Why Gold Still Has a Long Way to Run

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The supply of paper currencies is infinite; the supply of gold is finite. This striking contrast provides an excellent reason to exchange the former for the latter.

The gold supply is limited…very limited. According to one estimate, all the above-ground gold in the world totals between 120,000 and 140,000 metric tons. Let’s split the difference and call it 130,000 metric tons (about 4.2 billion troy ounces). If you brought it all together and made it into a gigantic cube, it would measure about 19 meters along each side – about three meters short of the length of a tennis court.

Furthermore, about 20% to 25% of all the gold is stored in the world’s central banks as country reserves. So the total amount of gold in private hands is enough for just 14 grams for each living person – that’s less than half the quantity of a standard one-ounce coin like a US Gold Eagle or a South African Krugerrand.

At present, only about 2.25% of the world’s total wealth – or 4.5% of world’s financial wealth – is allocated to gold, including jewelry. But resurgent inflation could raise that percentage dramatically, while raising the gold price dramatically in the process.

To gain perspective, let’s examine a brief history of the gold price relative to US inflation. The gold price peaked in January 1980 at $850/oz. But this peak was very brief. Gold jumped 29% alone in the run towards $660. Probably a better reference point for the market top is the average price during 1980 as a whole. This was $615/oz. Since then, the gold price has increased only 125%.

Over the same timespan, however, the government’s most widely quoted inflation gauge, the Consumer Price Index (CPI), has increased 185%. Therefore, if the gold price had increased as much as the CPI, it would be selling for $1,753/oz today, not $1,390/oz. But the official inflation figures might not be the real story. Using alternative inflation figures calculated by ShadowStats.com, consumer prices have soared an astounding 789% since 1980, which means that the inflation- adjusted gold price would be $5,467/oz.

Gold Price vs. CPI Over the Last 30 Years

Interestingly, if we look at the market bottoms for gold – 1970 and 2001 – instead of the market tops, the ShadowStats data seem to provide a much more accurate inflation gauge than the CPI. For example, in January 1970 – before gold’s 10-year bull run – the price of gold was just $35/oz. Thirty-one years later – after soaring to more than $800 an ounce in 1980 – the big bear market in gold bottomed out at $256/oz. And the average price for 2001 was $271/oz.

Therefore, during this 31-year period – through gold’s full bull and bear market cycle – the gold price advanced 674%. Over the same timeframe, the ShadowStats inflation measure advanced a nearly identical 688%. By contrast, the CPI increased only 370% during this period. In other words, the cumulative CPI readings from 1970 to 2001 failed to account for all the inflation indicated by the rising gold price. The ShadowStats figures, on the other hand, were pretty much bang on target.

I’m staying conservative, and there’s nothing to suggest that just because using the ShadowStats inflation worked for the bear market lows it will work for the bull market highs. But if the ShadowStats figures above are a guide, then maybe they point to a price north of $5,000/oz for gold – or even $7,000 for a short time.

I’ve just thrown a lot of numbers at you. But the point is this: gold looks like it has plenty of upside. But let’s be really clear about one thing. I’m not making a hard prediction or setting a price target here. These figures just provide reference points. We also need to watch out for gold “going mainstream” – when references make their way into TV programs, when taxi drivers start talking to you about gold and when your mother calls to ask how to buy an ounce of the stuff.

I can easily see gold getting into the $2,000/oz to $3,000/oz range in the next few years – maybe higher. And there’s a very real possibility that we’ll have a short-term spike – a genuine investment bubble – that takes us into the $5,000/oz to $8,000/oz.

None of this is certain. And it most likely won’t happen smoothly. There could even be big corrections along the way – like between December 1974 and August 1976 when gold fell 47% before powering ahead again. But I hope I’ve shown you that there are good reasons to think that gold still has plenty of room on the upside.

Conclusion: If you own plenty of gold already, then hang on for the ride. If not, buy more on the dips.

Regards,

Rob Marstrand,
for The Daily Reckoning Australia

Rob Marstrand
Rob Marstrand worked for UBS for 15 years, mainly in corporate strategy, before escaping the banking world and moving to South America. His ex-employer was the largest global wealth manager and world's biggest stock trader. The strategy job involved all areas of the business in all parts of the world. Reviewing current businesses, developing entry strategies for new businesses and countries, and working on acquisitions and joint ventures. This work involved detailed review and valuation of competitors and takeover targets. Rob lived in Hong Kong, China from 2002 to 2005, where he was particularly involved in negotiating joint ventures and acquisitions in China. He has also worked on projects, acquisitions and joint ventures in Japan, India, Saudi Arabia, the US, Switzerland, Indonesia and South Korea, amongst others. He is British, married to an Argentine wife, and emigrated to Buenos Aires, Argentina with his wife and two children in 2008.
Rob Marstrand

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Comments

  1. That graph could have gone back another 10 years to show that gold went up 2000% in the 70s but starting from Gold’s peak price in 1980 suits the story better.

    Reply
  2. “There could even be big corrections along the way ”
    I cannot see any reason why not. After a good deal of time trading/watching tape in various time-frames I felt that price movements in gold were completely orchestrated. Day after day it seemed the shake-outs were contrived after which the tape would flow more naturally for a period. Just when you worked out a signature through a particular period it would change rendering all your work useless. Churning it up.
    Where a fiat/debt system exists then the free market supply and demand fundamentals are almost inconsequential…almost at least.
    I expect a mega dump on gold at some time.

    Reply
  3. Comment by Lachlan on 8 January 2011:

    I expect a mega dump on gold at some time.

    Me as well. May even happen sooner than later and then a run up to the peak.
    I still expect it to break $2000USD/Oz at some point. Might not be till 2012 or later. I will take profits on Gold stocks that make my targets. I have 6 Gold Mining stocks with set targets in mind for my sell positions, if these all come to fruition I will be a happy man indeed.
    I am watching the market to make my switch to energy plays as well.
    Gold is not a long term proposition, my exposure to Gold is very high at the moment, that is not a good long term strategy. Some exposure to gold in a portfolio is good but it is not the be all and end all of an investment portfolio.
    Have a couple of copper plays as well.
    IMP is the only energy stock I am carrying at the moment, there are a couple on my radar but not yet. 1 of them is in Queensland and is “wet weather impaired” at the moment…
    Have a finger in a explorer/miner in WA with a good prospect for Uranium, Nickel, Gold, Copper. Trading around 2 cents, bought 100000 with dividends from another stock, drilling 1st Quarter this year on what they think could be the company making tenement, if 1st drill results are half decent will probably increase holdings. Will stick with just a $2000 speculative investment at this stage. Clue.. Easy one. A roman General who became a gladiator.

    Stillgotshoeson
    January 9, 2011
    Reply
  4. Actually Shoes I’ve thought quite a few gas plays are good buying for some time being so boring and out of favour and technically cheap….quite a few at least.
    Re:gold. Something might crack soon in the world monetary sense. The welfare states are heading into critical space. People might get hungry and miffed. I’m holding to the view that gold will stay favourably valued against other assets with or without dollar denominated shake-outs. But nobody knows the future for sure.
    The point for me is that unless total anarchy arrives then I need to swap my gold for some land because that will improve my earning prospects greatly (a commercial proposition ie seeds)….and self sufficiency/lifestyle prospects. So its a trade for me unless the world goes nuts at which point it becomes money or wealth preservation by default.

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  5. “So its a trade for me unless the world goes nuts at which point it becomes money or wealth preservation by default.”

    Lachlan, we’re surprisingly similar in mind :). When you say gold is a ‘trade’ I assume you are talking about gold with a counterparty(etf, unallocated storage, etc).

    Just remember than when ‘everyone turns to gold’ physical supply will be ZERO, as nobody will trade physical for worthless fiat. If this idea is interesting look at what’s happening in silver right now. The COMEX has reserves to satisfy about 10,000 contracts, possibly 20,000 if you even believe their inventories exist that is. Open interest is 70,000 and is looking to get bigger for delivery in march. Most mints around the world stopped minting due to bullion supply issues. So, currently physical sellers have closed up, but ‘paper’ sellers like non backed ETF’s can grow, so, despite the lack of a price spike, you just can’t get any physical anyway. I expect the same with gold if we came to ‘what we are think about’.

    I like your seeds idea… though confess that I have only been thinking that for a few weeks (I save seed at home, and am a few generations in to some species).

    I DO see gold cracking up and to be fair, it’ll probably go towards zero, BUT, this will be in the absence of physical availability, aka similar to silver above. Paper gold will reprice down as people realise that the delivery contracts cannot be filled and get written down. Since that 85% of the traded gold, we could very well see an almost complete gold drop. Physical gold value would not have price discovery as very few(none?) ‘on exchange’ transactions would be visible.

    That’s not to say that that you won’t be able to trade a kg for a large vinyard, or that the vinyard is ‘worth’ $4k that the paper gold is :P

    I hope this is not too obscure. For more information google ‘harvey organ’.

    Chris in IT
    January 10, 2011
    Reply
  6. @Chris

    I bought a 1kg bar of silver on Friday in Melbourne, Dealer appeared to have a reasonable amount.. maybe a dozen or so customers (myself included) of physical bullion (gold and silver) were there.

    Stillgotshoeson
    January 10, 2011
    Reply
  7. @Chris
    “as nobody will trade physical for worthless fiat”

    Many “goldbugs” will switch out of gold (paper) for fiat to buy alternate hard assets that now appear as “value” they will never need have the physical.

    Others are leveraged into the gold miners, cheap way of buying gold, however a little riskier..

    Stillgotshoeson
    January 11, 2011
    Reply
  8. UK Financial News’ (Dow Jones) Giles Turner reminds his readers that “The biggest potential trigger for a collapse in gold prices is an increase in interest rates. As gold does not offer any form of dividend, it often loses out to fixed-income investments as interest rates rise. For example, when the US increased federal funds rates in 1980, reaching 20% in 1981, it led to a collapse in gold prices.” Indeed, rising interest rates could be the initial trigger for a different turnout in 2011 for gold and other commodities. Yes, and so could the end of de-hedging by miners, a shift in ETF gold uptake patterns, etc.

    However, it is another ‘component’ of market structure that, these days, poses a potentially larger threat to bullion prices. FN points out that: “When interest rates rise, the widespread use of stop losses may exacerbate a potential fall in gold prices. Andrew Thompson, head of advisory portfolio management at Kleinwort Benson, remains bullish on gold in 2011, but has placed a series of stop losses to protect clients from a fall in gold prices.”

    http://www.kitco.com/ind/nadler/jan102011.html

    Reply
  9. “I bought a 1kg bar of silver on Friday in Melbourne, Dealer appeared to have a reasonable amount.. maybe a dozen or so customers (myself included) of physical bullion (gold and silver) were there.”

    Sydney’s ABC is pretty much out. They had 3 x 1kg PAMP bars. No 5’s, no 15’s, no 30’s (though I’d hesitate buying that just out of the sheer difficulty in moving \ storing it! The 5’s and larger quantities of 1’s (like if you wanted say 20-50 of them) had a delivery date of 4-6 weeks in the future when I had last contact with them in mid dec.

    If you don’t mind a bit of a premium, then you can still get foreign coin at a good price from bullionbourse, perth mint luna’s as always have a high premium.

    “Many “goldbugs” will switch out of gold (paper) for fiat to buy alternate hard assets that now appear as “value” they will never need have the physical”

    Very true! They are in it for a different reason, however, at the point that a major currency tarts to crash, like the USD for example, you will want to VERY QUICKLY move from your paper long to RE or something physical, as you’ll have to beat the seller to knowing what they are getting will son be worthless. Since RE transaction normally take weeks it may be risky.

    The premium or physical gold is only 2.5% plus storage around $200 a year for a small box. Not exactly a high barrier for entry considering you spent that much just buy in to an average etf or stock fund…

    Of course, as you’ll notice, once you have physical, the jittery fiat system is just a show to watch. :)

    Chris in IT
    January 11, 2011
    Reply
  10. @Chris. Good point. The rush for the door effect is real and should not be ignored.
    “The bankers who dealt in morgtage backed securities knew the risk, but they planned to be the first out of the exit when it went bad.” Quote from “the ascentof money” documentary. Each dealer thought they were smarter than the others and were planning to exit first, leaving the others to wear the losses. However they were all about as smart as each other and got they all got stuck in the doorway when they ran for it simultaneously.

    Reply
  11. LOL.. My wife found that doco a few days ago. We sat together two night ago and streamed all three parts down… It was a nice follow on for the wall st movie a few weeks ago.

    Of interest… also consider the fact that billionaires are now moving in to gold and silver as well as the chinese (private and public) in a really big way. In many cases if everything goes nuts, production will be either nationalised or at the very least redirected by big internal orders. Walk up bullion dealers will be starved as the source will be drawn down.

    Keep you eyes open for a divergence between physical and front month forward price by the premiums increasing. That’s how you know that ‘paper gold’ is being traded for physical in a big way (This will occur just before shortages).

    For those that don’t believe a rust to the door will occur, have a look at the Brisbane supermarket. Now consider this… the gold market in todays dollars is tiny compared with all the currency sloshing around. A few billionaries would easily eat the whole physical market’s annual production (not paper, but that has a value near zero if it’s not unbacked as who want to play musical chairs).

    “but has placed a series of stop losses to protect clients from a fall in gold prices”

    If you have ever traded FX near a news release or crude around the inventory report you’ll know that stop losses are worthless. A ‘stop loss’ to me is actually WORSE than nothing, as it allows bucketshops to snipe you. All a stop is, is a market order that fires at a particular price point. SOMEONE still need to take the other side and sell to you at that price. You market order will be filled by the first buyer found and that could be a LONG way down. In fact for the adventurous, there is a technique whereby you prey on stop losses around news releases by entering bogus limit orders WAY off spot. In times when the market is bidless your ‘crazy’ order can fill someone with a really shitty price, and once liquidity returns(clearly there is risk here or a REAL move, so experience is needed to fine tune the values). This isn’t a ‘nice’ way to make money, but I chatted with someone once who does this and the returns are reliable, and besides, he preys on news traders, so it can’t be all bad ;)

    Chris in IT
    January 13, 2011
    Reply

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