Global investors are radically underinvested in gold today. Years
of relentless stock-market rallying to endless new record highs have
left this classic alternative investment deeply out of favor. But
this gold-demand ebb is ending. The same central banks that fueled
these extreme stock markets through epic easing are reversing to
massive and unprecedented tightening. As stocks roll over, gold
investment will return.
Gold
is a unique asset class established over millennia that should play
a critical role in every investment portfolio. Unlike virtually
everything else, gold generally rallies when stock markets
inevitably suffer their periodic major selloffs. That effectively
makes gold the anti-stock trade. A substantial gold
allocation is essential and necessary to diversify and protect
stock-heavy portfolios, moderating their overall volatility.
But
late in major stock bulls after years of rallying on balance,
complacent investors mostly forget about gold. If stocks apparently
do nothing but rally indefinitely, then why bother with
counter-moving gold? Thus their collective gold allocations
gradually slump to unsustainable lows as stock euphoria mounts. The
lack of gold investment demand leaves it languishing at
relatively-low prices, deeply out of favor like today.
Like
nearly everything else in the global markets, gold prices are
heavily dependent on investment capital flows. When
investors are buying gold in a meaningful way, demand exceeds supply
which drives gold’s price higher. When they’re materially selling,
supply trumps demand thus gold’s price naturally retreats. This
past year or so has been stuck in the middle, with gold investment
flows generally neutral on balance.
The
definitive arbiter of global gold supply and demand is the World
Gold Council. It publishes quarterly Gold Demand Trends reports
with the best gold fundamental data available. As these typically
come out 5 to 6 weeks after quarter-ends, the Q4’17 GDT hasn’t been
released as of this writing. But 2017’s world gold investment
demand current to the end of Q3 still reveals the radical
underinvestment in gold these days.
During the first three quarters of 2017, global gold investment
demand ran 935.0 metric tons. That was down sharply year-over-year,
collapsing 32.6% or 451.4t from the comparable 9 months of 2016!
This plunging gold investment demand was more than responsible for
the entire 388.1t drop in overall total gold demand in that span.
Investment demand is further split out into traditional bars and
coins and new ETFs.
Physical-bar-and-coin demand actually proved strong in the first
3/4ths of 2017, rising 13.0% or 87.1t to 755.3t. But ETF demand
cratered a catastrophic 75.0% or 538.5t YoY! Due to their ease
of trading and trivial commissions compared to physical gold, ETFs
have become the gold vehicle of choice for stock investors. And
with stock markets surging extraordinarily on taxphoria last year,
gold was largely shunned.
Gold
exchange-traded funds act as conduits enabling vast amounts of
stock-market capital to slosh into and out of physical gold
bullion. These big changes in collective buying or selling
really move gold. Since the gold ETFs seek to mirror the underlying
gold price, they have to shunt excess ETF-share supply or demand
directly into actual gold bars. There’s no other way for gold ETFs
to successfully track their metal.
The
world’s leading and dominant gold ETF is the venerable American GLD
SPDR Gold Shares. Every quarter the World Gold Council also ranks
the world’s top-ten gold ETFs. At the end of Q3, GLD alone
accounted for a whopping 36.9% of their total gold-bullion
holdings! GLD was 3.8x larger than its next biggest
competitor, which is the American IAU iShares Gold Trust. GLD is
the behemoth of the gold-ETF world.
The
supply and demand of GLD shares, and all gold ETFs, are totally
independent from underlying gold’s own supply and demand. So
when stock investors buy GLD shares faster than gold is being
bought, the GLD share price starts decoupling from gold to the
upside. That is unacceptable, as GLD would fail its mission to
track gold. So GLD’s managers must vent this differential buying
pressure directly into gold.
They
do this by issuing sufficient new GLD shares to meet the excess
demand. All the money raised by these GLD-share sales is then
plowed into physical gold bars that very day. This mechanism
enables stock-market capital to flow into physical gold. Of course
this is a double-edged sword, as excess GLD-share selling pressure
forces this ETF to sell real gold bars to raise the capital to buy
back its share oversupply.
What
American stock investors are doing with GLD shares is the primary
driver of gold’s trends! GLD has grown massive since its launch
back in November 2004, and acts as a direct pipeline into gold for
the vast pools of stock-market capital. Nothing is more important
for gold prices now than GLD inflows and outflows. These are very
transparent, as GLD reports its physical-gold-bullion holdings daily
in great detail.
I
call stock-market capital inflows into GLD as evidenced by rising
holdings builds, and outflows as seen by falling holdings
draws. In recent years there have been plenty of quarters where
GLD builds and draws alone accounted for the entire global change in
gold demand! Rather incredibly, GLD has grown into the monster tail
that wags the global-gold-price dog. American stock investors
dominate gold’s fortunes.
Amazingly many if not most investors still don’t grasp GLD’s
critical role in gold price trends. They attempt to understand
today’s gold’s price action in historical pre-gold-ETF-era terms.
But for better or for worse, the gold world is radically different
now. GLD, and to a lesser extent the other large gold ETFs trading
in foreign stock markets, changed everything. Gold investors
ignoring GLD’s holdings are flying blind.
This
chart drives home this critical point. It superimposes GLD’s daily
physical-gold-bullion holdings in blue over the gold price in red.
Carved into calendar quarters, gold’s performance in each one is
noted above GLD’s quarterly holdings changes in both percentage and
absolute terms. The correlation between GLD’s physical-gold-bullion
holdings and gold prices is very strong. GLD capital flows
explain much for gold.
Rising GLD holdings reveal stock-market capital is flowing into gold
bullion via GLD, due to differential GLD-share demand. Conversely
falling GLD holdings show stock-market capital coming back out of
gold, thanks to differential GLD-share selling. When American stock
investors are either buying or selling GLD shares at much-faster
rates than gold is moving, their collective capital flows greatly
impact its price.
This
is readily evident in strategic and tactical terms. GLD’s holdings
are highly correlated with gold price levels. American stock
investors sold down GLD’s holdings in 2015, and gold fell in
lockstep. But that all reversed sharply in early 2016, when stock
investors flooded back into GLD which catapulted gold into a new
bull. Gold kept surging as long as differential GLD-share
demand persisted, then stalled when it abated.
After Trump’s surprise election win in November 2016, stock
investors dumped GLD shares at dizzying rates and gold plunged.
Then GLD’s holdings stabilized and largely drifted sideways on
balance in 2017, so gold did too. GLD capital flows and gold prices
are joined at the hip. What American stock investors are
collectively doing and likely to do with GLD shares is critical for
gaming where gold is likely heading next.
Thus
the key question for gold investors today is what motivates stock
investors to buy or sell GLD shares en masse? The answer is simple,
stock-market fortunes. Gold is effectively the anti-stock
trade since it tends to move counter to stock markets. So gold
investment demand via GLD shares surges as stock markets suffer
major selloffs, and withers when stock markets rally to lofty
euphoria-generating heights.
The
entire reason gold investment demand has stalled out over the past
year, which left gold drifting, is the extreme euphoria in US
stock markets. Wall Street constantly claims there’s no euphoria,
but that’s not true. The words “euphoria” and “mania” are often
confused. Mania means “an excessively intense enthusiasm, interest,
or desire”. In the stock markets, manias are associated with
bubbles at bull-market tops.
Euphoria is a milder term meaning “a strong feeling of happiness,
confidence, or well-being”. There’s no doubt investors have been
euphoric on hopes for big tax cuts soon since Trump won the
election. And since those Republican corporate tax cuts actually
became law in late December, stock markets have arguably entered
the mania phase. This is readily evident on fundamental,
technical, and sentimental fronts.
The
flagship S&P 500 broad-market stock index is starting 2018 with its
elite component stocks trading literally at bubble valuations.
The simple-average trailing-twelve-month price-to-earnings ratio of
these 500 stocks was running 31.8x at the end of January! That’s
above the 28x historical bubble threshold, or double the 14x fair
value over the past century and a quarter. These stock markets are
dangerously expensive.
Despite that fear of missing out fueled extreme capital
inflows in the opening weeks of 2018 as investors rushed to buy
stocks high. In this year’s first 18 trading days, the S&P 500
rocketed 7.5% higher which annualizes to an absurd 104% pace of
gains! That stretched this leading stock index as much as 14.0%
above its 200-day moving average, making for some of the
most-overbought conditions ever witnessed.
Sentiment indicators were universally crazy in January too,
revealing the most-extreme herd bullishness, optimism, and greed
seen since soon before huge past selloffs. Those included
late 2007 leading into a 56.8% S&P 500 bear market, early 2000 ahead
of the previous 49.1% S&P 500 bear, and even 1987 prior to October’s
infamous Black Monday crash where the S&P 500 plummeted 20.5% in a
single trading day!
With
virtually everyone totally convinced these euphoric, bubble stock
markets can keep surging forever, it’s no surprise gold has fallen
out of favor. Investors are so caught up in this
irrationally-exuberant late-bull psychology that they don’t perceive
any meaningful downside risk. So there’s little motivation to
prudently diversify stock-heavy portfolios at all, let alone with
gold. That’s driven radical underinvestment in it.
This
is actually measurable to some extent using GLD’s
physical-gold-bullion holdings held in trust for its shareholders.
Since American stock investors’ gold capital flows via GLD shares
often dominate gold’s fortunes, the value of its holdings
approximates overall gold investment. Looking at the ratio of
that to the total market capitalization of all the S&P 500 companies
reveals rough gold investment levels over time.
This
ratio between the amount of capital invested in GLD and the total
value of the S&P 500 is rendered below in red. That’s superimposed
over GLD’s total gold holdings in metric tons in blue. Once this
ETF ramped up past its initial early-adoption years, this metric
revealed relative baseline gold investment levels for American stock
investors. And gold investment has been very low during the recent
taxphoria surge.
American stock investors’ gold portfolio allocations as measured by
this GLD/SPX value ratio have been extremely low throughout the
entire taxphoria rally since Trump’s victory. The amount of capital
invested in GLD shares has been running around just 0.14% the
amount invested in S&P 500 companies! Gold really can’t get much
more out of favor than an implied portfolio allocation of a trivial
1/7th of one percent.
The
last quasi-normal years in the markets came between 2009 to 2012.
That was sandwiched between the first stock panic in a century and
the Fed’s extreme open-ended money printing in QE3 that wildly
distorted the markets ever since. During that span, gold investment
was much higher. The capital invested in GLD shares averaged 0.475%
of the collective market cap of the S&P 500, nearly half of one
percent.
That
implies American stock investors’ gold portfolio allocations are
well under a third of normal levels by recent standards! They
would have to soar 3.4x merely to mean revert, not even overshoot
which is very likely after such anomalous lows. While getting back
near a 0.5% gold allocation would require massive capital inflows
into GLD for years catapulting gold prices far higher, that level of
gold investment remains conservative.
For
centuries most of the world’s smartest and most-successful investors
have recommended portfolio gold allocations of at least 5% to 10%
for every investor. One recent example came from Ray Dalio, the
universally-respected founder of the world’s largest hedge fund
Bridgewater Associates. With his $17b net worth, when Dalio talks
Wall Street listens. Back in August he wrote an essay echoing this
classic advice today.
Dalio was warning about the serious downside risks in these lofty
stock markets. On gold he said, “We can also say that if the above
things go badly, it would seem that gold (more than other safe haven
assets like the dollar, yen and treasuries) would benefit, so if you
don’t have 5-10% of your assets in gold as a hedge, we’d suggest you
relook at this.” That wasn’t just idle talk, as Bridgewater’s Q3’17
investing proved.
Funds have to report their holdings to the SEC in quarterly 13F
reports. Bridgewater was buying GLD shares hand over fist as Ray
Dalio advised building 5%-to-10% portfolio gold allocations. In Q3
alone its GLD holdings skyrocketed a staggering 575%
quarter-on-quarter to 3.9m shares! Bridgewater’s $474m in GLD
shares was its fourth-largest position, making this hedge fund the
eighth-largest GLD shareholder.
As
these insane mania stock markets inevitably roll over into their
long-overdue bear,
other investors will follow Dalio’s lead. The last time the stock
markets corrected, fell more than 10%, was early 2016. That
followed an extraordinary 3.6-year correction-less span thanks to
extreme Fed quantitative easing, one of the longest on record. So
gold was languishing near a deep 6.1-year secular low before stock
markets fell.
The
S&P 500 merely dropped 13.3% over 3.3 months leading into early
2016, relatively minor as far as major corrections go. Yet gold
investment demand turned on a dime as volatility returning awoke
stock investors from their complacent slumber. As the first chart
showed, in Q4’15 gold fell 4.9% on a 6.6% or 45.1t GLD draw. With
stock markets very high and euphoric, investors wanted nothing to do
with gold.
Yet
in Q1’16 after that modest stock-market correction, gold surged
16.1% higher on a gigantic 27.5% or 176.9t GLD build! Once
investors realized stock markets could fall too, they rushed to
diversify a little of their capital into gold. Provocatively that
GLD build alone accounted for 95.2% of the total jump in world gold
demand per the latest WGC data! Gold was catapulted into a new bull
market on a mere stock correction.
That
big gold investment buying continued in Q2’16, where gold rallied
another 7.4% on another 16.0% or 130.8t GLD build. The only reason
this trend stalled in Q3’16 was the S&P 500 surged back to its first
new record highs in 13.7 months. The catalyst was hopes for more
central-bank easing following that UK vote where the British
people decided to leave the European Union. Record stock markets
kill gold demand.
It’s
going to explode again like in early 2016 the next time these
euphoric bubble-valued stock markets sell off materially. Given the
extreme fundamentals, technicals, and sentiment rampant today, it’s
hard to imagine the overdue and coming major selloff not at least
testing the upper limits of corrections. That’s a selloff
approaching 20%, probably the best-case scenario for the bulls.
Anything beyond 20% is a new bear.
Unfortunately that new-bear scenario is far more likely. As
of late January this S&P 500 bull has soared an extreme 324.6% in
8.9 years, making for the third-largest and second-longest stock
bull in all of US history! Much of those gains were fueled by epic
central-bank easing far beyond anything ever before seen in world
history. This year both the Federal Reserve and European Central
Bank are slamming on the brakes.
The
Fed just started its first-ever
quantitative-tightening campaign in Q4’17 to unwind years and
trillions of dollars of quantitative easing. QT is going to
gradually ramp up in 2018 to a powerful $50b-per-month pace
starting in Q4 this year. Per the Fed’s schedule, it will
effectively destroy $420b of capital in 2018 by letting QE-purchased
bonds roll off its balance sheet. Nothing remotely close has ever
happened before!
On
top of that the ECB just slashed in half its own QE campaign
in January to a €30b monthly pace, with a targeted QE end date of
September. That means ECB QE will collapse from €720b in 2017 to
just €270b in 2018, a radical 5/8ths plunge. Between the Fed’s QT
and ECB’s QE tapering, there will be the equivalent of $950b more
tightening and less easing in 2018 compared to 2017! That’s going
to leave a mark.
The
Fed and ECB will literally
strangle this
stock bull by unwinding and slowing the QE that grew it. And
this isn’t just a 2018 thing. In 2019 the Fed and ECB are on track
to have another $1450b of tightening compared to 2017. So
these stock markets are in real trouble with central-bank liquidity
being pulled regardless of their extreme overvaluations and
overboughtness. 2018 sure ain’t gonna look like 2017 at all!
Bear
markets ultimately tend to cut stock prices in half, literal 50%
losses in the SPX. The
last couple bears
that started in March 2000 and October 2007 saw the SPX drop 49.1%
in 2.6 years and 56.8% in 1.4 years! Bear markets are exceedingly
dangerous and not to be trifled with. They also tend to grow in
size in proportion to their preceding bulls, so the next bear should
be bigger than usual after such a massive bull.
When
stock markets start materially weakening, investors return to
gold. Gold is the ultimate portfolio diversifier because it
tends to move counter to stock markets. Gold is forgotten when
stock markets are high and euphoria and complacency abound. But
once major selloffs inevitably follow major rallies, gold demand
explodes as investors rush to diversify their stock-heavy
portfolios. Gold is effectively the anti-stock trade.
Given the radical gold underinvestment following this extreme stock
bull, investors will likely have to do big gold buying for years to
reestablish normal portfolio allocations. That will continue to
fuel this young gold bull born in late 2015 in the last stock-market
correction. At best gold was only up 29.9% so far as of mid-2016,
nothing yet. The last gold bull powered 638.2% higher over 10.4
years ending August 2011!
While investors can ride the coming gold bull in GLD shares, far
better gains will be won in the
stocks of its
leading miners. They tend to amplify underlying gold gains by
2x to 3x due to their profits leverage to gold. With gold so out of
favor, the gold stocks are
deeply
undervalued today. That gives them huge upside as gold mean
reverts higher, dwarfing everything else in all the stock markets.
Fortunes will be won.
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trade and when. As of the end of Q4, this has resulted in 983 stock
trades recommended in real-time to our newsletter subscribers since
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The key to this
success is staying informed and being contrarian. That means
buying low before others figure it out, before undervalued gold
stocks soar much higher. An easy way to keep abreast is through our
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The
bottom line is global investors are radically underinvested in gold
today. Years of relentless stock-market rallying to endless new
record highs has left prudent portfolio diversification with
counter-moving gold deeply out of favor. But the same central banks
that fueled this extraordinary stock bull are now reversing to
massive and unprecedented tightening this year, which will
inevitably force stock markets to roll over.
As
stocks sell off in what is almost certain to become the long-overdue
next major bear, gold investment demand will make a glorious
renaissance. Investors will flock back to gold to stabilize their
bleeding stock-heavy portfolios, catapulting its price much higher.
It will likely take years of gold investment buying to restore
overall gold portfolio allocations to reasonable historic norms.
That’s super-bullish for gold! | 
