Gold Still Has Significant Upside

An exodus of capital form the equity market serves as dry powder for the commodity markets.

Debt market yields continue to trend lower leaving investors hungry for a low systematic risk asset with potential upside.

The Unite States- China trade war creates an environment for global uncertainty, further strengthening the case for investors to seek safety.

Intro:

Over the past few weeks, gold has stagnated from its highs of $1,560 and has made its descent down to the psychological and technical support line of $1,500. I believe this is in most part due to easing tensions between the United States and China, a high likelihood of another rate cut, and an overall sanguine attitude towards the general equity market. This has led people to embody a more risk on appetite, at least for the time being.

There are still fundamental uncertainties within the global economy such as the trade war projected to lower global GDP and around $15 trillion of negative yielding debt.

In previous articles I have written about the 3x gold leveraged fund (JNUG) to swing trade the highly uncertain markets of June and July, but I believe the next run in gold will be a steady increase that is fueled by an amalgamation of global economic events.

Capital Exodus:

To effectively fuel gold's next bull run, there needs to be a shift in capital allocation from the traditional equity markets into other assets, such as gold. In the third quarter of this year, investors took over $60 billion out of the equity markets which was the largest exodus from the equity since 2009. Even though the U.S. stock market is approaching its all-time highs, investors are skeptical if there is any room left to grow. This comes off the widely agreed upon theory that we are approaching the end of the business cycle and will see a downturn in the equity markets in the near future.

Investors who left the traditional equity markets still wanted to deploy their money somewhere, with a large portion going into the debt markets. Bonds took in $118 billion in the third quarter while money market accounts grew by $225 billion. This evokes a staggering realization that investors are becoming increasingly risk adverse and are pursuing safety at a rate not seen since 2009.

Over Saturated Debt Markets:

In almost every article I have published regarding commodities, I have stressed that the debt markets are over saturated. The historically low global interest rates pose an issue for any investor who has an inkling of a risk appetite- or even wants to keep up with inflation. I believe that gold gives these investors an alternate investment that is a deflationary asset, tangible, and has held value for thousands of years. Now, obviously buying (GLD) will not result in a gold bar being sent to your house, but it is redeemable for physical gold in large quantities.

Currently, the U.S Ten Year is hovering at about 1.7% and has even seen a yield of 1.5% in the past few weeks. If the FED decides to continue to lower rates, bonds will continue to feature lower yields, and this seems highly likely as the futures markets determine there is around a 65% chance that the FED lowers rates in the next weeks. Beyond this, U.S securities look incredibly attractive compared to some European bonds such as the German Bund yielding -.4% and Swiss Government Bonds yielding -.6%, both for their 10-year.

This creates a dynamic where falling interest rates seem to be a global trend, and there doesn't seem to be any reversal coming soon. Investors may now be willing to accept a measly 1.7% for guaranteed safety, but as the yield creeps lower, investors will be looking for an asset that does extremely well in a low rate environment.

United States and China:

Over the past year, possibly the greatest economic pressures is the United States, China trade war. Although there seems to be a lull in activity and retaliations between these two economic superpowers, there is a looming threat that tensions could continue to be escalated. This adversely impacts the global economy as the IMF expects global growth to slow to a level not seen since 2008. They cite that economic uncertainties have made it extremely difficult to have a positive attitude towards global growth. The IMF quantified what they believed would be the impact of the continuing trade war and they said we could expect a .8% global decrease in growth. Over just this past year, the fund has cut global growth forecast by three times.

Conclusion/Actionable Idea

Gold's run has cooled off in the past few weeks, but I believe it is primed to continue the second leg of its run. Global uncertainties still loom, and constantly lower interest rates should propel investors into seeking a product that has virtually no correlation to systematic risk and the potential to yield a return far superior to any bond. Basic economics says that for any increased shift in demand, there should be a subsequent increase in price.

As for an actionable move, the general rule of thumb is your portfolio should be around 10% gold, and I would put an overweight emphasis on this. Depending on your risk appetite, I would begin to shift a portion away from traditional low yielding securities such as the 10-year and money market accounts and hold gold until the market gives a little more clarity to its direction.

Disclosure: I am/we are long GLD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.