The idea of the “golden constant” is that gold always keeps its purchasing power in the ultra long run. But we live in times of huge global change. Today there are many factors, above and beyond general price inflation, that are positive for gold investors. These are the big things that will drive gold higher in future, and at a faster pace than most expect.
It’s said that a well-to-do Roman, with a wish to be kitted out in togas and tunics, needed the same weight of gold to make the purchase as today’s man about town. Possibly that’s true, but surely it depends which town you live in.
Just over a decade ago I lived in Hong Kong for three years. I was on an overseas posting for UBS, the Swiss investment bank where I worked at the time.
Suits are the essential uniform of bankers, and Hong Kong tailors were both cheap and fast. I had a number of suits made for about a fifth of the price in London (and in about a third of the time).
In other words, measuring where the gold price is relative to the golden constant has its challenges. Which place and which products do you choose?
That immediate detail aside, it’s clear that gold doesn’t lose value in the long run. It’s been cherished by people for millennia. That’s not about to change.
Put another way, gold preserves its value, given a long enough time frame. The price goes up when measured in weaker fiat currencies – whether they’re pounds, dollars, yen, rupees, renminbi yuan, euros, pesos or anything else.
Of course that’s not the whole story. In the short run the gold price is driven by skittish financial speculators with short attention spans. Perhaps we should refer to them as “goldfish”?
Because of these paper traders the price ride can be bumpy at times. Over weeks, months…even several years…the gold price (in currency) can move far away from the long term trend. Bull markets, bear markets, bubbles, busts – gold runs through market cycles, just like any other investment asset or commodity (and gold is both).
The US dollar gold price has comfortably beaten official US consumer price inflation (CPI) by 2.1% a year over the past 40 years (see here and here). Consumer prices went up 4.2 times. Gold went up 9.3 times over the same four decades.
(See here for some of the unique factors driving gold during the past 15 years, and also what Donald Trump’s policies could mean in the short term.)
That was then. What’s more interesting is to think about what could happen from here. Are there forces in place that will keep driving gold higher at a faster pace than inflation? I believe there are. And they are many – at least 13 big things.
Here’s what I’ve come up with (let me know if you think of more):
- The world’s total population is growing at 1.2% a year. India – the world’s second largest gold buying country after China – will add 400 million people by 2050. Africa will double its population to 2.4 billion over the same time.
- All the gold mined in history is estimated around 184,000 metric tonnes. Newly mined gold production is about 3,300 tonnes a year, meaning the global stock increases by 1.8% a year. Two thirds of that growth is already “taken” by the 1.2% population growth, leaving only 0.6% to absorb any other new drivers of gold demand – such as wealth growth and the money supply.
- Unlike fiat currency, gold has a finite supply. New finds of ore deposits are lower and lower quality. What’s more they tend to be in more and more remote locations. Over time this drives up the marginal production cost of gold, which is a kind of price floor. If the market price is lower than production cost then production falls as mines shut down. In turn this increases scarcity, driving up the price to bring the market back into balance.
- The world’s fiat money supply continues to rise at a rate well above official CPI. That’s not necessarily a problem if production of goods and services is also rising. But some of that money will find its way into gold, not least because it’s a “good” (jewellery), and bid up the price. It’s difficult to get global money supply figures, but here is a selection for the past year from the IMF: US M2 +7%, UK M3 +10%, China M2 +12%, India M2 +11%, Eurozone M3 +5%, Japan M2 +3%. (There are various different measures of money supply and not all countries produce all of them. The most common ones are M0, M1, M2, M3 and M4. For a brief definition see here.)
- Lower income emerging market economies will continue to grow faster than higher income developed countries. Of course there will be cycles, but it’s the long run that really counts. The IMF expects advanced economies will have real (after inflation) GDP growth of 1.8% next year. For less developed countries the figure is 4.1%, or more than twice as much. China and India are both growing at a 7% clip.
- This emerging market growth, spread across vast populations, means a lot more people with a lot more money to spend and invest. Inevitably a lot of that money will find its way into gold. Either because it’s what I call “the ultimate consumer good” (jewellery) or for wealth preservation and investment (coins and bars).
- Although China’s growth has slowed in recent years it’s growing off a much larger base. Measured in US dollars, China’s economy is four times as large as a decade ago. In absolute dollar terms, today’s (real) growth of 7% a year amounts to over twice as much growth as a decade ago. More and more Chinese money will find its way to gold. The same is true for India.
- Developed countries are drowning in debt. Bonds are still in a bubble, with low or negative yields. Many stocks are expensive, especially in the US, much of Europe, and many emerging markets. Bank deposits still pay next to zero. More investors may look for alternative investments, and gold will attract some of their money.
- The next time a recession hits the US or Europe (very soon?) deeply negative interest rates and bond yields could be the result. This would be good for gold.
- Alternatively, governments could experiment with “helicopter money” – which they would spend straight way in the real economy. This could result in inflation even during a deep recession (aka stagflation). If it’s combined with suppression of bond yields via the tired old trick of quantitative easing (QE) – which is printing money to buy financial assets – then gold will take off due to negative real yields.
- The “war on cash” continues, and would intensify if banks are forced to charge to take customer deposits. The physical cash exit would have to be blocked to prevent a bank funding crisis. Savers would flock to gold instead (see here and here).
- The Middle East and North Africa will remain unstable, even if the hot spots change from time to time. Terrorism is here to stay. So are the waves of migration into Europe, which inevitably include some fanatics. The gold price will periodically jump as attacks are made and fear takes hold.
- Linked to this, and after decades of failed policies, Europe’s political upheavals will continue. Brexit was just the start. Both the European Union (27 countries excluding the UK) and the eurozone (19 countries) look set to lose members over the coming decade. One or more of those countries is likely to be France, Italy or the Netherlands – all right at the core of the EU project. Other contenders include Greece, Ireland and Portugal. All this means heightened uncertainty, “surprises” and market shocks. Uncertainty is good for gold.
Not all of these big things will work out as expected. And some will be disrupted along the way before coming back into play. Recessions happen. Speculators roll out of bed on the wrong side. Politicians and central banks occasionally do something sensible.
But if you put it all together there are many powerful, underlying trends that should drive gold higher over time. Eventually. Which is why every investor should own some physical gold as part of their overall investments and not worry about the short term price swings (see here for more).
We live in a fast changing world. Gold will endure. That’s the real “golden constant”.
Stay tuned OfWealthers,
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