Gold Bull Market Merely On Hold

By AG Thorson

Sunday, September 23, 2018 5:08 PM EDT

It’s time to revise my big picture outlook for gold. I don’t believe gold is entering a new multi-year bear market nor do I think prices will drop to $700. I believe the bull market was merely suspended and lower prices should be bought. There is a massive financial storm on the horizon, and gold will benefit greatly in the years to come.

The Economy Strengthened:

Between the 2018 tax cuts and the federal budget increase, the US economy gained nearly 2-trillion dollars in stimulus. That’s a lot of money. In comparison, it took the same amount (about 2-trillion) to arrest the 2008 financial crisis. Trump’s efforts extended the business cycle and postponed golds bull market.

As I stated in the “Trump Effect” article, the economy was rolling over into a recession in 2016. Smart money saw this and gold responded. Prices rallied over $300 by July 2016 (see chart below). The major turning point arrived after the 2016 election. Trump won, and big money immediately dumped gold and jumped into stocks. Precious metals hesitated in 2017 as the outlook for the economy remained unclear. The tax cuts and jobs act was signed into law December 22nd, 2017 and the massive stimulus package gained traction this year. The economy shifted back to modest growth and risk-on with consumer discretionary stocks leading the way.

Had Hillary won, the economy would have continued into a recession and gold would be much higher.

So what does this mean for gold investors? The stimulus package postponed an economic recession by a couple of years. However, it will probably make the next downturn much worse. I see the potential for a perfect storm of events that will likely snowball into a massive crisis by 2020/2021. That is when gold will begin to shine.

Domestic And Global Issues That Support Gold

Index Bubble:

Passive investing is at record levels. Investors simply buy the index and outperform most managed funds. This strategy is distorting stock market gains and valuations. Let me explain, if SPY receives 100 million dollars it distributes that money according to market weight. So without discretion, they put $4,348,817 into Apple, $3,508,018 into Microsoft, $3,147,969 into Amazon and so on. No fund manager worth his salt would be pouring money into Amazon with a P/E ratio at 152. Valuations don’t matter, as long as money keeps pouring into the indexes they have to buy these stocks.

Amazon, Netflix and Microsoft together this year are responsible for 71 percent of S&P 500 returns and for 78 percent of Nasdaq 100 returns. See CNBC article published July 10th, 2018.

Liquidity Crisis:

So what happens when Index buying turns to selling? It could get ugly for the high flying FAANG stocks. Prices go down much faster than they go up. As fear spreads, money exiting indexes will explode. Fund managers will indiscriminately sell according to market weight just as they bought. A positive feedback loop could emerge as selling and panic beget more selling.

Three entities – Vanguard, State Street and Black Rock control approximately 88% of the S&P 500 companies. Essentially they are the market. Who are they going to sell to when buying collapses? If things get really bad, the Fed may have to step in.

Pension Crisis:

There is a global pension crisis brewing. After the 2008 financial collapse, governments slashed interest rates to zero and kept them there for nearly a decade. Federally mandated pensions, required to hold a certain amount of bonds earned virtually nothing during this period. Many are now insolvent or close to it. The liquidity crisis outlined above and succeeding bear market in stocks would drive pensions below their minimum thresholds. That could result in bailouts or restructuring. Want to see civil unrest, start slashing pensions.

Sovereign Debt Crisis:

Europe and emerging markets are a mess. Several countries will have to restructure their debt and essentially go bankrupt. Money is fleeing these countries at a record pace into US stocks, bonds, and the Dollar. Many used Bitcoin as a transfer vehicle to sidestep currency exchange controls.

The Dollar:

Originally, I felt the Dollar was breaking down into a new bear market now I’m not so sure. The dollar is the most liquid and recognizable asset in the world. Global money flowing to the US could support prices.

If the dollar rises significantly, US tourism, exporters and domestic companies that do business abroad will be hurt. Also, countries that borrowed in US dollars when it was cheap will find it difficult to service their debt with a rising dollar.

As you can see, there are way too many crisis events brewing to keep gold down for long. When the economy begins to rollover, big money will flow back into gold just like it did in 2016. However, this time prices will breakout and enter a true bull market advance. I think 2020/2021 will see some or all of the above life-altering events. Metals could catch a bid sooner if the Democrats win the House in November and attempt to impeach Trump.

Metals Strategy:

In the short-to-medium term, I’ll scale back my allocation and keep a small amount to play the swings either up or down. Long-term, I believe physical metals are a buy. I’ll probably buy silver and platinum before gold. Prices could go lower, so I’ve decided to select a dollar amount to allocate every month or on sharp declines. Besides physical, I’ll look to build long-term positions in GDX and quality individual miners if prices continue lower. I’ll do this until big money returns to the sector. Then I’ll switch gears and begin to add leverage.

GOLD