 Contending Gold
Perspectives
Adam Hamilton
Archives
February 19, 2005
Like probably every other major market move in world history,
the bull market in gold is generating ever-increasing interest.
Not surprisingly though, while the raw price data is absolutely
indisputable, there are a myriad of varying opinions on whether
gold is going higher or lower and why.
Differences of opinion on the markets are fantastic and ought
to be celebrated, not feared. Investors and speculators have
a natural tendency to feel threatened when others advance opinions
contrary to their own. Instead these differences should be viewed
as priceless learning opportunities. The more perspectives from
which we can view any market, the higher the probability that
we will make the right trading decisions.
Differences of opinion also make markets. If everyone
felt the same way, we would all be buyers or all be sellers and
there would be no counterparties with which to trade. The markets
would grind to a halt! In addition, a mono-opinion market
culture would be extremely dangerous, breeding stupendous bubbles
as everyone tried to buy and shockingly brutal crashes
as everyone tried to sell.
The diversity of opinions is the spice of the markets, creating
a thriving intellectual wonderland that truly is the ultimate
marketplace of ideas. Personally I am always excited to learn
about different market opinions, whether aligned with or contrary
to my own, as studying them inevitably deepens my own understanding
of these fascinating markets in which we sojourn.
I am launching this new series of essays in the spirit of this
marketplace of ideas focused on gold specifically. Rarely do
48 hours of my life pass by without subscribers and clients writing
me and saying something like, "Adam you say gold ought to
go higher in the years ahead but [Insert Name Here] says
that due to [Insert Reason Here] gold is going to [Insert
Outcome Here]. What do you think about this?"
My hope is that this series of essays can provide a forum to
critique and analyze contending gold perspectives. I want to
do this with a gentle spirit, trying to foster mutual understanding
rather than sowing the seeds of conflict among competing schools
of thought. I have immense respect for everyone playing
in the challenging market arenas, whether I happen to agree with
their worldview at the moment or not.
Since I will be analyzing ideas and technical approaches advocated
by other analysts and speculators, I think it is only fair that
I subject my own ideas to the glaring spotlights first. Since
2000 I have been an outspoken gold bull, unapologetically long-term
bullish. I have written countless dozens of essays
on gold and have been blessed with great realized profits trading
this gold bull to date.
On the very trading day before gold carved its multi-decade secular
bottom in early April 2001 I concluded an
essay with, "History, economic fundamentals, and logic
dictate gold is amazingly undervalued and due for a monstrous
rally. My capital will be ready for the coming gold rush!"
The next day gold briefly fell under $257 but has never looked
back since.
My gold worldview is long-term bullish as I believe gold is in
a massive secular bull market that ought to gallop higher for
many more years, perhaps a decade, before it fully runs its course.
As in all other bull markets in history though, this long-term
bull has been and will continue to be punctuated by periodic
corrections as prices flow and ebb, taking two steps forward
before one step back to regroup.
Why do I believe gold is in a bull market likely to run for many
years yet? Please allow me to briefly outline 10 major
reasons. I have also hyperlinked in some previous essays that
explain some concepts in much greater detail if you would like
to dig deeper to understand my bullish outlook on gold.
1. Supply and Demand. The ultimate arbiter
of any price is supply and demand. When demand exceeds
supply, prices are forced to rise. The rising prices work
on a chronic supply/demand deficit from both sides, providing
an incentive for producers to increase production while
providing a parallel incentive for consumers to decrease
consumption. Eventually the rising prices bring supply and demand
back into equilibrium where production and consumption are balanced.
In gold's case, its global demand is growing much faster than
its global mined supply, so the only economic resolution for
this deficit is higher prices to bring supply and demand back
into balance. I'll discuss the reasons why gold's demand is rising
below, so for now let's focus on why its mined supply just cannot
rise fast enough to meet demand growth.
Unlike almost every other business, gold mining is totally dependent
on highly local geology. Obviously you can't build a gold mine
unless there is gold to mine! Since gold is so scarce in
the natural world, it is very difficult to find a site with enough
gold to mine economically. And even if you manage to find such
a site after endless exploration, you are totally at the mercy
of local and national governments, all of which are corrupt and
love to extort profits from captive mining ventures.
And if you manage to find a suitable gold-mining location and
can jump through all the flaming bureaucratic hoops, you still
have to raise tens or hundreds of millions of dollars to build
roads, put up buildings, sink the shaft, and buy the necessary
capital equipment. And even if you somehow manage to secure financing,
it still takes several years at best to spin operations up to
full speed.
So not only is gold mining an extremely tough business plagued
with geological quirks and government harassment and enormous
up-front capital costs, but even if you can overcome all of these
stellar hurdles you won't be selling any of your gold for years.
Thus, no matter how high the gold price travels, it will literally
take years for producers to find new deposits to develop,
mine, and sell.
Gold mined supply is therefore very inelastic (unresponsive
to price) and highly constrained over anything short of a half
decade or so. Today's higher gold prices will take at least
several years for producers to respond to, and only after
these producers believe that this bull will be persistent enough
to make a big bet on it. The rate of mined gold supply growth
will not grow very fast in the coming years for these reasons.
2. Long Valuation Waves. The general
stock markets move in great 33-year cycles known as Long
Valuation Waves. For the first half of these cycles, like
from 1982-2000, stock valuations and prices rise in massive bull
markets. But in the second half, like from 1966-1982 or 2000-20XX,
stock valuations relentlessly mean
revert back down to long-term averages. We are in this brutal
valuation wave winter today.
While stocks make horrible long-term investments during the latter
half of these Long Valuation Waves, thankfully commodities and
hard assets thrive. Commodities also move in roughly third-of-a-century
cycles over time, but they tend to oscillate 180 degrees out
of phase to the equity valuation waves. Thus, secular commodities
tops like in the early 1980s coincide with secular equity bottoms.
And secular equity tops, like 2000, coincide with secular commodities
bottoms.
Our current Great
Commodities Bull launched in 2001,
just after the secular top in the general stock markets after
a mighty equity bull lasting for half of a 33-year valuation
cycle. Market history is very emphatic in demonstrating that
the 17 years after this parallel commodities bottom and equities
top should be great for commodities but very poor for equities.
This precedent suggests commodities should be strong and equities
weak for another decade or so from today.
And indeed commodities capital investment was neglected for two
decades prior to 2001 so production is low while demand is skyrocketing,
particularly out of Asia. Just as with gold specifically, for
commodities in general constrained supply growth accompanied
by accelerating global demand guarantees higher prices.
Why languish in a secular stock bear when your investments can
thrive in a secular
commodities bull? As more and more investors come to
realize this, their demand for gold and other commodities-related
vehicles will only grow greater and greater. We may as well bet
on the horse most likely to win in the next decade!
3. King of Commodities Investments. Out
of all the ways to invest in a Great Commodities Bull, gold is
the single easiest and safest. Physical gold is easy
to buy, requires no upkeep, and a great deal of wealth can
be secured and stored in a relatively trivial volume. Unlike
many other major commodities, physical gold is not perishable
and can be stored indefinitely. Gold has always been the ultimate
commodities investment.
For pure investment purposes, every other commodity falls short
of gold. You can hide $1m in gold coins in an old unused pipe
section in your house and no thief will find it in a million
years. If you buy $1m in wheat though, you will have to purchase
land and bins to store it, and insects and humidity could wreck
it in less than a year if it isn't stored perfectly. Oil may
be the king of commodities in general, but try to get zoning
permission to build a giant tank to store $1m worth of crude
oil in your backyard!
Silver is ultra-volatile and one of the greatest speculations
in history, but it is inferior to gold as a store of wealth.
In addition to its brutal gut-checking price
volatility, its value-to-volume ratio is vastly lower than
gold's. $1m worth of silver weighs far more and takes up a great
deal more room than $1m in gold. For investors wanting to deploy
capital into the secular commodities bull, gold is the most logical
choice today just as it always has been.
4. Ultimate Alternative Investment. Some
investors will buy gold to ride the commodities bull, while others
will buy gold to escape the equities bear. This distinction may
seem subtle, but it is very important. Gold is a natural destination
for equity flight capital since it is the ultimate alternative
investment in world history.
Mainstream financial investments are virtually all intangible
paper. All of the stocks and bonds we own, even all of our bank
accounts, are ultimately nothing more than someone else's
promises to pay. If these promises are not honored, then
the stocks and bonds are worth no more than the paper on which
they are printed. During the descending half of Long Valuation
Waves, after enough years of punishment investors' confidence
in paper assets wanes. Remember the 1970s?
Gold is the ultimate alternative investment because it is tangible.
It is a real physical asset that has intrinsic value in
and of itself, never dependent on someone else's mere promises
to pay. Since gold is fully independent from the paper financial
system and its underlying fragile web of promises, it has long
been perceived as the most ideal safe haven when investors flee
paper.
Interestingly, as equity flight capital bids up gold prices in
the years ahead it will create a virtuous circle that attracts
even more capital. Gold, like all investments, becomes more attractive
to more people the higher it goes. This is contrary to
normal supply-and-demand profiles, where demand becomes lower
at higher prices. In gold's case investors bidding up its price
end up putting it on the radars of even more investors, who bid
it up further and accelerate the cycle.
5. Relentless Fiat Currency Inflation. Speaking
of paper, every national currency on the planet today is pure
fiat, just paper monopoly money backed by nothing but faith
in the issuing government. Since today's monetary supplies have
no roots in reality, governments can and do grow money much faster
than the underlying pool of goods and services on which to spend
it. The US dollar has not been backed by gold since 1971.
When money supplies grow faster than underlying economies, soon
relatively more money is bidding on relatively fewer goods and
services. This increase in money supply is, of course, the scourge of inflation.
Inflation is a diabolical and immoral stealth tax imposed by
governments on their unsuspecting populaces. Ordinary people
work hard for a lifetime saving money, but when they retire they
find that their money will buy a lot less than it did back when
they were saving.
As more and more investors perceive the dire threat of inflation
to their families' futures, they will naturally migrate into
gold. Gold keeps pace with inflation, buying roughly the same
amount of real goods and services regardless of currency
in circulation. In the 1920s one ounce of gold would buy a decent
men's business suit at $20. Today one ounce of gold at $425 will
still buy the same grade of suit, while the original $20
in paper won't even buy lunch!
While paper money supplies tend to grow by 5% to 8% annually
in the First World thanks to irresponsible and unaccountable
central bankers, the newly mined physical gold supply rarely
exceeds 1% a year in growth. This stable and very low growth
rate is why gold has been the ultimate form of money for six
millennia now. With fiat currency growth rates far exceeding
the gold supply growth rate, it is inevitable that relatively
more paper will chase relatively less gold, bidding up its nominal
price.
6. Negative Real Rates. The first corollary
to fiat inflation is today's brutally low or negative real rate
environments, where bond investors either break even or actually
lose purchasing power by the mere act of lending out their
hard-earned capital. When the rate of underlying inflation exceeds
the nominal interest rates available in the markets, bond investing
becomes a losing proposition.
Free markets hinge on the crucial concept of mutually beneficial
transactions. The bond markets are where savers, who consume
less than they earn, meet up with debtors, who earn less than
they consume, to consummate capital transactions. True free-market
prices of this money, or interest rates, provide a reasonable
return to the saver and a reasonable cost to the debtor, a mutually
beneficial transaction. Interest rates should always be set by
the free markets instead of the abomination of the Fed.
But with today's artificially low interest rates, it is nearly
impossible for bond investors, savers, to get a fair return on
their capital. If they can only earn 3% on their capital but
inflation is running 4%, then they actually lose 1% of their
purchasing power every year. They are punished for being
savers, something Greenspan and his minions absolutely revel
in for reasons that escape me. It is saving that should be encouraged
and debt that should be punished if a nation truly wants to grow
its wealth!
As such, when central banks artificially manipulate interest
rates too low bond investors gradually pull out of the rigged
market. Since they can't beat inflation in bonds, they gradually
migrate into gold so they can at least maintain their purchasing
power. Negative
real rate environments are one of the most bullish scenarios
imaginable for gold investment demand, since it drives capital
out of bonds and into gold.
The Long Valuation Wave winter will drive exasperated equity
investors into gold, but the unfair and artificially gutted interest
rates will drive fed-up bond investors into gold. It is foolish
to allow a central bank to force savers to subsidize wanton debtors.
The savers may as well just buy gold to ride out the inflationary
storm and say to heck with the debtors taking advantage of them.
7. Central Banks Always Lose. Of the
roughly 150,000 metric tonnes of gold thought to be mined in
all of world history, today central banks control about 20%,
30,000 tonnes. Since central banks rightfully consider gold to
be a threat to their dishonest fiat regimes, investors sometimes
fear central bank intervention in gold. Surprisingly though,
central banks are probably the worst institutional gold traders
in world history.
One of the most foolproof indicators that a secular gold bear
is ending or a secular gold bull is getting underway is central
bank sales. Like the Bank
of England's recent fiasco of dumping gold at a multi-decade
bottom, for some reason central banks tend to sell at exactly
the wrong time. Central bankers, amazingly enough, are
human too and subject to the same greed and fear as all speculators.
It is only at the end of long demoralizing bears when they start
believing Keynesian propaganda that gold is a barbaric relic
and think about selling.
And when they do sell, usually near multi-decade bottoms, their
gold sales are always very temporary in impact. The only way
to control a global price is to put a gun to the head
of every buyer and seller of that particular commodity
on the planet. 120,000 metric tonnes of gold, or 80% of
world supplies, are not controlled by the central bankers.
Investors buying and selling this vast majority of non-official
gold ultimately determine world prices through their supply and
demand. The central bank tail can't wag the bull for long!
Betting against central banks on gold is the ultimate contrarian
gold play. In the early 2000s they were selling aggressively
and remember what happened? Did gold go from $255 to $200?
Nope! Instead it went from $255 to $455 despite
the heavy central-bank liquidation. Expecting central banks to
seriously hinder a secular move is like expecting a bureaucracy
to be efficient, a very low probability bet. They are all talk
with very little if any long-term leverage in gold.
8. Information Free Markets. For all
of human history until 1995, large organizations like governments
had a vast advantage over individual investors when it came to
information. But since the World Wide Web started growing popular
outside of academia in the mid-1990s, the inherent information
asymmetry working against individuals has vanished. Today a cheap
PC and broadband grants you information-gathering capabilities
vastly superior to those of entire empires in world history.
Gold is the ultimate free-market asset and currency and thrives
in eras when information flows the most freely. Today's Information
Age is witnessing the greatest free-flow of information in world
history, far beyond the wildest expectations of empires past.
Thanks to the ease of learning about anything instantly from
your own home today, governments can only pull the wool over
the eyes of its citizens who willingly choose to remain
ignorant.
Today investors around the world can easily learn about monetary
history, stock-market history, gold, the immoral stealth tax
of inflation, and countless other crucial core topics essential
to long-term wealth building. Thanks to the Internet governments
no longer have a monopoly on monetary truth. Investing in gold
is the inevitable outcome of learning more about the treacherous
history of markets and money, not to mention government.
The dazzling Information Age is also facilitating the rebirth
of private 100% gold-backed currencies, this time in the
form of digital
gold. Why store your transactional money in the form of rapidly
inflating fiat when it could be stored in digital gold and hence
never losing purchasing power? As gold-backed digital currencies
gain popularity, demand for physical gold to back them will continue
to grow.
9. The Rise of Asia. With China destined
to become the next superpower while the West wanes, the locus
of global economic might is shifting to the Far East. Unlike
Western cultures like us Americans who are brainwashed into thinking
of gold as a barbaric relic, inferior to paper assets, Asian
cultures still have strong affinities for physical gold. A great
example is Indian families storing wealth in the form of intricate
gold jewelry.
As Asian citizens and investors grow wealthier, their traditional
love of gold will ultimately lead to huge amounts of capital
shunted into physical gold as they diversify their investments.
As Asia's hard work leads to greater affluence, its per capita
gold investment consumption will utterly dwarf that of the West.
While an average (read non-contrarian) American investor may
have less than 1% exposure to gold, an average Asian may want
10% or even 20% of his or her portfolio invested in gold.
Even if the average Asian remains poorer than an average American
in an absolute sense for another couple decades, the combined
effect of hundreds of millions of newly-liquid investors
buying small amounts of physical gold could be staggering. I
suspect that if Western central banks are dumb enough to dump
their entire 30,000 metric tonnes of gold in the years ahead,
the awakening Asian giant will collectively swallow it all up
without even breaking a sweat.
Asia is probably the single biggest gold investment demand story
in world history. It should ultimately dwarf US equity flight
capital and US bond flight capital and could very well lead to
the biggest gold boom the world has ever seen.
10. Technical Proof. The only sure way
to understand true underlying supply and demand fundamentals
is by observing price action over a secular period, at least
several years. If global gold demand is really growing faster
than global gold supply, then the gold price has to rise.
There is simply no other economic alternative in a free market!
And make no mistake, the gold market is free until every
single buyer and seller on Earth can be physically coerced by
a single entity.
The chart below shows our awesome secular gold bull to date,
the proof of the pudding. For about four years now, a secular
time span, gold demand has exceeded gold supply driving up prices.
If it was the other way around, if supply, including central
bank selling, exceeded demand, this would be a downward-sloping
bear trend.
Gold has climbed higher in
US dollar terms for four years in a row now, with annual percentage
gains noted on the X-axis. Bull to date the Ancient Metal of
Kings is up 77.4% as of late last year. Gold's long-term support
lines have held rock solid for its entire bull, running parallel
with its strong upward-sloping 200-day moving average. Gold has
carved five major higher interim highs and five major
higher interim lows, an unmistakable secular bull fingerprint.
This gorgeous secular
gold bull chart would never have happened if gold demand
was not growing faster than gold supply in the last four years.
Nor would it have happened if the rampant central bank selling
since 1999 was anything more than a temporary nuisance. A
multi-year secular trend is beyond argument, as it reflects bullish
underlying supply and demand fundamentals for gold.
Conclusion. I hope these quick macro thoughts help clarify
why I remain long-term bullish on gold. While whole books could
be penned on each of these 10 major reasons why I am bullish,
I hope the general flavor was communicated here.
Now that I have a baseline established and my biases are exposed
and on the record, I am looking forward to delving into contending
gold perspectives in future essays in this series. Other gold
bulls believe other things and there are even prominent gold
bears today forecasting new multi-decade lows in gold.
All of these perspectives are valuable to analyze and provide
worthy pursuits to diligent students of the markets.
If you are with me in the long-term bullish gold camp and are
interested in actively investing in this gold bull, you may wish
to consider subscribing
to our acclaimed Zeal
Intelligence monthly newsletter.
My partners and I have been painstakingly analyzing virtually
every publicly-traded gold company over the past four or five
months and are starting to delve into our extensive work with
gold juniors in the upcoming March newsletter. Few speculations
offer greater leverage to gold's bull-market gains than the very
best junior miners!
In the meantime, it is in the best interest of all serious students
of the markets to consider perspectives contrary to our own.
Even if we reach the conclusion that a contending gold perspective
is lacking in some way, the mere act of studying and thinking
about it will increase our own understanding. And the more we
understand, the more successful our trades ought to be!
February 18, 2005
Adam Hamilton, CPA
Thoughts, comments, or flames? Fire away at zelotes@zealllc.com. Due to my staggering and perpetually increasing e-mail load, I regret that I am not able to respond to comments personally. I will read all messages though and really appreciate your feedback!
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