond-buying program and that key interest rates will almost certainly rise in 2015. Higher interest rates will only bolster the U.S. dollar further. And thanks to the inverse relationship between our currency and the pricing of dollar-backed commodities, a stronger dollar means gold prices will fall...
The strength of the U.S. economy: There’s a 6.1% unemployment rate, which is down nearly 4 percentage points from peak levels and the lowest since September 2008. At the same time, claims for unemployment just hit the lowest level since early 2007....Corporate profits also look robust. According to research firm FactSet, the estimated earnings growth rate for the third quarter is 6.2%, with most analysts predicting double-digit growth in the fourth quarter....There’s tons of other data that indicates the U.S. economy and corporate profits continue to improve. So why would investors flee stocks or other “risk on” investments to hide out in gold?
Global demand slumps: Looking beyond U.S. borders, global demand also is bleak for gold. China, which overtook India as the largest gold-buying nation last year, has recently seen demand for the precious metal slump sharply....And while India did see a bump in gold demand and gold prices about a month ago thanks to religious festivals, the Wall Street Journal noted that “sales in the rest of the world are sluggish despite a number of geopolitical risks that normally increase demand for the safe-haven metal.”
Barry Ritzholtz looked at gold a few months back, and added a few more reasons that gold has not been able to regain its former traction:
Economic stability: Following the tumult of the financial crisis, the past five years have been relatively stable. Growth has been steady, albeit modest.
Low inflation: Despite ominous forecasts of hyperinflation, there has been only a modest increase in consumer price index. For five years, inflation has been a no-show.
Geopolitics: The Ukraine crisis seems to be mostly a Russian affair, while disputes between China and its neighbors are specific problems to Asia. Yes, it always seems like we are on the verge of war breaking out somewhere, but geopolitics has been a minor this year.
No equity crash: The long-awaited bubble popping hasn't occurred. Expectations are that once this finally happens, investors will flock back to the precious metals.
To add insult to injury, even Warren Buffett can't find a good thing to say about gold. As reported in USA Today:
Warren Buffett didn't become one of the greatest investors of our generation by investing in gold. In fact, he pretty much hates the shiny metal. Buffett seeks to surround himself with assets that are constantly producing value. Income that flows through the business is reinvested in new lines of business that go on to produce more income. It's a never-ending cycle where new wealth is created each and every year. It takes advantage of the wonders of compounding income and leaves behind the folly of being allured by a lazy, good-for-nothing, shiny object.
The "strong dollar" argument is found frequently in the financial media these days. Last week, I read this interview with Mohamed El-Erian, the former CEO of Pimco. With respect to the strength of the dollar, he had this to say:
First, the U.S. is on a different economic track than Europe and Japan. The U.S. isn't growing as much as we'd like it, but it's growing and continues to heal. Japan and Europe are going the other way. Second, policy is starting to diverge. The ECB is stepping harder on the stimulus accelerator while the Fed is slowly easing off the accelerator. Third, the geopolitical tensions affect Europe a lot more than the U.S. So what we have seen is a major move in the dollar versus both the yen and the euro.
Larry Kudlow and Stephen Moore offered their most recent rationale for a strong dollar on Friday:
Maybe the U.S. economy, a weakling for the last six years, is finally starting to flex some muscle. We're referring to the return of king dollar. For those who haven't been paying attention, the greenback is in the midst of a rally not seen since the 1990s. It's racing past the euro, the yen and other currencies. Investors worldwide are buying the equivalent of stock in America Inc. If the rise in the dollar's valuation is sustainable, it's welcome news for the stock market, for fighting inflation, and for U.S. growth prospects.
Admittedly, I've been more on the optimists' side of the gold argument. That stemmed mainly from my expectation that the Fed QE programs would lead to inflation and undermine the dollar. Clearly, that hasn't been the case. Yet. Historically, a weak dollar has been bullish for gold and a strong dollar (which we're experiencing) has been bearish. Which means it's a good thing I don't make my living publishing a newsletter on gold. Our most recent article on gold, How SMI Readers Can Reduce the Risk of Investing in Gold, was published six months ago. Our conclusions at that time still stand:
For those desiring "currency insurance," SMI still believes that owning a small amount of physical gold as part of a well-diversified portfolio is a reasonable (though certainly not mandatory) stance. This can provide peace of mind, and if the worst-case scenarios ever do play out, physical gold will be extremely helpful. However, for most readers, we recommend limiting this allocation to 5-10% of the total portfolio.... For most readers, relying primarily on DAA for gold exposure is likely sufficient. DAA offers a strategy that can accurately value gold relative to other investment options on an ongoing basis. Hopefully its inclusion in our toolbox will allow you to put your gold investing on autopilot, simplifying your decision-making while simultaneously making your gold investments more profitable.
Back to the beginning of the post and the idea that gold has been tarnished "for good." Gold aside, it's generally not a good idea to assert in a headline that any asset class is permanently doomed (or, for that matter, upward trending). Asset classes rise and fall over time. Just as there are seasons in a year, there are cycles in markets. When looking at current trends, whether great or dismal, it's good to remember, "This too (eventually) shall pass."