Gold: Uncertainty Creates Opportunity

09/10/2014 9:00 am EST

Focus: COMMODITIES

Michael Burnick

Editor, Real Wealth Report

According to data from the World Gold Council (WGC), demand for gold has plummeted; however, the reality is gold demand statistics faced an impossibly difficult comparison this year with the same period a year ago, explains Mike Burnick in Money and Markets.

Recall that it was during the second quarter of 2013 that gold prices dropped a breathtaking 25%. The decline was driven mainly by fast-money investors in a panic to sell gold-backed ETFs, with most of the outflows coming right at the bottom.

Second, while speculators were dumping paper-gold a year ago, smart money investors were buying the real thing, as demand surged for gold bullion, coin, and jewelry.

The fact is that long-term buyers of gold backed up the truck to take advantage of what was described at the time as a "once in a generation event."

Predictably, as a result of the surge in physical demand a year ago, 2014 second-quarter results showed a slump in gold bar, coin, and jewelry buying compared with 2013; it was simply impossible to measure up to last year's buying stampede.

Third, there was also some good news in the WGC report that wasn't widely reported. For starters, ETFs—which triggered the sharp 2013 selloff—have apparently exhausted their selling.

Also, central banks continue to be eager buyers, with demand up 28% this year alone. In fact, global central bankers have been some of the steadiest buyers of gold, adding to their official holdings for 14 consecutive quarters.

Central banks are fond of talking-their-book about the absence of inflation, as they continue to print money with reckless abandon. But their actions speak much louder than their words. The lesson: ignore the scary headlines that don't give you the whole story and stick to the facts instead.

I consider gold and especially precious metal stocks to be outstanding bargains today from a contrarian point of view. Mining shares in particular offer a unique combination of undervaluation and investor neglect that is often found in great long-term buying opportunities.

You see, the consensus view about gold is uncertain at the moment…and that's a good thing because it creates a bargain buying opportunity without having to fight a crowd of eager buyers.

The global economy is still in the midst of an epic tug-of-war between the forces of inflation and deflation. Ultimately, the outcome will have major implications for the trend in gold, energy, and other commodities, not to mention bonds, global currencies, and many other markets.

On the deflationary front, we have a big chunk of the global economy sliding back into recession; this is clearly a negative for gold and precious metal stocks.
On the inflationary side of the ledger, decent upbeat data on the US economy paints a brighter picture. So far this year, the CPI has accelerated at a yearly pace of 2.5%. That's double the 1.2% rate during the first seven months of 2013.
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Now, Janet Yellen will tell you this is nothing more than noise in the data, but, lately, the volume of inflationary noise is just too loud to ignore anymore. Obviously, this is long-term bullish for gold.

While this tug-of-war plays out, uncertainty prevails and investor anxiety is on the rise. This translates into higher volatility for gold, silver, and mining stocks in recent months. It all depends on whether each new piece of economic data is inflationary or deflationary in nature.

But uncertainty is precisely what great buying opportunities are made of. Of course, we can't know the exact day or hour gold will bottom.

Perhaps the low is in place already, months ago, or maybe the ultimate low lies in the future.

Gold suffered a bear market from the peak in 2011 to last year's low, declining 28% in value during 2013 alone! But now the price of gold is reverting back to the mean, from deeply undervalued territory. And it has plenty of room left to rally.

Gold mining shares performed even worse, with the Philadelphia Gold and Silver Index (XAU) of mining stocks plunging 47.6% last year, but this year we've witnessed an upside trend reversal.

But, for over a year now, gold mining stocks have been outperforming the price of gold to the upside, a very bullish sign. Year to date, XAU is up 17.3%, far ahead of the 4.7% gain in gold itself.

This bullish performance puts gold mining stocks far ahead of nearly every other stock market sector this year.

This tells me gold in the ground (mining stocks) is correctly being recognized as a bargain at today's prices...and the smart money is already buying ahead of the crowd.

Bottom line: The last time gold mining shares were this undervalued and neglected by investors in 2008, XAU soared 266.4% higher in just two years. Will history repeat over the next few years? Keep tabs on the inflation-deflation tug-of-war.

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