Why Gold Has the Potential to Soar… But Probably Not Quite Yet

Gold and for that matter, potentially silver even more, are assets that we think have a significant amount of potential return over the next few years.  We are at the end of a massive up cycle, that was driven up in the last 30 years by debt.  The party is over which can be seen by desperate actions of Central Banks, including zero or negative interest rates; and printing massive amounts of money to spur economies but failing.  Governments have shown how desperate they are as well, living on monstrous deficits and creating the greatest debt monster in history.   Here is how you can build massive wealth in the coming economic and stock market crashes…..

Gold and silver’s bull market began in 2001 – how have they done relative to stocks:

The reality is, the world is living on borrowed time.  There will be an event that triggers the next collapse and there are many that can happen. Included in this list is a massive bubble in derivatives of over $600 trillion outstanding, a major reason for the last financial crisis; emerging market debt and economic implosion – it is happening; continued commodity price crash, creating a massive amount of bank write-downs and select economy weaknesses, including Canada; Central Banks backing off recognizing there is nothing left for them to do; continued war and terrorist increasing in the current world cycle we are in; Japan’s reckless fiscal and monetary mess finally imploding; or Europe’s big banks collapse under the weight of monstrous non-performing loans.  The list could go on, but it is safe to say that we live in the riskiest time in history.  So where will money move to – safe havens and precious metals, especially gold, is one area the money is going.  Here are a few reasons:

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  • Fortrus believes that the world will move into a severe economic downturn. Precious metals tend to perform well during such periods.
  • Currencies today are fiat currencies, meaning they are only backed by the credit worthiness of the issuing government.  They use to be backed by gold, but that changed in 1971 under Nixon.  We think that we will be moving into a period of concern for re-payment of country (sovereign) bonds in countries that have a significant amount of debt.  In these environments, gold and silver become a safe haven.
  • Interest rates are either zero or now negative in pretty much all the developed world.  There use to be an argument that gold produces no income – well that argument is now weaker than ever
  • Corporate revenues and earnings continue to shrink in what is a very expensive stock markets.  We also have to remember that much of stock moves for the last many years has been due to financial engineering, not healthy organic growth.  That period is ending, and world economies are struggling…should lead to further earnings challenges
  • War cycle continues to ramp up as we are seeing with escalating terrorist attacks.  Syria, North Korea, tensions in China Sea, Israel –  Palestine, Afghanistan, Iraq and much of the Middle East, Libya, and Russia – Ukraine are examples of problem areas.  Of course, ISIS is a problem worldwide, and risk of terrorism continue to increase.  Precious metals tend to perform well in such periods.
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How Has Gold & Silver Performed Since The 2001 Bottom……

History is important so let’s look at trends and performance.  First a historical chart on both metals since 1915 to current:Gold Silver 1915toMarch2016

Gold traded pretty much sideways from 1915 until 1971 as it was pegged to US dollar.  Post-1971, volatility started as it traded freely.  As you can see, there have been two periods where both precious metals soared.  The peak in 1980 saw gold reach $920 US an ounce.  In today’s dollars (i.e. inflation adjusted), that works outs to be over $1800 an ounce.  Silver soared even more.  In early 1980, it reached a peak of close to $110 (inflation adjusted).  That is much higher than the recent peak of just over $50 in 2011.  We believe that the metal markets have the final major bubble phase coming at us shortly.  Saying that, we still believe that a downside to between $900 and $1000 US is very possible.  This is the reason we took some excellent profits in the sector in the Fortrus portfolios.   We will explain in more detail below.

Looking only at the current bull market that began in 2001, in both the US and Canada, gold has gone up an average of more than 10% per year.  If you look at its compounding return per year, it has been 8.5%.  In today’s world, that is a very respectable return.

Silver has not done quite as well as gold but has outperformed both the major US and Canadian Indices.  It has averaged 6.0% per year compounded returns.  Of course, it performed much better during the initial phase of the secular bull market up until April 2011, where it averaged 22.5% compounded per year return.  Gold also did extremely well in the initial phase of the bull market, from 2001 to August 2011, where it went up 17.1% per year.

 Looking at the major index, the S&P500, it has only gone up about 4.3% per year, including dividends since 2001.  If you look at a mutual fund, you can lower that number by about 2% per year on average, as 80%+ of funds underperform their benchmark indices, bringing the average per year return to just over 2%.

The Toronto Stock Exchange has done a little better, averaging around 5% per year including dividends.  Once again, if you look at a mutual fund, you should lower that by about 2%, resulting in a net return of about 3% per year.  The difference in ending portfolio balances in owning precious metals versus stock indices is dramatic…but we do not think we have seen the best from precious metals and worst from stocks.

Short-term, we are concerned that precious metal prices may fall – breakout levels tend to be re-tested and seasonality works against them today

In our Fortrus newsletter portfolios, we recently sold our gold positions at a 23% and 14% returns in less than 3 months.  Given that  we believe gold and silver have significant upside potential over the next number of years , why would we take profits?   First, when you get a significant return in 2.5 months, you have to consider locking in those gains.  We are not a trading service but sometimes circumstances dictate, taking profits and running.   We believe this is one of those times.  If previous metals end up holding better than expected, we will get back in, possible 2-4% higher.  We do not worry about having to pay up a bit more for positions as risk management will always be a primary motive for all recommended moves.

Our customers should always remember, that we have always recommended buying some actual gold or silver and holding for the long term.  This is outside of the portfolio that we recommend and, of course, depends on a customer’s net worth, risk tolerance, and cash flow needs.  A position of up to 10% of one’s liquid net worth would be a good level to hold.  On these positions (outside the portfolios we recommend), we will still advise you if you should consider selling at some point in the future.   We may do so if we get a double or more in either precious metal.  We do believe the potential returns are much higher than that in the 6-year maximum timeframe.

Here is one of the reasons beyond the metals and stocks attached to the metals running too far, too fast in the first quarter 2016:

Seasonality of PMs

Seasonality plays a role in precious metal investing.  Historically (at least, during this bull market, although longer term data agrees with the results), the worst time to own precious metals is in Q2 during a year.  The April to June timeframe has seen the lowest average return for gold at 2.56% and has resulted in a negative return for silver, averaging -2.87%.  The other three-quarters of the year provide solid returns, with Q1, which we are just finishing showing the best results.

Here is a chart on months and how precious metals have performed:

Gold Seasonality MonthlyReturns

As you can see from this chart on gold, March is the worst performing month for gold.  The best months are January and September.  If you break the year into two periods, the period to own gold is August until the end of February.  The period March to the end of July is very weak.  Again, a reason we have taken profits at this stage.

If you are holding, that is fine.  Just do not get upset if we do possibly get a 15% – 25% correction.   Gold looks very positive intermediate and long term, as it has broken out of its triangle channel; 3.3% above the 50-day moving average (MA); 5.9% above the 330-day MA; 8.1% above the 200-day MA; and 15.3% gold’s bottom in December 2015.  We do expect to see gold test the 200-day MA.  When it does, that may be the bottom.  We will reassess at that time.

 Gold 2011toMar2016 Trendline Triangle

 On a breakout, most times the security, in this case, gold, comes back to test the breakout point. If it does that and starts to move up again, that will be a very bullish signal.  We will be watching.

Hopefully, that gives you some perspective on why we are a little uncomfortable holding precious metals today.  To recap, they ran up too much too fast; breakouts tend to re-test their breakout level, and seasonality is against the metals.

Gold’s bull market and comparisons to other secular bull markets historically…

Now let’s look at some historical bull market comparisons, and why we still love gold and silver:

DJI vsGold BullMkt Comparisons toMarch2016

As you can see from the chart above, if gold is in a long-term growth market like the DJIA has been since the early 1980’s, we have something in store for us moving forward.  Now, our belief at Fortrus is that gold will not go through the length of cycle that the major US index has gone through, as precious metal cycles are shorter.  Saying that there is an argument how gold could go much higher for a much longer period:

  • Fiat currencies of all developed countries are at risk, as debt levels have rapidly ratcheted up.  If the creditworthiness of governments is challenged, including their ability to repay their outstanding bonds, gold can be in a very long secular bull market as the safest currency available with no debt attached to it
  • Economic growth is stagnating worldwide, and if we move into a global recession, as we anticipate, there should be a movement of assets to safety – gold will be one of the major recipients
  • Deflation is taking hold throughout the world.  In such an environment, again, money will flow towards safe assets that should preserve their value.  This could include such things as agricultural properties and precious metals
  • Interest rates throughout the world are now at zero or in many cases negative.  Safe monies will not necessarily now go towards fiat currency bonds or leveraged corporate bonds.  They offer no yield and will be considered risky.  Again, gold will be a viable option

Let’s have a look at three other bubbles that we have seen historically and how the current bull market in gold compares:

BubbleAnalysis Gold Oil NASDAQ 16YrPeriod

The gold market of 1970 to 1985 saw the major spike in 1980 followed by a choppy market until about 1973 when gold started its long-term descent.  The NASDAQ boom also ended after about 9-10 years before starting its descent in 2000.  As in the gold bubble of the 1970’s, the return at the peak reached around 800% in inflation adjusted terms.  The last comparison is Oil, which ran from 1999 to Q4 2008, again a 9-10 year move to peak.

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The previous gold market of the 1970’s may provide some clues as to what we should expect from gold in this cycle moving forward

This should elicit a question:   could the current bull be over as it peaked at the 9-10-year level as well?  Of course, it is possible, but we do not think probable.  We provided some reasons above as to why we think gold completed its first phase up in 2011, with a subsequent correction to 2015.  We do believe that a bottom is forming currently, and a move upwards will start to occur in late summer or the fall.  It may rally sooner, which is why we have triggers in place, where the market prices advise us as to where the underlying assets want to go – up, down or sideways.

Let’s have a closer look at the comparison between the current gold secular bull market with that of the one in the 1970’s:

Gold 1915toMar2016

There are similar elements to each bull market.  The one in the 1970’s was shorter in duration but similar in structure to date.  The first phase up in 1970 was four years in duration and gained 282%. The first phase of the current gold bull market started in 2001 and went for 10.5 years, with a total gain of 423%.

The reason we believe the current gold market will be double the length of the one in the 1970’s is due to the massive Central Bank interventions as well as huge government debt.  Both parties have done everything possible and more to stimulate economies but instead have created bubbles.   First in real estate, which is ending for many countries including Canada and the second phase ending in others including the US.  Second in bonds where interest rates have been brought down to near zero percent with the massive quantitative easing programs and zero interest rate policies (now becoming negative interest rate policies).  In commodities, which peaked primarily in 2008 with energy in 2014 and had subsequently crashed.  Stocks are in a bubble phase as well, as much of the trillions of dollars that were supposed to go to Main Street to stimulate job growth and economies instead went to Wall Street and other stock markets.  We anticipate both bonds and stocks to move down as commodities have over the last number of years.

Back to the comparison of the cycles.  The down phase in the earlier gold bull market lasted for 2.75 years and fell by 46%.  The current cycle saw the correction phase last four years and fell 42%.  As you may be sensing, the current cycle tends to be double in length of the previous one.  That would mean that the next up phase should go for about 6-7 years as the final blow-off phase in the late 1970’s went for 3.5 years, rising by 356%.  If we get an extended magnitude with a higher percentage move in the final phase of this bull market, gold should be targeted to around $5000.  Predictions are simply that, an educated guess.  But saying that, we use history, the macro environment, fundamentals and cycles to allow us to know the trends we expect.  We then let the price action tell us when to be in and out of securities.  Gold’s time is coming fast.  It may be here now, but our instincts say not quite yet.

One positive correlation that has been in place is ‘so goes Federal Reserve balance sheet, so goes the price of gold’.  That changed in early 2013:

Gold vs FedReserveAssets 2004toMar2016

We believe this correlation will once again come closer together, especially as Feds are forced to utilize some form of quantitative easing in the next economic and investment market breakdown.   Look for gold price to play catch up here.

Here is a look at the areas where we think the opportunities will be the greatest.  Frist, both gold and silver should have significant runs, but if history is our teacher, silver may present the better opportunity:

Gold Silver Ratio 30Yrs toMar2016

Over the last 20 years, we have seen the gold-silver ratio (the price of gold divided by the price of silver) trade in a range between 47 and 80.  Today, we are at the top end of that range.  Silver is known as poor man’s gold, and the biggest thing against it is that silver is not just a monetary metal, but it also has a significant industrial use. The demand here has been steadily falling, as world economies continue to stumble.  Saying this, we do believe that when times get ugly, silver, due to its much lower price than gold, will rally strongly…an area of opportunity.

If gold runs, how far will it run?  We showed you above that $5000 would be an extremely aggressive target, and we will simply let the price action tell us if this is where the price wants to gravitate towards.  The last gold market shows us that this kind of move is very possible as the next phase of this bull market could be much more significant than the first phase of it from 2001 to 2011.

Another way to analyze potential for the price of gold is the Dow-Gold Ratio:

Dow Gold Ratio 100yrs toMar2016

During difficult periods, the Dow-Gold Ratio tends to move down below 5, actually falling to less than 1 in the late 1970’s.  The last two secular bear stock markets were during the period when this ratio went down significantly.   We think that we will once again see this ratio fall to at least 3 and possibly 1.  This does not necessarily mean stocks have to crash, but it does mean that gold has much more upside that the DJIA.  Here are a few possibilities:

Dow-Gold Ratio at 3 (Gold currently at $1220; Dow at 17,600:

Dow at 15,000:     Fall by 15%         Dow at 10,000: Fall by 43%         Dow at 5,000:  Fall by 91%

Gold go to $5000: Gain of 317%    Gold go to $3333:  Gain of 178% Gold at $1667: Gain of 37%

Dow-Gold Ratio at 1:

Dow at 15,000: Fall by 15%           Dow at 10,000:Fall by 43%          Dow at 5,000:  Fall by 91%

Gold to $15000:Gain of 522%       Gold to $10000 Gain of 355%     Gold at $5000:Gain of 127%  

As you can see, in all cases the DJIA will fall, and gold will rally big time.  Given our premise that we think stocks are overvalued and will go through a major corrective phase, we think that the DJIA is more likely at 10,000 as a positive result or closer to 5,000 in a collapse scenario.  Gold in both cases would provide great returns if we move to historically normal Gold-Dow ratios from 1 – 3.

Wealth is created and lost via investing at the right time in cycles or for that matter the wrong time.  Make sure you are in the school of being the former….


Matt Sammut,  Founder & Chief Investment Strategist,  www.FortrusFinancial.com