One analyst sees downward pressure on gold. Does this effect our bullish thesis on the yellow metal?

We expect a considerable drop in gold prices.

That was the headline on Monday from Kitco, a popular website that focuses on gold. The article featured analysis from ABN Amro, a Dutch Bank.

Now, regular Digest readers know that we’re bullish on gold.

Given unprecedented fiat currency creation across the globe, the pandemic, and social unrest (as just a few reasons), we believe that diversifying some of your wealth into gold is critical for investors today.

So, when we read a bearish headline about gold, do we ignore it? A defensive mechanism to “tune out the noise”?

While that might feel good, avoiding articles that contradict your investment narrative is a great way to be blindsided if markets turn against you.

Instead, actively seeking out reasons why your market view could be wrong is how professional investors live to trade another day.

After all, there’s the old saying that goes something along the lines of “inexperienced investors focus on what can go right, experienced investors focus on what could go wrong.”

So, are we wrong on gold?

***”The gold trade is too crowded”

 

That’s the bottom-line takeaway from ABN Amro.

“We continue to think that positions are too crowded and that prices are too high to recommend re-entering longs,” wrote ABN’s analyst. “We also expect a considerable drop in gold prices …”

ABN believes we’ll see a rotation out of gold this month, leading to flows into riskier assets.

Given this rotation, ABN is looking for gold to fall to $1,575 by the end of June. As I write Wednesday morning, gold trades at about $1,700, so we’d be looking at roughly a 7% drop.

Now, ABN might be correct.

Below we see a one-year chart of gold. We would draw your attention to the chart action beginning in April. In short, gold has been trading sideways, establishing a wedge pattern.

 

 

Now, let’s add an indicator to this chart called Average True Range (ATR).

ATR is a volatility indicator. It shows how much an asset or security is moving up and down in a given time frame. Higher ATR readings are higher volatility readings, and vice versa.

As you can see in the chart below, gold’s ATR is trending lower. In other words, gold’s volatility has been “compressing” coming out of the heightened pandemic-volatility in March.

 

 

A study of market history shows that assets often make strong moves after going through periods of compressed price action and compressed volatility.

Though gold’s ATR isn’t enormously compressed, the lower it trends as gold’s price remains contained in this wedge pattern, the more likely we are to see a substantial breakout — which could be higher or lower.

So, might be see a 7% decline in gold?

Sure.

… but then what?

***Nothing has changed about the longer-term bullish case for gold

 

With investing, there’s no shot-clock … no final two minutes … no 18th hole.

There are simply seasons — whether you’re a trader and that season is a matter of days, or you’re a long-term investor and that season represents years, possibly decades.

For longer-term investors looking at gold today, the best response to a potential 7% decline by the end of the month is “okay, and then what?”

For that, let’s turn to our global macro specialist, Eric Fry. Eric is one of the most successful analysts in the investment newsletter world, having dug up more 1,000%+ returning investments than any analyst we know.

From Eric’s recent update:

The Federal Reserve, along with other major central banks around the world, are now implementing very large and aggressive QE programs.

And most major governments are also throwing trillions of dollar of debt-financed rescue packages and stimulus measures at the global economy.

… these titanic monetary and fiscal efforts should boost the relative value of gold over the next year or two.

Yesterday, The Wall Street Journal (WSJ) reported on the status of the next stimulus package from the federal government. You may recall that House Democrats passed a gargantuan $3.5 trillion bill last month, though it has no chance of getting through the Senate in its current form.

But it appears that another stimulus package will be coming. From the WSJ:

The price tag of the next legislative package also remains in flux, though Republicans said it could reach as high as $1 trillion …

And remember, this is just the U.S. If we look around the world, global central banks have unleashed at least $15 trillion of stimulus via bond-buying and budget spending.

So, if stimulus measures should boost the relative value of gold, then gold has a lot of boost coming its way based on what’s happening in the world today.

With this in mind, a 7% decline in gold by the end of the month would actually be welcomed by many gold investors, as it would simply provide a cheaper entry price for the longer-term bull market that appears to be setting up.

***What “season” are you looking at?

 

ABN Amro was evaluating gold’s potential performance over the next several weeks/months …

Eric’s update above referenced gold’s potential returns over the coming year or two …

But what about, say, 10 years?

A decade-long bull market in gold has happened twice before in modern history.

The first was in the 70s when gold climbed 1,755% from December of 1969 from through September of 1980.

The second was in the 2000s, when gold tacked on 611% from August 1999 through August 2011.

Now, let’s zero in on a short window time during this 2000s bull market.

Here’s gold, falling almost 27% from March 2008 through November 2008.

 

 

But let’s now put this 27% decline in the context of the decade-long bull market.

 

 

Again, so gold might fall 7% by the end of the month?

Great!

Such a pullback might be a red flag for short-term traders, but for investors who turn to gold as a means of protecting the purchasing power of their wealth over a longer time-frame, a 7% drop is mostly irrelevant.

***Yesterday, the interest rate discussion took a turn, adding more fuel to gold’s potential gains

 

The U.S. government is facing historic debt levels.

I’ll remind you of this chart from analyst Charlie Bilello. It shows how the U.S. debt-to-GDP ratio hit 116% last month — and this is obviously before whatever coming stimulus package is passed.

 

 

For context, according to the Congressional Budget Office, the highest prior ratio level we’ve seen was during World War II, when it peaked at 106%.

With this much debt, the U.S. simply cannot allow interest rates to climb significantly — and that alone is incredibly bullish for gold.

But now, a new twist …

Negative interest rates.

Yesterday, CNBC reported that St. Louis Fed economist Yi Wen has suggested negative interest rates for the U.S. in a paper posted on the St. Louis Fed’s website.

From Wen’s paper:

I found that a combination of aggressive fiscal and monetary policies is necessary for the U.S. to achieve a V-shaped recovery in the level of real GDP. Aggressive policy means that the U.S. will need to consider negative interest rates and aggressive government spending, such as spending on infrastructure.

Fed Chair Powell has previously said he didn’t feel negative rates would be appropriate in the U.S. Of course, that’s no guarantee his position couldn’t change, especially if pressure began building from the various Fed presidents like Wen.

If interest rates are pinned to the floor for the foreseeable future — possibly going negative — it removes a massive headwind for gold, potentially paving the way for not just a year or two of gains, but perhaps a decade’s worth.

Here’s Eric with the final word:

Investors rarely buy gold because they want to.

They buy it because they have to.

We have entered one of those rare episodes. Gold has become such a compelling trade in the current environment that it is difficult to walk away from it …

I have never seen a more promising setup for a gold trade in my 30-year career.

Have a good evening,

Jeff Remsburg