Love Gold? Hate Gold? I Agree!

Written by Adam English
Posted May 19, 2017 at 8:00PM

Gold bugs and haters are both right, and terribly wrong.

It is true that gold doesn't do a thing except take up space. It is immutable and unchanging. It doesn't generate revenue. Only a fraction of global supply has any industrial use.

I am really not a fan of this aspect of it as an investment. The wealth-generating power of a tried-and-true company that can take money today and turn it into exponentially more money down the road is profound.

However, the argument against it completely, and conveniently, ignores exactly why gold is so important because it doesn’t do a thing.

Gold is a great investment because too many risk factors exist, and too many unknowns can be in play in an overheating market like we have today.

While the people at the helm of the global fiat currency and economic systems can manipulate and undermine everything and anything else.

Meanwhile gold follows a simple equation. While shorts can push market prices around, reality inevitably prevails.

Gold, the “barbarous relic” as it is pilloried, is far from being a thing of the past. In fact, it is finding new importance right now.

We're seeing the classic supply and demand equation supporting higher gold and silver prices already, and a new variable emerge from the latest economic abominations that will only support it further.

The Standard Equation

The gold market is defined by supply, demand, production costs, and currency values.

The value of the U.S. dollar has always had an inverse relationship to gold prices for obvious reasons. If a dollar is worth more, it can buy more gold, thus the same amount of gold is worth less in dollars.

This was the defining force behind sinking prices in 2014 and 2015, following a period where QE and some economic stability brought down gold prices from dizzying heights:

gold v usd 19may17

However, only a fraction of gold is priced in U.S. dollars. Roughly 90% of gold demand comes from the rest of the world, and gold prices were stable or went up around the globe in 2015 when priced in local currencies, including the most important markets — India and China.

That demand, coupled with sinking currencies, and emerging market and Chinese economic weakness, is only climbing. However, supply isn't easily matched to demand.

While demand can change quickly, supply cannot. Mining is capital intensive, and it often takes 20 years or more for gold in the ground to actually make it to the market:

Production is going to start trending down, and most estimates put 2014 and 2015 as the peak of production for many years to come.

Add in the debt burden of mining companies and the overly high cost of pulling gold out of the ground for major producers — most major miners have all-in sustaining costs around $1,000 per ounce — and there isn't much change to free up cash for capital investment.

So, to sum it up, outside of suppressed prices in U.S. dollars, gold prices are trending up in the global market, demand remains strong, yet supply is going to be hindered for years to come due to falling production and lack of capital.

The standard gold metrics support higher prices. Then there is the new variable being added to the equation.

The New Variable

Gold doesn't change, but people and the tools they use to manipulate things to their advantage sure do.

That is where our new variable comes in, the one that is proving that gold is far from a “barbarous relic.”

Thanks to central bank intervention lasting so long, we're looking at another downward cycle in the global economy with no traditional monetary policy tricks remaining to manipulate investor behavior.

We're now well into uncharted territory, with many major central banks pushing even deeper.

There are $10 trillion in negative yield bonds on the global level. Central banks are turning to corporate debt to pump cash into markets, and running out of stuff to buy.

There is no room in a sane world for there to be any demand to lose control of money for years, then to receive less of it back in the end, yet this is happening now on a massive scale.

These ever-expanding balance sheets cannot be easily unwound.

The ECB plans to maintain its balance sheet forever, in the hopes that Europe's economy outgrows it.

The Fed has been the subject of much talk in this regard. It bought Treasuries, now totaling about $2.5 trillion, and mortgage-backed securities — loans packaged together as bonds now valued at around $1.8 trillion.

Two options exist. Simply don’t rollover the bonds when they mature, and gradually shrink the balance sheet over a decade or so, or start selling into the market.

The former provides huge stability perks at the cost of time. The latter provides a quicker return to normal at the risk of flooding the market.

However, both will impact interest rates, forcing them higher. And all the while, the central banks have no tools to combat another downturn, essentially betting on another decade of unprecedented, if tepid, stability.

The Only Middle Ground

This isn't going to be resolved quickly at all. Coupled with very high market valuations and mediocre or mixed economic data, and we're stuck between the proverbial rock and a hard place.

So should we sit on the sidelines? Or should we try to time it right and capture the gains while we can? I think we can do both, if we play both sides of the pro- and anti- gold argument.

Thankfully there is a middle ground. Money is flowing into gold-producing companies, and prices have been steadily recovering all year long.

So ignore the naysayers, detractors, and the imbeciles who say that gold is a useless relic of the past. And while physical holdings have their virtues, don’t forget that it will just sit there, doing nothing.

Be agnostic, don’t pick sides, and get the best of both worlds.

Look at the best-in-breed gold companies that will rise on both gold prices, and capital investments they are making today that will multiply value — and your wealth — over time.

Take care,

adam english sig

Adam English

follow basic @AdamEnglishOC on Twitter

Adam's editorial talents and analysis drew the attention of senior editors at Outsider Club, which he joined in mid-2012. While he has acquired years of hands-on experience in the editorial room by working side by side with ex-brokers, options floor traders, and financial advisors, he is acutely aware of the challenges faced by retail investors after starting at the ground floor in the financial publishing field. For more on Adam, check out his editor's page

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