Gold, Debt And Gold Reserves

Source: www.sharelynx.com

The above chart had always been interesting. The chart compares the US debt limit with the rise in debt and the rise in the price of gold. As the US debt limit was increased and the US debt grew, gold prices appeared to move in lockstep. That is until about 2011 when gold prices took off. Since the gold price has gone through one of its biggest shakeouts. Now it has fallen behind the debt limit and debt about as much as it exceeded them at the top in gold prices in September 2011. So will it adjust again to bring the trend back into balance?

That remains to be seen. Many have cited this chart as proof that as the US debt and debt ceiling rises, gold prices rise generally in lockstep. The chart, unfortunately only dates back to 2000 so it says nothing about the relationship prior to that. The relationship may or may not have held.

The US first set a debt limit in 1917 during WW1. Its purpose was to allow the executive branch to issue bonds and take on other debt without going back to Congress every time. Prior to 1917, the US had to have each bond issue authorized by Congress. In 1939, the US instituted the first limit on total accumulated debt over all instruments. Since then there has been numerous debt limit debates and the debt limit has grown over time.

The table below shows the growth in the debt limit since 1940 (earliest numbers I could find). The debt limit has been compared to the annual average price of gold. It was quite surprising to find that the gold/debt limit ratio initial was quite high when compared to later years. The ratio only ever approached the level of 1940 again in 1980 when gold prices spiked to $850.

Source: MGI Securities

On average the gold price/debt limit ratio has been around 0.11 if one eliminates the two high readings in 1940 and 1980. By that definition gold’s price is somewhat undervalued at current levels. Gold prices should be around $1,800 in order to maintain or at least get back to a 0.11 ratio. At the recent top in September 2011, the ratio was just over 0.12. As can be seen it has since fallen.

When one factors in the US’s gold reserves and the value of the gold reserves a slightly different picture emerges. US gold reserves have actually fallen sharply since peaking at over 20,000 metric tonnes in 1950. Today US gold reserves are stated at 8,133 metric tonnes. In 1940, the value of the gold reserves to the debt limit was at 0.44. It has never been close since. Setting aside the other high reading of 0.17 in 1980 the average has been around 0.04. Today it is 0.02. If gold were to return to the average, gold prices would need to rise to $2,600. In September 2011, at the most recent high in gold the value of US’s gold reserves to the debt limit ratio was still only 0.03.

Whether one measures the gold price against the debt limit or the value of the US’s gold reserves to the debt limit, the gold price appears to be undervalued. On the other hand, things could be worse. In 2000 and 2005 the gold price/debt limit ratio was at 0.05 and the $ value of US gold reserves/debt limit ratio was at 0.01. I would rather be an optimist that the mean should be seen again.

Copyright 2014 All rights reserved David Chapman

General disclosures

The information and opinions contained in this report were prepared by MGI Securities. MGI Securities is subsidiary of Industrial Alliance Insurance and Financial Services Inc. Industrial Alliance is a TSX Exchange listed company and as such, MGI Securities is an affiliate of Industrial Alliance. The opinions, estimates and projections contained in this report are those of MGI Securities as of the date of this report and are subject to change without notice. MGI Securities endeavours to ensure that the contents have been compiled or derived from sources that we believe to be reliable and contain information and opinions that are accurate and complete. However, MGI Securities makes no representations or warranty, express or implied, in respect thereof, takes no responsibility for any errors and omissions contained herein and accepts no liability whatsoever for any loss arising from any use of, or reliance on, this report or its contents. Information may be available to MGI Securities that is not reflected in this report. This report is not to be construed as an offer or solicitation to buy or sell any security. The reader should not rely solely on this report in evaluating whether or not to buy or sell securities of the subject company.

Definitions

“Technical Strategist” means any partner, director, officer, employee or agent of MGI Securities who is held out to the public as a strategist or whose responsibilities to MGI Securities include the preparation of any written technical market report for distribution to clients or prospective clients of MGI Securities which does not include a recommendation with respect to a security.

“Technical Market Report” means any written or electronic communication that MGI Securities has distributed or will distribute to its clients or the general public, which contains a strategist’s comments concerning current market technical indicators.

Conflicts of Interest

The technical strategist and or associates who prepared this report are compensated based upon (among other factors) the overall profitability of MGI Securities, which may include the profitability of investment banking and related services. In the normal course of its business, MGI Securities may provide financial advisory services for issuers. MGI Securities will include any further issuer related disclosures as needed.

Technical Strategists Certification

Each MGI Securities technical strategist whose name appears on the front page of this technical market report hereby certifies that (i) the opinions expressed in the technical market report accurately reflect the technical strategist’s personal views about the marketplace and are the subject of this report and all strategies mentioned in this report that are covered by such technical strategist and (ii) no part of the technical strategist’s compensation was, is, or will be directly or indirectly, related to the specific views expressed by such technical strategies in this report.

Technical Strategists Trading

MGI Securities permits technical strategists to own and trade in the securities and or the derivatives of the sectors discussed herein.

Dissemination of Reports

MGI Securities uses its best efforts to disseminate its technical market reports to all clients who are entitled to receive the firm’s technical market reports, contemporaneously on a timely and effective basis in electronic form, via fax or mail. Selected technical market reports may also be posted on the MGI Securities website and davidchapman.com.

For Canadian Residents: This report has been approved by MGI Securities which accepts responsibility for this report and its dissemination in Canada. Canadian clients wishing to effect transactions should do so through a qualified salesperson of MGI Securities in their particular jurisdiction where their IA is licensed.

For US Residents: This report is not intended for distribution in the United States.

Intellectual Property Notice

The materials contained herein are protected by copyright, trademark and other forms of proprietary rights and are owned or controlled by MGI Securities or the party credited as the provider of the information.

Regulatory

MGI SECURIITES is a member of the Canadian Investor Protection Fund (‘CIPF’) and the Investment Industry Regulatory Organization of Canada (‘IIROC’).

Copyright

All rights reserved. All material presented in this document may not be reproduced in whole or in part, or further published or distributed or referred to in any manner whatsoever, nor may the information, opinions or conclusions contained in it be referred to without in each case the prior express written consent of MGI Securities Inc.