Possible Scenarios To End Gold's Bull Market

We (at Casey Research) received dozens of responses – 63 pages worth – to our November 11 invitation for ideas on how the bull market in gold will eventually come to an end.

It's made for interesting reading, and I'd be surprised if anyone fails to discover something new and surprising among the suggestions provided by Casey readers. You'll find the responses below (lightly and respectfully edited for readability) organized into a series of themes. David's question is so important, and the topic so complex, that with every theme I've taken the opportunity to play devil's advocate.

Theme #1. Punitive regulations will force people to sell their gold, which will depress the price.

Your comments:

• Holders of precious metals will be criminalized as aiding the “enemy,” money laundering, or greedy speculators destroying our nation’s currency.
• If it were to become illegal to use gold or silver coins for trade or barter, as part of a massive confiscation with the penalty of prison and hefty fines, that in itself would preclude the productive ownership of gold or silver coins.
• Travel restrictions preventing access to metal accounts out of one’s home country.
• It's really simple – the bull market will stop dead when the government makes everyone turn in their gold. Plus the government will pay for that gold at, say, $200 per oz and then once they have all of it, they'll raise the price to $2,000 per oz.
• Wouldn't surprise me if the government declared personal ownership of gold illegal.
• My greatest fear is that our government, sensing blood in the water, will once again confiscate gold.

Observations on this theme:

The forced gold sales of 1933 provide ample precedent for punitive anti-gold regulation. But for today’s politicians, the benefits would be much less than they were 77 years ago.

The 1933 gold ownership prohibition was a prelude to raising the official price from $20 per ounce to $35. The government saw the higher price as a means to inflate the currency and stay on the gold standard. Today, with a fiat dollar, there is no gold standard for the government to protect. The forced sale itself was a device for the government to capture a profit that otherwise would have fallen to the public. Today's politicians don't think that way. Their attitude is that the government already owns everything – and can collect through taxation whatever it wants.

So while the risk of punitive regulation isn’t zero, it isn’t high. And even if it should occur, the effect on the price of gold isn’t clear. On one hand, the threat of penalties would be a reason for U.S. investors not to own the metal. On the other hand, the sight of the U.S. government behaving in such a high-handed fashion would be another blow to confidence in the dollar, which would translate into an increase in the demand for gold by non-U.S. investors and even by some not-entirely-compliance-oriented Americans.

Theme #2. Punitive tax rules will force people to sell their gold, which will depress the price.

Your comments:

• Imagine if governments started imposing heavy taxes, perhaps even draconian taxes, upon gold production or gold sales… considerably simpler and more workable than outlawing gold ownership.
• The IRS simply adds a line that requires all gold holdings to be declared annually, and then it charges a luxury tax every year at whatever percentage it likes. That wipes out any gains systematically and effectively confiscates your wealth.
• Governments tax the living hell out of all "speculative" returns on investment to push investors back into buying "prudent" government debt. This would reduce the liquidity of physical bullion and kill the ETF gold market. It is (a) politically attractive and feasible in the short term ("tax the speculators who are to blame for all of this"), and (b) governments would find trustworthy allies in the mainstream banks.
• Make it illegal to hold gold in retirement accounts and then tax any gains at instead of 28%, say, 56% or even 90%.
• Rather than making the holding of gold illegal, the government would tax the appreciated value of one's holdings, even though it is "paper profit."
• Taxes on the sale of gold are raised to 95%. All purchasers of gold are required to submit a 1099.

Observations on this theme:

U.S. tax rules already discriminate against gold. Only certain forms may be held in IRAs and other self-directed plans, and the tax rate on a long-term capital gain on gold is 28% – not 15%. Tightening the tax noose on gold investors would be easier to administer than banning gold ownership and would produce less squawking, especially if done at a time when little else but gold is showing a profit. But the revenue to the government would be puny in the scheme of things, and the measure would go counter to the psychology that supports the tax system – we’re all in this together, all prisoners are treated equally.

Punitive tax rates would hurt the demand for gold. And they are a possibility, but consider how likely that possibility is.

Theme #3. A technological leap in the production of gold will increase the supply and depress the price. The ideas ranged from the vague…

Your comments:

• Gold could go down in case they master synthetic production.
• I have read that they are creating all kinds of new materials in the lab using nanotechnology. What is stopping them from creating gold?
• A new method of production is discovered that brings on new supply of gold at dramatically lower prices.

… to the fanciful…

• The mad scientists at the superconducting supercollider discover how to add a proton to the nucleus of lead.
• It is actually possible to synthesize gold from humble mercury in a nuclear reactor.

… to the more serious…

• We will have to mine the seawater (and the seabed) one day when we have exhausted land deposits, and gold may well be a byproduct of such activities. There is also a bacterium that concentrates gold, so genetic engineering may make gold extraction feasible and put a cap on the gold price.

Observations on this theme:

Is there a technological advance coming our way that will make it cheaper to produce gold? Of course there is, because the long-term trend is for knowledge to accumulate and production costs to decline. But is there any reason to expect such an advance soon? Not that I know of.

Theme #4. A massive deposit could be found that would end gold's scarcity.

We only received one message with this suggestion. A geologist would say, "No, that's not going to happen. Because of the way gold deposits are formed, we are certain that there is no 1,000-ton gold nugget anywhere in the Earth's crust."

Nonetheless, there might be another Klondike waiting to be discovered. Finding it in an accessible part of the world would be a negative for gold, but not a big negative. If the world's above-ground inventory of gold is growing at, say, 2% per year and the world's inventory of paper money is growing at 10% per year, the price of gold will keep rising.

Theme #5. The bull market in gold will be brought to an end by market manipulation.

Your comments:

• The government announces that there is a health risk associated with handling gold. People, especially Americans, respond to fear, and the major button is their health.
• The government promotes a public resurgence in the belief in alchemy as described in Popular Delusions and the Madness of Crowds.
• Release trial balloons about outlawing the holding of gold/silver without actually outlawing it.
• What if the G20, together with other governments, decide to dump their gold reserves on the world market. This would crash the price, they could buy back at the new low prices and/or introduce confiscation of private gold holdings, and/or fix the gold value, as you have mentioned, at a new lower rate.
• Given the trillions that the Fed & Treasury have committed to manage the economy and public perception about its direction, why wouldn’t they throw a few million per week at the Chicago Mercantile Exchange and short gold futures?
• The bullion banks continue to short and crash the market.
• Modify margin requirements on the futures exchange in unpredictable ways (already done once this week for silver).
• The SEC/CFTC/Attorney General/other regulatory bodies can issue press releases alleging or hinting at manipulation/criminal activity that is causing the price of gold/silver to increase. Such measures will reduce investor enthusiasm and slow price increases.
• Gold could drop sharply if margin requirements are increased dramatically and maintained for a long period of time.
• Since no rational cause for precious metals to "take it on the chin" seems apparent, an irrational one, like the massively short bullion banks creating a selling panic, could do it.
• Along with their cronies, China would flood the market with gold. China works in cahoots with million-ounce buyers, or perhaps is in fact one of the buyers, selling to them at ever decreasing prices. Those buyers then sell back to China at ever decreasing prices, and China also buys from the public as people start to panic. This cycle continues until gold reaches the $100$/oz range, while China continues to increase actual holdings with each sale.
• Each year, the government would sell a regularly announced amount in quantity or by price. They could control the price the way De Beers did with diamonds. The same central banks as today would be buyers, and the U.S. could decide whom to sell it to and at what price. The U.S. would be on a de-facto gold standard.
• Gold could end its reign when Goldman Sachs tells the Fed to stop diluting the dollar and at the same time sells gold short.

Observations on this theme:

Most of these just don’t add up, at least not for me. Misleading announcements about gold might fool some people for a while, but not many people for long.

And it's true that if a government or other organization has enough gold, it can push the market price down by selling heavily. Or it can use cash as margin for short sales in the futures market. But it can hope to buy back at a profit only if a special condition is present. “Sell and buy back cheap” can only work if the marketplace is thick with self-made victims who will sell their gold because the price has dropped. It can happen at crazy moments, but investors who follow a “Buy high, sell low” strategy seldom have a lot of money to play with.

The last two scenarios, however, do make some sense.

Steady, programmed, pre-announced sales by the U.S. or other big holders would depress demand for gold by depressing the prospects for a price rise. But the payoff for the political decision-makers would be tiny – a respite from rising gold prices reporting sotto voce that “the politicians are clueless.” And eventually the government’s gold would run out, as its silver did in the 1970s.

If a government agency cooperated in helping a private party (whether Goldman Sachs or someone else) in making a big score, it wouldn’t be the first time, or even the ten-thousandth. But there are so many ways to use government for private looting, I don’t know why shorting gold would be the first choice.

Theme #6. An unstoppable deflation will take over and hammer the price of gold and everything else.

• What is happening now is not a repeat of the 1970s stagflation... it’s something more like the 1930s. And that is all about deflation, and when part 2 of the deflation hits, well, a chart of 2008 will show you where gold is going in price. Sorry guys, the one-way gravy train ride for gold is over.
• If Japanese-style deflation gets a good grip, would that not depress the price of gold and silver along with everything else?
• According to Bob Prechter, the ongoing credit contraction will force people to sell good assets, including gold, to pay off debt.
• Raising interest rates globally creates debt implosion, massive defaults, and severe deflation of all assets, including gold.
• Deflation. Yes, the monetary base has been expanding, but nowhere near enough to offset the destruction of money caused by debt defaults, losses, and write-downs.
• Gold is going to get slammed in a depression, at least it will in the next deflationary phase, and if it hasn't just started, it will early next year. When the top does come and the deflation is in full swing, gold is going to be slaughtered.
• As in 2008, a blow to the world economy starting off in equities triggering panic sales and flight to cash, which will also suck in other asset selling.
• As more homes are foreclosed on, people will become increasingly desperate for dollars – not gold, cotton, silver, or pork bellies. The implosion in credit will dwarf the Fed's desperate attempt to prop up the economy, resulting in deflation. If the stock market tanks, it will only be icing on the cake. Gold goes up in expanding markets and down in contracting ones. Think of late 2008. People wanted paper with Ben Franklin's face on it, not gold coins.
• Global collapse of monetary system and the advent of extreme hard times in which governments collapse and local bartering for basic existence (cans of beans, guns) is of importance, and thus if you can’t burn it for energy or eat it, then it is of no value.
• Look at the reality, Casey himself says we are just coming out of the eye of the storm into the second part of the storm. What happened in 2008, that was the first part of the storm, right? Look at where commodities, including gold, went.

Observations on this theme:

There’s some truth in these ideas, but a critical piece is missing. Fear and uncertainty do inspire people to deleverage and pay down debt, which is deflationary. But the inflation machine runs on zero energy and at virtually zero cost. It can always produce more paper money, as much as it takes to overcome any deflationary force.

There are little fires, like the one in your barbeque. There are big fires, like the kind that destroys a house. And there are gigantic fires that take away entire cities and forests. But there is no fire so big that no amount of water can put it out. The Federal Reserve has a fire hose with an unlimited diameter and a pump rated for unlimited pressure.

Theme #7. The dollar is still the safe haven for worried investors around the world. What is good for the dollar is bad for gold.

• The EU or Japan fail and completely collapse. Investors rush back into the U.S. dollar.
• The USD is still the world reserve currency, and when there's another foreign crisis, we could see another flight to "safety," a strengthening dollar, insolvent debtor institutions, and tumbling gold.

Observations on this theme:

Yes. And no. A bad day for the euro or for any other important non-dollar currency does boost demand for the dollar, which tends to hurt gold. But it hurts gold only temporarily because it does nothing to cure the dollar's long-term problem of giant government deficits and non-stop money creation by the Federal Reserve.

Theme #8. A new currency will undermine the demand for gold.

• The final nail in the gold coffin would be a gold-backed world currency, which may be nearer than we think.
• An announcement that the IMF is working on a new international currency with the full support of the G20 nations.
• World adopts a different precious metal or mineral as a backing for its currency, i.e., Mexico and silver.
• A new form of asset takes hold as an alternative to gold that is portable, divisible, and easily stored for long periods. Maybe a resource and land trust credit system. Or maybe an invention that can store energy in a new form.
• An international fiat currency agreed to by the U.S., Western Europe, and China, perhaps linked to gold.
• There is the option of creating a new “world” currency, which would be fiat, of course.
• The U.S. government along with others create a common currency.
• China adopts a gold standard.

Observations on this theme:

Now would be a particularly bad time to launch a new common currency, whether it is sponsored by just a few big governments or by many. Given the euro's large and well-publicized problems, a new common currency would have little chance of gaining acceptance. Whether it is named the yuandol or the Earthy, no multi-state currency is going to undercut the demand for gold.

A gold-backed national currency would be another matter. If a stable government, the U.S. especially, were to return to gold convertibility, that currency would stop gold in its tracks. But it would stop it at a high price, since the convertibility rate would need to be set high enough to protect the issuing government treasury from unsustainable gold outflows. It would be the happiest ending: the gold train would stop at the station, and we could all collect our belongings and step off.

Theme #9. The U.S. government will rescue itself and the dollar by selling off property it doesn’t need; the economy will get healthy, which means that gold will get sick.

• Sell 60 million ounces of federal gold reserves. Sell not as a bulk commodity, but via the U.S. Mint, in the form of special commemorative "paying down the debt" coins in half-ounce and one-ounce sizes.
• When a company is in trouble, they bring in a workout manager. He inventories the assets and liabilities and cuts expenses. He slashes debt by selling assets. The U.S. government owns 30% of the country’s land mass, or about 672 million acres, much of it valuable in timber, hard minerals, and oil and gas. The government also owns unneeded military bases and buildings. Trillions of dollars worth of property are sitting on the side lines. Sell off these assets and the deficits are eliminated.
• The U.S. government owns something it could exchange for its debt: land in the U.S. A deal with the Chinese, the Japanese, and others to swap the money owed them for U.S. land would cut the debt sharply, which would drive gold down.
• An easy, politically acceptable solution could be large-scale asset sales. A government garage sale. Obvious candidates would be vast federal land holdings and overseas military bases and equipment. It could bring in several trillion dollars. The entire federal highway system could be auctioned off and turned into toll roads

Observations on this theme:

A government garage sale certainly would get my vote. And I'd throw in all the desks in the Senate, all the chairs in the House, and every piece of government-owned air conditioning equipment in the District of Columbia.

For reasons I don't understand, governments tend strongly to be packrats. They like to acquire stuff but seldom dispose of anything except munitions.

Nonetheless, it's imaginable that a financially desperate U.S. government could try to rescue itself by liquidating unneeded property. That would move the government's finances in the right direction, and it would be good for the economy, since it would convert wasting assets into productive ones.

The consequences for gold, however, wouldn't be a sure thing. So long as the Federal Reserve believes that it should try to cure every recession by printing more money, the dollar will be at risk, and the risk supports the demand for gold.

Theme #10. China uses its economic muscle to stabilize the value of the dollar.

• What would stop gold from running higher would be the Fed backpedaling on QE2 as the U.S. government receives the assurances they need from the Chinese. Watch the yuan… appreciation may mean U.S. monetary policy takes a different direction.
• The Chinese might pressure the Fed/Treasury to cease their quantitative easing by communicating the following: Dear Mr. Bernanke, You have embarked on QE because inflation is too low. If you continue with QE, then we will immediately begin liquidating U.S. notes and bonds. We will use the cash proceeds to buy oil, grains, metals, and other commodities. With the prices of gasoline and food sharply up, good luck convincing the American people that you "don't have enough inflation." This course would be painful for us, but it would be far less painful in the long run to act now rather than waiting for you to destroy the value of your debt that we now hold. We recommend that you suspend further QE for a period of time – and never resume it. We will be watching and will take action immediately, as outlined above, should you attempt to further inflate your currency.

Observations on this theme:

Perhaps China or other restless creditors will give the U.S. government a shove in a sensible direction. A return to fiscal and monetary sanity would almost certainly derail gold. Watch for it, and let us know if you see any signs that the government is changing its stripes – and we’ll do the same.

Theme #11. The government stops cold turkey on its free-spending, money-printing ways.

• The government takes the zombie banks off life support and lets them die on the table. The government quits taxing and regulating.
• Prepackaged bankruptcy. A partial default would be accompanied by some cuts in "mandatory" spending and, sadly, some tax increases. The necessary spending cuts will unleash far less ire if it's shown that everyone is going to suffer a little.
• The Fed is terminated; a flat tax instituted; term limits enacted; corporate tax slashed; and an ax taken to government spending.
• The new "Tea Party" Congress refuses to raise the national debt ceiling early next year.
• The international community stops printing money and goes back to the gold standard. The Fed raises interest rates sky high as Volcker did in 1980.

Observations on this theme:

It sure would be fun to watch. A disaster movie about Keynesian economics. But even if every member of Congress started wearing a big teabag where a necktie usually goes, it’s not likely to happen – too much pain between now and the next election.

Theme #12. Fewer people would mean less demand for gold.

• The only thing that can take down the price of gold is the elimination of billions of people. Supply and demand will always dictate price in the long run. If you eliminate 90% or more of the planet’s population, demand will go down.

Observations on this theme:

It's confirmed. There is a PETA member among the Casey readership.

Theme #13. The U.S. government comes to its senses.

• If Obama's Deficit and Debt Commission passes its resolution and Congress adopts it, gold as priced in American dollars will surely dip and will stay down. No one, including the commission, thinks it can happen, but if it does, gold takes a hit.
• Bernanke is immediately replaced by Paul Volcker or Ron Paul. They announce QE2 has been cancelled. They let interest rates rise 1/4 point per quarter until they reach 4%. Republican Congress refuses to fund any further spending (balances budget). Bush tax cuts made permanent, and corporate tax rates made competitive with the rest of the world.
• Bernanke’s answer to a college student in Jacksonville, Florida, who asked about the gigantic surge in gold prices: "The Fed has the tools to unwind and tighten policy at the appropriate time." Bernanke is ready to do anything to skew the gold market and from what he has done until now, this man has a great quality... he doesn't fail his promises.
• Let the real interest rate move high enough, and the opportunity cost of holding gold suddenly is greater than the potential return. In my mind, opportunity cost as dictated by real interest rates is the primary driver of gold prices.
• With Republicans promising to attack spending and companies free to begin rebuilding once the reign of government regulations is taken off the table – the economy grows. Austrian economics at its best. Increased tax revenue coupled with smaller government reduces the deficit, which strengthens the dollar. So the dollar goes up and gold goes down.
• Make the corporate tax rate zero – permanently. Manufacturing will return to the U.S., making employment rise and hence expanding the tax base. Simple, I know, and very obvious. Eliminate the Fed. Cut government spending across the board in three tranches of 20%, one year apart each.
• Yes, I could see the gold bull market over if President Obama announced shortly that he would not run for a second term and would work with both parties and Independents to bring the nation back together. Without the need to listen to pollsters and begin campaigning, he could focus on the real issue and could become a great one-term president.
• My sense is that the litany of factors indicative of "fixing" the economy would not have to be as complete as represented in order for gold to retreat a significant amount. The emotional impact of making inroads in a number of areas would be enough to inspire a sense of being on the road to recovery. Once the ball begins to roll, there will be significant forces for business to begin to rehire, raising tax dollars and disposable income, etc.
• You and I agree that the economic theories to which Bernanke et al. subscribe are entirely unsound, but I believe they understand that hyperinflation is a worse outcome than deflation. They would reverse course if things started to get out of hand.
• Large deflationary forces are overhanging the global financial markets, and those forces could have adverse short-term effects on gold. Other currencies could race to the bottom more quickly than the dollar, and rent-seekers in Washington have more to gain by preserving the dollar as the world reserve currency than they do destroying it.

Observations on this theme:

Gold investors have been so right for so long about the government's addiction to folly that I was surprised so many readers offered such hopeful scenarios.

I suspect they will be proven right, but not anytime soon. The economy will go through more suffering before the politicians and the voters are ready to back off from the idea that the government is an all-purpose problem-solving machine. But it could happen.

That may strike some readers as a bit too optimistic, but the U.S. political system has come back in from the ledge before. The Reconstruction ended. Prohibition was abandoned. The 91% tax bracket was eliminated. There's no more draft. Such things do happen, but only after pushing them away has become too painful and the pain has come to be widely felt and widely understood. We are nowhere near that point, yet.

We didn't offer a prize for the best response to David's question about how the bull market in gold will end. Had we, my vote would have gone to this one:

Hi David,

Personally, the end of the gold bull market doesn't matter a lot to me. (And I'm speaking from the standpoint of someone who has 50% of their net worth in precious metal investments.) Why? Because I'm probably never going to time it well enough to sell at the "top." But that's not my prime consideration. My prime consideration is how cheap, relative to gold, are other income-producing investments, such as multi-residential real estate, or prime agricultural land, oil and gas infrastructure plays, or other types of investments. When all those other things look very cheap, then the time has come (probably) to start moving into them. Also, there is the remote possibility that gold may play a part in a future currency and the "bull market" in gold may plateau for the rest of our lifetimes.

Thanks and best wishes.

Brian R.