Where to now for the Gold Bull

Where to now for the Gold Bull

By Shane Carroll –

We are 10 years into a precious metals bull market which has seen gold go from under $300 an oz at the end of the stock market bubble in 1999 and 2000 to over $1500 dollars today. In the same time frame the Dow Jones has gone from 11722 on January 14th 2000 to 12084 on June 20th 2011. Impressive. Gold’s rise has been steady but not meteoric.


Against the euro the gains over the last decade have averaged 14% per annum and against the dollar those gains have been slightly higher at over 18%.But after a decade of good returns on gold and silver is it time for investors to exit the market ? Lets have a closer look at the factors in the years ahead that are likely to drive the gold price…


    1. Euro Sovereign Debt – debt loads in the P.I.G.S are unsustainable. In Greece’s case corrupt, incompetent politicians lied about their economic data for years. In Ireland’s case the state has been saddled with debts of private banks. Now, and as a direct result the state itself is heading towards bankruptcy and default. Greece is certain to default and Ireland is likely to follow. What is interesting to speculate is how long will it take investors to realise that it’s not small peripheral European  countries debt they should be worried about but the elephant in the corner – the heart of the current fiat system, the US itself and it’s impending default, outright or by stealth.


  1. Federal Reserve QE – The Fed is due to call a halt to Quantitative Easing this month. So we have the paradox that the Federal has pumped unparalleled liquidity and Keynesian stimulus into the US economy and yet its still tettering on the edge of a cliff with a raft of dismal economic data emerging this month indicating no signs of a robust recovery. Now the Federal Reserve, which has been buying up in excess of 70% of US government debt in the last 6 months is supposedly going to step back and allow private market participants to take up the slack. If the Fed had the guts to move into a tightening stance and step back from Quantitative Easing the US would go into a depression. But in order to correct the government induced imbalances in the economy that is what the Americans need right now. No chance the Fed will let this happen.
    1. South East Asian Support of US debt markets – China, Japan and South Korea are key to the health of the US bond market. Since the late 1990’s and the Asian currency crisis these countries have been building up their foreign reserves to protect themselves and their currencies should such a crisis recur. These three countries are amongst the biggest holders of US debt with Chinese holdings of US bonds being the biggest in the world. Interestingly, as the Federal Reserve has been buying more US bonds over the duration of QE2 China has fallen behind Brazil as the biggest buyer of US debt.


    1. US deficit – The US government is projected to run a record deficit of 1.4 trillion dollars this year and we have a farcical situation emerging where Congress is constantly being forced to raise the US debt ceiling amid warnings of financial Armageddon if ceilings are not constantly lifted. This is the equivalent to a spendaholic  consumer who can’t balance his income and expenditure and constantly has to raise the limit on his credit card to keep the ship afloat. No consumer is allowed to do this. So why should a country? The outcome, obviously, cannot be good. The US currently has a 14.3 trillion dollar debt ceiling. Does it really need more? Or should it just start trimming its expenditure instead of chasing US citizens all over the world, from Switzerland to Hong Kong trying to squeeze every last penny out of them. There is a very good reason US citizens are looking at other countries to park their wealth securely.


    1. Obama’s policies – Obama is a charismatic, movie star style president, in the JFK mold, no doubt about it. But that does nothing for a country that needs a hard nosed business focused president who puts moral and social issues on the back burner and focuses on balancing the countries books. That means low taxes, low regulation, sound money. But Obama doesn’t understand the impact of high tax and high regulations on business investment and he has never even heard of sound money. But he is odds on to win the next US election. This metals bull has a long way to run. As long as he is in power a weak dollar can be taken as a fact of life.


    1. US balance of trade – The US trade deficit is 43.7 billion as of April 2011. The trade deficit with important trade partners like China is a perennial US political football but nothing has been done to solve the problems leading to US over consumption and under production. The decline in US manufacturing is a tragedy for that country and rebuilding manufacturing capacity will be a slow difficult grind for that country. An economy that does not export more than it consumes will always have a pronounced tendency towards a weak currency and will suffer from spiralling debts. In Congress the argument is always thrown out that the Chinese are competing unfairly with America through low wages etc. But if this argument had any merit then how is it that a high income country like Germany does so well with its exports to China? In fact, Germany with a population only a fraction of the America’s exports more to China than the Americans do.


    1. American umemployment – unemployment in the US is stubbornly high at over 9%. The Federal Reserve’s stimulus has done little to reduce this. Governments and central banks cannot create employment in a stagnating economy – only private enterprise can do this. If government creates one job in the public sector they have to raise taxes to pay for that position – that money comes out of the productive economy and cannot then be used for investment in manufacturing capacity etc.


    1. European and US interest rates – under Jean Claude Trichet the ECB has kept interest rates at historical lows of half a percent while the US has rates of 0.25%. Both of these rates are far below rates to offer savers a return over inflation and provide a disincentive to keep wealth in paper form. This continues to fuel precious metals investment interest. In order to change this scenario significantly it would be necessary  to raise rates dramatically, back to historically high levels. Raises of .25% and .50% will not be sufficient to derail metals market participants. Prospects of the rates being raised back above the 5% to 7% level seem remote in the extreme at this point. But without them, why hold your wealth in paper?


    1. Break up of the Euro – if the Euro starts to crack and Greece defaults, and Ireland then does likewise, what will happen to the single currency? Who will want to hold the single currency if there is a possibility it will not exist in a few years time? But as we’ve discussed, the dollar, has many issues which make it potentially a worse guardian of your wealth than the Euro. With such enormous problems, neither of these two currencies look like a safe bet in the years ahead. This will continue to foster strong precious metals sentiment.


  1. Chinese investment market – wealthier consumers in China are buying metals and being encouraged by government to invest in commodities rather than an overheated property market. The Chinese Government has tried to dampen property speculation by raising property taxes and mortgage down payment requirements  and this has driven more investment in the metals markets by private citizens in China. The Chinese have huge savings rates compared to anywhere else in the world and as more of those savings are moved into metals this will have a profound impact on patterns of demand worldwide and on prices. As inflation in China becomes more of a concern (a result of the Chinese government trying to maintain a consistent price relationship between the Yuan and the US dollar) this trend towards metals purchases will likely accelerate. China is now the world’s largest Gold Producer and yet it produced only 340 metric tonnes of Gold compared to consumption in China of 700 metric tonnes leaving a deficit of 360 metric tonnes of Gold last year. These sorts of numbers give an idea of how influential China’s growing appetite for Gold will be in the investment landscape in the years ahead.


Over the last 10 years gold has risen approx. 600%. But compared to other asset classes gold still appears undervalued  – it still takes 8 ounces of gold to buy 1 share of the Dow Jones for instance. It still takes over 150 oz of gold to buy an average house in most western countries today (Ireland and the US being the obvious examples). After 40 years on a fiat money system it looks as if the dollar is headed the same way as all other historical fiat currencies – right back to its intrinsic value, zero. A new hard currency structure is the likely successor to all this chaos we are enduring now as central banks and governments use their best Keynesian box of tricks to no discernible effect except more chaos. You can’t change all of this. But you can protect yourself and preserve your wealth while others are losing theirs. Stick with gold in the difficult years ahead.

A New Gold Standard - Robert Zoellick

A New Gold Standard?

Robert Zoellick Head of the World Bank since 2007 has called for a discussion on a new Gold Standard in an article in the Financial Times this week. Since 1971 when the US effectively declared bankruptcy by ending the Bretton Woods peg between the dollar and gold ($35 dollars equaled 1 oz gold) the global financial system has been a floating currencies system based on a paper dollar as the global reserve currency.

Zoellick suggests using gold as ‘an international reference point of market expectations about inflation, deflation and future currency values’. Even more significantly, and in our opinion, accurately,  Zoellick suggests that ‘although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today’.

The suggestion that we have been operating under a system Zoellick calls ‘Bretton Woods 2’ since 1971 is perhaps slightly misleading. To call the structure that international currencies have operated under as a system of any sort is very generous. ‘Organised chaos’ might be a better way of defining currency management since 1971. With no restraint on how much of the global reserve currency they printed the US has been on a printing spree with unintended consequences across the entire globe as deflation was exported abroad to developing countries in the 1990’s and then inflation on a vast scale was seen in both housing and stocks in the US and around the world.

As it becomes clear that this use of the dollar as a global reserve currency at the same time as the Federal Reserve uses and abuses the currency to try and ‘pump prime’ the American economy is becoming more untenable and less and less beneficial to other countries around the world the era of dollar hegemony appears to be drawing to an end. Despite this, the reaction to the idea of a new Gold Standard has been mainly negative. Almost none of the commentary reacting to Zoellick’s FT article has displayed any knowledge of how a Gold Standard actually works. Many of the critics of the idea have said it’s simply not practicable because the quantity of Gold available is not sufficient to support the modern world’s rate of growth etc.

A real functioning Gold Standard can operate on a single Krugerrand. All that matters is that governments set a credible price peg for their currencies against that single ounce of Gold. If the currency’s value falls below the peg then remove currency from circulation until the currency’s value rises to its pegged value again. If the currency’s value rises above it’s peg then do the opposite, and print more paper currency to reduce the value of the currency back to its peg (think QE2 with a purpose and end point). Economists, governments and central banks around the world, under the influence of Keynesian thinking seem to have forgotten that any government with a printing press has total control over its currency’s value  – reduce supply/increase value & increase supply/ reduce value. Simple, but far too straightforward for the brain boxes in the US Federal Reserve and the IMF. Defending currency value with interest rates is an invitation to speculators to put a currency to the sword.

What about a Gold Standard’s capacity to allow for rapid growth in an economy such as China’s or any other around the world today? Demand needs to be considered in relation to how much currency is produced. But consider this, if currency demand starts at 100 dollars and then rises to 200 dollars in a given economy then government can print an additional 100 dollars and double the paper money supply without any disruption to the Gold Standard price peg. Demand for Gold itself will not vary sharply in a well managed paper currency where the government’s promise to maintain the peg makes that currency as ‘good as gold’! This means that a proper Gold Standard can easily accommodate and facilitate any level of growth in an economy contrary to the misinformed commentary from so many economists today on CNBC, Bloomberg et al.

It is encouraging to see the beginnings of a debate around a new global economic system which will involve ‘hard’ currencies and will reduce the chaos a soft money system underpinned by a falling dollar causes. But Zoellick’s comments are only a beginning. And the outright rejection of his comments certainly highlights the fact that this debate will take years to resolve as governments and citizens around the world begin to recognise the need for a new Bretton Woods type agreement. And all the while this debate rages the precious metals bull market will continue to run and run.