Just How High Can Gold Climb?

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Source: Thinkstock

Source: Thinkstock

From my analysis, gold is in a fundamental long-term bull market that will last for several years, and possibly a decade or longer. There are several reasons for this.

First, gold has largely lost its role as a monetary metal over the past 40 years or so. While this began to change somewhat in the wake of the 2008 financial crisis, many investors still view gold as an “alternative” investment when in fact it is a long term store of value — aka it has a monetary function. While many other assets have been given this role over the past several decades such as shoter term U. S. government debt, money markets, bank accounts (which are legally “loans” to the bank”), and even so-called “blue-chip” stocks, the fact is that these assets are overvalued relative to gold given that they no longer offer returns (or, yields) that justify the risk that comes with owning them.

Banks pay no interest but they are arguably riskier than ever. Stocks pay very small dividends because they are viewed as a superior alternative to cash earning virtually nothing in the bank. Government bonds also earn virtually nothing unless we go way out in the yield curve. Nevertheless, these assets are used as if it were money; banks and even individuals are allowed to borrow aggressively against them, which only serves to push their pries even higher. Gold, which used to be used as collateral, is now considered risky. I think that by the time the bull market is over, these two sentiments will be reversed.

Second, the money supply in the United States has been rising dramatically. While it has accelerated ever since the Federal Reserve’s Quantitative Easing Program has been announced, the fact remains that a rising money supply has been the norm for decades, and the price of gold simply hasn’t caught up given its 20-year bear market in the 1980s and in the 1990s. Even during the bull market, the money supply has been rising faster than the gold price, and in effect gold is cheaper on this basis now than it was back at the bottom in 1999.

Third — and this reflects the second point — the cost of mining gold makes the endeavor extremely difficult, and in many cases simply uneconomical. In 2013, if we consider all of the costs that miners incurred from digging up ore to processing it to taxes, interest payments, and so forth, it costs about $1,100 – $1,200 to mine an ounce of gold. Furthermore, this doesn’t reflect irrational mining of low-grade gold ounces, as this would be reflected in a significant increase in gold mining. But in fact, gold mining seems to have peaked out and it is expected to decline somewhat this year. When the bull market is over, we will see gold mining increase substantially.

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