by Mark O'Byrne, GoldCore:
– 4 reasons why “gold has entered a new bull market” – Schroders
– Market complacency is key to gold bull market say Schroders
– Investors are currently pricing in the most benign risk environment in history as seen in the VIX
– History shows gold has the potential to perform very well in periods of stock market weakness (see chart)
– You should buy insurance when insurers don’t believe that the “risk event” will happen
– Very high Chinese gold demand, negative global interest rates and a weak dollar should push gold higher
This week gold broke through the key resistance of $1,300. For some time market commentators have been signalling this level as the point of entry for a new bull market.
Often price can be distracting when it comes to trying to figure out what is going on. Two Schroders fund managers called the new bull market in gold about a week before the price broke through the key level.
Gold has entered into a new bull market. As we have discussed previously, there are four main reasons for our stance:
- Global interest rates need to stay negative
- Broad equity valuations are extremely high and complacency stalks financial markets
- The dollar might be entering a bear market
- Chinese demand for gold has the potential to surge (indeed, investment demand in China for bar and coin already increased over 30% in the first quarter of 2017, according to the World Gold Council)
Whilst they offered up four key reasons for the strength in gold, they highlighted the issue of broad equity valuations and market complacency as the most ‘pertinent’ of the four drivers.
Given the current state of play in the world, James Luke and Mark Lacey ‘strongly believe gold could turn out to be an underowned and well-priced insurance policy.’
Extremely high broad equity valuations look precarious
Starting with the S&P500, Luke and Lacey believe that it is currently very expensive based on a variety of measures.
The S&P500 made an all-time high of 2478 in July and is now up just under 11.5% year-to-date (source Bloomberg, 17 August 2017).
The valuation of this index is expensive on a variety of measures. Whether we look at simple price/book, trailing price/earnings or enterprise value/cashflow (each of which are different ways to value a company), the index is trading on valuation multiples which are 60% to 100% higher than the historical median over the last 90 years.
Whichever your preferred metric, historical regression analysis suggests expected returns for equities, from today’s starting point, are very low.
Why is the S&P500 so overvalued? This is something we have covered previously. There is an almost infallible belief that future earnings growth will be supported by Trump’s drive to cut corporate tax and the the fact that companies’ cost of capital is at an all-time low.
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