Why Every Gold Retreat Presents a Buying Opportunity

It’s been a huge year for gold, with the precious metal gaining about 26.60% year-to-date. It hasn’t been a smooth ride up there, though. There have been times when the price of gold retreated in such a way that some market observers were already thinking the rally could be over.

For instance, in the month of May alone, gold was down by over 5.5%. In addition, between March 4 and April 1, gold was down by 5%. And most recently, between July 8 and July 25, gold went down by over 3%. In reality, we would still see more periods during which gold will retreat again.

However, investors should see each of those periods of retreat as opportunities to buy gold. Here’s why.

Equities are bound to see lower returns for a long time

McKinsey Global Institute released a report in May in which it argues that investors need to lower their exceptions, as the next two decades could see lower investment returns relative to 100-year averages – which is also below the returns that investors have enjoyed over the last three decades.

The researchers at McKinsey say, “The economy drivers of equity and fixed-income returns are shifting.”
 

As the image above shows, investors have seen stellar returns over the last three decades driven by falling inflation and interest rates, productivity gains that lead faster GDP growth and growing corporate profits. It also explains that a reversal of these trends is a great possibility over the next two decades.

If nothing, we’re already seeing two of these holding true. Productivity is falling and corporate profits are shrinking.

The US Labor Department reported on August 9 that the US worker productivity, which measures hourly output per worker, went down at a 0.5% annual rate in the second quarter. It was the third consecutive quarter that the productivity is dropping. In reality, though, the drop in productivity is a trend that has been building up in recent years.

The chart shows US nonfarm labor productivity since 1985 – provided by Trading Economics. The overall story is that the US has seen tremendous labor productivity over the years. However, a closer look at the chart would show that labor productivity growth in the US is flattening out.

While doesn’t automatically mean that this trend will continue, global economy weakness, which has led to lower demands of goods form the US, would continue to weigh on productivity, according to Trade10. And if productivity growth continues to shrink, it is almost inevitable that corporate profits would also shrink with time.

Both of these are signs of economic weaknesses, which is what safe-haven assets, like gold, thrive on. More particularly, if corporate profits shrink, equities will see lower returns, as earnings growth is one of the key factors that decide what an equity returns. It is worth noting that the US Bureau of Economic Analysis is forecasting a downward trend corporate profit – at least until 2020.

Perhaps, this is why successful investors like George Soros are tilting their portfolios toward gold. On an overall basis, if McKinsey’s forecast turns out to be anything near the reality, the gold is set to have a good couple of years. Now is just the time to start buying the yellow metal.