The Bearish Case for Gold and Silver

In the interest of keeping an open mind and avoiding blind spots, it's important to remain objective.  This author says the bull market in gold is over--after 12 years of rising every year.  You be the judge.

http://www.businessweek.com/news/2013-01-07/lbma-s-best-gold-forecaster-hochreiter-says-bull-market-is-over

Looking at history and contrarian calls at inflection points (tops and bottoms), often the calls were correct directionally--before they turned and ended up being completely wrong down the road (hence, the contrarian label).  For instance, Businessweek's infamous cover in August of 1979 declaring "The Death of Equities" has been declared as the ultimate contrarian call.  Equities were falling out of favor, but lo and behold, the market bottomed in 1982 and the biggest bull market in stocks continued until 2000.

So Businessweek's call for "the death of equities" was correct for 3 years (and contrarians would have lost their shirts going long in 1979).  But when it bottomed out in 1982, being short was exactly the wrong place to be because the huge bull market began then.  So it was a good contrarian indicator--albeit, 3 years early.

So could gold peak at some point?  Probably, but given the stealthy bull market of 12 years and running, gold is still scorned and even hated in most circles.  Imagine the analysts and cocktail hour discussions if the stock of Google went up for 12 consecutive years.  They'd be jumping up and down like Tony Robbins on speed.

In other words, time-wise, this precious metals bull market is getting long in the tooth.  But if you study bull markets at all, the last mania phase is when most of the nominal gains are made, as prices enter the parabolic stage.  Most of the nominal gains from the 14-year bull market in gold from 1966 - 1980 were made in the final two years, when gold leaped from $400 to $850 in only a few months time span, from a base of $35 in 1971.

If gold and silver do enter the mania phase, I expect gold prices to peak around $6300 and silver $400, based on previous market bubble peaks, including the NASDAQ and gold.  Cycle theorists would then declare a smashing of prices, and the subsequent cleansing of the global financial systems to sort things out.  However, if the dollar collapses in the "Great Reset", then there will be no "peak" in gold or silver--or any other commodity for that matter, because if the dollar goes to zero, prices of everything else go to infinity.  There would be no peak as prices of everything would stay perpetually at infinity, as the old dollars expire worthless.

In that scenario, gold and silver won't be just optimal--they would be the ONLY money worth having.  Sounds improbable, right?  Think again.  Back in the early 1980's, Paul Volcker was able to finally reign in inflation by causing short term interest rates to soar to 23%.  It also logically coincided with the peak in gold prices.  The austerity was very painful to the economy--but also very necessary to clear out the bad debt.  Many went bankrupt.  But it was necessary--and achievable for only one reason:  America was the world's biggest creditor at the time.  Which meant a rise in interest rates benefited US Treasury coffers, as other countries had to pay higher coupon rates.

Today, the opposite is true:  the US is the world's biggest borrower in the history of mankind.  We are no longer a creditor--but a debtor on a massive scale.  A rise in interest rates converts our unofficial insolvent status into official bankruptcy.  It would be very similar to a homeowner holding an adjustable rate mortgage--and having the interest rate rise to 23%.  Bernanke likes to point out that he can withdraw liquidity anytime he wants should the economy improve, causing bond yields to rise.  No, he cannot.  He cannot stop the spigots of liquidity because the already fragile economic recovery would tank without injections of credit and liquidity, so what makes him so confident he can not only stem the liquidity injections, but actually reverse them?  The answer is he cannot--he is forced to continue QE'ing because if he stops the money printing, the music will stop playing and the economy would collapse.

Structurally, our economy is still built on quicksand.  Our economy is 70% consumer-based, and the consumer is still tapped out and over-indebted.  The debt problems are still there--in fact, they are even bigger.  Private sector debt (banks) have merely been transferred to official government debt (central banks) on a global scale with all the bailouts.  Who will bail out the Fed and other global central banks?  The Fed's balance sheet has exploded over 3 times since the 2008 financial crisis.  With additional QE, it will double once again to $6 trillion.  Let me repeat that:  in 2008, the Fed's balance sheet was $900 billion.  By the time the Fed is done with QE in 2015, its balance sheet will be north of $6 trillion.

So Bernanke won't be able to withdraw liquidity and raise interest rates should inflation accelerate.  In fact, the Fed has declared that they will pin interest rates to zero until at least 2015.  My interpretation is they will have to ATTEMPT to do that into perpetuity, because the debt problems will not go away--they will only grow due to compounding.  But market forces have a predilection of overwhelming manipulation by central planners eventually.  Market controls never work in the long run.  Something will break, whether it's runaway inflation, or rising interest rates--or both.  Although those forces are normally countervailing, inflation and rising interest rates have occurred simultaneously in the past.  See 1979 - 1980.

The question is then:  will rising bond yields and interest rates kill the bull market in gold?  The answer is yes--eventually, probably after a lag where both inflation and rates rise in tandem.  But can the Fed afford to have bond yields rise?  The answer is no.  In fact, the purpose of QE is to artificially increase demand for US Treasury bonds in a market where buyers have shunned Treasuries, so the purchasing of said assets by the Fed can artificially keep bond yields lower than what a free market would demand.

As long the Fed continues to have an explicit policy of suppressing interest rates, holding gold is still prudent, as the opportunity cost in a negative, real interest rate (inflation-adjusted) environment is de minimis.  However, even if bond yields at the longer end of the curve (30-year and 10-year maturities) get away from the Fed, the intractable outcome is default by the US government, which should make gold even more attractive for holders.  The problem with that scenario is that the world may not end, but the world as we know it will end.