To paraphrase the great Steve Martin, today’s investors are very passionate people and passionate people tend to overreact at times. An overreaction is exactly what’s happened in gold and global markets in recent weeks. While market bulls have been sniffing out data points to support their case, market bears have continued to take a glass-half-empty approach.
Gold and China are two areas that have been caught in the bear trap this week, but we believe the gold and China bulls still have room to run.
Short-Term Challenges for Gold
Rising bond yields, a stronger U.S. dollar and an improvingU.S. economy have squelched expectations for a third round of quantitative easing (QE3) and consequently, spelled trouble for gold. Since late February, gold has declined more than 7%.
As confidence improves, UBS says the yellow metal is losing the dual role of safe haven and risk asset: “Gold is moving off center stage, while growth assets are moving to the fore.” Earlier this month, we saw the largest weekly contraction in long gold positions on the Comex since 2004.
As I wrote in my blog this week, the selloff has pushed the price of bullion below its 200-day moving average for only the 30th time over the past 10 years. Over this time period, gold has declined on average 2.1% over the 10 days following the cross-below date. This means we’re likely only one-third into the correction in terms of price and duration.
All is not lost for gold.
In his latest Gold Monitor, Dundee Wealth Economics Chief Economist Martin Murenbeeld lists 10 positive factors for gold, one of which is monetary reflation. We are currently experiencing one of the greatest global liquidity booms the world has ever seen. Over the past seven months, there have been 122 stimulative policy initiatives from central banks around the world, according to ISI Group.
You can see from Canaccord’s chart below that injecting liquidity into the global monetary system has been a steroid for stronger gold prices over the past decade. The global monetary base has ballooned three times larger, with gold increasing nearly six-fold.
While we are seeing strong signs of improvement in the global economy, it’s important to remember that the recovery has been built upon a mountain of printed money that cannot be hastily unwound. Dr. Murenbeeld explains, “Money doesn’t grow on trees; it will have to be borrowed by some government and/or it will have to be printed by some central bank.”