End of the bull market is good for gold bugs

You don’t need a great imagination to see global financial markets entering another crisis. So what does that mean for the gold price?

The price of gold has risen as much as US$50 an ounce since my last column called a market bottom. Gold has become much more popular than it was in the early days of August.

For a gold investment commentator of seven years, that was not such a hard call. Gold prices usually bottom out in August before the Indian religious festival season causes demand to pick up. But unless you have not been reading the newspapers recently, you will be aware that gold’s rise has been because of rather more than that this year.

Global stock markets are tanking, led by China, and many currencies are devaluing against the US dollar – again led by China, whose sudden decision to devalue really put the cat among the pigeons. This was also a boost for gold as a haven asset and currency independent of any central bank.

Where do people invest their money when they lack confidence in governments and central banks? There are few alternatives. Indian brides still go for gold as a safe store of value for their married life, and when the modern world of finance goes wrong there is a return to traditional values.

But to get a perspective on where gold prices will go over the next 12 to 18 months it is necessary to speculate about where financial markets are heading. Will there be a smooth recovery with interest rates gradually raised to normal levels? Or is what is happening in China setting us all up for another crisis?

Just ask a UAE resident whether oil near $40 a barrel is good news for an oil-producing nation. China’s distress is pulverising emerging markets and commodity producers, and most of them do not have the financial strength of the emirates to fall back on.

You do not need a great imagination to see global financial markets entering another crisis. What does that mean for the gold price?

If 2008-2009 is any precedent, then it might be bad at first and then exceptionally good. Back then, gold prices dropped like a stone with every asset class but rebounded faster and higher than any other except silver.

However, history rhymes but does not necessarily repeat itself. Waiting for even lower gold prices after gold’s four-year bear market could be a big mistake. What if prices just carry on up from here, with the odd correction?

The smart investor is not looking to exactly time a market bottom, but to position themselves for best returns in the coming bull market in that asset.

Clever traders in the options market always do very well if they choose the right asset class and ride the bull market up. But for gold there is another easier way to leverage the market without having to constantly adjust option positions with the constant fear of making a mistake.

Gold stocks are the way to go. South African gold mining companies are already up by a third in value since the gold price took off after my last article. That is the best example, but it is indicative of how things will move from here in a bull market for gold.

Gold mining stocks have become so cheap that their valuations are lower than anybody in the market can remember. There is an enormous potential for a recovery here, even if the rest of the stock market is being shot to pieces.

Look back at the last great gold price explosion of the late 1970s. Back then, gold shares in the US and UK stock markets made huge gains, and silver stocks did even better – the silver price always tends to outperform gold in a bull market because of the tighter supply situation.

For the average investor the exchange traded funds for gold shares such as GDX and GDXJ offer a simple way to participate in this bubble, which looks to be taking off. This avoids the need to pick individual stocks and spreads the risk among a basket of companies.

GDXJ is particularly interesting, as the so-called junior gold explorers are the leverage upon the leverage of the gold stocks. These companies own the concessions to search for new gold supplies, and they are almost worthless when gold prices are low but become very hot properties when it booms.

George Soros has been known to take out options on GDXJ to leverage up further, which is about as far as you can go with gold. This is not for the average investor, although the potential gains are huge in comparison to the stake required.

Expect to hear a lot more about how to squeeze the most of out an advancing gold price over the next 12 to 18 months.

Peter Cooper is the editor of ArabianMoney.net