Submitted
by Phoenix Capital Research
Warren
Buffett once noted, Gold doesn’t do anything “but look at you.” It doesn’t
pay a dividend or produce cash flow.
However,
the fact of the matter is that Gold has dramatically outperformed
the stock market for the better part of 40 years.
I say 40
years because there is no point comparing Gold to stocks during periods in
which Gold was pegged to world currencies. Most of the analysis I see
comparing the benefits of owning Gold to stocks goes back to the early 20th
century.
However
Gold was pegged to global currencies up until 1967. Stocks weren’t. Comparing
the two during this time period is just bad analysis.
However,
once the Gold peg officially ended with France dropping it in 1967, the
precious metal has outperformed both the Dow and the S&P 500 by a massive
margin.
See for
yourself… the above chart is in normalized terms courtesy of Bill King’s The
King Report.
According
to King, Gold has risen 37.43 fold since 1967. That
is more than twice the performance of the Dow over the same time period (18.45
fold). So much for the claim that stocks are a better investment than Gold
long-term.
Indeed,
once Gold was no longer pegged to world currencies there was only a single
period in which stocks outperformed the precious metal. That period was from
1997-2000 during the height of the Tech Bubble (the single biggest stock
market bubble in over 100 years).
In simple
terms, as a long-term investment, Gold has been better than stocks.
Moreover,
I think there is considerable value in Gold today as an investment. Many
investors argue that Gold has no intrinsic value. I disagree with this
assessment as it does not consider the nature of the financial system.
Let’s
compare Gold to the US Dollar.
Every
asset in the financial system trades based on relative value. Ultimately,
this value is denominated in US Dollars because the Dollar is the reserve
currency of the world.
However,
even the US Dollar itself trades based on relative value. Remember the Dollar
is merely a sheet of linen and cotton that is printed by the Fed and is
backed by the full faith and credit of the Unites States.
In this
sense, the Dollar’s value is derived from the confidence investors that the
US will honor its debts.
A second
item to consider is the fact that the Dollar’s value today also derived from
the Fed’s money printing. Indeed, a Dollar today, is worth only 5% of a
Dollar’s value from the early 20th century because the Fed has
debased the currency.
As a
result of this the world has adjusted to this change in relative “value”
resulting in a Dollar buying less today than it did 100 years ago.
In this
sense, Gold’s value is derived from investors’ faith in the Financial System
(ultimately backstopped by the Dollar) and the Fed’s actions.
Gold also
moves based on investors’ confidence in the system. If investors’ are afraid
that the system is under duress (meaning that they have little confidence in
the Dollar-based financial system) then they perceive Gold has having a
higher value.
Similarly,
if the Fed prints Dollars by the billions, Gold is perceived as having a
higher value relative to the Dollar.
Thus, Gold
does not have any less intrinsic value than the US Dollar does. In that
regard we can price it relative to the Fed’s actions and to the fear of
systemic risk to get an assessment of its true value.
With that
in mind, today Gold is clearly undervalued relative the Federal Reserve’s
balance sheet (see Figure 3 on the next page).
Since the
Crash hit in 2008, the price of Gold has been very closely correlated to the
Fed’s balance sheet expansion. Put another way, the more money the Fed
printed, the higher the price of Gold went.
Gold did
become overextended relative to the Fed’s balance sheet in 2011 when it
entered a bubble with Silver. However, with the Fed now printing some
$85 billion per month, the precious metal is now significantly undervalued
relative to the Fed’s balance sheet.
Indeed,
for Gold to even realign based on the Fed’s actions, it would need to be
north of $1,800. That’s a full 30% higher than where it trades today.
However,
we can easily make another cigar butt argument that Gold’s true value is in
fact higher than this.
As noted a
moment ago, every asset in the financial system trades relative to investors’
confidence in that system. With the US Dollar as the reserve currency of the
world, that confidence is ultimately based on the idea the US will pay you if
it owes you money.
If you
remove this confidence, then the entire system collapses as the reserve
currency is no longer perceived has having value.
The
problem with this setup however is that the US, like almost every other
country in the world (I’m including China which is sporting a Debt to GDP
ratio north of 200% if you account for its Shadow
Banking liabilities), has made promises that it cannot possibly keep.
The US
“officially” owes nearly $17 trillion in debt. However, if you include unfunded
liabilities this amount surges to at least over $80 trillion and
likely north of $100 trillion.
These are
promises the US has made. And the US Dollar’s value is based on the belief
that the US will honor these promises.
The US is
not isolated in this regard. Indeed, the problem of unfunded liabilities
exists throughout the world.
In the
case of Europe, the situation is so bad that the average EU country would
need to have an amount equal to over 400% of its GDP sitting in the bank,
earning interest at the government’s borrowing rate, in order to fund its
unfunded liabilities.
The same
goes for Japan and even China where the shadow banking system has liabilities
north of 200% of China’s GDP.
These are
promises that cannot be kept. And when these promises are broken confidence
in the system will be broken. This will inevitably lead to a period of
currency collapse. After this, ultimately there will be a need to restore
confidence in the system.
The only
way to do this will be by backing currencies with Gold again (or a basket of
items that includes Gold).
Given the
limited amount of Gold in the world, (a little over 171,000 tons) and the
enormous amount of US Dollars in the world, this would require a revaluation
of Gold to north of $10,000. Dylan Grice formerly of Societe
General lays this out beautifully in the below chart.
I cannot
possibly predict when all of this would happen. All I can state with 100%
certainty is that ALL fiat currencies throughout history have failed.
This
failure has been based on a loss of confidence. And the only way to restore
confidence is to limit the ability of Central Banks to print money.
This will
inevitably lead to some form of a Gold backed currency. Gold has been used as
currency for over 5,000 years. It will be considered currency again in the
future. When it does, the price of Gold will be much higher (remember, Gold
has risen over 34 fold in the last 40 years).
