The Phenomenon That Will Force Central Banks to Buy Gold

Gold bullion isn’t getting much respect these days…and that’s perfectly fine with me.

The Goldman Sachs Group, Inc. (NYSE/GS) says the precious metal has a risk of going below $1,000. Bank of America Merrill Lynch cut its forecast for the yellow metal as well. Its forecast says gold bullion prices in 2014 will be around $1,294 an ounce. (Source: Market Watch, September 27, 2013.) Other big banks have similar opinions.

While the big banks were proven right back in April and June when they said gold bullion prices would decline (and much had been written on that “forced” price decline), I don’t think their predictions will come true this time.

At the very core, gold bullion is a store of value, and it protects against uncertainty and currency fluctuation.

As readers of Profit Confidential know, I believe central banks will ultimately be the biggest buyers of gold bullion, and they will ultimately be responsible for higher prices.

Long-term, history has proven when there’s too much money in circulation, the value of paper money goes down and the hard asset prices go up. This economic cycle will be no different.

In fact, at his point in history, central banks in the global economy are printing paper money in overdrive mode, and they presently don’t seem worried about any consequences. Our own central bank is printing, the European Central Bank is printing, and the Swiss National Bank said it will print an unlimited amount of paper money if that’s what’s needed to keep its currency value low.

And while developed nations are printing, money printing in emerging markets is out of control. (In the end, it will be the central banks in the emerging countries that will be the ones desperate for gold bullion.)

Just look at these hard facts:

The basic money supply (paper notes and coins in circulation) has increased 156% since January of 2006. (Source: Federal Reserve Bank of St. Louis web site, last accessed September 27, 2013) And the printing continues in India.

The situation is similar in China. The basic money supply there more than doubled from January of 2008 to this June. (Source: Ibid.)

Central banks are wrong in thinking money printing will solve their economic problems (Japan today is proof that money printing doesn’t work). Sure, the longer paper money printing goes on, the better the outlook for gold bullion. But it’s not just about central banks. Actual demand for precious metals by citizens in countries that are increasing their money supply (the U.S., India, China, and others) has been aggressively rising.

For now, I sit back and anxiously wait to see how this will all unfold. I am not worried about the short-term picture for gold bullion, as I believe the long term looks nothing but shiny for the yellow metal.

Michael’s Personal Notes:

The bear dressed as a bull has done a masterful job at luring more and more investors back into key stock indices.

Data from the Investment Company Institute shows that for the week ended September 18, long-term stock mutual funds had inflows of $3.3 billion. For the week prior, inflows were $5.2 billion. (Source: Investment Company Institute, September 25, 2013.)

Those who are buying stocks now cannot see the losses ahead!

The fundamentals behind the rally in key stock indices continue to deteriorate.

Companies in key stock indices are playing tricks to make their corporate earnings per share look better. They are buying back their own shares; and the more they buy, the better their corporate earnings per share look. In the second quarter of this year, the S&P 500 companies in total bought $122.8 billion worth of their own shares. The stock buyback activity in the second quarter was 24.2% higher than the previous quarter! (Source: FactSet, September 23, 2013.)

The troubles for key stock indices don’t just end here. Look at the chart below. It compares consumer sentiment (green line) and the S&P 500 (red line). Pay close attention to their relationship.

Chart courtesy of www.StockCharts.com

While consumer confidence has basically been flat, the S&P 500 has risen. The theory behind this is that when consumer sentiment is better or increasing, consumers go out and spend. As a result, companies’ corporate earnings increase. This is not the case right now.

Last but not least, we are hearing companies in key stock indices warning about their corporate earnings going forward. So far, 82% of the S&P 500 companies have issued negative guidance about their corporate earnings for the third quarter. How significant is this? The five-year average of S&P 500 companies providing negative guidance about their corporate earnings is 62%. As a whole, the number of companies proving a negative third-quarter outlook, in numbers, makes up almost 18% of the index—or 88 companies. (Source: FactSet, September 20, 2013.)

From my point of view, the disparity between the underlying fundamentals and stock valuations has increased to an unprecedented level. Be very careful with equities; easy money and tricks can only drive key stock indices higher for so long.

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