David Rosenberg: This Is How We Get To $2,750 Gold
As Rosie dedicates more and more attention to gold, his latest piece demonstrates why the melt up in gold will make the surreal "lift each and every offer" move in stocks seem like child's play.
Another reason to be bullish on gold is the recurring trade spats. Indeed, this is good news for the commodity complex as security of supply resurfaces — see China Attacks U.S. in Fresh Trade Spat” on page 2 of the weekend FT. If it’s not Chinese-made tires fingered by an increasingly protectionist U.S.A. one day, it’s steel pipe the next. This latest anti-dumping measure by the United States is facing a severe rebuke, as per the press reports, in China.
In addition to these trade protectionist actions, there is also the matter of more stimulus measures being undertaken in a mid-term election year at a time when the Treasury is expanding its debt issuance to new records right across the maturity spectrum. All anyone needs to do is have a look at the article Congress’s Blank Check For Housing in the weekend WSJ — to see this happening at a time of 10% budget deficit-to-GDP ratios, had indeed become a bottom-less fiscal pit.
Since the USA will not default, not raise taxes nor cut spending, the only logical recourse will be to print vast sums of U.S. dollars to fund this surreal foray into deficit finance. In other words, reflate. As we keep on saying, under Dr. Bernanke’s tenure, the monetary base has risen twice as much as nominal GDP has and the two lines continue to diverge. At the same time, gold production peaked a decade ago. It’s all about scarcity of supply, and as Sri Lanka’s central bank just reminded us, and India before that, there are buyers with deep pockets lining up to diversify into bullion. Here are the ‘what if’ realities stack up:
- If India were to lift is gold share of FX reserves from 6% to 20%, where it was during the strong U.S. dollar policy days of 15 years ago, we estimate that gold would go to $1300/ounce.
- If China were merely to copy what India just did and raise its share to 6%, then gold would go to $1,400/ounce, based on our in-house analysis.
- If the USA were to go back to a 40% ratio of gold reserves to money supply (using the monetary base), where it was a century ago when the Fed was first created, from 17% currently, that would equate to three years’ supply of bullion, and alone take the gold price up to $2,750/ounce, based again on our research on price sensitivities to central bank buying activity.
Now gold is in a secular bull market and by no means are we suggesting that everyone line up at the vaults right this second — for the time being, it is too much front page news and a crowded trade, so it won’t hurt to wait for a pullback and get in at better prices (as an example, see Inside the Global Gold Frenzy on the front page of the Sunday NYT business section).
You see, when Bob Farrell wrote “The 10 Market Rules to Remember” he made sure that they were interesting reading and in doing so, some people get a laugh out of Rule Number 9 (“When all the experts and forecasts agree, something else is going to happen”) and Rule Number 10 “Bull markets are more fun than bear markets”). Nevertheless, they are just as important as the other eight rules. The obvious reason why Rule 5 is important (“The public buys most at the top and least at the bottom”) is that it also captures the inverse relationship between sentiment and the position of the market (ie, bullish sentiment peaks when the market tops and turns down and bearish sentiment peaks when the market bottoms and turns up). All that “agreement” adds enormous credibility to conventional opinion, just when it is most important to envision and prepare for the contrary. Lately, (you) have been experiencing shock at the policy responses by the U.S. government relative to the credit crisis and economic slowdown. Policies that encourage increased indebtedness by households and businesses are combined with massive deficit spending and Federal Reserve balance sheet expansion and the latter particularly, has enormous inflationary implications while exerting downward pressure on the value of the U.S. dollar. The problem with this understanding is that most everyone agrees.
To wit: According to Consensus Inc., bulls on the U.S. dollar are currently at 28%. Bulls on Treasury bonds are currently at 59% after hitting a low of 21% in early June when rates peaked in this cycle. Bulls on gold are at 78%. Bulls on the stock market are at 74% and they haven’t been that high since October 2007. It has become a crowded trade, and something very contrary to the expected outcome is likely to occur, at least over the near term.
Walter Murphy, our favourite technical analyst, expects a substantial rally in the U.S. dollar and a decline in gold over the medium term, even if those moves are counter-trend. He thinks that the war is on inflation, but the battle is deflation and this is a bear market rally in stocks. We have said repeatedly that it seems too early to call for an economic expansion with so much unfinished business in the process of household balance sheet repair. And, keep in mind that the deflationary forces emanating from the household are much greater than the inflationary forces associated with government stimulus, at least so far.