David’s Commentary:
Most of our readers probably think that inflation and the dollar have the greatest affect the price of gold. They would be wrong. In fact, it is not the dollar that is relevant to gold bull markets, but the stock market. Dr. Leeb says,
“A bear market for stocks for nearly two centuries has been a bull market for gold.”
Ah, but here is where things get interesting. Since 1972 things have changed. And what could have possibly caused that? We can thank Richard Nixon, who in August 1971 removed gold as the backing for the U.S. Dollar. Nixon let the price of gold “float” instead of fixing it to the dollar at a set price.
Dr. Leeb writes,
“What’s particularly relevant for investors today is that the three most recent periods of poor market performance/positive gold performance occurred during commodity bull markets, years in which commodity scarcities led to rising commodity prices and higher overall inflation. In all three periods, the first of which started in 1972, gold was the leading performer among assets considered commodities (gold should be viewed as both a commodity and a currency).
In other words, since 1972, gold has been behaving in a very different manner from all the years before. The change occurred in the context of gold prices that, starting in the early 1970s, were no longer fixed and with gold no longer playing a direct role in the global monetary system. (Jastram likely thought the gains in gold in the 1972-77 period were not durable when he made the conclusions we noted above.)
Gold Will Rise During Bear Market In Stocks
This is more than a history lesson. Rather, it offers a clear message to investors today: If there is a bear market in stocks in 2019 that leaves the three-year total return in equities in negative territory, gold is nearly sure to rise.
Here is where the rubber hits the road. Dr. Leeb says,
If there is a bear market in stocks in 2019 that leaves the three-year total return in equities in negative territory, gold is nearly sure to rise. So we need to look at how likely it is we might get such a bear market in stocks, one that could wipe out the gains we have seen since 2016 and will leading to the blistering bull market in gold that will underlie a new monetary system in the East and possibly the entire world.
This is another theme I have been pounding on. Gold will not start its bull market move until the stock market implodes.
Dr. Leeb says, “It all revolves around China.”
The U.S. won the Cold War by outspending the Soviet Union on defense, with the Soviet Union running itself into the ground by trying to keep up. That led to a decade or more of dire consequences for most of the FSU, including Russia.
This time around it’s the U.S. vs. China, a much more formidable foe. And this time around, it’s the U.S. that appears to be in the far more vulnerable position.
A startling recent data point has been the poor performance of defense stocks despite blockbuster earnings. Whenever stocks sell off in the face of much better than expected earnings, it signals that investors have some general unease about the sector. In this case, I see it as a sign that investors believe we won’t be able to raise defense spending. Even Trump in a cabinet briefing on October 31st said defense expenditures will fall in 2020. The current allocation of $716 billion has become a ceiling not a floor.
In other words, when it comes to defense we have shot our bolt. We are spending as much as we can afford given all our other obligations, which now translate into trillion-dollar deficits.
A strong military defense is one of the critical ingredients for any country that has or wants to maintain its currency as a global reserve currency. And when it comes to defense, China has some major advantages over the U.S. First and most important, it isn’t looking to dominate throughout the world. Rather, the sphere where it wants to be dominant is the East and in most emerging economies. This more limited objective means it doesn’t risk bankrupting itself by seeking to be everywhere at once.
After a brief discussion of China’s military spending and relationships with Japan and India, Dr. Leeb concluded,
China has the edge in defense, in the size of its economy, and in trade. Those are the three key factors that make a currency credible and desirable as a reserve currency. It’s why it seems so evident that the yuan – which, as China has made plain, will be linked in some fashion to gold – will become the new reserve currency at the very least throughout the East.
Perhaps this is why China has been accumulating massive amounts of gold for the past decade or two. Gold has been moving closely in sync with the yuan. Is this the precursor to a yuan-gold backed new “reserve currency?” Leeb thinks so.
The dollar’s global reserve currency status at this point is essentially a legacy based on oil and the petrodollar. This brings us back to the Eastern oil benchmark that China has launched and that I’ve written about a lot previously. I had expected that by now we would have seen more progress in gold as well as a strengthening of the yuan in response to the benchmark. But the tariffs threw a curve ball – one that, for all the reasons cited above, I expect will prove temporary. In addition, China is deleveraging, and to mitigate any near-term damage from the tariffs it has let the yuan fall. That, in turn, has kept gold – which as we’ve pointed out has been moving closely in sync with the yuan – in check for now.
As we go forward, we expect to see the tariffs wind down and to be less of an issue. Among other things, the U.S. can’t afford to shoulder the effective tax that tariffs impose. And that will leave the path free and clear for the yuan. In the end, the current quiet period for gold should turn out to be just a brief hiatus before a new monetary system, backed by gold, falls into place.
A New Monetary System
As I have said before this new monetary system will likely be defined in terms of baskets of currencies and commodities that are exchanged using sophisticated blockchains. Gold will be the floating backstop. And given the amount of world trade I continue to expect most of us to see five digit gold prices in our lifetimes.
Adam Tumerkan, @ Palisade-Research.com points out that central banks are buying their most cold in years as they look to reduce risk. He says,
‘Gold is key for risk reduction’
Having a certain amount of gold in a portfolio works well to protect against sudden market drops – as I’ve shown previously (
read here).
As I wrote then – “Just look at the average price of gold during times when the S&P 500 fell more than 15% over the last 20 years. . . You can see that during times when markets collapse more than 15%, gold positions would do very well. The gold mining equities and warrants do even better. . .”
Here is his data on central bank gold purchases…
This highlights the trend we’ve seen by central banks charging in to gold since after the 2008 crisis.
I wrote two weeks ago (
click here if you missed it) that post-2008, central banks – especially the Emerging Markets – have insatiable gold appetite. And I believe this is helping to put a floor under the price of gold.
Just look for yourself. . .
