In
the early 2000’s, I recommended to associates that we were in for a major gold
boom.
Most thought that this was a
ridiculous suggestion and didn’t buy a single ounce. I continued to recommend
the purchase of gold regularly over the ensuing years, and the price continued
to rise. Only in 2011 did they start to buy, at a time when gold was peaking. We were due for a correction and in 2012, it
arrived.
For
several years, the price has remained in the neighbourhood of $1200 - roughly
the price it needs to be to bother removing it from the ground.
During
that time, gold has periodically risen a bit, then gotten knocked down again. It’s
understandable that this should happen. Central banks have a stake in holding
down the gold price, since a rising gold price makes it appear more attractive
than storing cash in banks. We’ve reached the point that the central banks have
run out of tricks to float the economy and we’re already past due for a crash.
But
crashes don’t always occur as soon as they become logical. As long as the
public can be fooled into remaining confident in the system, a doomed economy
can limp along for a bit before toppling. Statistics on unemployment and
inflation can be fudged (and they have been). The stock market can be falsely
pumped up (and it has been) in order to create the illusion that all is well. These
factors, taken together with knocking down the price of gold periodically,
helps to convince people that they should keep their money in cash and their
cash in the bank, not in gold.
Just
as in 2000, the number of people who understand that gold is not the equivalent
of a stock, but a store of wealth during dramatically changing times is quite
small – certainly less than 1% and more likely less than 1/10 of 1%. Those that
possess this understanding tend to hold gold long term and are relatively
unconcerned about fluctuations – even if they’re over $100 in a given month.
They’re in it for the long haul and believe that, eventually, gold will rise
dramatically and may well be the only safe haven after a crash.
But,
let’s go back to those speculators that waited until gold had risen
dramatically before jumping on board the gold train. During the last four-year
period, whenever gold rose as a result of economic and political developments,
many of them would buy in once more, after it had risen significantly. Then,
when it had been knocked down again, they tended to sell – often at the new
bottom.
Of
course, this behavior is not limited just to the purchase of gold. In fact, a
very high percentage of investors “play” the stock market in this way. They
wait until everyone and his dog is buying in and the price is peaking, often
buying on margin in order to maximize their positions. Then, when the bubble
pops, they tend to ride the market down, hoping in vain that the price will
return at least to what it was when they bought in. In essence, they tend to buy high and sell low
almost every time.
The
gold bears – those investors who don’t truly understand that gold is a very
different animal from stocks, typically dislike gold, but buy high when it
becomes trendy to do so and sell low after it’s been knocked down. This dance
is guaranteed to cause the gold bears to lose money time after time.
The
dance is sometimes described as “chasing the market,” or “following the
trends.” Brokers keep the dance going by advising their clients of established
trends, telling them that they’re “missing out if they don’t get in
now.” They serve as the market’s
equivalent of a caller in a square dance: “Swing your client to and fro – watch
his investment dollars go.”
Just
as few investors understand the economic nature of gold, they also tend to
overlook the fact that the broker doesn’t benefit from the
success of the client, he makes his money when the client buys and
sells frequently. So,
of course his
advice is going to be for the client to keep dancing.
So,
will this dance go on as it is, ad infinitum? Well, no. There will be a
dramatic change following a crash in the markets. Following any major crash, a
panic occurs and whatever money is left on the table scrambles to find a new
(hopefully safe) home. Following the coming crash, a portion of that money will
head into gold. The price will rise dramatically, very possibly to such a
degree that it can no longer be easily knocked down by the central banks.
At
first the gold bears will assume that it’s an anomaly. Then, as gold passes
$1500, some will dip their toes in. As it passes $1800, some will wade in. Beyond
$2000, this trend will strengthen quite a bit. As the crash deepens, stocks
will tumble further. The bond bubble may also pop, increasing gold’s shine.
At
some point, bankers may begin to freeze accounts, create bank holidays and/or
confiscate deposits. At that point, gold will head into its long-predicted
mania phase and the bears will be falling over each other, chasing the buying trend.
Gold
will rise to a logical price in keeping with its value as a hedge against a
collapsing economy. At that point, it would make sense for it to stop, but
that’s not what will happen. Those who understand gold will cease their
purchases and sit on what they have. But then a new dance will begin. The bears
will become decidedly bullish. It’s important to note that, at this point, they
will not fully understand why gold is rising so dramatically, they’ll just know
that it is. They’ll want to get in on the gold rush and will do whatever they
have to in order to keep buying.
They’ll
find that physical gold is in short supply, as traditional holders are
unwilling to sell, seemingly at
any
price. Potential buyers will offer $50 above spot, then $100 above spot, then
more. They’ll additionally buy on margin in order to increase their position.
It
will be at this point that the mania will take hold. Irrationally high prices
will become the new norm. How high will it go? $10,000? $20,000? Impossible to
say. It will rise as high as desperation makes it rise, and we cannot now determine
what that level of desperation will be.
A
new bubble will be created, but this time, it won’t be in stocks or bonds, it’ll
be in gold and, like all bubbles, it will eventually pop. This will occur when
those who understand the nature of gold recognize that the price has far
exceeded what’s logical and, as much as they value gold, they’ll sell a portion
of their holdings and use the proceeds to invest in whatever assets have
already bottomed and have nowhere to go but up.
They’re
likely to retain a portion of their gold holdings for the same reason they
always have, but will be happy to release a portion when it becomes
significantly overvalued.
This
will cause the gold bubble to pop and the gold bears, who have recently become
bulls, will wonder where it all went wrong. At this point, they still won’t
understand gold; they’ll simply have chased yet another trend and lost.
So,
is there a moral here? Well, if so, it’s simply that an investor should not
become involved in a market that he doesn’t understand.
Nor should he trust his broker to understand it for him.
Ironically,
as long as there have been markets, there have been those who go out on the
dance floor without first learning the dance. A great deal of profit will be
made by some gold investors, but the majority are likely to leave the floor
with empty dance cards.
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Jeff Thomas is British and resides in the Caribbean. The son of an economist and historian, he learned early to be distrustful of governments as a general principle. Although he spent his career creating and developing businesses, for eight years, he penned a weekly newspaper column on the theme of limiting government. He began his study of economics around 1990, learning initially from Sir John Templeton, then Harry Schulz and Doug Casey and later others of an Austrian persuasion. He is now a regular feature writer for Casey Research’s International Man (http://www.internationalman.com) and Strategic Wealth Preservation in the Cayman Islands.
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The author is not affiliated with, endorsed or sponsored by Sprott Money Ltd. The views and opinions expressed in this material are those of the author or guest speaker, are subject to change and may not necessarily reflect the opinions of Sprott Money Ltd. Sprott Money does not guarantee the accuracy, completeness, timeliness and reliability of the information or any results from its use.
