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.
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?
Why the U.S. needs to encourage
Americans to hold gold
We have always believed that citizen ownership of physical gold is in the national best interest, not just the best interest of its accumulators. In the event of a worldwide economic breakdown or a realignment of the global monetary system, it would be good for the country to have a storehouse of gold held by the populace. China encourages citizen gold ownership for precisely that reason.
“With a growing number of countries encouraging their central banks and citizens to acquire gold,” writes The Federalist‘s Sean Fieler, “it is increasingly reasonable to assume that gold will be part of the world’s monetary future, not just its past. The U.S. Treasury should embrace policies that will attract more of the world’s gold to America and better position our citizens and our nation for whatever the monetary future may hold.”
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.” – Janet Yellen, Former Federal Reserve chairwoman
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.
from the July 2017 edition of
News & Views
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How much gold is enough?
Investors often ask about the percentage commitment one should make to precious metals in a well-balanced investment portfolio. Analyst Michael Fitzsimmons offered an interesting take on that subject in a recent Seeking Alpha editorial, “Assuming a well-diversified portfolio (which does include cash for emergencies),” he says, “my belief is that middle-class investors (net worth under $1 million), should own at least 5-10% in gold. I also believe that as an American investor’s net worth climbs, the higher that percentage should be because, in my opinion, he or she simply has more to lose by a falling US$. For instance, an investor with a net worth of $2-5 million might have a 15-20% exposure to gold; $10 million, perhaps a 30-40% exposure.” USAGOLD recommends, as it has for many years, a diversification of between 10% and 30% depending on your view of the risks at large in the economy and financial markets.
Coins & bullion since 1973
Yap stone money inflation
Monetarily speaking, everything progressed smoothly on the island of Yap where large stones weighing hundreds of pounds were transported around to serve as money. That is until something unforeseen happened to the value of the money. For centuries, the stones served in exchange because there wasn’t much of this type of rock on Yap itself. The depreciation of the stone money began when an enterprising Western businessman realized he could produce stone money cheaply and in copious quantities on a neighboring island and transport it to Yap, where it could be used to procure goods in demand elsewhere. In other words, this oceanic cousin of John Law printed Yap stone money to buy his wares at what might be called a “favorable” discount. By this process, the yap stone money was debased until it became worthless. Little did the citizens of Yap know that they were deprived of their wealth, and their money destroyed, by the process of monetary inflation.
Coins & bullion since 1973
Of 17th-century tulips, 21st-century stocks
and ageless gold
During the Dutch Tulipmania, the price of one special, rare type of tulip bulb called Semper Augustus sold for 1000 guilders in 1623, 1200 guilders in 1624, 2000 guilders in 1625, and 5500 guilders in 1637. Shortly thereafter, the bottom fell out of the market and prices plummeted to 1/200 of their peak price – a mere 27 guilders. In the artwork above an individual, portrayed in fool’s garment, is shown trading a hefty pouch of gold for a handful of tulip bulbs. It is no mystery who got the better part of that bargain. History teaches us that no era is immune to financial mania including our own. As a matter of fact, a good many believe that we are fully immersed in a stock market mania right now.
Since the earliest days of the USAGOLD website (the mid-1990s), we have enshrined a quote from Thomas Bailey Aldrich at our home page: “The possession of gold has ruined fewer men than the lack of it.” Aldrich’s axiom has held true down through the ages. It applied in ancient Greece and Rome, in 11th century China, in the time of the Medicis, the Dutch Tulipmania, the South Seas Bubble and French fiat money mania, during the long string of panics in the late nineteenth and early 20th centuries (Aldrich’s time), the spate of post World War I and II hyperinflations (Austria, Germany, Greece, Hungary, et al) and it still applies today.
The crisis ready investment portfolio
In a recent essay published at Project Syndicate, Harvard economics professor Kenneth Rogoff sets an ominous tone. Humanity, he says “is facing something akin to alien invasion” – an apt analogy, we thought. “With each passing day,” he goes on, “the 2008 global financial crisis increasingly looks like a mere dry run for today’s economic catastrophe. The short-term collapse in global output now underway already seems likely to rival or exceed that of any recession in the last 150 years.”
At the moment, as shown in the chart below, the level of stress in financial markets is at its highest point since the credit crisis of 2008. Keep in mind the current high reading is without the impetus of any financial institution or fund of consequence reporting serious difficulties and/or requesting a bailout. Note with that in mind the acceleration in the index after the Bear Stearns and Lehman failures in 2008.
Below we have reconstructed the same chart only with the price of gold superimposed. As you can see, gold responds directly to stresses indicated in financial markets and that the effect can persist even after the initial threat dissipates. Gold ownership, in short, is a way to make one’s portfolio crisis ready on a permanent basis – a means to batten down the hatches against recurring financial storms and, for the minority who own it, an effective and ever-ready defense.
“If you look at the history of currency, gold has a unique role and I don’t think it’s accidental,” writes Rogoff in his latest book, The Curse of the Crash which predates the coronavirus crisis. “Some people say that if gold hadn’t been selected as a currency thousands of years ago, it would not have a role today. I don’t agree. Gold has a lot of useful properties and unique features so I don’t think its status is in any way accidental. It’s a monetary asset and I think if you replayed history another way, you would come out with gold again.”
Please see Mapping the COVID-19 Recession by Kenneth Rogoff, Project Syndicate
When the United States owned
most of the gold on Earth
Chart courtesy of GoldChartsRUs
Few Americans know that just after World War II the United States owned most of the official sector gold bullion on earth – about 22,000 metric tonnes or 80% of the world total. As part of the 1944 Bretton Woods Agreement, though, the United States allowed unrestricted redemptions from its reserves at the benchmark rate of $35 per ounce. In the 1960s, a group of European countries, led by Germany and France, got the idea that U.S. trade and fiscal deficits had undermined the dollar, making gold a bargain at the $35 benchmark price. Steadily over the next decade, they exchanged dollars for gold at the U.S. Treasury’s gold window. By the early 1970s, 14,000 tonnes of gold – or 64% of the stockpile – had departed the U.S. Treasury never to return (See the chart above).
The transfer of gold finally ended in 1971 when President Nixon halted redemptions, devalued the dollar and freed the greenback to float against other currencies. The era of global fiat money with the dollar as its centerpiece had begun. Gold transformed from its official role as backing the dollar to serving as a hedge against its depreciation. Since that role reversal, gold has risen in fits and starts from the $35 official benchmark in 1971 to a peak of over $1900 in 2011. It is trading now in the $1750 range. For the central banks and private investors who redeemed their dollars for gold at $35 per ounce, the gains have been extraordinary – over 4800% at current prices or 8.25% annually compounded over the 49-year period. Simultaneously, the 1971 dollar has lost more than 84% of its purchasing power.
What if pension funds put 5%
of their total asset value into gold?
Along comes the Ohio Police and Fire Pension Fund (OP&F) to announce in late August that it will allocate 5% of its nearly $16 billion investment portfolio to gold as a “strong diversifier” and “effective hedge against inflation.” A 5% allocation to gold, if achieved, would amount to roughly $800 million at $2,000 per ounce – about 400,000 troy ounces or 12.5 metric tonnes. Even though that commitment amounts to a formidable boost for the annual demand table, OP&F is just a small slice of the $22.4 trillion U.S. pension fund universe.
Pension fund total assets
(United States, 2002-2018)
Chart courtesy of Statista.com • • • Click to enlarge
If by some stretch of the financial imagination, U.S.-based pension funds were to follow the OP&F’s example and allocate 5% to gold across the boards, over $1.12 trillion would suddenly enter the gold market – the equivalent of almost 17,500 metric tonnes at current prices and an amount equal to half central banks’ total gold reserves. That is not a likely outcome but we throw the number out there just to offer an idea of pension funds’ purchasing power. Globally, pension funds have roughly $35 trillion under management. If only 1% were allocated, it would translate to almost 5,5oo tonnes – still a significant number.
Mike McGlone, Bloomberg’s chief commodities analyst, reports in a recent commodity outlook that gold ETFs absorbed 20% of mine production in 2019 and that they are on pace to absorb 30% in 2020. “Starting from zero in 2004,” he says, “gold ETFs are a relatively nascent investment vehicle with plenty of room for maturation.” Taking into account the latent purchasing power just in pension funds – not to speak of what could be generated if private equity, insurance companies, and sovereign wealth funds were included in the mix – it is not difficult to understand what might have motivated Warren Buffett’s interest in the gold sector.
Coins & bullion since 1973
Gold, vanadium, europium reveal the existence of a mysterious particle
“To observe the Majorana fermions, the team of physicists from the Massachusetts Institute of Technology, the Institute of Technology at Delhi, the University of California at Riverside, and the Hong Kong University of Science and Technology, designed and built a material system that consists of nanowires of gold grown atop a superconducting material, vanadium, and dotted with small, ferromagnetic ‘islands’ of europium sulfide, which is a ferromagnetic material that is able to provide the needed internal magnetic fields to create the Majorana fermions.” – Valentina Ruiz Leotaud, Mining.com/
USAGOLD note: This must have been what Ben Bernanke was talking about years ago when he said he didn’t understand gold. [Smile] Gold’s allure, to be sure, is a mystery to some, but for those who understand the ever-present dangers imposed by the money printing press, the only mystery is why so few own it.
Gold coins, hoofs found in 2,000 year old Chinese tomb
“Chinese archaeologists. . . discovered 75 gold coins and hoof-shaped ingots in an aristocrat’s tomb that dates back to the Western Han Dynasty (206 BC – 24 AD). The gold objects — 25 gold hoofs and 50 very large gold coins — are the largest single batch of gold items ever found in a Han Dynasty tomb. They were unearthed from the tomb of the first ‘Haihunhou’ (Marquis of Haihun) in east China’s Jiangxi Province. The coins weigh about 250 grams each, while the hoofs’ weights vary from 40 to 250 grams, said Yang Jun, who leads the excavation team.” – Xinhuanet/11-17-2015
USAGOLD note: These gold artifacts were found along with a portrait of Confucius, perhaps the oldest known. Wisdom and gold make easy company. Confucius once said something that has current applicability: “In a country well governed, poverty is something to be ashamed of. In a country badly governed, wealth is something to be ashamed of.” Or at the very least, well-hedged ………
The story of the year in financial markets
“One could be excused for wondering if gold can maintain its pace,” writes Jeff Clark in a Strategic Wealth article, “but how many of the risks that pushed it higher in the first place are gone? Check out the risks that remain around the world and see if it’s really time to reduce exposure – or instead make sure one has enough ounces.” These days, the name of the game is maintaining wealth under extraordinarily difficult economic circumstances. The Stein cartoon above is from another time but it still resonates today.
An argument can be made that the difficulty we’ve encountered has yet to manifest itself entirely on Wall Street and in other financial centers. On the other hand, it has certainly begun to manifest itself in the gold market. “I think [gold] is the story of the year in financial markets,” said Sprott’s Peter Grosskopf in a recent Financial Times article. “Gold has finally come on to Main Street as an asset people actually need to have.”
2010-2020 – a profitable decade for gold investors
Investors who purchased gold anytime over the past ten years (since September 2010) could have sold it at a profit in September 2020 – in some instances at a significant profit.
10-Year Chart (as of September 18, 2020)
Chart courtesy of the St. Louis Federal Reserve
Soource: ICE Benchmark Administration • • • Click to enlarge
Only real intrinsic money survives the test of time
Here is a timeless observation from the now-deceased Richard Russell (Dow Theory Letter):
“Paper money is now being created wholesale throughout the world. Stated simply, all paper currency is now valued against each other. But more important, ultimately ALL paper is ultimately valued against the only true, intrinsic money – gold. In world history, no irredeemable paper currency has ever survived. Since all the world’s currency is now irredeemable (in gold), this means that in the end, the only form of money that will survive is real intrinsic money – gold. It’s not a question of whether gold will survive, it’s a question of when the world’s current paper money will deteriorate and finally die. I can tell you that irredeemable paper will not survive – but obviously I can’t tell you when it will die. The timing is the only uncertainty.”
The chart below from the World Gold Council speaks to Russell’s point. It shows the performance of various currencies – past and present – against gold over the long term. When the end comes, as the chart illustrates, it can come abruptly and without warning. For those who stick to the proposition that gold is not really an inflation hedge, or that it is not really a safe-haven against currency debasement, the chart offers instruction. For those who already own gold as a safe-haven, it provides justification. For those who do not own gold, it serves as an incentive. As the old saying goes: All is well until it isn’t.
Chart courtesy of the World Gold Council
The coronavirus pandemic will forever
alter the world order
In a recent Wall Street Journal editorial, former Secretary of State Henry Kissinger said that the pandemic has created “political and economic upheaval that could last for generations” and that this crisis is even more complex than the one that began in 2008. “When the Covid-19 pandemic is over,” he says, “many countries’ institutions will be perceived as having failed. Whether this judgment is objectively fair is irrelevant. The reality is the world will never be the same after the coronavirus.” If global authorities – governments and, in this case, central banks – will be perceived as having failed, then what will be the knock-on effect in financial markets that have leaned heavily on their largesse since 2008? The new normal may be in the process of being replaced by a new abnormal that every investment portfolio should take into account.
‘No one questions its value. . .’
“No one refuses gold as payment to discharge an obligation. Credit instruments and fiat currency depend on the credit worthiness of a counter-party. Gold, along with silver, is one of the only currencies that has an intrinsic value. It has always been that way. No one questions its value, and it has always been a valuable commodity, first coined in Asia Minor in 600 BC.” – Alan Greenspan, former chairman of the Federal Reserve
Image courtesy of the British Museum Collection/Lydia, croesid, ca 550 BC
“Bear markets are sneaky beasts. . .”
“Bear markets are sneaky beasts and they like to do their damage as secretly and as unobtrusively as possible. I hate to say it but somewhere ahead, the bears going to get it all together and the innocent little stream is going to turn into a waterfall. What can you do about it? Stay out of the market? Protect yourself by remaining in pure wealth, gold. For thousands of years, silver and gold have been treated as pure wealth. As the standard measures of wealth (stocks and bonds) have deteriorated, veteran investors have forgone profits and moved their assets into pure wealth.” – Richard Russell, King World News, 2016
USAGOLD note: King World News called the late, great Richard Russell – who regaled us with his wisdom in the Dow Theory Letter for nearly half a century – “the greatest financial writer in history.” We can only guess what Russell would have had to say about the current state of affairs, but the quote above provides a clue. Never predictable in his opinions, he was rock solid on one axiom throughout his career – the necessity and transcendence of gold as a permanent component of the well-balanced investment portfolio. As he said, so often, it helped him sleep at night.
Part 4 of 5 . . . . .
What makes this gold market rally
different from all others
Bullion banks are covering their shorts on price retreats, not piling-on
Declining global interest rates have put a damper on another traditional source of physical gold supply – bullion bank leasing programs. “We can conclude,” writes gold market analyst, Alasdair Macleod, in an insightful paper published at the GoldMoney website, “that the basis for highly geared interest rate arbitrage by borrowing gold is running into a brick wall. Not only is there no incentive for lessors but also there is also a diminishing appetite for lessees because the opportunities are vanishing. Synthetic gold liabilities are being gradually reduced, not only by ceasing the creation of new obligations, but by buying bullion to cover existing ones. This will have been particularly the case when the USD yield curve began to invert in recent months (itself a backwardation of time preference), and was the surface reason, therefore, that the gold price moved rapidly from under $1200 to over $1500.” This change in direction for bullion banks represents another fundamental difference between this rally in the gold price and rallies of the past. What’s more, given the entrenched low-rate environment, it looks like it might remain a factor for some time to come.
How to hedge electronic circuitry run amok
With respect to the growing dominance of machines on Wall Street, I recall the old Star Trek episode that involves a visit to a planet where the inhabitants seem to be living in a state of perfect bliss. Captain Kirk knows that this cannot be right. There is no such thing as perfect happiness. As it turns out, the population is controlled not by a loathsome dictator who has drugged the population into compliance, but by a computer that has evolved sufficiently to somehow gain control of their minds. Something must be done, concludes Kirk, to break its hold. Spock comes up with the solution by instructing the computer “to resolve the value of pi” – an impossibility because its resolution, as we all remember from high school math class, is infinite. The computer spends all of its time and devotes all of its resources trying to achieve the impossible and the dictatorial hold it has on the population is released – a trick we might want to keep in mind for the day computers complete their mastery of Wall Street.
Similarly, Financial Times once told the story of the textbook, The Making of a Fly: The Genetics of Animal Design. It started out selling for $113 per copy at Amazon – that is, until the governing algorithm misfired between two third-party sellers. The price then skyrocketed to $23 million before someone took note and fixed the problem. We forget that computer software, and this applies to Wall Street’s trading apparatus as readily as it does the Amazon pricing platform, is only as reliable and intelligent as the code by which it is instructed to operate. The practical equivalent to Mr. Spock’s solution in the financial realm is to store sufficient capital in the form of gold and silver coins detached from electronic circuitry that might run amok. – MK