By Alex Stanczyk, Michelle Johnson – Physical Gold Fund
Gold’s performance in 2020 has been nothing short of spectacular rising roughly 25% over the last year, outshining nearly every other asset class. The yellow metal in fact, reached an important milestone cresting above $2,000 an ounce for the very first time in August. Whilst the gold price has since retreated from these levels, a bull market does appear to be well intact. After years of consolidation gold is once again turning heads and raising important questions for investors.
Recent price performance certainly seems to reflect the traditional catalysts and positive underlying fundamentals for a respectable move but are we starting to witness something deeper? Might there be more to this rally than meets the eye? Is gold’s role being re-evaluated in a meaningful way as a strategic versus tactical asset?
In recent months we’ve witnessed important shifts in perspective with regard to gold from some of world’s most respected wealth managers, as well as the Bank of International Settlements (BIS). In the spring we heard from legendary investor and billionaire Stanley Druckenmiller, who became increasingly bullish on the metal after sharing concerns about the Fed’s loose monetary policy and prospects of inflation. At that time, Druckenmiller also made gold his largest currency allocation.
We also heard from veteran hedge fund manager, Ray Dalio founder of Bridgewater Associates, who’s been quite vocal in recent months warning the Fed could get locked into a debt-purchasing spiral as it buys bonds abandoned by investors now favoring rising equity and gold prices. Dalio also warned that the U.S. dollar as the world’s reserve currency is under threat, weakened by the Fed’s unprecedented fiscal stimulus, which has gone into overdrive since the coronavirus pandemic in March. Dalio sees gold as one of the primary beneficiaries in this scenario.
Even long-standing gold bear, Warren Buffet the “Oracle of Omaha”, appears to be whistling a different tune of late. In mid-August, Berkshire Hathaway sold substantial positions in the banking sector and announced a $500 million dollar stake in Barrick Gold Mining Company. This is the first notable investment of Buffets company into a gold related vehicle, as he has famously held a negative view of the metal for not providing investors with a yield. Today’s near zero interest rate environment certainly seems to have put a hole in the boat of this argument, at least for the time being.
And finally, last April, with surprisingly little fanfare from the media, something very important took place at the Bank of International Settlements (BIS). Under the new Basel III rules, gold was moved from Tier 3 to Tier 1, as a zero-risk monetary asset. Thus, the BIS will now recognize central bank holdings of physical gold as reserve assets equal to cash or a treasury bond. This change has of course provided bullion rich banks with an upgrade to their risk profile while potentially incenting others to add to their holdings, and add they have.
For those unfamiliar with the BIS, their website mission is “to serve central banks in their pursuit of monetary and financial stability, to foster international cooperation in these areas and to act as a bank for central banks”. The BIS is also the trading agency of the International Monetary Fund (IMF) and central banks for gold. The BIS transacts gold on behalf of its customers, which are central banks. Some 189 banks follow the rules established by the BIS. The purpose of the Basel III is to reduce the ability of banks to damage the economy by taking excess risk. The current version of these rules, known as Basel III, is a key element of the international regulatory reform agenda put in motion following the global financial crises of 2008. Aside from the history lesson on the BIS, these new regulations do not appear to be tactical in their nature, however quite the opposite.
What’s Changed? Chaotic Conditions and Endless Money Supply, Not Gold
For those who believe the bull run in USD gold price is over, it is necessary to subscribe to the idea that the US Federal Reserve will be able to tighten monetary policy and maintain a strong dollar in the face of unprecedented turbulence in the US geopolitical landscape, and an ever growing balance sheet fueled by the creation of the equivalent of 110 million median man hours of labor out of thin air. It took 94 years for the Federal Reserve’s balance sheet to reach $1 Trillion. It took only 12 years for it to reach $7 trillion. At this rate, within the next decade it could surpass $20 trillion. The idea that the endless monetary doses that have been administered in order to keep the economic patient alive can somehow be removed, is being proven to be nothing but wishful thinking. The balance sheet has not been reduced; it continues to explode as each new crisis unfolds. There is no way out of the stimulus trap they have placed themselves in. This will ultimately end in the continued erosion of the value of the US dollar and further highlights the importance of gold as the anchor of value both now and in the future.
It is our view that conditions in the global monetary system have changed, but gold has not. Gold has remained the same for thousands of years. Gold exists as atomic number 79 on the periodic table. It is chemically inert and does not react with oxygen or water. It is the only element with properties that make it completely immune to the forces of entropy because gold cannot be destroyed. Everything else can be. Computers, stock exchanges, fiat currencies, cryptocurrencies, power grids, companies, nations. If you blew up the entire planet the gold atoms would still be there. Gold does not need anything else to be gold, and unlike almost every paper investment does not rely on the solvency of a counterparty to retain its value or liquidity. The reasons for investing wealth in gold over the course of human history are the same reasons astute investors are accumulating gold today.
Conclusions – Gold’s Ascent Is Just Beginning
When it comes to assessing the Feds and other central banks attitudes towards gold, it is important to watch what they do and not necessarily what they say: they do not hold coffee, copper, or bitcoin. Increasingly, however they do own gold.
Gold forms a critical base component of the entire global financial system, and at the highest levels, financial elites who manage the global financial system know the truth of this. You can find it buried in the details, even if it is denied to the public. If you listen to the commentary of former central bank governor’s regarding gold after they leave office, you can find clues about gold’s true significance. At the very least they acknowledge that gold would act as an emergency reset button if confidence in fiat money issued by governments is lost.
Monetary inflation being created by central banks around the world through money printing is unprecedented, with no end in sight. While velocity at this time remains low, we must ask ourselves if that will always remain the case. As velocity kicks in, inflation may skyrocket.
Gold has long been considered an excellent hedge against inflation and hyperinflation.
A political storm is brewing around the 2020 US presidential election with neither side likely to accept defeat come November. It seems the foundation is being laid for a potential constitutional crisis. Follow on scenarios which were perhaps once unthinkable, could potentially unfold and further cause confidence in the US establishment and critically the US Dollar to weaken. Regardless of the election result, it appears a day of reckoning for the greenback could be just around the corner. This situation, whilst regrettable, none the less bodes very well for gold.
There are trillions upon trillions of dollars in bonds that are approaching zero yield or are already at negative yields. These bonds will be rolled over but must find new buyers. We question how that will work out. The argument by incentivized money managers that “gold creates no yield and so we invest in bonds” is evaporating. It is our view that as additional stimulus forces continue to exert pressure on the bond markets, capital will come out of bonds and must go into something else. Again, we see gold and as the winner in this scenario.
M2 is a measure of the money supply that includes cash, checking deposits, and net time deposits. In the chart below, we see that M2 has gone ballistic in comparison to previous periods of stimulus. Importantly, the amount of M2 created in the most recent round of stimulus dwarfs what was created in the 70’s where gold gained over 2000%+ in US Dollar terms.
Historically, the combination of massive injections to the money supply and rising velocity of money has led to powerful increases in the price of gold.
As it pertains to Shariah rules, gold is a fungible item which belongs to the broader category of Ribawi items, and the subcategory of monetary items (the two media of exchange, the other being silver). Physical Gold Fund is one of a small handful of regulated gold products that is certified as Shariah Compliant, and all of our operations and processes are in line with the AAOIFI Shariah Standard on Gold.
As you evaluate your precious metals allocation, consider the following: Are the counterparties in the strategy exposed to systemic risk, and if so does this defeat the purpose of holding gold in the first place? Is the gold held in physical form? Is it allocated? Can you take delivery if you wanted to? How will liquidity work during a crisis? Does your current strategy reflect an appropriate weighting given the current environment?
Physical Gold Fund, www.physicalgoldfund.com
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