Poor gold bugs. Everywhere they turn, another can of Raid.
Gold is “doomed,” says one gloomy headline. Gold demand is the weakest in six years. And perhaps the most insulting: Gold is just a “pet rock.”
For contrarians, about all we need now is the classic negative magazine cover to confirm it’s time to buy gold.
But really, there’s no need to wait for that. Sentiment is already gloomy enough. It’s time to buy gold — at the very least for the bear market rally that will soon take the metal 10% to 30% higher, say several gold experts.
The bullish percent index, an indicator that measures the number of stocks in a group that are in a bullish trend, was recently at zero for gold miners.
“People are gratuitously ganging up against gold,” says John Hathaway, manager of the Tocqueville Gold Fund . To him, the current price smackdown is “symptomatic” of a tradable bottom. “You see this supreme confidence that you can’t lose by being on a certain side of a trade.” That would be betting against gold.
“Capitulation in the gold miners is telling us the selling should be over soon,” says Lawrence McDonald, head of U.S. macro strategy at Societe Generale. “We are witnessing seller exhaustion, and we don’t believe the recent breadth of the selling is sustainable.” He’s betting on another bear market rally. And soon.
Credit Suisse gold analyst Anita Soni says gold is poised for a rally in the third and fourth quarters because the bearishness is overdone. She puts the trading range at $1,100 to $1,300 per ounce over the next several quarters.
Besides the tradable bounce, you might also want to take advantage of low gold prices to put some in your portfolio as a form of disaster insurance. More on that logic in a moment.
Meanwhile, get exposure via gold mutual funds like Hathaway’s Tocqueville Gold Fund, or a gold exchange traded fund like SPDR Gold Shares . Gold miners are down even more than gold, so that’s a good way to go, too. Consider the Market Vectors Gold Miners ETF . I also suggest several individual gold-mining stocks favored by Goldman Sachs, at the end of this column.
Before we get to those companies, click ahead to see four reasons you have to buy gold now.
Reason 1: Sentiment is extreme
News headlines are a great way gauge sentiment, to line up contrarian plays. But there’s no shortage of quantitative measures for gold, too.
The short position, which measures the depth of the bet against it, is very high, points out Rohit Savant, the director of research at CPM Group, a commodities-research firm. He says investors were short 16 million ounces of gold as of July 21, 2015, compared with an average of 3.9 million since 1995. The last time the short position was that high — near record levels — was July 2013, and that was promptly followed by a 36% surge, according to analysts at Barclays.
The bullish percent index (BPI), a technical indicator that measures the number of stocks in a group that are in a bullish trend, was recently at zero for gold miners. That marked good entry points for gold in 2008, 2013 and 2014, points out McDonald. “This has been a good ‘buy’ signal indicator,” he says.
A measure called the Daily Sentiment Index recently put gold bulls at just 10%, says Hathaway. “That’s, for sure, an extreme,” he says.
He also cites high levels of outflows from gold funds, and lots of asset divestitures by mining companies trying to right their balance sheets — two other events that can mark the bottom for gold prices.
The bottom line: Investors have yellow fever. They are sick of gold. Good time to buy.
Reason 2: Dollar strength is unsustainable
Typically when the dollar goes up, gold weakens. The dollar has been quite strong again lately, which helps explains gold’s plunge. But many analysts think the dollar is at an extreme peak that will reverse, too. If so, gold will strengthen.
But why will the dollar weaken?
Let’s look at two theories. One holds that the Federal Reserve worries a lot about dollar strength, because it’s bad for U.S. growth. A strong greenback makes exports more expensive. It makes foreign goods more attractive. It cheapens the reported value of overseas profits earned by U.S. companies.
To knock down the dollar, the Fed may well push out interest rate increases currently expected by consensus for September, believes McDonald. If not, it might raise by much less than the expected quarter percentage point. Either of those scenarios would weaken the dollar and support gold.
Wells Capital Management chief investment strategist James Paulsen also expects the dollar to weaken, but for different reasons. He thinks stimulus programs in Europe and emerging market economies are kicking in. As they boost growth, they’ll attract investment interest in those regions, and bid up their currencies against the dollar.
Two different scenarios. Both lead to a weaker dollar and higher gold prices.
Reason 3: China growth is picking up
One country to watch in particular is China, since its robust growth in the past 15 years played a big role in creating the commodities “super-cycle” — the sustained bull market in commodities for years.
Now, though, one of the chief reasons commodities, including gold, are so weak is investors’ angst that China’s growth will continue to cool. But if Paulsen is right that China’s growth is bottoming and about to pick up, that’ll reverse the negative sentiment toward commodities and put a bid under them. Including gold.
“China purposefully tried to slow its economy down in 2011. It was successful in that policy pursuit,” says Paulsen. “China really didn’t try to get its economy going until late last year,” he says, referring to government stimulus programs. “A year lag is normal.” The economy also gets a boost now from lower energy prices.
Indeed, now China’s growth is starting to improve. Recent data show either a stabilization or pickup in indicators like retail sales, exports, fixed asset investment, industrial production and exports.
Those results “are consistent with stronger-than-expected money growth and credit expansion, suggesting the earlier policy-easing measures have started to take hold,” agrees Barclays analyst Jian Chang.
Reason 4: Gold season is around the corner
Historically, gold demand in China and India is strongest the fourth and first quarters, in part, because of buying related to religious holidays. The current low gold prices will also spark demand by people in both countries looking to pick up gold as an investment, or to protect against currency depreciation, says Credit Suisse’s Soni. Rising incomes in those countries will also add to higher demand for gold jewelry.
How to play the coming gold bounce
Besides gold ETFs and mutual funds, it makes sense to focus on gold miners because their stocks have sold off much more than the metal. Goldman Sachs analyst Andrew Quail has “buy” ratings on Goldcorp , Barrick Gold , Stillwater Mining and Silver Wheaton , a play on mine royalty income. Quail has 12-month price targets on all those stocks anywhere from 70% to 140% above current levels.
McDonald, at Societe Generale, doesn’t think you should wait that long if you buy gold miners now. He suggests selling right away into the bear market rally he expects to play out in the coming several weeks.
Gold as insurance
But holding at least some gold as portfolio insurance also makes sense. That’s because gold does well as a flight-to-safety play in a crisis. What might go wrong in the world? Anything, of course. But here are three scenarios.
First, rising U.S. debt levels could jeopardize confidence in the dollar, and that would spark a renewed interest in gold, says Tom Winmill, who manages the Midas Fund . “The U.S. government monetary and fiscal situation is not stable. When the wheels fall off is anyone’s guess, but it is just a matter of timing.”
Next, heightened central-bank lending and government-spending programs around the world could finally spark inflation. Inflation typically makes gold move higher, as investors buy it as a store of value.
And don’t forget that the current level of global central bank borrowing to save us all from the 2008 financial crisis represents an unprecedented policy experiment. By definition, this means there’s no playbook that tells us how they’ll get out of it. Sure, it could all end well. But if you think you know that for sure, you’re a dreamer. “Nobody knows how this is going to end,” says Hathaway.
How much gold and gold-mining stocks should you own as a hedge against disaster? Around 5% to 10% of your portfolio, says Matthew McLennan of First Eagle Investment Management. Less than 5%, and it’s not a hedge. More than 15% and it’s a directional bet, he says.
“We think gold has an enduring role in portfolios,” says McLennan. “And you can buy that hedge at lower price now than any time in the last five years.”
Written by Michael Brush of MarketWatch