Gold’s relativity: Do Not Take Your Eye Off The Prize

Gold’s value is relative. It doesn’t really matter how many digits it takes to express the price. Its true value lies in what those digits represent in terms of purchasing power. During the post-World War I hyperinflation in Germany, for example, a 20-mark gold coin in 1918 purchased the equivalent of twenty marks worth of goods and services in the marketplace. By 1924 that same 20-mark gold coin (weighing roughly one-quarter troy ounces) provided the purchasing power of nearly 25 billion paper marks.

By pointing out this example of gold’s constancy, we do not intend to imply that the United States is headed the way of the Weimar republic.  What we do mean to say, though, is that those who track the nominal value of gold by itself without taking into account the current and future value of the currency in which it is measured take their eye off the prize. 

What are the intentions of the central bank and federal government, we should ask ourselves, and what will be the likely effect on the currency?

In a recently released report titled Gold Views: In search of a new reserve currency, Goldman Sachs’ Commodities Research team warned that debasement of the dollar is already underway. “We believe this disconnect,” it says, “is being driven by a potential shift in the US Fed towards an inflationary bias against a backdrop of rising geopolitical tensions, elevated US domestic political and social uncertainty, and a growing second wave of COVID-19 related infections. Combined with a record level of debt accumulation by the US government, real concerns around the longevity of the US dollar as a reserve currency have started to emerge.” [Emphasis added]

The research team at Goldman went on in that report to forecast a $2300 price of gold and $30 price of silver over the next 12 months. The day the report was published gold traded at $1955 per ounce and silver at just over $24. It took only eight trading days for silver to threaten Goldman’s $30 target (at $29.80) and for gold to hit a new record price of $2,070. Those numbers, given the rest of the analysis, look more a beginning than an end.

New smart money queues up in the gold market

First institutions and funds came over to gold’s corner, then central banks. Now, one of the more important stories in the gold investment arena is the developing interest among a whole new grouping of professional investors – pension funds, private wealth management, insurance companies, and sovereign wealth funds.  “It’s a bit like what happened to big tech,” says highly respected economist Mohammed El-Erian. “People like [gold] because it’s defensive. People like it because it’s a reflation trade. People like it because it’s inflation protection.  What we are starting to see with the narrative about gold is starting to be like the narrative about big tech.  It gives you everything.” These groups bring considerable purchasing power and market savvy to the table. One immediate result might be more buying interest on price dips.  Another might be a better blend of investment psychology and objectives that could have a settling effect on the market overall. 

Government spending is a tailwind for gold

Cartoon courtesy of MichaelPRamirez.com

The problem with monetary stimulus is that it requires takers, i.e., people and businesses willing to borrow and spend. Private borrowers, though, are not as prolific as the Fed or federal government would like at this juncture. Governments, on the other hand, are ready borrowers and big ones at that.  In fact, as Manhattan Institute’s Brien Riedl recently pointed out in a National Review article, the Fed has already financed roughly half of government spending to combat the economic hit from COVID-19.  How is all of this a ‘tailwind’ for gold?  The overlay chart below showing the federal debt and gold tells the story at a glance.  With the rest of the world worried about financing its own debt, the buyers of U.S. debt are likely to become scarcer and that is where the Fed steps in by monetizing those obligations. When all is said and done, that is perhaps the most basic reason why gold has behaved as it has since March of this year when it sold for $1470 per ounce.

Sources: ICE Benchmark Administration,  U.S. Treasury, St. Louis Federal Reserve [FRED]
The national debt trendline (graphed quarterly) does not reflect the current $26.5 trillion figure.

Blinded by the Money Illusion

“Would I say there will never, ever be another financial crisis? You know probably that would be going too far but I do think we’re much safer and I hope that it will not be in our lifetimes and I don’t believe it will be.” – Fed chair Janet Yellen

With those words, Janet Yellen put investors around the world on notice, though probably not in the way she intended. In the past, such smug assurances have been enough to send contrarian villagers heading for the safety of the nearby woods. The informed student of financial history knows that panics, manias, crashes, and collapses are as common to investment markets as thunderstorms are to placid summer afternoons. To think that suddenly we have banished their recurrence for ‘our lifetimes’ smacks of the kind of misguided hubris that contributed directly to the 2008 meltdown and subsequent untold financial hardship. Just about the time most everyone came to the conclusion nothing could go wrong, everything went wrong …… and in a hurry.

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