Where the Gold Bears Are Wrong: 3 Misconceptions About the Market

Source: Thinkstock

Source: Thinkstock

With the price of gold falling once again to under $1,300/ounce, the bears are once again arguing their case that there is no reason to own the yellow metal. But their arguments are short sighted. The fact remains that gold remains in a long term secular bull market. The value of the dollar is slowly declining as its importance on the global economic stage wanes and as its supply increases. Furthermore, the growing middle class in emerging economies is buying gold: People in these countries (Russia, India, China…etc.) have experienced devastating inflation and see gold as a pillar of stability in a world that isn’t.

Nevertheless we have seen several bear arguments emerge as gold trades down, and as a bull I feel I must address them.

1. China is buying less gold.

A report recently came out that suggested that China—the world’s largest gold buyer—imported 19 percent less gold than it did last year. This is true, but it is a highly misleading statement. First, while Chinese gold imports may be down, gold production in China—the world’s largest gold producer—is up, offsetting this decline. China has quickly become the world’s largest gold producer as production stagnates in the rest of the world, and the Chinese do not export their gold production.

Investors should also interpret this decline in gold imports in context. Gold imports to China may be down 19 percent this year, but they are up several hundred percent over just the past 3 or 4 years. With this in mind it is more accurate to assert that Chinese demand is growing rapidly but that it has cooled off somewhat. For long term investors this last point should hardly make a difference.

Source: Thinkstock

Source: Thinkstock

2. The economy is strengthening, and this is bad for gold.

First off, the entire premise is simply not true. Recall that the gold price rose from 2004 – 2007 while the economy was improving. Back then we saw corporate profits hitting record highs, rising GDP, and a booming housing market. What was actually happening back then was more a general inflation of all assets than an actual economic boom. While it is true GDP was rising this was mainly due to a large increase in the amount of outstanding debt relating to the booming housing market. This weakened the dollar and drove demand for gold.

Second, the first clause is highly suspect. The strength in the U. S. economy over the past several years has been predicated on Federal Reserve stimulus. Every time the proverbial punch bowl as been removed the stock market has fallen and fears of a downturn brought the Fed back in more aggressively each time. Now we see that GDP fell by nearly 3 percent in the first quarter although the unanimous viewpoint among pundits is that this was weather-related.

While unemployment data seems to be improving, I have argued that this isn’t the case, and that the falling unemployment rate is the result of people leaving the workforce, and this shrinks the denominator in the employed persons to total workforce ratio. So the economic strength we’ve been seeing is highly suspect, contingent upon an unprecedented monetary policy, and primarily benefitting the rich who are most heavily invested in the stock market. This bodes well for gold, although we won’t see this strength until we start to see cracks in the stock market and more cracks in the economy.

Source: Thinkstock

Source: Thinkstock

3. Geopolitical tension hasn’t lifted gold, which is bearish.

Geopolitical tension is supposed to be good for gold given its status as a safe haven asset. But we haven’t seen this take place as problems have escalated in the Ukraine and in the Middle East. Now the trading logic is that if a bullish event doesn’t lift an asset then you should sell it.

And this may be true for gold, which could experience short-term bearish price action. But the geopolitical tension isn’t going away. In fact it is escalating, and while we may see a slow grind down in gold in the near term there is a risk that we will see a sharp spike higher if the risk of war between the U. S. and Russia or Israel and Palestine rises.

Thus, while this viewpoint may make sense from a short term trading perspective, it is hardly a fundamental investment thesis, and the bottom line is that gold will react to this bullish event in time.

Disclosure: Ben Kramer-Miller owns gold coins and shares in select gold miners.

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