Getting Comfortable with a Higher Gold Price

As someone who has observed and participated in the gold market since 1972, we are used to the criticisms of both main stream media and main stream Wall Street advice.  When not being compared to an insect (as in gold bug), we have been told often by Warren Buffett and others that gold is not an investment because it does not produce cash flow and income.  Because one can’t discount future cash flows, there is no way in their world it can be “valued.”

Our favorite insult was popular in 2015 when gold was compared to owning a pet rock by Jason Zweig of the Wall Street Journal.  He doubled down on his claim a year later.

We have to relate a personal foible.  We like buying gold when others are calling it a pet rock. We like buying things that are out of favor.

Today, things are looking a bit different.  Governments all over the world are simultaneously spending huge gobs of money by printing bonds, that are then being purchased by central banks with electronic money conjured out of nothing.  Production is falling, and money balances are rising, all to promote currency inflation that will “socialize” the cost of the fighting the Wuhan virus.  We literally have a rising tide of money chasing a declining supply of goods and services.

While we never bought the idea of a mechanical or stable mathematical relationship between the supply of money and the price level (the Quantity Theory of Money), clearly too much money chasing too few goods will lead to currency debasement.

And since we are also fighting the unstable world of too much debt, by adding even greater quantities of debt, markets will become in the end even more violent and unstable.

Note as well, there is no political resistance to the spending.  Weeks ago, we mentioned that the gargantuan government spending being proposed was simply a down payment. Congress is just now passing an additional almost half trillion in SBA loans.  There will be more.

The reason is that the normal conservative political objection has been short circuited by unique circumstances.  Government literally put millions of our countrymen out of work and destroyed the value of businesses for the higher need of saving lives.  Whether that was justified by the actual numbers is a debate we should have as a society, but irrelevant to our argument.  The fact is most Americans view the forced closing down of one’s business as a form of a “taking” or something akin to eminent domain.  For public need, the government has shut people down and it is right therefore, that they be compensated for their loss. Hence, no real objection to the wild increase in spending. It also seems like a reasonable way to try to cushion a depression.

As we have pointed out in previous blogs, gold does its best when debt is rising faster than GDP.  In terms of just the fiscal debt we will be moving from debt to GDP of about 5%, to likely as high as 25%.  This is full on wartime finance.

So, it’s not surprising that the main street viewpoint about gold is shifting.  In just the last day or so, considerable ink has been spilled over a report from Bank of America/Merrill Lynch that gold will be heading to $3,000 per ounce.  The author does not say when and wisely does not suggest it will be without the normal, “two steps forward, one step back” kind of price action.  But clearly, both Wall Street and Main Street cannot avoid the fact the government is spending like crazy while the economy is rapidly contracting.  And it is not just the United States.  Virtually every major economic power is doing likewise, even the minor economic powers.

The late, great market analyst Richard Russell of Dow Theory fame, suggested that bull markets come in three phases.  The first phase is rather quiet, as only the most knowledgeable investors start to accumulate.  The momentum of prices turns quietly positive. This is part of how a major bull market unfolds.

In the second phase, the reasons why the informed early money was buying becomes more widely accepted and the price movement becomes more emphatic, and that begins to attract investors that never really paid much attention to the particular market advancing.  In this phase, the reasons why the market is advancing has become more obvious.  The circle of investors expands from the really savvy to the informed.

The third and final phase is the speculative phase where the general public comes in, and it is usually the largest of the three.  Near the end, the price will move in a parabolic fashion as the public comes into the market with new and expanded rationalities.  Not only does the general public come in, but they come in with leverage and borrowed money.  They are buying not for the original reasons but simply because the price is moving and the opportunity for big and quick money is irresistible.

Advancing prices attract more and more investors, more and more speculation, until it is exhausted in a buying panic that send prices to unreasonable and unsustainable levels.  The bull market then ends, killed off by its own internal excesses.

The fact that the general public and Wall Street is now paying attention to gold should not be feared.  It will take more people and more buying power to send prices higher.  That is part of the process. For now, we appear to be in the second phase of this great bull market in gold and we must be comfortable that Merrill Lynch sees the trends.

At some point several years ahead, pricing will go parabolic, and caution will be warranted.  Right now, we are not even near that phase.  The public is just now beginning to understand the gravity of the situation as a society that was already running huge deficits must now finance a new crisis with money created without any commensurate increase in production.

Neland D. Nobel, is a retired portfolio manager and Certified Financial Planner with 45 years of market experience in the securities and gold industry.