By Stephen Leeb
The Complete Investor
Yes, gold has had a great run - but there's no reason to think it's going to end any time soon. Don't call us crazy for thinking gold could top $5,000 within the next half decade.
We've been urging investors to own gold since we began publishing The Complete Investor more than seven years ago. And our gold credentials go back further still. In the late 1990s, in my book Defying the Market, I predicted that commodities would be the stars of the following decade and that gold would sharply outperform stocks and bonds. In The Oil Factor (2004), I projected gold could reach $2,000 an ounce in coming years.
What was true back then is even truer today. Gold, even after its long strong run, is poised for gains that might sound laughably high. But it's gold investors who will be laughing hardest. We're not abandoning other investments, but at this point we think investors should weight gold at least on a par with cash, stocks, and bonds. (By gold we mean not just bullion but also gold stocks and even weightings in other precious metals.)
Someone recently commented he couldn't get excited about an investment like gold just because it buys five times more lobster today then a decade ago. Well, a lot of people might be happy with five times more lobster, or anything else. But it raises the point: why has gold, an essentially fallow investment done so well?
To answer, let's look at the plight of the median American, whom we'll dub Mr. Jones. Around a decade ago his income was $52,000. Today it's below $50,000 - but that's overstating what he has. A decade back, energy accounted for around 4 percent of his income. Today the figure is close to 10 percent. In all, Mr. Jone's purchasing power has dropped by more than 10 percent.
As Mr. Jones was losing money because of slow economic growth and commodity inflation, the Federal Reserve was printing dollars like mad. The number of dollars in circulation plus the number of dollars held by banks has increased by three and a half times, from about $600 billion to $2 trillion. In other words, Mr. Jone's purchasing power has eroded despite a massive increase in dollars. It could take a further increase in dollars to keep Mr. Jones from losing even more ground.
Against this backdrop, holding dollars is a losing proposition. Rather, investors should seek a currency that will hold its value, and then some, in the face of all the factors pushing median incomes down. That currency, clearly, is gold.
Gold has been a currency for millennia. It is prized for its special chemical properties that enable it to maintain its shine and to be infinitely malleable. It's also prized because there is only so much of it around, and what there is of it is essentially indestructible. Nearly all other metals, by contrast, have industrial uses that would detract from any role as a currency.
Is gold better during inflation or deflation? The correct answer is both. The key to gold's appeal as a currency is whether a particular economic scenario eats into purchasing power, which can happen under inflation and deflation alike. Have the past 10 years been inflationary or deflationary? You can make a case for either. What matters is that gold shines when more and more of a currency buys less and less - in other words, when a currency is being debased.
Many now claim that gold is in a bubble. We totally disagree. To explain why, we'd start by arguing that currencies are always being debased to some extent or at least are subject to potential future debasement. In other words, there's always a case for at least some gold. How much or how little depends on the degree of current or anticipated debasement.
One way to judge if gold is over- or underpriced is to look at the ratio between the gold supply and the money supply. However, money supply is measured differently today than in the past - for instance, the U.S. no longer calculates M3 - making historical comparisons tricky.
A more accurate method is to look at the ratio between gold prices and gross world product (like GDP but for the entire planet) before inflation. This tells us how much gold is in the world relative to all the goods being produced. Because gold doesn't get consumed the way oil and iron do, the price of gold is a good reflection of the total value of its supply. The simple premise here is that the more volatile and iffy the world, the greater the need for a shelter and thus the higher the ratio of gold to underlying economic activity.
Since the early 1970s, the ratio of gold to GWP has averaged 0.65. Today it stands at 0.57, which tells us gold is actually cheap today despite its gains over the past decade.
How high would gold prices need to go before they could be considered overvalued? The last time gold peaked was in 1980, when the ratio averaged 1.72. At the absolute peak in February that year, the ratio was over 2. Therefore gold prices would have to more than triple from today's price before gold is overpriced relative to its past peak. Specifically, we would be looking at gold at $4,300 per ounce.
But we actually think gold's potential is even greater. In the 1980s, for instance, there were ready answers as to what was wrong with the world and how to fix it. Today there are no clear solutions. We have no Paul Volker-like figure assuring us that commodity prices will stop rising, China will stop growing, or U.S. real incomes will stop falling.
Besides, we calculated the ratio based on today' GWP. Over the next five years, we expect annual growth of 5 percent (nominal, not real). The price gold must reach for the ratio to hit its previous peak will also rise, raising our five-year target for gold to $5,500 per ounce.
But there's more. This assumes currency debasement will be no worse than in the 1970s. In fact, it could be much worse, meaning the gold/GWP ratio could rise much higher before peaking.
The bottom line: until there's a basis for low-inflationary economic growth - growth without currency debasement - as in the 1990s, gold prices will continue to rise in an accelerating trend.
All this tells us that investors ought to be buying gold now and buying aggressively on any dips that arise. We used to recommend you hold 10 percent to 15 percent of your portfolio in precious metals. Now we think an even higher percentage will serve you well. The more that nations debase their currencies, the more that gold will reward you.
Even if you just see gold as insurance against potential deflation or inflation, that insurance is very cheap right now - and until the world economy gets a lot healthier, your need for insurance is very high. So take advantage of the opportunity.
Both gold itself and gold stocks will be big winners, with stocks likely to generate the greatest profits. The easiest way to invest in bullion is through the ETF SPDR Gold Shares (GLD) (Growth Portfolio). Among gold stocks, we like large caps such as Barrick Gold (ABX), Growth Portfolio's Randgold Resources (GOLD), and Newcrest Mining (NCMGY), as well as a basket of miners as with ASA Ltd. (ASA). And some of the highest returns will come from small caps like FundFind's Osisko Mining (OSKFF) and Small-Cap Value's NovaGold Resources (NG) and newly added New Gold (NGD).
Editor's Note: Stephen Leeb is editor of The Complete Investor, P.O. Box 248, Williamsport, PA 17703, 1 year, 12 issues, $72. Dr. Leeb, using his two unique key indictors, has predicted nearly every major market movement during the past 30 years. Because of this, he has had the distinction of being named America's #1 market timer by the Timers Digest. He was editor of Personal Finance for 13 years, and is routinely a winner or the runner up for the top NEPA financial journalism awards. He is the author of six best-selling investment books. For more information on The Complete Investor and a Special Offer for Bull & Bear readers, visit www.completeinvestor.com.
