Previously, we were very bullish on gold and silver (and commodities in general). History shows that commodity prices tend to consolidate in big ranges UNLESS there is a massive supply/demand imbalance. When such an imbalance occurs, commodity prices go on a multi-year journey to Bull Market Town.
This happened in the 1970s. Artificial price controls that depressed natural resource prices were lifted and comodities soared. Then the U.S. and global economies experienced multiple MASSIVE geopolitcal shocks that disrupted the supply of oil and other raw materials. This resulted in double digit inflatino.
A massive supply/demand imbalance also occurred from the early 2000’s to 2011. China’s breakneck growth sucked 1/3-1/2 of the world’s supply of many commodities such as copper and iron ore. This soaring demand drove the entire commodities sector higher for many years.
When commodities are in a massive range for many years, there will be occasional spikes driven by events such as the Persian Gulf War. However, none of these events are significant enough or last long enough to truly push commodity prices through the roof.
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Before the U.S. election last year, we did not see any signs that a massive supply/demand imbalance would return. Inflation is nowhere near high-single digits and there is no massive economic growth anywhere in the world. Although the global economy and its main areas (U.S., China, Europe) are all growing nicely, they are doing so at a moderate pace.
And then came the election. Like many other investors, we believed that Trump’s proposed pro-growth infrastructure program would give commodities that massive boost. Even just half of Trump’s $1 trillion proposed program ($500 billion) would have caused a massive supply/demand imbalance for commodities.
But all that has changed. A fractured Republican party has ensured that Trump’s tax and infrastructure programs are already dead in the water. Even if these programs are passed, they will be severely watered down.
- There’s a real big supply/demand imbalance in the economy, or….
- Inflation picks up “bigly”…
commodities cannot go up in the long term. There will be medium term spikes, but commodities such as gold and silver will consolidate in a massive range in the long term. That is what’s happening with oil right now, which is stuck in the $40-$60 range.
We are in the final few years of the current economic expansion, which means that inflation will start to rise on its own over the next few years. However, this is a slow and gradual process. Inflation is not high enough to push commodity prices through the roof right now.
Several economists that we speak to believe that inflation will not pick up noticeably in 2017. We agree. They also said that inflation will start to pick up in 2018, primarily via rising wages.
Thus, it’s likely that commodities will bounce in a giant range for the rest of 2017, and then start to slowly go up in the long term in 2018 and 2019.
There is also a less likely case that we need to consider:
- Many assets are above their mean valuations. Bonds are very expensive with rates at all time lows, and stocks and real estate are also relatively expensive.
- Although our models state that the bull market in stocks will continue, commodities are the cheapest asset class. Perhaps many large hedge funds will start to buy commodities like gold because A) it’s cheap and B) they anticipate inflation?
- We’re already some signs of this. Massive hedge funds run by legendary investors like George Soros, Jeff Gundlach, and Jeremy Grantham are stockpiling precious metals.
*Note that we do not invest in precious metals. Our outlook on precious metals impact our outlook on the S&P 500. For the last stage of a bull market in stocks, the S&P and commodities go up together (a 1-1 positive correlation).