The modern view of a set Gold Standard began with Sir Isaac Newton around 1700 and essentially continued until the financial calamity that was the 1930s with contracting economic conditions leading to pressures on currencies. Competitive devaluations were common, but history best records the highlight of the brazen confiscation of US citizen’s gold at US$20.67 by US president Roosevelt before revaluing to US$32/oz and devaluing the US$.
The US$32/oz continued through WWII and towards its end in 1944 was set at US35 at Bretton Woods until another US president Nixon in 1971 took the US$ off the Gold Standard to stop the growing outflow of gold built up during the war and to just print money. And the rest is history.
From that abandonment of the Bretton Woods Agreement the world no longer had a measure of value. Think about it. Floating currencies. Nothing had any fixed relativity again. Nothing economic or financial can be measured any longer. How would you really compare any national GDP figures in US$ when that currency rises or falls? A price is just a price and your price in your currency is not my price in mine.
So the floating of currencies has allowed politicians to simply spend more money than they can raise by taxes and to run deficits that are no longer financed by gold in the Treasury but by IOUs in the form of bonds they all hope inflation reduces in value.
The world now has about US$100 trillion in (mostly) sovereign government bonds. And some people are paying these politicians to hold their money. This cannot end well.
You would like to think that some discipline will need to prevail on this spending and debt. Well, gold is finally providing that discipline but it seems to me that it is only just starting.
Gold has been re-emerging as the great store of value and its surge began back in 2000 with its first up-leg. And what an up-leg it was – US$248/oz to US$1,032 into the commodity highs of the 2008 version of financial crisis and then showing its power with a further 86% rush to US$1,923 in 2011 whilst most commodities were retreating.
All such runs need digestion and consolidation so the retreat to around US$1,030 was normal.
We know the issues of debt and deficits have certainly not gone away so that underlying push will likely be with us for 20 years before it is properly recognised and eventually somehow addressed. The IRR on welfare spending is not high and rising interest rates will kill off many such projects. Coupons on bonds must rise to tell politicians the free money party is over.
This action will surely drive gold higher.
But there are other reasons to underpin a higher gold price.
"Drivers of gold are many but simply supply and demand says the West is running out of easily available gold. Likewise for easily mineable gold. Gold prices must rise
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Most important is the 3,300 million people in Asia and others in Africa, South America and elsewhere.
In countries repeatedly wrecked by incompetent leaders who habitually debase their citizens’ currencies through inflation, the value of gold is well known. Accordingly, gold is always in demand and with the now higher and still rising wealth the demand for gold is very strong.
We have seen this demand through the trade figures and it is reinforced by the establishment of new gold exchanges in Shanghai and Dubai where prices are set in the physical markets in cash and not in the futures markets on margin.
The past few years have witnessed a flow of gold from Western sources to Swiss refineries melting down 400oz bars for delivery as kilo bars to Asia in strongly one-way traffic that can only increase.
The demand for jewellery and gold bars into India (plus-1,300 million people) and China (almost 1,400 million) alone is likely to grow for at least another 20 years. The statistics show almost half the world’s gold is tied up in jewellery and mostly of the high carat value storage kind that has been shown to provide miserly recycling rates. Jewellery demand is surely to get bigger.
The gold flows into India and China currently comfortably match global mine production plus scrap and given China is the world’s largest gold producer with about 450tpa (15% of global output) the numbers are daunting. The West is now running down its inventories of physical gold. By definition.
As the graph below shows central banks are net buyers again and ETFs are also increasing their holdings so whoever has been selling the gold doesn’t have much left!
Some form of squeeze will surely develop in the not too distant future.
A further reason for holding gold is that the huge increases in money supply from various QE programmes are likely to show the effects of this monetary inflation.
The world’s equity markets are now breaking higher in the global boom described in the last column in that sort of inflation and the indications are that market sentiment is turning up through the real economy. Most major indices prices are at highs and near technical resistance levels that extend back 15-20 years and prices typically rise quickly once the resistance is penetrated. Many are already running.
The QE tied up in US bank balances is also now being freed and the best indicator is the rising housing starts that are trying to make up the six-million unit shortfall there and the housing sector stock prices making new 10-year highs. Bears should ignore this at their peril.
The impact on commodity prices is only just starting but here in the resources industries we know just how low terminal market inventories are at a time of cyclically low prices and we can’t really imagine how low the total inventory pipeline is. Keep in mind that once consumption shows any strength the demand to replenish the pipeline will be strong and price response will be sharp.
And all this reflects an inflationary environment, something not seen for decades.
So, coming back to gold.
In times past the managers of large bond portfolios rightly feared the effects of inflation on bond yields and hence bond prices. To offset the real or perceived impact on their portfolios these managers would hedge their positions by buying gold and commodities and the gold and commodity equities through hedge funds.
Early evidence of incipient inflation is pushing the fund managers to again hedge their bond portfolios and the prices of the major gold companies are rising solidly. Recall the size of the global bond markets are now huge and dwarf equities and commodities. And low coupons on bonds give high price volatility and on long dated bonds the volatility is massive.
So a 1% hedging premium on US$100 trillion of bonds would buy just about all the world’s listed gold and resources stocks at current prices with loads of cash to spare.
The drivers of gold are many but simply supply and demand says the West is running out of easily available gold. Likewise for easily mineable gold. Gold prices must rise.
Gold mining equities have just started to move in a long term sense and seem to have much more to go in price and time. For MPS clients in Australia that “just started” meant almost two years ago, but for mainstream it has only been in 2016.The MPS untraded fixed investment gold equities portfolios are up over 250% since December 2014 and 160% since January 1, 2016. Yes, these numbers are real.
And for those who take the very long term view, this very long term price history of the Barrons Gold Mining Index (above) strongly suggests a major low has just been reached in gold shares and the next cyclical up-leg has begun. Note the magnitude of the major moves and the long time frames of each.
My target for this index is off the page in height and time. Aim for the sky.
*Barry Dawes, BSc FAusIMM MSAA, has had more 35 years’ experience in the resources financial markets in key roles as a fund manager, commodities and equities research analyst and corporate financier. He worked at BT Australia, was head of resources research at Deutsche Bank and also at Macquarie Bank prior to setting up and running Martin Place Securities for almost 17 years. He is currently executive chairman and head of resources.
