Summer thoughts on the markets and gold

Goldilocks Scenario 1: Good economic news continues to come in, the stock markets’ recent rally continues. Talk of a double-dip recession recedes, the U.S. economy begins to recover further. Even Europe starts to look better. Abenomics works and Japan starts to grow.

All looks great. The Federal Reserve’s efforts to save the U.S. economy and financial system succeed.

So what happens next under this, albeit the least likely, scenario? The banks start lending more money … credit flows through the pipelines … and the trillions of paper dollars the Federal Reserve has created begin to work their way through the system.  Normal credit creation fully resumes. So all the money created starts to be lent out and inflation begins to take hold in the USA and the rest of the world . . . Obviously, gold would soon bottom and start moving up again as it would be inflation and interest rate driven.  (Remember gold rose in the 70’s with rising rates)

Now consider …

Scenario 2 (most likely): More bad economic news starts to come in … the U.S. economy goes from OK to so-so and it becomes painfully clear that governments’ and central banks’ rescue efforts have yet to work.

In Europe and Japan economies slump further, and sovereign-debt defaults proceed across the globe.  The interesting thing here is money will very likely flow into the USA markets as fear comes across Europe and Japan.  Giving the illusion that the US is actually doing well — as it must be right, the US markets are going higher! You will see the US$ and gold rise at the same time. The US market will rise higher than many predict as it will be the last game in town.

The Fed and other central banks pump trillions more dollars into their economies. But to no avail, because it also becomes painfully clear to almost everyone that countries are BANKRUPT. And so are their central banks.

What happens under this scenario? All currencies dramatically lose purchasing power and the entire world plunges into a “greater” depression. The world’s monetary system is under huge pressure but, the sun still rises and life carries on.

Physical gold and gold shares will protect those who have them.

The reason we have seen such a big sell off in gold:

• that inflation expectations are currently in check due to China’s slowdown
• at the same time the US’s industrial production is trending lower
• Governments worldwide still have a massive debt overhang
• deflationary forces are still acting on us

Medium to Long-term, with all the central banks printing full steam, gold will move higher. It is just a matter of time. So short term gold may still move lower, but in the medium to long-term we think you will see gold go a lot higher.  The real bull market in gold will only begin once we have passed the 1980 inflation adjusted high: our guess is this will start to happen in 2015~ 2018.

In either scenario gold will bottom soon (if not already) and head higher, for the simple reason that gold is insurance against a global economy that really has only two future scenarios right now, as laid out above.

Our advice would be to hold and continue buying gold and gold miners, as gold starts a path higher toward a minimum target of $2,300 an ounce, the inflation-adjusted high that would be equivalent to what $850 gold was in February 1980.

Investors all over the world are soon going to start loving gold, all over again. There will be shocks along the way:  we may not have seen the low in this cycle yet but, the downside is now at worst around $1,000 for gold while the upside is beyond $3,000.

Call us to discuss the differences in Gold ETFs and various mining shares and funds.