Central banks, SDRs and the US dollar
Today, I (Shae) bring you Jim’s latest analysis of the gold market. After several years of working with Jim, I can tell you that no one knows the gold market quite like him.
A little over two months ago, Jim dropped his most radical idea yet. He believes it’s not the US dollar gold price that’s falling. Rather, it’s about the gold price finding its value measured in special drawing rights (SDRs).
If you haven’t heard of SDRs, don’t worry. Most people haven’t. SDRs are the creation of the International Monetary Fund (IMF).
Think of SDRs as the world’s ’emergency’ money.
SDRs draw their value from five different currencies — the US dollar, euro, pound sterling, Japanese yen and Chinese yuan. And each currency has a different weighting, depending on how big a role the currency has in international trade.
Given the dominance of ‘king dollar’, it’s no surprise to learn that the US dollar accounts for 41.73% of the value of SDRs.
Now, SDRs may draw their value from these currencies, but they are essentially backed by nothing.
Yet, their presence in the global marketplace is growing.
Up until 2008, only 34 billion SDRs had been issued to the world.
That all changed during the market crash in 2007.
When the financial panic ripped through the markets, the IMF stepped in. From 2008 to 2011, some 280 billion in SDR value was issued, or $544 billion in Aussie dollars.
The IMF handed out SDRs — as ‘money’ or a line of credit — as a lifeline to countries at risk of not being able to pay off their international debts.
Basically, the IMF needed to make sure the debtors could pay back their loans. In other words, the flood of SDRs was to prevent a bunch of countries going bankrupt…and keeping the financial system afloat.
Jim has written previously that he believes the gold price selloff we are witnessing is actually about the gold price resetting to its ‘ideal’ value in SDRs…not US dollars.
Today, Jim shows us how gold has neared the bottom in SDR values…and that this is what the gold price needed to rally from here.
Not only that, Jim wraps this up with a chart that shows the divergence between the physical gold price and gold miners.
In the past, few gold mining stocks have fallen significantly lower than the physical price of gold.
Meaning, these beaten-down stocks could be setting up for one heck of a rally.
But does that mean now is the right time to buy into gold stocks?
Elites have set the gold price
Jim Rickards, Strategist
This year has seen a string of developments that threaten market stability, including a market collapse in Turkey with potential for emerging-market contagion.
There is a slowing of the Russian and Chinese economies, partly due to US sanctions and tariffs, increased tension in the South China Sea, no progress on North Korean promises to denuclearise the Korean Peninsula, state failure in Venezuela, a new financial war between the US and Iran, and political turmoil in the UK.
This list goes on.
The point is that if this array of tensions — with worse to come — won’t get gold to higher levels, what will?
While this market risk analysis has some appeal, it ignores the biggest factor of all in driving gold prices lower, not higher. That factor is the strong US dollar.
Gold’s value in ‘world money’
When you express the US dollar price of gold, you are not really looking at the value of gold. You are looking at an exchange rate between two forms of money — the US dollar and gold.
If the US dollar is stronger, the US dollar price of gold will typically be lower.
If the US dollar is weaker, the dollar price of gold will typically be higher. Of course, there’s more to the analysis, but that’s the prime mover.
This US dollar/gold cross-rate dynamic does not always hold.
In a true financial panic, similar to 2008 or worse, it’s possible for gold and the US dollar to move higher at the same time, as investors flee every other asset (euros, yen, yuan, stocks, etc.) and rush
to the two stalwarts, gold and the US dollar.
Similarly, it’s possible to envision a panic scenario in which the US dollar itself became the weak asset class.
In that case, gold would soar and the US dollar would collapse relative to other asset classes such as real estate, fine art, silver and other hard assets.
Markets are not at that stage.
The current scenario is one of fear about emerging markets, and disappointment about continued low interest rates in the UK, Japan and Europe. This makes US dollars the preferred currency and drives the US dollar higher.
Yet, that trend is not a full-scale panic and not enough to drive the US dollar price of gold higher, side by side with the US dollar. For now, gold is just another asset and its dollar price drops as the dollar itself grows stronger.
What will change this dynamic in favour of gold?
There’s some evidence that the dynamic is already changing.
Gold bounced between US$1,185 and US$1,233 just in the past month alone.
If we measure gold in special drawing rights (SDRs) — the IMF world money that China targets — gold has rallied from SDR863 to SDR885 in the same time period.
It looks like an inflection point has already been reached and a new rally has started.
The force behind this is not hard to discern.
Fed Chairman Jay Powell’s August speech in Jackson Hole, Wyoming gave the markets new reason to question if the Fed really knows what it’s doing (it doesn’t), and revealed that the chance of the Fed taking a pause in its current path of interest rate hikes is greater than the markets had been estimating.
A pause in Fed rate hikes implies lower rates and a weaker US dollar, which translates directly into a higher US dollar price for gold.
Also, the evidence is mounting that the US-China trade war is here to stay — something we warned about months ago — and the impact on global growth may be greater than most economists had expected.
Gold miners ready to spike higher
The result will likely be less tightening of monetary conditions, a weaker US dollar and a higher US dollar price for gold.
Another factor in this trifecta is the surprise announcement that Russia purchased almost 30 tonnes of gold in July.
This is not news to our readers; the Russian gold acquisition program has been going on for 10 years (as I explain in this CNN interview).
What caught analysts’ attention this time was the fact that Russia has now surpassed China as a gold power, according to official data, and Russia is closing in on 2,000 tonnes of gold in its reserves.
Analysts are finally waking up to the geopolitical implications of this Russian gold rush and the market implications for the US dollar.
Considering US and Chinese economic weakness, the potential for slower rate increases from the Fed, a weakening US dollar and continued large gold purchases by Russia and others, the market is set up for new strength in gold.
This trend may be even more apparent in the market for gold mining shares.
Traditionally, gold and gold mining stocks correlate fairly well, with gold miners outperforming gold during rallies due to high fixed costs and scalability in gold mining.
Lately, the opposite has happened, with gold prices (purple line) declining and gold mining shares (blue line) falling even faster, as shown in this chart:
Gold miners fall faster than gold
If gold has begun a turnaround, as the data suggests, gold mining stocks may be in for an even bigger rally.
All the best,