While gold has outperformed all other asset classes in the past ten years, an analysis of our current economic and financial environment indicates that the ongoing increase in precious metals has only just begun and should ensure a sustainably positive environment for gold [and silver, gold and silver shares and warrants in the years to come]. Words: 2095
Dear Mr. Wilson,
I have just released my new benchmark report* on gold which I think is a really high quality read! Feel free to share this report with the public. We’ve got to spread the (golden) word!
Best regards from Vienna. Your regular reader,
Ronald-Peter Stöferle, CMT, Erste Group Bank AG, Vienna, Austria
As editor of www.FinancialArticleSummariesToday.com I am following through on Stöferle’s request and present below further reformatted and edited [...] excerpts from his 71 page report* for the sake of clarity and brevity to ensure a fast and easy read. Stöferle goes on to say:
Gold is the seismograph for the financial system’s health
In periods where “black swans” are no singular occurrences but are practically coming in flocks, the status of gold as a safe haven has yet again proven its worth. Gold is the money that has won the favour of the free market over the past millennia. Gold has always been a seismograph for the health of the financial and monetary system, as well as inflation.
Gold remonetisation has started
Gold is an excellent measure of the quality of paper money. It contains no liquidity risk, and it is globally accepted and traded around the clock. There is also no credit risk associated with gold, and gold cannot turn worthless.
The economy develops in cycles. In times of prosperity and growth, confidence surges, and so does the risk appetite. In such periods, the need for safety is relegated to the sidelines. This behaviour is currently undergoing a radical turn-around, and we believe that the remonetisation of gold has now finally begun.
Gold is not in a bubble
The statement that gold is “a bubble” has cropped up many times. We wholeheartedly reject this contention and will give you a number of reasons on the following pages as to why the parabolic phase is still ahead of us.
There are those who claim that gold is a bad investment which would surely be a sound argument for anyone who bought gold at its cyclical high in 1980 but the most explosive increase only lasted three months (through the end of 1979 to the beginning of 1980). The story changes once we compare gold to equities, however. It took the Dow Jones index until 1954 to pass its 1929 highs; the Nikkei index is still more than 75% below its all-time high of 1989. The Dow Jones has increased by a cumulated 1,400% since 1971, whereas gold (not being fixed anymore from 1971 onwards) has soared by a factor of 40.
Gold as perfect portfolio insurance
Gold is often portrayed as the investment of doomsday prophets, pessimists, and fear mongers who are hoping for the collapse of the financial system. However, they tend to forget that gold is an excellent portfolio insurance with a history dating back thousands of years. Nobody taking out fire insurance would wish for their house to burn down. The goal is only to protect oneself against the negative consequences, and in doing so, one pays a premium. However, it is crucial to hold the insurance policy before the actual damage occurs. As the saying goes “hope for the best, but prepare for the worst”.
Gold is an excellent “event hedge”
The fact that on 40% of the weakest days of the S&P 500, gold not only outperformed the market in relative terms but also recorded the best performance in absolute figures, illustrates that gold is an excellent “event hedge”.
Gold is being bought in net quantities by central banks
In 2009 we saw a paradigm shift with the central banks turning into net buyers for the first time in 20 years, even though gold had been repeatedly called “too expensive”. The Indian and the Chinese central bank were seen on the buying side yet again, while the Central Bank Gold Agreement (CBGA) hardly reported any sales. We think that this structural shift heralds a new phase of the bull market.
Gold’s long-term target price is USD 2,300
The gold price has de-coupled from the U.S. dollar and this latest development shows that a stronger greenback does not necessarily entail a weaker gold price. In spite of the recent dollar rally the gold price has remained high and even set a new all-time high. This is even more remarkable in view of the weak seasonality, and might suggest a new phase in the current bull market. Bull markets in gold are also characterised by two extremely strong human emotions: fear and greed. The combination of these two factors should trigger a parabolic increase in the last phase of this trend, and as a result we expect the gold price to reach our long-term target price of USD 2,300 at the end of the cycle.
Positive environment for gold likely in the coming years
Three years ago nobody would have expected the Federal Reserve to take USD 1,250bn worth of mortgage-backed securities (MBS) on to its balance sheet. This most certainly was not beneficial to building confidence in paper money – and neither are the countless desperate stimulus and bailout packages of the past few years. On the other hand this represents a clear argument in favour of gold and should thus ensure a positive environment for gold investments.
The “Long Term Budget Outlook“ of the CBO (http://www.cbo.gov/ftpdocs/102xx/doc10297/06-25-LTBO.pdf) paints a bleak picture. The report for the period of 2010 to 2080 starts with the words “Under current law, the federal budget is on an unsustainable path – meaning that federal debt will continue to grow much faster than the economy over the long run…” According to the report the USA will not be able to produce a budget surplus in the next 70 years.
In spite of the fact that the limelight is on Greece and the other PIGS countries, the situation in the USA (and the UK) is just as precarious. We cannot see any austerity measures in the USA. In August 2009 the forecast for the new debt of the coming decade was revised upwards from USD 7 trillion to 9 trillion. From May 2009 to April 2010 debt increased by USD 1,710bn or 11.7% in terms of GDP. Currently US government debt amounts to USD 13 trillion, which equals USD 42,000 per capita.
A vicious cycle of debt is being set off
If it is impossible to generate a surplus even in prosperous times, clearly the problems are of a systemic nature. Due to compound interest, debt grows exponentially, which causes massive problems in the long run. As soon as debt plus interest is growing faster than revenues, a vicious circle of debt is set off.
The USA is expected to issue more Treasury bonds this year (20100 than the rest of the world combined. The balance sheet of the Federal Reserve has deteriorated dramatically as well. Between December 2008 and March 2009 it purchased fixed rate securities worth USD 1,700bn, or almost 12% in terms of GDP. The majority (USD 1,250bn) was made up by mortgage-backed securities of highly dubious value.
Debt deleveraging usually takes 6 – 8 years
A McKinsey & Company report entitled, “Debt and deleveraging: The global credit bubble and it’s economic consequences”, (January 2010) analysed 45 deleveraging phases since 1930 and in 50% of the cases the debt was paid off through a stepped-up savings ratio – which lead to deflation almost every time. The growth path (i.e. continued spending) was undertaken three times but typically involved war. On average the payoff would commence two years after the onset of the financial crisis and last six to eight years according to the study. From 1929 to 1933, i.e. in the thick of the Great Depression, the private household debt fell by 32%. As a result of the reduction of private debt, the public sector had to step up its debt so as to offset the lack in demand. Thanks to these measures, the economic growth rates was positive, but clearly below the potential.
Gold is the optimal investment both in deflation and inflation
The central question of whether the next few years will be dominated by inflation or deflation, however, still remains unanswered. In periods of inflation, tangible assets are the preferred asset class, whereas in times of deflation, cash is king. Gold is liquid, divisible, indestructible, and can be easily transported. It has a worldwide market and there is no default risk associated with it, which means it is cash of the highest quality. Therefore gold is the optimal investment both in deflation and inflation. To be precise, gold shows a positive performance in 8 of the 10 deciles showing a clear outperformance in the 7th, 9th, and 10th decile of the CPI development albeit showing weaker returns during times of low inflation.
Higher inflation is the most feasible remedy
Nowadays there are a substantial number of experts who regard the concept of inflating the economy as the only possible solution to the excessive level of debt. Kenneth Rogoff, former chief economist of the IMF was already quoted at the end of 2008/9 in the Central Banking Journal as claiming that a higher but controlled rate of inflation of 5-6% over the next couple of years was healthier than a deflation of 2-3%.
Exceptional times require exceptional measures, according to Rogoff. He believes that otherwise taxes would have to be raised by 30-50% in the USA, which is illusory and, as such, inflation is the only feasible “exit strategy”. His successor, chief economist Olivier Blanchard, recommended to the central banks that they should accept rates of inflation of up to 4% instead of 2% in the future. This is particularly remarkable seeing as the IMF would traditionally consider monetary stability as no.1 priority.
Gold price correlates very strongly with inflation
Although the inflation rate is currently on its way down, this is not the least due to the statistical base effect. The gold price correlates very strongly with inflation as soon as the latter hits extreme values.
- From 1971 to 2009 the monthly correlation coefficient of gold and the inflation rate was 0.48.
- In the period of high inflation from 1978 to 1982 it soared to 0.76. When the rate of inflation in the USA and Europe soared to new highs at the end of the 1970s, so did the gold price.
We know a similar situation from history, i.e. from WWI and the Weimar Republic. From 1914 to 1918, the German money supply soared from 8.5bn to 55bn Reichsmark, which paved the way for hyperinflation of historic dimensions. In January 1919 one ounce of gold would have set you back by 170 Mark, whereas by November 1923 the price had shot up to 87 trillion Mark. An important feature of high inflation is the rapid loss of trust in the own currency.
Gold is an excellent hedge in periods of deflation
In times of pronounced deflation public budgets are strained, the financial sector is faced with systemic problems, currencies are depreciated in order to reflate the system, and the money supply is continuously rising. The credit worthiness of companies and countries is queried, the confidence in paper currencies falls, and gold is subjected to remonetisation.
Gold shares perform well during inflationary periods
However, the most significant share price increases happened only after the deflationary period (1929-1932) and at the sudden onset of inflation 1932-1935. [For example, the shares of Homestake Mining went up 737% from their 1929 low (during deflationary times) to their high in 1936 (at the height of inflation) while those of Dome went up from $6 to $61.25 during the same period of time. Source: Ian Gordon, Longwave Group] We can well imagine a similar scenario for the foreseeable future.
Taking into account the fear of deflation and numerous texts and speeches by Ben Bernanke (e.g. “Deflation: Making Sure “It” Doesn’t Happen Here”), we believe that further interventions by the Federal Reserve are likely. The natural shakeout during a deflationary recession will probably be fended off at all costs.
The groundwork is being set for major gains as the above scenario depicts and this should ensure a sustainably positive environment for gold [and silver, gold and silver shares and the warrants associated with gold and silver companies in the years to come].
- The above article consists of reformatted edited excerpts from the original for the sake of brevity, clarity and to ensure a fast and easy read. The author’s views and conclusions are unaltered.
- Permission to reprint in whole or in part is gladly granted, provided full credit is given.
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