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“Gold is not a financial asset to be compared with dot-com stocks or
Miami condos and
it is not a commodity like pork bellies or crude oil. It is the ultimate
currency for the truly sophisticated wealth holder in a time of substantial
unreserved credit promotion.”
--Paul Brodsky (Fund Manager)
The recent correction in gold has once again led, to financial
commentators warning of a bubble—just as they have incessantly since it
first passed $400 an ounce. A bubble usually ends with day after day of
speculative higher highs, not corrections like we have just seen or as we saw
in August where a $200 fall was followed by the resumption of its decade long
rise. That gold continues to climb a wall of worry, and that so many are even
calling it a bubble, is actually an extremely bullish indicator since
financial bubbles burst only after sustained periods of exuberance. We are far
from the days when people lined up for blocks each day to buy gold, as they
did in Toronto in 1980.
A simple rebuttal, however, is never enough when discussing gold. It
will continue to be subjected to the most aggressive “perception
management” assault of any asset class, because it is a direct
challenge to all the world’s fiat currencies. Since no paper currency
is convertible to gold at this time, this is some challenge. The warnings of
bubbles and the many other reasons for not owning gold will continue unabated
as gold persists to $10,000 an ounce, or higher. Independent study of the
underlying causes of gold’s rising price, in my opinion, is the best
way to gain sufficient confidence to buy and hold gold long enough to protect
one’s wealth through the turbulent years ahead.
This is the premise of my upcoming book, $10,000 Gold—Why it
will get there sooner than you may expect. In this article, we will look at
three of the most significant reasons why gold is not in a bubble and will
continue rising in value for years to come.
There are two ways of looking at gold. The first is the Western way,
viewing gold through the lens of fiat currency training. This approach sees
gold as a wealth-gaining asset that can be traded like any other asset class
or commodity for currency gains. The second way is how the world’s
major gold buyers at this time see gold. The Chinese, Indians and Middle
Easterners see gold as a wealth-preserving asset that serves the purpose of
money. The second group will ultimately be responsible for driving gold into
the five-digit range. Many of these people have had direct experience of the
damage to one’s wealth a currency crisis can cause. The most aggressive
buyers, the Chinese, experienced 4,000 percent inflation per month between
1947 and 1949.
If gold were a commodity it would be in a bubble, but it is not. Gold
has been money for over 3,000 years, and still is today. Although never
officially recognized as such, gold trades on the currency desks of all the
banks and brokerages, and is held by central banks. Since 2009, central banks
have become net buyers of gold. Pension fund manager Shane McGuire makes the
point in his book, Hard Money: Taking Gold to a Higher Investment Level , that gold and silver are really the newest asset
class, not the oldest, since until 40 years ago they were money. Many readers
will remember a time when silver dollars were exchanged in stores at face
value.
To step outside a fiat mindset, we encourage our clients to think in
terms of ounces of gold rather than dollars—a task that is much easier
to do when one owns gold. We encourage them to ask questions like,
“What is the risk in ounces of an investment?” and “How
many ounces can I expect to gain in return?”
This perspective gives us the single most important insight into
gold’s true behaviour, as it tells us that
gold is not rising in value—currencies are losing value against gold.
This means that gold, as money, can appear to rise in value as far as
currencies can fall. In light of this, we can look at three features of
gold’s rise that tell us it is not only not in
a bubble, but unless current monetary policy is drastically changed, it will
almost certainly rise to $10,000 an ounce and beyond.
These features are:
- The loss of purchasing power of global
currencies
- The inflationary effects of money
creation
- Irreversible trends will continue to
cause gold to rise
1. Loss of Purchasing Power
A basket of goods that cost $100 in 1800 would have cost $102 in 1900.
During this time, the dollar was pegged to gold. Today that same basket would
cost over $4,000. This is what we mean by loss of purchasing power. Over the
past decade, the Canadian dollar, the euro and the Japanese yen have lost
over 70 percent of their purchasing power against gold (Figure 1).
The US dollar and the British pound have lost over 80 percent.
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The next chart (Figure 2) takes a longer view. It
shows how the same currencies, including the venerable Swiss franc, have
performed against gold since President Nixon closed the gold window in
1971.
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What is the cause of this loss of purchasing power, and will it
continue? Currencies lose purchasing power against gold for one simple
reason: Currency supplies are expanding faster than gold supplies. Bullion
is the one form of money governments cannot artificially multiply. Since
1980, above-ground gold bullion supplies have risen, on average, about 3
percent per year. We can see in the next chart (Figure 3) a
comparison with the much more rapid rate of currency creation provided by
MZM, one of the most reliable indicators of currency supply.
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Another way to understand this loss of purchasing power is by
looking at the number of ounces it would have taken at different periods to
buy a house, a car or the Dow. In 1971, an average car cost 66 ounces
of gold; an average house cost 703 ounces of gold and the Dow cost 25
ounces of gold. Today, 66 ounces of gold would buy nearly four cars, 703
ounces of gold would buy two houses and only 6.5 ounces of gold would be
needed to buy the Dow (Figure 4).
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2. The inflationary effects of currency
creation
In 1983 Webster’s Dictionary defined inflation as:
“Inflation is an increase in the amount of money, resulting in
a fall in its value and a rise in prices of goods and
services.”
Since the presidency of Bill Clinton, government Consumer Price
Index (CPI) reports have moved from being a fixed measure of a standard of
living to a flexible measure of a standard of living. Through a variety of
machinations such as hedonic regression and substitution (if steak becomes
too expensive, remove it and substitute with hamburger), these measures
grossly understate true inflation. Currency debasement (a term derived from
the Roman practice of hollowing out gold and silver coins and filling them
with base metals), leads directly to inflation. In the few dozen
hyperinflations that have occurred throughout history, all have been the
direct result of governments attempting to compensate for slowing growth
through currency creation, which is exactly what we see happening today. Figure 5
shows that this currency creation has already turned exponential.
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Fortunately, one economist, John Williams of ShadowStats (Figure 6) continues to track the
original basket of goods governments used to track inflation prior to the
early 1990s. His data shows inflation running at a much higher rate than is
publicly acknowledged. His CPI is at 12 percent, over eight points higher
than the “official” inflation reports.
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Eventually, we will have to admit the truth about inflation, the
truth that anyone who eats, drives or sends their
children to college already knows. Figure 7 shows what gold and silver
would trade at if we were to accept Mr. Williams’ CPI numbers.
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3. Irreversible Trends Will Continue to
Cause Gold to Rise
Finally, there are many independent trends that are having a direct
impact on the price of gold. The most prominent are central bank buying, Chinese
and Indian buying, the movement away from the US dollar, peak gold and
under-investment in gold by pension funds.
Central banks were net sellers for nearly two decades until 2009,
when they officially became net buyers. We can expect this trend to last
two decades as well. During the gold “bull” market of the late
1970s, the Chinese public was not allowed to own gold. Today, their
government encourages gold ownership, and has even made several significant
innovations to facilitate this goal. The Chinese government has also led by
example, with China’s central bank publicly stating it would like to
increase its reserves from 1,100 to 6,000 tonnes.
Unofficially, they have stated a target of 10,000 tonnes.
There can be little doubt that a race to exit the dollar is
underway, as governments feel the US has no choice but to continue debasing
their currency just to meet existing obligations. Peak gold, like peak oil,
occurs when gold miners fail to increase production or discovery despite
the rising price of the underlying commodity. Gold production has fallen
since 2005, and is only slightly higher in 2010. To quote a recent
exhaustive Standard Chartered Bank report:
“In our study of 375 global gold mines and projects, we note
that after 10 years of a bull market, the gold mining industry has done
little to bring on new supply. Our base-case scenario puts gold production
growth at only 3.6 percent CAGR over the next five years
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With pension funds holding less than 1.5 percent of their assets under
management (AUM) in gold bullion, they will have little choice but to
increase their position as gold continues to outperform all other asset
classes.
These trends are significant, but they are all capable of being
changed, however unlikely that may be. What cannot be changed are the
“irreversible trends.” These have an indirect impact on the
price of gold; they are causing growth to slow, and are therefore creating
the need for governments to compensate through ever-increasing currency creation.
Three of the most significant “irreversible” trends are:
- The aging population
- Outsourcing
- Peak oil
The largest population sector, the baby boomers, are starting to
retire, and living longer than any previous generation. Their demands,
which previously fuelled growth in the global economy, will reverse. They
will downsize, reduce spending, liquidate investments and draw down on
pension funds, social security and medical benefits. This will reduce GDP,
increase unemployment, reduce government revenues, increase budget deficits
and require even greater currency creation. This will reduce confidence,
further debase currencies and result in increasing gold prices.
With the advent of globalization and outsourcing, politicians and
multi-national corporations have let the genie out of the bottle; this has
resulted in the decimation of the manufacturing base in Western economies.
This will manifest as systemically high unemployment, reduced GDP, higher
government deficits and further currency debasement. Again, this will lead
to higher gold prices.
In September 2010, a German military think tank
reported the German government was taking the threat of peak oil
seriously and preparing accordingly. Numerous studies around the world have
concluded that we are very close to peak oil production, which will be
accelerated due to Gulf drilling bans. This will lead to higher price
inflation for most goods, reduced GDP, higher trade deficits, and higher
budget deficits. More monetization will result, thereby debasing currencies.
Higher price inflation together with further currency debasement will again
be a driver for higher gold prices.
Like a spinning top must continue spinning or fall, our modern
economic debt-based fiat system depends on perpetual growth. It is
disturbingly similar to a classic Ponzi scheme, which requires new
borrowers to bring currency into existence that can be used to pay the
interest on the previous loans. The greatest threat to its health is
slowing growth or deflation. With interest rates near zero, central banks
have only one tool left to combat slowing growth—currency creation,
which means inflation. These irreversible trends, therefore, virtually
ensure gold will continue rising in value for years to come.
In conclusion, I know many readers are hesitant to buy as they feel
they have “missed the boat.” Perhaps this Chinese proverb will
help:
The best time to plant a tree is twenty years ago.
The
second best time is today.
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Nick Barisheff
Bullion
Management Group
Nick Barisheff is the co-founder
and President of Bullion Marketing Services Inc., which was established to
create and manage The Millennium BullionFund. The
fund is Canada’s first and only RRSP eligible open-end Mutual Fund
Trust that holds physical Gold, Silver and Platinum bullion www.bmsinc.ca
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