Is the Gold Bull Run Over?

I would not blame anyone for declaring the gold bull run over. According to the standard definition of a bear market—namely a 20% decline from a top—gold would be in a bear market given its $450 (23%) decline from the 2011 high of $1920.

The question now is, can it recover from this? It recovered from a 30% drop in 2008 and continued to soar another $1,200 from its $720 low of that year, rising some 166% over the following 3 years.

Can gold rise out of the ashes again?

Gold’s Forecast

Not according to a Bloomberg survey:

“Prices will close the year at $1,550 an ounce…according to the median of 38 estimates compiled by Bloomberg…Investors are selling bullion held through exchange-traded products at the fastest pace on record…Societe Generale is predicting a fourth-quarter average of $1,375, the lowest for the period in three years.”

“Goldman Sachs Group Inc., Barclays Plc, Credit Suisse Group AG and Morgan Stanley are also among those forecasting lower prices,” the survey showed. “While Goldman ended a recommendation to sell on April 23, the bank said further declines are likely.”

On the other side, “[UBS] now expects gold to average $1600 during 2013 … and $1625 in 2014,” informs Mineweb.

Far be it from me to be adamant one way or the other. As some point all bull markets end. And at some point all corrections end. Which point is gold at now? The end of the bull, or the end of the correction?

It’s All About Inflation

The practice of forecasting markets is not a perfect science because no one really knows what all the participants in a market will do. And conditions are constantly changing. This is why “10 of the 38 analysts surveyed by Bloomberg expect gold to gain for a 13th year,” the news service includes.

What could these 10 gold bulls be seeing? Do not all analysts use the same numbers?

Yes, but they apply different past experience to them. That is the individual’s contribution to the equation, as each analyst or investor draws on different past experience.

Let’s take some climate readings and apply past experience, then. Currently inflation is low, with little evidence of it rising any time soon. Since the U.S. dollar has been strengthening as of late, “inflation expectations measured by the break-even rate for five-year Treasury Inflation Protected Securities reached the lowest since November on April 18,” Bloomberg informs.

“The stronger the dollar gets and the more America starts to recover, the weaker the gold price is going to get,” Bloomberg quotes Rene Hochreiter, chief executive officer of Allan Hochreiter (Pty) Ltd. and last year’s most accurate forecaster in the London Bullion Market Association’s annual price survey. “The direction is going to be down for a while to come.”

Gold is often held as a protection against inflation. The 28 gold bears do not see inflation posing any serious risk and would rather take money out of gold to invest in equities, which have been on a tear lately.

What are the 10 gold bulls seeing? Their past experience reminds them that inflation often arrives with a burst, suddenly, with little warning. Although those dark clouds are still way, way off in the horizon, the 10 bulls see them coming.

Central banks are seeing those conditions too and have continued their gold purchases, taking advantage of the cheaper gold prices. While hedge funds have been selling gold to invest in stocks, central banks still possess almost one-fifth of all the gold ever mined.

“Their combined reserves have risen to an eight-year high as nations from Russia to Kazakhstan (916.046) to Mongolia expanded holdings, IMF data show,” reports Bloomberg. “The banks bought 534.6 tons last year, the most since 1964, and may add as much as another 550 tons in 2013, according to the London-based World Gold Council.”

Mark O’Byrne, executive director of GoldCore Litd in Dublin, Ireland, sees the buying continuing. “Given that the fundamentals remain as sound as ever, we remain bullish,” he argued. “Global demand for physical bullion is set to lead to a recovery in prices.”

Change or No Change?

Clearly, while both bulls and bears see the same conditions—namely low inflation expectations, a strong U.S. dollar, and rising equities on the back of a recovering U.S. economy—they arrive at different conclusions regarding the future of gold prices.

Why? It’s all about momentum and change. The bears see current conditions staying the same, while the bulls see them changing.

The gold bears see a rising stock market and believe it will continue. Hedge funds continue liquidating gold positions to buy more stocks, “cutting their net-long [gold] position by 25 percent in the week ended April 23, U.S. Commodity Futures Trading Commission data show. They held 69,726 contracts betting on a decline, the second-biggest position since the data begin in 2006,” Bloomberg supports.

They also see that the Fed’s loose money policy has not changed, as was reiterated Wednesday, helping lift stocks higher with ever greater upside momentum.

The gold bulls, on the other hand, see things changing. They see weak corporate earnings and the painfully slow employment recovery as signs that the momentum in equities will have to change sooner or later.

Even though the Fed’s policy is clearly not going to change for some time, the gold bulls see the continuing bond purchases and low interest rates as forces applying downward pressure on the USD and upward pressure on inflation.

After all, the Federal Reserve could not have been any clearer when it said it wants a moderate level of inflation in the 2 to 2.5% range. The Fed wants some inflation, and it will not stop until it gets it.

Even so, the gold bears are not worried about moderate inflation, believing that the Fed will be able to contain it and stabilize it at 2%. Yet the gold bulls contend that by the time inflation arrives, it will have so much momentum built into it from so many years of easy money and low interest rates that containing it will be like trying to stop a ship with a rope and a little rubber dinghy.

So while the gold bears see nothing changing, the gold bulls see everything changing. And that applies to the recent performance of the gold price as well.

Fight Now or Fight Later?

The gold bears say, “Don’t fight the Fed; buy stocks.” The gold bulls say, “Don’t fight the Fed; buy gold.” Both sides believe they are in perfect sync with the Fed.

The difference between them is that the gold bears are in sync with what the markets are doing today, while the gold bulls are in sync with what they expect the markets to do in the future.

What will the markets do in the future as a result of all this Fed spending and stimulus? We need only look to what has been happening in Japan, where stimulus has lifted equities, crushed the yen, and lifted gold to record highs as expressed in yen. And this has happened without inflation.

As for gold expressed in USD, the Federal Reserve’s three stimulus packages since 2009 have indeed raised equities and propelled gold to all-time highs several times until 2011. The reason gold has not experienced sudden upward thrusts lately is because Fed stimulus has not been as abrupt as before, but is now a steady measured flow.

It is a lot like turning up the hot water in the shower. You feel it when the hot water is turned up in sudden spurts, but not so much when it is turned up slowly. That is what the Fed is doing now—increasing the money supply slowly.

Even so, as the temperature continues rising, at some point you will feel it scorching. The gold bulls are expecting precisely that: the scorching sting of inflation brought by the continued release of money into the system.

And let’s not forget those dastardly credit rating downgrades that so many nations have been receiving over recent years. It has been two years since the U.S. was last downgraded, which gave gold that final push to its 2011 spike. With its credit limit due to be reached yet again this July, will another U.S. downgrade be forthcoming?

With so much happening locally and around the world, I’d say it is way too early for anyone to state where gold will finish 2013. And I won’t either.

It all depends on your time horizon. Conditions will most likely remain in gold’s disfavor today but change to gold’s favor tomorrow.

Joseph Cafariello

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