Has the secular bull market in gold ended? (Part One – Bullish arguments for gold)

16 April 2013

The honest answer to the above question is “I Don’t Know”. The most I can do is to list out the long-term factors for or against gold, and evaluate the probabilities accordingly.

Factors favouring a continuation of secular bull in gold

1. Central bank money printing

Central banks continue to print money and expand their balance sheets in order to fend off what they perceive as deflationary forces and prop up the economy. There is even talk of the US central bank headed by Ben Bernanke moving to a single mandate — combating unemployment.

While the money printing is not immediately inflationary due to the deleveraging process still underway, the slow velocity of money, and global excess capacity, money printing eventually leads to distorted asset prices, and should ultimately be beneficial for gold as people start to find ways to defend against the depreciation of purchasing power of fiat money.

Many in fact have argued that the current stock market rally especially in the United States has been a result of money printing.

2. Devaluation of developed countries’ currencies

The USD appears strong now, only because other currencies like the Euro, Sterling, and Japanese Yen are even weaker due to poorer fundamentals. The BOJ in fact has embarked on an aggressive policy of currency devaluation and money printing in order to create inflation and push up stock prices. The Yen will fall further, and faster than ever before.

The Euro is only marginally better. It is fundamentally flawed. You cannot have a monetary union without having a fiscal union. Now, the Eurozone is paying the price for the over-indebtedness of some of its member countries. The crisis will not be over soon. Eventually, Germany will be forced to either accede to money printing, or accept a long drawn-out debt crisis that may even cripple the Eurozone fundamentally. No matter what happens, the future is bleak for the Euro.

The USD is not a good currency, but it is nonetheless still the world’s reserve currency, and in the short term may function as a port in the storm.

But that being said, the USD is also likely to falter in the years ahead especially against emerging market and commodity currencies as the US faces its own problems of over-indebtedness and profligate spending, and is forced to eventually deal with the time-bomb of social security. This will be a very long term issue, so don’t expect immediate USD weakness, in a climate where other developed countries’ currencies are of much poorer fundamentals.

Developed countries will always eventually choose inflation and currency depreciation over austerity, higher tax rates, and cuts in social spending, because the former two options are far more politically palatable. This may not be the case for the Eurozone now, but it will eventually be, some way or other, no matter what Germany says.

As developed countries’ currencies including the USD depreciate against those of emerging economies, this could serve as tailwind for gold and other commodities like crude oil.

3. A looming funding crisis and loss of confidence in central banks to preserve the purchasing power of fiat money

The is a funding crisis looming ahead in the not-too-distant future. As developed countries show reluctance to bite the bullet and deal with their debt crisis decisively, investors and other central banks around the world will lose confidence in the sovereign debt of developed countries, and force interest rates up. This will lead to a funding crisis for developed countries which will be extremely damaging for risk assets.

A crisis in confidence in central banks, especially their ability or willingness to preserve the value of fiat money, will ensue. The process has in fact begun. As this psychology sets in over the coming years, people may start turning back to gold and silver as a form of “central bank insurance”.

To round up:

These 3 factors does not imply that gold will necessarily rebound over the coming months. These factors will take a long time to play out. In the meantime, psychology against gold can become even more negative, and selling can continue as stale bulls continue to bail out.

Over the next few years, we may see these 3 factors come into play and cause a resumption of the secular bull in gold. However, there are also factors working against gold, which may result in the 10-year long secular bull in gold (2001-2011) coming to an end.

We will examine the bearish factors against gold in my next blog post. Suffice it to say, I believe the bearish factors that I will be outlining in my next post outweigh the bullish factors I have mentioned here.