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Gold has been depressed and has underperformed other assets since 2011 when the yellow metal parabolic rise ended. There are many reasons why gold is depressed. The media cites three main reasons; rising stock markets, dollar strength and the distraction from bitcoin. To say that gold is weak because the stock market is rising has no forecasting value because this statement is based on actual facts and past performance. I think what investors want to know is what the future holds.
The question should be, what could push gold higher in 2018?
Stock market: this bull market is one of the longest on record, it started in 2009 and while it is not easy to predict when it will end, Elliott wave analysis points to a terminal pattern. This pattern has been in place for a while, but the US stock market keeps pushing higher on extreme optimism. You will note that the FTSE 100 already peaked (in June).
Sentiment plays an important part in the stock market, stocks are expensive based on historic price/earnings ratio and the good news (tax plan) is in the price. There is not much fuel left to push the stock market significantly higher next year. But when investors are in bullish mood they will keep buying irrespective of the strength of the fundamental factors that drive stock prices higher. By doing so the rally will extend to bubble proportion. I believe we are near a peak in optimism, this is reflected in the VIX at multi-year lows, there is no fear.
History tells us that extreme optimism coincides with major tops, and extreme pessimism coincides with major market bottoms. This is why I think upside is limited in the stock market and this will favour gold. One example of a major market bottom in stocks was in 1979, the year when an article titled “The death of equities” appeared on the cover of Business Week.
Well that was a typical example of extreme pessimism and guess what? That was the bottom. In 1979 the stock market was at the start of a raging 20-year bull market.
What people tend to forget is that when investors are too pessimistic it is a buy signal, when they are too optimistic it is a sell signal.
The US dollar: I am not an expert on the dollar but if people think the dollar will rally in 2018, I have some doubts. A dollar rally would create headwinds for gold. What we know is that the vast amount of stimulus added to the financial system since the last financial crisis has not produced any inflation. This tells me that either the money did not find its way in the economy (through bank lending for example) or consumer are spending less and saving / investing more. Indeed, this could be the answer to the lack of inflationary pressure. If consumer don’t feel confident about the future, they will be reluctant to spend. And if we take into account the limited upside in the stock market in 2018, or a potential bear market, investors will be more cautious about spending. This happens at a time when property prices are stagnating which is another reason to be cautious. In addition, the debt bubble has continued to expand, there is more debt now than prior to 2007. The worry is that central banks are engineering the next credit crunch. For that reason, I think US interest rates in the US will remain unchanged for an extended period of time next year. Based on this scenario there is no reason to expect a long-term rally in the dollar.
Bitcoin: I don’t think bitcoin is a distraction for gold investors. Gold has an intrinsic value, bitcoin has no intrinsic value. Gold is a legitimate investment bitcoin is not. Gold is a safe haven, bitcoin is the riskiest investment there is. As Goldman Sachs said, investors are not leaving gold for bitcoin. There may be some investors switching from gold to bitcoin but the proportion is tiny to justify weakness in gold.
The real reason why gold is depressed is sentiment and the rising stock market. Investment opportunities come and go in cycles, from extreme pessimism to extreme optimism.
In 1979 stock investors were pessimistic about the future, that was the bottom. Today they are too optimistic, the stock market is near a top. The next move is a multi-year bear market but I won’t say when this bear market will start, in a bubble situation stocks can rise for longer than expected before the bubble bursts.
A few years ago, bitcoin was not considered an investment, we can’t say sentiment was pessimistic because people did not invest in bitcoin. Today we clearly have lots of investors involved and we see extreme optimism. An asset will show extreme optimism in various ways: the proportion of bulls is 80% or higher. Everybody is talking about it, for example on Twitter half of the tweets I read mention bitcoin. On Bloomberg most experts are asked about bitcoin. Bitcoin will appear on the front page of national newspaper like The Times. Your cleaner will ask you how to buy bitcoin…all this is a sign of extreme optimism and a good indication the trend in bitcoin will turn down.
Sentiment on gold works in the same way. In 2011 I remember everybody was talking about gold, on social networks, Bloomberg, everywhere…then the bubble popped. Today I would not say sentiment is pessimistic but after a four-year decline followed by a two-year sideways period very few investors are interested in gold. Yet Gold is not far away from a major bottom. When the economy enters a new cycle of contraction, when geopolitical risks rise again (don’t forget North Korea), when people lose confidence in the dollar, when the stock market turns down, gold will soar. The rise of bitcoin coincided with the fall of gold. If history is any guide this relationship is about to change soon.
Thierry Laduguie is Trading Strategist at www.e-yield.com
