Why The Gold Price is Rising, and Why it Will Continue To Do So

Why Gold Isn’t a Pet Rock

Do you remember last year, when an opinion piece in the Wall Street Journal referred to gold as nothing more than a ‘pet rock’? At the time, gold was trading for around US$1,130 an ounce.

A year later, gold is trading around US$1,350 an ounce (up around 20%), while the S&P 500 is up only a few percent, despite closing at another record high today, at 2137 points.

The author of that article, Jason Zweig, returned last week in his regular Intelligent Investor column to defend his pet rock call. While he acknowledged some important reasons for gold’s enduring allure, he trotted out some pretty lame reasons for sticking with his 2015 call that gold is basically just a rock.

Given the increasing interest in gold over the past few weeks (there’s nothing like soaring share prices to get people interested, is there?), today I want to explain to you why I think the gold price is rising, and why I think it will continue to do so in the years ahead.

The first thing to acknowledge is that the gold price IS rising, despite what you may personally think about it. This might seem like an obvious statement. But as I pointed out yesterday, ‘knowing that you don’t know’ is a fundamental way to cope with today’s heavily manipulated markets.

Like Jason Zweig, you may not agree with it, but to ignore it and stubbornly think you’re right, believing the market is wrong instead, could cost you big time.

The chart below shows an important trend change for gold. It’s a weekly chart, which is less volatile than the daily chart, giving you a better idea of the longer term trend. Moving averages are good representations of a trend. The blue and red lines in the chart below represent the 50 and 100-day moving averages.

As you can see in the chart, the blue line is just about to cross above the red line, which is an indication that the longer term trend is turning bullish. The last time this happened was in January 2002. It was the start of a multi-year bull market.

Source: Optuma
[Click to enlarge]

So, in my view, this is not just another bear market rally, like you saw in mid-2013, and in early 2014 and 2015. There is an important change of trend taking place.

That doesn’t mean gold won’t fall from here. It’s had a big run. A correction back down to US$1,300 or below wouldn’t be surprising. But you have to respect the fact that the market is telling you that a change of long term trend is underway.

Once you accept this, you need to ask ‘why?’ Is there a solid fundamental reason behind the recent gold price surge? It’s not always easy to answer this question. Markets mostly move ahead of fundamentals. The reason for an early move is only apparent in hindsight.

So why is gold moving higher now? Put simply, it’s because the market views it as a currency. In the 2001–2011 bull market, gold traded as a commodity. It simply moved higher, along with all other commodities.

But this time around, the market appears to view it differently. It is gold’s ancient role as money, or as an ‘immutable and fiduciary value par excellence,’ as De Gaulle famously put it, that the market is now pricing in.

This shouldn’t be surprising, given we are years into a global currency war that doesn’t look like ending anytime soon.

But the currency wars didn’t just get underway recently. So why did gold ignore it until recently? After all, the gold price continued to fall up until the end of 2015.

What happened to change things at that point?

As far as I can work out, this is when the market realised the Fed wasn’t going to raise interest rates anymore. It was the moment the US dollar joined the currency wars, along with the euro and the yen.

Then came Brexit, which put pressure on the next most important global currency, the pound. At this time, gold broke out above US$1,300 an ounce to a new two-year high.

In my view, the market is starting to price gold as another global currency, one that global central bankers can’t easily debase. This is why US stocks and bonds are also at record highs. Investors want out of cash (denominated in any fiat currency) and into any assets…not just gold.

It’s only because gold fell so much in the preceding four years that it is now playing catch-up. And it is playing catch-up fast because the market knows that more QE and greater negative interest rates will no longer boost the real economy. Stimulus is now having a corrosive effect.

In arguing against gold’s rise now, Jason Zweig from the Wall Street Journal gets it wrong by saying:

In October 2008, the depths of the global financial crisis, the gold price was 30% lower than it is now. In August 2011, when Standard & Poor’s downgraded the U.S.’s credit rating, gold was nearly 40% higher than it is now. Is today’s chaos that much worse than the financial crisis? Was the summer of 2011 so much darker than today?

This analysis is poor, and it ignores the fact that everything is relative. By looking at gold’s absolute value now compared to 2011 and 2008, Zweig doesn’t take into account the movement of other asset values over time.

The question you should ask then is: Where is gold compared to, say, the S&P 500? Looking at this relationship will give you a much better idea of gold’s relative value.

The chart below does that. It shows the gold price performance relative to the S&P 500. It tells you that, relative to the S&P 500, gold looks cheap. It tells you that gold is much, much cheaper than it was back in late 2011, when the price of bullion was around US$1,900 an ounce and the S&P 500 traded around 1150 points.

In an era of financial repression and central banks making cash holdings increasingly costly, big money managers allocate capital according to relative value. And the chart shows you that relative to stocks, gold is still good value, given all the external influences we’re currently experiencing.

The other interesting thing about the chart below is that it shows gold — from the start of 2016 — starting to outperform US stocks. If this trend continues, you can expect to see gold rise faster than US stocks.

Source: StockCharts
[Click to enlarge]

Zweig also makes the point about gold’s endurance as a store of value:

The same quantity of gold that a Roman centurion earned annually under Emperor Augustus (27 B.C. to A.D. 14) would cover one year’s pay ($46,500 to $65,000) for a U.S. Army captain today.

That in itself isn’t a good reason to own gold. Not unless you’re planning on bequeathing it to your great grandkids. But in an age of currency wars, it’s a pertinent reminder that gold has sailed through all monetary storms in history. It will sail through the next one too.


Greg Canavan,
For Markets and Money

Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:

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