I've promised to explain why I think gold is on the verge of another bull run. As I've said in my post On Gold and Precious Metals, I’m not in the business of making short-term predictions of gold prices. I consider making short-term price predictions to be a fool’s errand because price movements are so dependent on reading the tea leaves of government policymakers’ thinking, the often self-fulfilling prophecies of technical analysts, and rumor-mongering. It’s tempting to participate in the game because few talking heads are held accountable for their poor forecasts, but I still refrain. Instead, I mostly focus on the fundamental agents I think will drive gold prices over the mid- to long term. I’ll outline those price-drivers in this post and discuss them in more depth in the future.
So, why buy gold now?
In a nutshell, follow the adage: buy low, sell high.
How do I know gold prices are near the bottom? When there’s panic selling and blood on the floor, and sellers are being trampled at the exits, you know you’re close. That’s where we are today. Since January, gold has fallen $500 an ounce—almost 30 percent— to inflation-adjusted prices last seen four years ago.
But how do I know that gold has actually hit its low? I don’t…and nobody else does either. But if it’s not at the bottom yet, then it’s near it. Smart buyers know there’s no Magic 8 Ball that’ll turn up an icosahedral die reading “Gold Bottoms.” They don’t try to guess the bottom.
So, here are six reasons I think gold is set for a new bull run:
1. Reductions in mine production
At $1200 an ounce, gold is at its average global cost of production. That means roughly half of the gold mined today is no longer economically viable. Even after a decade of skyrocketing prices, the financial condition of many gold mining companies was weak. And that was before this year’s $500 price decline. These companies have little cushion to sustain production at current levels or anything close to them, and some miners are likely to go out of business. Others will make big cutbacks in production and radically reduce plans for expansion. News stories to this effect will start appearing soon.
These will not be short-term reductions in mine production. Once a mining company goes down or a mine closes, production takes a long time to recover. And even when a company survives, the lead-time is long before lenders are ready to finance new capital investments. And even once they do, it’s still years before those investments lead to higher production.
2. Continually-rising risk premiums
Over the longer term, two other supply factors will drive prices upward: First, gold is becoming more difficult to find and more expensive to mine. The easy gold is already out of the ground. Second, gold is increasingly produced in countries where geopolitical risk is high, adding a continually-rising risk premium to gold prices.
3. Outlook on federal stimulus programs
As I discussed in my last post The Case for Buying Gold, the Fed’s QE3 announcement last month triggered the latest sell-off of gold. But the Fed’s intent was misread. It’s unlikely to ramp down QE3 anytime soon. I also described the role of gold exchange-traded funds (ETFs) in the gold-selling frenzies of April and June which led to today’s bargain prices.
4. Global economic and political uncertainty
Gold is a refuge in times of great economic and political uncertainty—like the world is today and will be for the foreseeable future. The market is currently hyper-focused on short-term economic factors and overlooking economic and financial vulnerabilities and geopolitical risks abroad. And then there’s the fragility of the world financial system due to Washington’s failure to do anything to prevent a repeat of the 2008 financial crisis. In fact, our vulnerability is greater now because the too-big-to-fail banks are bigger than ever and the too-big-to-jail bankers are just as reckless.
5. Gold demand abroad
Bargain basement prices will lead to strong gold demand from Indian and Asian buyers, reinforced by the launch of the first gold ETFs in China. Also, central banks in Asia, Russia and elsewhere in emerging economies will add to gold reserves in order to reduce their exposure to a declining dollar.
6. Depletion of the world's gold reserves
And finally, a long-overlooked fact: Based on estimates by the United States Geological Survey, the gold standard for such estimates, at current rates of production the world’s gold reserves will be exhausted in as little as 20 years. Even under the USGS’s most generous estimate, world gold reserves will be exhausted in only 35 years at current rates of production.
