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What Is Really Driving Gold?

Secular Investor's picture




 

NOTE: We are excited to release our first column under our new name. Loyal readers of Zerohedge have read many of our insights under Sprout Money [http://www.zerohedge.com/blogs/sprout-money]. As of this week we will continue to bring the best of ourselves under Secular Investor [http://SecularInvestor.com]. This name reflects what we stand for: a research team that identifies and monitors secular trends in order to provide maximum profits for subscribers.

cheap gold mining stocks

If anything, gold bulls are continuously looking to confirm their bullish outlook. Most precious metals websites are filled with stories, news and developments from the gold market, accompanied by the implication that they will drive the gold price up. Examples of this include gold coin sales, Shanghai gold withdrawals, central bank buying volumes, evidence of market manipulation, money printing volumes, velocity of money, etc.

The ongoing narrative is that there is a positive correlation between monetary stimulus and the price of gold. However, as you probably know by now, precious metals collapsed during the Fed's QE to infinity program. The long-term gold chart (first chart below) shows that gold stabilized when the Fed started tapering and around the end of QE, which is very counterintuitive to say the least. That is not to say there is no correlation, but there is definitely not a direct correlation.

This begs the question: what drives gold and the whole precious metals complex?

Before answering that question, readers should understand gold's dual role. Fundamentally, it provides protection during times of monetary crisis. That is why a secular investor needs physical gold in its portfolio, especially as the current government debt bubble and global currency crisis unfold. However, this type of protection is only useful in exceptional times.

Next to that, gold is an investment asset. We are aware that the average gold bug does not agree with this, but let's face it, most of the time we do not find ourselves in extreme circumstances. Gold follows the dynamics of market cycles as well: it goes up until it is (severely) overbought, it goes down until it is (severely) oversold, it consolidates (for a long time), and starts all over again. Admittedly, this is a very simplistic view, but that is essentially what a normal cycle looks like.

What we, as humans, tend to do is associate 'events' with market developments, because we need an 'explanation' for everything. Similarly, when trends change, we want to be able to explain why that is happening, and associate it with some sort of 'event'. That is human nature. This has a drawback, however, as it prevents investors from looking at reality. Think about this for a second and try to identify the last time it happened with yourself.

One of the real drivers of investment assets, however, is opportunity and opportunity cost. What does that mean? It means that people prefer assets that are likely to have better yield. Alternatively, if an asset climbs too high and/or too long, the opportunity cost becomes high.

This is true today more than ever before and there is a reason why we are emphasizing this. The point is that all trading decisions nowadays are computer based. More than ever before, small and large investors are using chart and market analyses to make decisions.

On top of that, algorithmic trading is becoming more prevalent. We, just like everyone who is in some way disadvantaged by algo based trading, are no fans of this practice. But let's face it, algorithms have the same driver as the humans that programmed them: they search the markets in search for maximum yield.

Electronic trading is a factor that should not be underestimated. It is driving markets more than ever before, and the gold market is no exception to that. That is not to say we like it; it is simply the way things are done nowadays.

To make that point, we have added several “events” to the long term gold chart. Note how gold was rising during QE1 and QE2. When the Fed went 'all-in' with its QE to infinity program, gold started to collapse. Clearly, there is no one-to-one correlation between the gold price and 'the creation of money', which was widely assumed up to that point.

gold_monthly_chart_1999_March_2015

Gold's uptrend in 2011 had lost so much momentum that alternatives started to look much more interesting. As a consequence, gold's strong trend started turning and it eventually reversed; just because other alternatives had higher yield expectations.

Gold's fundamental driver: inflation (expectation)

We went one step further and analyzed all market conditions when the big rally in precious metals started in the summer of 2010. The only observation that stood out was the record volume of short positions held by commercial traders in the COMEX gold futures market (not in silver though). Because of that, the short squeeze that followed was phenomenally powerful. COMEX helped fuel the rally, but it is doubtful whether it was the 'driver'.

The clearest driver, in our view, has been inflation expectation. The chart below makes that point. The red line, which represents TIPS (inflation-protected US Treasury bonds), an instrument that reflects real yields for maturities ranging from 5 to 30 years, moves almost perfectly in sync with gold. Similarly, we know meanwhile that disinflation (a slowing level of inflation, not deflation though) is gold's biggest enemy. That is confirmed by the stabilization of TIPS since mid-2013, which has been preventing gold from rising as the chart shows.

Another thing that stands out on the chart below is that gold does not correlate with interest rates (the grey line). There is a strong narrative currently around interest rate hikes and lower gold prices. The problem with that is the underlying assumption that all other conditions apart from interest rates remain the same, in particular the rate of (dis)inflation. For instance, if interest rates go up in an inflationary environment, we should see gold go up. Remember, it is the interest rate in the context of inflation expectations that drives gold.

TNX_GOLD_TIP_1999_March2015

We can hear you thinking, dear reader, that we are not taking manipulation into account. Manipulation works in both directions, however. When gold was going through one of the strongest and longest bull markets in history, there was also market manipulation. Just like it pushed gold prices higher back then, it has been reinforcing the downtrend since its peak. Consequently, as precious metals have been manipulated lower, there will be a point where the opportunity becomes so attractive that investors will increase their exposure to gold related investments again and we could be very close to that point.

The other argument that one could come up with is that we are not taking physical gold's supply and demand into account. The fact is these are not price drivers. Why? Demand for gold is truly different than demand for other commodities because the supply of gold is fixed (it only increases by approximately 2% per year). Consequently, higher gold demand means that gold is merely changing hands, without necessarily pushing prices higher.

Gold's investment driver: opportunity (cost)

At its all-time high in 2011, gold was severely overbought. There was simply more potential for yield in stocks. The long-term S&P 500 chart (see below) makes that point. The notes indicate that the rise of the stock market is not linked to one type of event, although it is commonly accepted that the creation of money has been fueling it.

Even more interesting, in 2012, when QE to infinity was launched, the chart setup for US stocks looked promising. There were several sell offs in the years before which prevented the overheating of momentum, as indicated by the two green circles. Gold, on the other hand, showed a failed attempt to push through its peak.

s&p500_monthly_chart_1999_March_2015

However, as time passes and conditions change the opportunity cost to not hold gold-related assets is subject to change as well, and to such an extent that it is turning into an exciting opportunity. Maybe the gold market will attract sufficient interest in one or two years, or in a couple of weeks, we simply do not know in advance. But the key point is the opportunity, and contrarian secular investors have a strategic plan which they are slowly but surely executing as the new trend unfolds.

When gold's trend changes, everyone will be ready with a 'reason' or an 'explanation' for the new uptrend. A new narrative will be created. Mark our words. Most investors, however, will enter very late in the new cycle because they are still blinded by the former narrative, the one which says that gold will not go up because of reasons x, y, and z.

Another golden opportunity in the making?

Going forward, what does all this mean for secular investors? We will answer that question based on the chart below as well as the long-term gold and S&P 500 charts above.

First, the S&P chart above looks tired. Momentum is fading, which does not bode well for the short and mid term. Is this the end of the stock bull market? Probably not, but hard to say. Assume a scenario in which stocks would correct and test the breakout point; that would point to a strong secular bull market going forward in US stocks. On the other hand, a break below 1,600 points would be ultra bearish.

Second, gold is building a solid base and there is a technical buying signal, evidenced by the green circle on its long-term chart (first chart above). If the consolidation continues, and gold doest not break below $1,000/oz, the opportunity cost for not holding gold related investments would simply become too high.

Consequently, if inflation picked up in an environment where the opportunity cost of not holding gold rises, gold would most likely continue its secular bull trend in a big way. Do you recognize the two drivers we discussed before?

Likewise, as long as the ongoing disinflationary trend continues, gold rallies will be capped.

Other asset classes, in particular commodities and the dollar, are somewhat mixed. On the one hand, commodities have fully retraced their multi-year rally and the chart does not look good. At the same time it seems that the downside is becoming limited. The dollar has had a strong rally, but keeping this up at the same pace is doubtful because of the exceptional strength of its recent rally, as we explained last month.

crb_tnx_dollar_s&p_2000_2015

So could we conclude that gold has an attractive outlook and that opportunity cost is rising? Being secular investors, we think so, but we would like to see more evidence.

What we would like to see, ideally, is an indication of rising inflation, which could come in the form of an uptake in economic activity; that would stop the ongoing disinflationary trend. However, there is another form of inflation. If interest rates rise, bond prices would fall. As the bond market is huge compared to other markets, it means that a significant part of those dollars and/or euros will flow to other assets. Because of that, the price sof stocks and commodities, including gold, should inflate.

And there you have our contrarian call. We at SecularInvestor.com are sensing that higher interest rates could become the next trigger to push precious metals higher in the years ahead.

Obviously this is a statement that goes against the ongoing narrative and consequently it is not in the minds of most investors. Why? Because almost everyone believes that gold can only go lower, that interest rates can only go lower, and that there is a one-to-one correlation between interest rates and gold. This has been fueled day after day by mainstream media, as usual.

>>> Check Out Our Latest Gold Report!

Secular Investor offers a fresh look at investing. We analyze long lasting cycles, coupled with a collection of strategic investments and concrete tips for different types of assets. The methods and strategies are transformed into the Gold & Silver Report and the Commodity Report.

 

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Mon, 04/20/2015 - 05:18 | 6010387 XXL66
XXL66's picture

Apparantly these investors of Sprout Money never saw a real 1kg gold bar...

Mon, 04/20/2015 - 03:28 | 6010352 Magooo
Magooo's picture

Love those red arrows. 

 

Perhaps you can explain how were are NOT fucked when growth stops with 100 oil --- yet the cost to extract a large portion of our oil supply is $100+

 

Looking forward to the brilliant explanation you fucking morons

Mon, 04/20/2015 - 02:57 | 6010338 Magooo
Magooo's picture

WE --- ARE --- FUCKED

 

 

 

THE END OF CHEAP OIL  Global production of conventional oil will begin to decline sooner than most people think, probably within 10 years

 Feb 14, 1998 |By Colin J. Campbell and Jean H. Laherrre    http://www.scientificamerican.com/article/the-end-of-cheap-oil/

 

HOW HIGH OIL PRICES WILL PERMANENTLY CAP ECONOMIC GROWTH For most of the last century, cheap oil powered global economic growth. But in the last decade, the price of oil has quadrupled, and that shift will permanently shackle the growth potential of the world’s economies.  http://www.bloomberg.com/news/articles/2012-09-23/how-high-oil-prices-will-permanently-cap-economic-growth

 

HIGH PRICED OIL DESTROYS GROWTH

According to the OECD Economics Department and the International Monetary Fund Research Department, a sustained $10 per barrel increase in oil prices from $25 to $35 would result in the OECD as a whole losing 0.4% of GDP in the first and second years of higher prices.  http://www.iea.org/textbase/npsum/high_oil04sum.pdf

 

BUT WE NEED HIGH OIL PRICES:  The marginal cost of the 50 largest oil and gas producers globally increased to US$92/bbl in 2011, an increase of 11% y-o-y and in-line with historical average CAGR growth.  http://ftalphaville.ft.com/2012/05/02/983171/marginal-oil-production-costs-are-heading-towards-100barrel/

 

Steven Kopits from Douglas-Westwood said the productivity of new capital spending has fallen by a factor of five since 2000. “The vast majority of public oil and gas companies require oil prices of over $100 to achieve positive free cash flow under current capex and dividend programmes. Nearly half of the industry needs more than $120,” he said http://www.telegraph.co.uk/finance/newsbysector/energy/oilandgas/11024845/Oil-and-gas-company-debt-soars-to-danger-levels-to-cover-shortfall-in-cash.html

 

THE PERFECT STORM (see p. 59 onwards)

The economy is a surplus energy equation, not a monetary one, and growth in output (and in the global population) since the Industrial Revolution has resulted from the harnessing of ever-greater quantities of energy. But the critical relationship between energy production and the energy cost of extraction is now deteriorating so rapidly that the economy as we have known it for more than two centuries is beginning to unravel. http://ftalphaville.ft.com/files/2013/01/Perfect-Storm-LR.pdf

 

Mon, 04/20/2015 - 02:20 | 6010314 Jungle Jim
Jungle Jim's picture

Like Manipuflation (sp.?) above, I have never traded paper and never will. The first "investment" I ever made was precious metals -- *physical* precious metals. ALL physical, all the time, and nothing else. To put it mildly, that has not worked out well for me at all.

*Unlike* him, I have no children, and just to live I have been forced -- FORCED -- to sell most of my "stack" at these preposterous prices, incurring HUGE financial losses. And I am SO sick of people telling me "the phony paper price doesn't matter."

Mon, 04/20/2015 - 02:11 | 6010312 Jungle Jim
Jungle Jim's picture

What about that new Shanghai Gold Exchange thing everybody was so excited about? Isn't that supposed to be open now? Is it making any measurable difference in anything?

Sun, 04/19/2015 - 22:29 | 6010004 ItsDanger
ItsDanger's picture

Bottom line on gold right now:  If the markets are being manipulated/rigged, its real easy to set the price at whatever you want regardless of demand/supply.

Sun, 04/19/2015 - 20:52 | 6009758 Manipuflation
Manipuflation's picture

I do not invest in any fund.  Sprott Money or whatever is this now  Secular Investor?  Whatever the case may be this is fact; Eric Spott has none of my money to fuck around with and never will for some very basic reasons.  I don't trade digits and to hell with the statement that as a Zerohedger I am some sort of permabull.  Sprott assumes that I am day trading for profit.  Wrong.  I'm not going to day trade digits and I never will.  I sure as hell will not run tranactions through a brokerage account.

Mr. Sprott you are missing the point of probably at least half of ZHer's.  We don't want paper statements saying this, that or the other about digit$.  Once shit money is turned into physical gold it stays as physical gold in our possesion.  When I buy I gold it is not for me and it is not meant to sell.  The metals are for my children and the medium of exchange, if you will, is gold and silver, both physical and numismatic.  Asset transfer will be much easier that way.  No one really knows what I have and to be honest I do not even know what I have.(but I have a good idea)

I do not need some private island in the Carribean or anything like that at all.  I have no interest in living anything other than a simple lifestyle.  Ramen noodles are fine if I can get a creat coin.  I have earned my rare coins and those are not bullion priced but that is different.  I am not saying that I know it all when it comes to numimatics but it has to be one best thing a person could to gather evidence as to what has all happened over the years regarding monetary policy.  Hey, I had to buy one of the few U.S. Gold Dollar coins that were ever made.  I wish I had the right mint mark but still it is expensive coin.  Remember the U.S. gold dollar?  That sort of coin cannot be explained away by some Failure REserve official.  

Paper trading is fine I guess but what we need around here is a numismatist blog once in a while.  Let's talk about some coins.   

All the Best to you Mr. Sprott.                   

Sun, 04/19/2015 - 22:28 | 6009998 the great rift
the great rift's picture

I'm making over $7k a month working part time. I kept hearing other people tell me how much money they can make online so I decided to look into it. Well, it was all true and has totally changed my life. This is what I do... www.globe-report.com

Sun, 04/19/2015 - 22:03 | 6009922 bilbert
bilbert's picture

Ummmmm...................... Sprout is not Sprott:

 

"NOTE: We are excited to release our first column under our new name. Loyal readers of Zerohedge have read many of our insights under Sprout Money [http://www.zerohedge.com/blogs/sprout-money]. As of this week we will continue to bring the best of ourselves under Secular Investor [http://SecularInvestor.com].

Sun, 04/19/2015 - 21:33 | 6009383 Hongcha
Hongcha's picture

I have about half of what I want.  Precious metals are despised now.  Seen as dead money.  No juice, no excitement, flatlined.  They are bouncing along at approximately the all-in refinement cost per ounce.  But you can't even depend on that.  Failing that line, mines will continue to produce at a loss to keep cash flow.  This final crushing has not occurred yet in the sector but I am personally staying my hand until it does.  That will be the period when a lot of diehards finally puke their holdings.  That is when I will get buying.  We are getting closer to that state of affairs, a.k.a. capitulation, but have not seen it this cycle.

The day will come to this country when the asians (because the west has been largely conditioned out of prizing it) will come over and clear coin shows in one day; the Fed will eventually either tax the living hell out of precious metal transactions or make them illegal. The criminality of the Fed will continue to metastisize until the organism arrives at demise.  You will still want gold and silver because it's good money.

Sun, 04/19/2015 - 18:12 | 6009368 Fun Facts
Fun Facts's picture

Nothing is driving gold.

There's a central bank virtual 1200 peg to the USD.

Hard not to notice.

Sun, 04/19/2015 - 17:29 | 6009273 Clesthenes
Clesthenes's picture

“What drives gold and the whole precious metals complex?”

And, you list only two engines: protection of assets; and as an investment asset.

However, the most fundamental engine that drives gold is the fact that it serves as collateral for probably all currencies and bank reserves issued by all central banks on the globe.

By “collateral”, I mean as gold once was used: you’d take a gold double eagle to a bank a hundred years ago and the bank would give you a 20 dollar paper note or credit your bank account with the same amount.

God was the collateral (an asset of the bank) and the bank note or bank account was the off-setting liability.

It is the same today; but only for banks: individuals are not allowed to play this game.

Go ahead, search financial statements of any central bank; there, you will find that gold is listed at the top of the asset statement; and bank notes or bank reserves are listed somewhere on the liability statement.

Actually, the first line on asset statements used to be “gold”; about 15 years ago they all changed it to “gold and gold receivables”; the US Treasury, to “gold swaps”.

In other words, central bank gold and gold receivables are the final collateral for all currencies and bank reserves issued by all the world’s central banks.

When we insert this factor into the equation that (eventually) determines the gold price, all other factors become quite trifling matters.

Sun, 04/19/2015 - 19:43 | 6009533 g'kar
g'kar's picture

That blog was a good read.

Sun, 04/19/2015 - 17:24 | 6009260 tocointhephrase
tocointhephrase's picture

What is really driving gold? Me....I just backef up the truck? 

Sun, 04/19/2015 - 16:57 | 6009207 jomama
jomama's picture

None of this shit matters until the day that it really matters.

That's all we're really interested in. When will that day come?

Sun, 04/19/2015 - 16:44 | 6009177 cpnscarlet
cpnscarlet's picture

When you can print all the fiat you want and people will still accept it as legal tender, you can make the price of ANYTHING do ANYTHING due to the trading of options and derivatives. Until...

If the central banks need the price of gold to stay down to make their confetti look good, it will be pushed down at the COMEX as far as they can push it until an uncontrolled marketplace starts buying and selling enough of the real thing to establish a price accepted by more people than the COMEX price.

Until that day, take all the charts and make a nice warm fire to sit by.

Sun, 04/19/2015 - 16:31 | 6009145 savagegoose
savagegoose's picture

i look at it like a savings account, unlike dollars in the bank its there when i need it.

 

Sun, 04/19/2015 - 13:44 | 6008725 Oldrepublic
Oldrepublic's picture

take a look at these charts

www.usagold.com/publications/Mar2015R&O.html

Sun, 04/19/2015 - 13:18 | 6008650 BoPeople
BoPeople's picture

Gold is a metal. Unlike other metals there is very little productive use for it, which frees it up to be used as jewelry and something to be promoted as an investment. Because there is little real productive use for it, gold supply and demand is almost completely dictated by advertising and propaganda... which then subjects it to manipulation.

As stated above:
"The long-term gold chart ... shows that gold stabilized when the Fed started tapering and around the end of QE, which is very counterintuitive to say the least. That is not to say there is no correlation, but there is definitely not a direct correlation."

All of the current markets are counterintuitive these days because they do not obey what we are told is a basic economic principle.

Economists would like us to believe that when supply exceeds demand price goes down and visa versa.

Associated with this is the understanding that when the supply of money increases relative to other assets (inflation) the price of the other assets should go up. One would think that the price (buying power) of money would be less because there is more of it and the demand for gold would be relatively greater.

However, the author implies that gold (and it can be directly related and correlated that to stock prices} price goes down as demand INCREASES. This is counterintuitive ... and it is meant to be. We are told that this is because people are stupid and only professionals can truly invest properly. The truth appears to be something completely different. All evidence suggests that in the case of gold and stocks (bonds and FX as well), the banks control price and they use price control to defraud people and steal their money and property. They propagate the myth that markets are free and then control it to do the exact opposite that a free market would do. People, real people working based upon supply and demand assumptions have ZERO chance. This forces people to give their money to banks to manage to ensure they do not lose it.

Mission accomplished.

Sun, 04/19/2015 - 19:22 | 6009491 fukidontknow
fukidontknow's picture

How many times do I have to say this - gold has many industrial uses only it is to valuable as a scarce fungible monetary asset to be used in much industry. 

Sun, 04/19/2015 - 22:15 | 6009955 Buster Cherry
Buster Cherry's picture

I remember the Apollo moon missions and.seeing that gold foil that covered the lower.parts.of.the lunar.module. I wonder why it was there and how much gold that was.

Sun, 04/19/2015 - 14:31 | 6008786 ebworthen
ebworthen's picture

You're halfway there.

Tangible assets such as our lives and Gold are devalued and repressed so that we must labor to profit banks/corporations/insurers.

People in the modern age have a much longer life expectancy and are much less likely to die young and yet our lives are worth much less because there are so many more of us.

The trick is making us believe that we have rights and liberty, that our fiat money has value, and that the rule-of-law and individual rights dating back to the Magna Carta have not been shredded and replaced with a neo-feudalist kleptoligarchy.

For a majority of the sheeple I would say "mission accomplished".

If you live in the U.S. I would say "weclome to the New Rome".

Sun, 04/19/2015 - 14:37 | 6008808 Dame Ednas Possum
Dame Ednas Possum's picture

'Mission accomplished.'

It's funny how that statement has a history of accompanying fails.

Sun, 04/19/2015 - 12:58 | 6008628 KnuckleDragger-X
KnuckleDragger-X's picture

I look at gold as an investment the same way I look at 1000 rounds of ammo as investment... It's better to have it and not need it than to need it and not have it.

Sun, 04/19/2015 - 22:55 | 6010054 Fukushima Fricassee
Fukushima Fricassee's picture

Ah yes , the condom phylosophyer.

Sun, 04/19/2015 - 13:41 | 6008718 BoredRoom
BoredRoom's picture

I think it is more like insurance than an investment....you hope you never need to use it but it's there if you need it.

Sun, 04/19/2015 - 12:56 | 6008623 bwh1214
bwh1214's picture

Here's a better way of thinking of PM investing as well.

It focuses on how PM's will likely replace bonds as the preferred safe asset when the bond bubble goes bust.

Sun, 04/19/2015 - 12:47 | 6008605 bwh1214
bwh1214's picture

For anyone who is acquiring precious metals this is a great little excel calculator that helps you buy the dips.  I just made my first purchase using it for guidance.

Precious Metals Calculator

Sun, 04/19/2015 - 13:37 | 6008706 BoredRoom
BoredRoom's picture

SPAM SPAM SPAM SPAM SPAM SPAM SPAM SPAM SPAM!

 

Which 'dips' are you talking about?

Sun, 04/19/2015 - 14:35 | 6008802 Dame Ednas Possum
Dame Ednas Possum's picture

two real drivers for the price of gold?

Blah blah blah blah... PAPER.

Blah blah blah blah... CRIMINAL REPTILES.

Mon, 04/20/2015 - 01:53 | 6010293 A Nanny Moose
A Nanny Moose's picture

Gold porn, TGTBATU edition

https://www.youtube.com/watch?v=nOr0na6mKJQ

Mon, 04/20/2015 - 07:01 | 6010330 philipat
philipat's picture

The definition of "Manipulation" in this piece seems to totally overlook Central Banks manipulating the PM prices via naked short paper sales on COMEX. Nobody can trade against the CB's because they can print as much fial as they need. They would NOT manipultae prices higher, just lower. In this environment Charts and Chart patterns don't mean anything other than "Painted" points which can be used to create waterfalls down at key inflection points.

The manipulation has become so blatant that I have been making good money using futures (The proceeds buy more physical) to trade Gold besed on the Total net short position of the Commercials as published in the weekly COT Reports in relation to the price of Gold. Basically, when net shorts are high, the next cycle for Gold is down and vv. It's worked like a charm so far for me and will continue so long as the manipulation remains so open and obvious.

In conclusion, it is PAPER that determines the price of Gold. Period. You're wrong.....

Do NOT follow this link or you will be banned from the site!