The 7 Words That May Jumpstart The Bull Market In Gold

Austin Hatley's picture

Wednesday, December 31, 1969 - 6:00pm

by Austin Hatley

Two weeks ago, Janet Yellen addressed the world as the new chairman of the Federal Reserve.

The market didn't like what she had to say.

For one, her speech reaffirmed the Fed would continue to "taper" -- bringing its monthly asset purchases down to $55 billion (currently $65 billion) starting in April.

But that wasn't the real shocker. The Fed has stayed on course with its "taper" objectives since it initiated the process last December. So the reduction comes as no surprise.

What really spooked the market was something she said in her press conference after the speech. It was seven words that nobody expected.

During the Q&A section of her first public address as Fed chair, a reporter asked Yellen: What does the Fed mean when it suggests that interest rates will remain near zero for a "considerable time after the Fed's asset purchase program ends?"

This was her response:

"The language in the statement... probably means something in the order of six months."

That remark alone was enough to send the market plunging almost 1% on the day of the announcement. Why?

To understand, you first have to know that the rally we've been enjoying lately is partially attributable to our current environment of low interest rates. That's because when interest rates are low, people move their money out of fixed-income investments like savings accounts and CDs and into higher-yielding assets like stocks. The reverse is true during periods of high interest rates.

You also need to know that for the last few years, the market has operated under the assumption that even when the Fed ended its quantitative easing program (that is, when it has finished tapering), interest rates would remain depressed for a "considerable period" of time afterwards.

The problem is no one knew how long a "considerable period" was. Former Fed Chairman Ben Bernanke never provided any explicit details on the matter. So when Yellen put a number (six months) on that estimate, it caught people off guard. No one was expecting a rate hike would come so soon.

So what does Yellen's comment mean?

It means the economy is getting better.

Not only has the U.S. experienced falling unemployment (currently 6.7%) and rising GDP growth (2014 estimate is 3.1%), we've also seen consumer spending make a big upward move lately.

It's paradoxical to think that an improving economy would be a bearish sign for the stock market, but that's the world we live in. Investors fear any change in the Fed's "loose-money" policy could derail the rally we've enjoying over the last few years.

But while there's no doubt that a sudden spike in interest rates would likely hurt stocks, we believe these fears are overblown.

For one, there's still little indication that stocks are in bubble territory. While the S&P 500 is up over 130% since 2009, the price-to-earnings ratio for U.S. stocks is still just 16 -- only slightly higher than the long term average of 15.5.

What's more, even if the Fed does raise rates six months after the taper ends, it will probably only be a 0.25% to 1% increase. From a historical perspective, that's still very low, and should keep stocks attractive for several years to come.

Of course, rising rates will affect each asset class differently. Some assets -- like gold for instance -- could take it harder than others.

We're already seeing this trend play out.

After returning 23% in the first two months of 2014, gold has fallen over 4% since Yellen's comment -- marking the metal's worst selloff in six months.

Dave Forest -- StreetAuthority's resident commodities expert -- has been bullish on gold since he first recommended gold miner Luna Gold (OTC: LGCUF) to his Junior Resource Advisor readers last September. Given his outlook for the metal, I was curious to hear his thoughts on the recent price action.

Here's what he told me...

The recent correction makes a bigger rally for gold even more of a certainty. The gold price as I write has fallen to $1,309 per ounce. And let's remember that the world's biggest gold miner, Barrick Gold, just told us that it must pay $1,282 to produce an ounce. By my math, that means the world's premier gold company is making a negative return once overhead and other costs are factored in.

That's exactly the kind of situation that's presented at market bottoms for centuries. When the biggest sources of production in a sector can no longer afford to produce, something has to change. And I would suggest that given the strong demand we're seeing for alternative currencies globally, the change isn't to produce less gold. The only option then is to have higher gold prices -- the kind needed to spur production.

But if Dave's bullish argument for gold stocks weren't enough, there's also another reason to like gold miners right now. And it can be explained with a single chart...

The chart below shows the price action for gold and gold miners. Since miners earn their living by selling the gold they produce, generally speaking these stocks move in tandem with gold prices. You can see this trend at work in 2007 and 2008. But lately, as you can also see from the chart, a disconnect has formed between gold stocks and gold prices...

It's hard to imagine that this disconnect can last much longer. After all, a brief glance at this chart shows that gold stocks are cheaper today than they were in 2007 -- back when gold was trading around $600 an ounce.

Of course, that's not to say gold stocks aren't without risk, but there appears to be an overwhelming opportunity in the gold market right now. As Dave Forest notes to his Junior Resource Advisor subscribers, "This is exactly the kind of situation that's presented at market bottoms for centuries."

P.S. -- If you're interested in gold stocks, or commodities in general, then you're going to want see Dave Forest's latest report -- The World's First $1 Trillion Boomtown. In this groundbreaking piece of research, Dave highlights an opportunity to reap 10-bagger gains by investing in the next commodities hotspot. In fact, one commodity producer he's found is already up 1,500% in the past year alone. To learn more about this company and this booming region, follow this link.

 

Austin Hatley owns shares of GDX.
StreetAuthority LLC owns shares of LGCUF in one or more of its “real money” portfolios.