Cool Video: Sketch of Bullish Case for Gold

by
Marc Chandler
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I know some people who are always bullish gold. I am not. In fact, I often think I can find higher returning assets. However, I have recently have turned bullish gold, and while in Toronto on business, I was invited to the set of Bloomberg to discuss my change of heart.

Many of the reasons the gold bugs cite would seem to justify owning gold bullion not paper claims on gold, like gold mining companies or gold ETFs. The cost of insuring and storing can eat away at the return on the non-yielding asset. On top that, interest rates may be understood as the opportunity cost of owning gold (foregone income stream). There are roughly $13 trillion of negative yielding bonds. In the US, the market is pricing in 75 bp of cuts in the Fed’s next four meetings. Other countries, bar a few, are considering easing policy. If rates are going to be lower for longer, the opportunity cost of owning gold falls.  

The tensions in the Gulf, which still seem more likely to escalate than dissipate. Indeed, Iran has already announced that it will exceed its enriched uranium quota within days. When the US pulled out of the treaty and imposed a new embargo on Iran, it set into motion this chain of events that deliver the EU a fait accompli. Europe tried developing payments systems as a workaround he US sanctions but may have to formally withdraw from the treaty given Iran’s actions.

As the US weaponizes access to the dollar market, other countries and investors search for alternatives. Although Russia still uses the dollar extensively, it has shifted its reserves more into gold. Other central banks are buying as well, and Venezuela’s gold is being redistributed. The gold market is too small to absorb even a significant fraction of China’s $3 trillion of currency reserves.

Regardless of how Trump and Xi’s talks go this weekend, I think that the US and China have entered a second Cold War. The fork in globalization, which I expect to be one expression of the cat-and-mouse competition, also would seem to boost the attractiveness of gold.

A bullish gold outlook dovetails with my argument that the third significant dollar rally since the end of Bretton Woods has ended. The interest rate leg that supported the bull market is weakening. Interest rate differentials between the US and Germany, the US and Japan, and the US and the UK peaked last November. The peak against Canada is more recent but still dramatic. The last phase of a big dollar bull market is often characterized by the reduction of the US premium.

The policy mix has no longer supportive. Last year, the US had a tighter monetary policy and looser fiscal policy. That is the best mix for a currency. Now it is the opposite. Fiscal policy has tightened, and monetary policy is set to ease.

US President Trump is right. It has been years since the major central banks intervened in the foreign exchange market. The dollar is overvalued because that is how the purported self-correcting mechanism of the market works. The rise in US rates, the fiscal stimulus, strong growth, high profitability, drew the world’s savings to America. As a consequence, the dollar appreciated. The OECD currencies usually do not venture beyond 20%-25% of its measure of purchasing power parity. The euro is about 22% undervalued, according to the OECD.

Lastly, technically, it has broken higher out of an extended bottoming phase. My target is $1700, which is 20% from the $1400 breakout level. Just like the criminal, they say, returns to the scene of the crime, it is not unusual for the break out to be tested again. When I look at a range of assets, it is difficult for me to see 20%. That is what I think gold offers.

And look at that; inflation was not cited.