The Bigger Picture View Beyond The Headlines

Perfect article to sum up the psychological state of the gold market this month from The Atlantic titled, "Gold Was A Horrible Investment From 1500 To 1965." The article goes on to list all the standard reasons why gold should never rise in price: it does not have any earnings, it does not pay dividends, and it costs money to store. The article finishes with two simple worlds using an exclamation point to bring home the point:

"Sell Gold!"

I'm sure I do not need to review this for most of the readers of this site, but there is one very simple reason why gold was a terrible investment during this period: the world was on a gold standard between 1500 and 1965. 

If you know that the paper money that you own can be redeemed for gold then there is no reason to own gold. I definitely wouldn't. From 1500 to 1965 when governments decided to spend more money than they brought in and ran an account deficit with foreign countries, it was ultimately settled with the removal of gold from the debtor country. If the country ran out of gold, they could no longer borrow. Then they would have to re-balance their budget, clamp down, and begin to run a surplus while the foreign country could now enjoy the fruits of their former surplus with additional spending.

In 1971, as gold began to flood rapidly out of the United States due to foreign entities concern that the U.S. could not repay what it has borrowed, the link was broken by Richard Nixon who announced the U.S. would pay only with paper I.O.U.'s. Currencies were no longer backed by gold, but by the trust that the governments would never run deficits too large or print too much money.

I don't need to finish the story on how it played out over the ensuing 4 decades to reach the point where we are today. Governments now run annual trillion dollar plus deficits financed 100% with printed money. The trust today is a legacy psychological state that has the ability to vanish overnight (see U.S. and Japanese government bonds violent sell off during 2013).

If the United States were to go back on a gold standard then I would sell my gold and hold cash. To do this they would just need to revalue the price of gold to account for the new money that has been created since 1971 (otherwise they would face an immediate deflationary crash). Depending on which monetary measure you use, the estimates for this gold per ounce revaluation range between $7,000 an ounce of gold to $57,000 an ounce of gold.

Whether the United States decides to do this first has little relevance. As investors panic around the world and dump paper gold, China is accumulating massive physical tonnes at an incredible rate. Estimates show that during the sell-off last week, China purchased 580 tonnes of gold; an amount equal to to 25% of annual global production; in one week.

As they prepare their currency reserves to have the necessary gold backing, China continues to set up currency exchange systems with trading partners around the world that bypass the use of the U.S. dollar. They continue to accumulate natural resource producers in countries around the world. It is a slow and steady process. The United States thinks about keeping the people happy to get through the next 2 year election. China is working on a strategy to be the largest economic player in the world by 2030.

This current monetary policy that began in 1971 is coming to its grand finale, and it will end in chaos. Central banks, currently considered god-like in their power, will lose control of the markets which dwarf them in size. Right now it appears that they have control but it is just an illusion. Markets had their first taste of this over the past few weeks, which is only a preview of what is to come.