What’s the “Real” Deal on the Gold Rally
With gold making all-time highs, I thought I would update some of my thinking for followers. Asset (commodity) prices move based on the fundamentals of supply and demand distorted by periods of the manic speculation of fear and greed. The rationale for the investment (buy, sell) decision is something completely different. There are primarily 4 categories of fundamental demand when it comes to gold according to data from the World Gold Council. The biggest, by far is jewelry, which has been consistently 50-60% over the past 20 years. Since the great Financial crisis and central bank largesse became the policy tool of choice more than a decade ago, investment demand has been on the rise. Central banks themselves hold gold as a reserve currency asset is a major swing factor too, which was a huge negative in the 1990s when bond yields competed heavily for safe haven and real returns. Finally, industrial use found mostly in technology, which is growing as well. Fundamentally, jewelry demand drops significantly as prices rise, which is common sense. Especially in parts of the emerging world where gold and precious metals are a common part of marriage gifting. In this regard the demand curve is price elastic. Simply, fewer people can afford it (and they trade down to silver, which tends to outperform late in the cycle). For prices to continue to rise, assuming supply is constant, which it tends to be for gold mining and recycling, investment demand and demand as reserve currency need to more than offset the loss in demand from jewelry. There are a few types of gold investors, speculators, speculators, speculators and gold bugs. The reason I say this is because gold does not pay interest. Longer-term fundamental investors typically invest for a cash flow income basis via interest or dividend. Capital gains are fundamental too, but it is the relationship of gold to money and inflation that drive this aspect of the fundamentals due to the lack of earnings in gold bullion. In this regard, it’s a very different kind of money, but make no mistake, gold have been a store of value and a medium of exchange for 2 millennium before Moses led the Exodus and King Tut was funky. And also make no mistake, the future of money is about 0’s and 1’s currency—we are not going back to exchanging gold bars.
In the 1990s, the central bank view was that holding gold was a drag on central bank balance sheets because it got no yield (though there is a leasing/lending market). They were dumping it under $400 an oz. Today, central banks, in part, are increasing exposure given the more fragile nature of the global economy and questions about the fiat system.
Our chart this week looks at the real (after inflation) yield of the 10-year US Treasury bond (on an inverted scale) compared to the price of gold. It’s clear the correlation and the main impetus for gold investors are the negative yielding debt. From what all the central banks are telling us, this will be the case until they see the whites of inflations eyes. As Jay Powell said this week to a journalist that asked about rate hikes “We’re not even thinking about thinking about thinking about raising rates!”
Gold has a long way to go! Here is one fundamental way to look for a price target. The inflation adjusted price from the 2011 and 1980 highs. They are 10% and 46% higher. In terms of Euro’s (Deutschmark before 1999), there is 35% more upside.
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