‘When you come to the end of your rope, tie a knot and hang on.‘
Franklin D. Roosevelt, US President
After two years of falling gold prices, maybe you’re sick and tired of reading about gold.
But realise the gold price went up for over 12 years straight!
It can’t keep going up in a straight line forever. Since hitting a low of $253.70 in July 1999, gold prices have surged over 650%, topping $1,921 per ounce in September 2011.
Gold is now going through a correction. That happens at the end of every price bubble. But make no mistake; eventually gold will make a very strong comeback. Let me explain why…
But first, let me be straight up – I still see some downside in the gold price. In fact, it could still fall another 15%.
Even so, I’ll still argue that gold stocks are a bargain today, let alone if the gold price hits near $1,000.
The bottom line is this: If you buy gold stocks today and hold them for the long term, I believe you’ll still make a great return.
Over the next few weeks in Diggers and Drillers, I’ll explain why the gold price has fallen and why, contrary to most mainstream views, gold is set to rise back to all-time highs.
Some of the topics I’ll discuss include:
But for now I’ll talk about the only two words you should know and remember when investing in gold – ‘Quantitative’ and ‘Easing’.
Quantitative Easing, also called ‘QE’ or ‘money printing’, is the most important reason that makes gold an attractive investment. These two words are why gold more than doubled from less than US$837 an ounce to over US$1921 an ounce in less than three years.
Money printing is simply where the US Federal Reserve prints money out of thin air and uses it to buy US government debt and mortgages from banks.
The US Federal Reserve initiated this program to avoid another ‘Great Depression’ of 1929. In 1929, millions of people lost their jobs and fell into poverty. Many banks either stopped lending or went out of business.
Whatever the critics say, the money printing program has worked to some degree by avoiding another ‘Great Depression’…for now anyway.
The problem is the US Fed’s money printing program doesn’t have an end date. There is talk of cutting back the program, but so far that seems more of a fairytale than a fact.
In fact since the program first stated, the US Fed has really put the ‘foot to the metal’ and accelerated the ‘money printing press’. You can see in the chart below that the US Fed owned less than US$1 trillion dollars of debt before the 2008 financial disaster. This has now increased to over US$4 trillion today.
But what’s the purpose of money printing? In simple terms, the aim is to drive interest rates down to ultra-low levels so that banks can lend money to investors at low rates.
Sounds great if you’re a borrower, but it’s only good in theory!
The problem in the real world is that people are choosing to repay debt and save instead of borrowing money. And can you blame them? Everyone remembers what happened to their superannuation and investment portfolios when the global financial disaster shocked financial markets.
But that’s not all. In many cases banks won’t lend money to people who want to borrow. Farmers can’t get a loan to expand, many resource companies can’t get a loan to explore, and if you want to start a company, good luck in trying to get a loan.
The following graph shows how much money people are saving in Australia as opposed to investing in the stock market or other assets. Since the financial meltdown, the savings rate has increased almost vertically.
Instead of increasing lending and borrowing, let’s see what money printing has really done over past couple of years.
The following graph shows the impact that money printing has had on the US S&P 500 Index (index with largest US 500 companies). The graph shows all four money printing programs since late 2008/09 (red line in chart below).
You should pay specific attention to the current money printing program, QE3 (orange line in chart below).
I realise that it may be hard on the eyes but the red circle at the bottom of the chart displays January 2013. Around this time, the US Fed’s QE3 program truly began to have an impact on financial markets.
Put more simply, QE3 involves the Fed buying US$85 billion of debt per month over an unlimited amount of time. This is an ‘experiment’ which has never been tried before in history.
What you can see is that all the money printing programs have seriously inflated financial markets to the point that they may now be in ‘bubble’ territory.
That makes it hard to figure out who’s more addicted to money printing – Wall Street or Ben Bernanke (US Fed Chairman).
As Warren Buffet says, ‘all bubbles inevitably pop‘. As I said above about gold, financial markets simply can’t rise forever either.
Essentially the US Fed has said to investors: ‘we’ll buy the debt and you can buy everything else’. As a result, you’ve seen the stock market go through the roof. The following graph shows the actual returns from quantitative easing for the US S&P 500 Index – over a 92% gain since it first began.
Not only have stock markets gone up but bond (debt) yields have fallen to all-time lows on the back of money printing. The Reserve Bank of Australia has cut interest rates by 2.25 percentage points to 2.5% since November 2011.
When bond yields fall, bond prices rise. With rates at or near record lows we are in the midst of a global bubble in bond prices.
Financial markets are going up all around the world, it’s a financial bubble mania!
Even Bitcoins skyrocketed!
But imagine what will happen to financial markets if the US Fed actually stopped entirely its money printing program.
If bond yields will rise, the stock market will fall and gold will ‘shine’.
The fact is that money printing is a giant experiment by the US Fed and other central banks (i.e. Bank of Japan) as they try to avoid another Great Depression.
Of course, some say that money printing was necessary and that it saved the world when Lehmann Brothers collapsed in 2008. At the time it was the world’s third largest investment bank and many argue that the Fed needed to take drastic measures. That’s debatable.
But even if you argue that money printing was necessary, there’s no doubt that this ‘experiment’ is getting out of control and financial markets are ‘cooked’ on money printing.
Let’s see what happens to interest rates when the central banks stop buying bonds.
Let’s see what happens to business conditions.
Let’s see what happens to corporate profitability.
No one knows the full long-term consequences of the money printing policies.
This is why gold as an investment is crucial. A lot of people underestimate its true value, which is…investment portfolio protection!
Gold will return and reward patient investors. When it does gold stocks will be back.
This is the art of contrarian investing.
As Warren Buffett, the world’s greatest investor says, ‘Buy when others are fearful and sell when they are greedy.’
Jason Stevenson
Resources Analyst, Diggers and Drillers
