2012-04-09

Gold is not a bubble; bears watch the wrong indicators

Ambrose Evans-Pritchard makes a point that I've made previously here in different ways, that non-Western forces are changing the markets.

Gold crash on Fed tightening and euro salvation looks premature
“The game has changed,” says Dennis Gartman, apostle of the long rally who now scornfully tells gold bugs that he is just a “mercenary”, not a member of their cult. “They genuflect in gold’s direction; we merely acknowledge that it exists as a trading vehicle and nothing more. There are times to be bullish, and times to be bearish … to every season, as Ecclesiastes tells us.”

...The stock markets of Europe, America, and Japan churned sideways over the same decade, and that precisely is the clinching argument against gold for contrarian traders. You avoid yesterday’s stars like the plague. “Gold is far too popular,” said James Paulsen from Wells Capital. It has reached a half-century high against a basket of indicators: equities, treasuries, homes, and workers’ pay.
What is wrong with their indicators? They are all Western! Did the 1960s U.S. bull market care about Chinese GDP? Do Beijing home prices care about Turkish housing demand? As a global asset, Western indicators do matter and as a massive economic force, the West still matters. That is changing, however, especially with respect to gold. The U.S. and Europe can impact the market massively because of their buying power, but right now demand pales in comparison to India and China. If gold is overvalued, it must be overvalued by Indian and Chinese metrics, not Western ones. I do believe $1900 gold was an overvaluation in the current market, because even at $1600 and change, India's current account is in deficit. China's economic slowdown may also hit gold demand. In the long-term though, these rising economies have a much more favorable attitude towards gold, while the relatively (absolutely?) falling Western economies have a less favorable view.

After running through a deflationary scenario that lays out a good case for gold prices falling (though Evans-Pritchard sees it as a case for central bank money printing and therefore bullish for gold), he writes:
Mr Steel said the “marginal cost” for mining gold is around $1450. That is when miners leave low-grade ore in the ground and weaker producers shut down. It creates a natural floor of sorts. Besides, `peak gold’ is a more immediate reality than `peak oil’, he said. There has been no equivalent to the shale revolution seen in oil and gas. World output has been stuck for a decade at around 2700 tonnes a year despite a fourfold increase in investment. There are no great finds, no Wittwatersrand this time.

There will come a day then the bullion super-cycle finally sputters out. My guess is that it will come once Europe’s monetary system has returned to a viable footing - either by real fiscal union, or by break-up - and once China’s RMB becomes fully convertible and takes it place as the third pillar of the world’s currency system. We are not there yet.
This time is different. Not on a 500 to 2000 year time scale, but on a 50-100 year time scale? Absolutely.

There is one group of bears that do have a good case against gold— the deflationists—but for them, gold is merely one asset that will also fall during a widespread deflation. I see the deflation argument as intellectually coherent and still believe it is possible. However, for people who are talking of rotating out of gold and into stocks, I believe their bearish gold position does not comport with the full picture. The bullish "gold bear" scenario is one where the economy has recovered and Europe, the United States and possibly Japan, can only see their debt troubles in the rear view mirror. As Evans-Pritchard says, "We are not there yet."

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