Prediction 4 – Gold Heads Towards $3,000 an ounce
Some years ago, I noted that the price of production of gold was around $1200 an ounce. Significant movements of its market price, are a function of a number of factors. Firstly, gold is a speculative asset. The rise in its price to $2,000, about 50% above its price of production, was an illustration of speculative demand, as a hedge against a number of other factors. To an extent, it amounted only to a process of mean reversion, counteracting the long period before 1999, when its market price was below the price of production. As I've pointed out before, given this nature of gold as an asset, and even as a commodity that is not consumed – every bit of gold ever mined is still in existence – this means that its supply is never determined solely by new production, but also by the extent that existing owners of gold, in its many forms, are prepared to sell it.
Speculative demand for gold is driven by concerns to hedge against inflation, or to provide a safe haven in turbulent times. With currencies being destroyed at a rapid pace as a result of QE, it might have been thought that this would have been perfect conditions for the speculative demand for gold to increase. However, the money printing has been of a specific kind not seen before in history on such a scale. In previous times, money printing has been undertaken to monetise the debts of governments, and has gone to pay for spending. In the last thirty years, and particularly the last twenty years, and even more particularly the last ten years, the money printing went to directly finance the purchase of financial and property assets.
Gold, as with other assets such as art, wine, classic cars, vinyl records and so on, benefited from that, as did Bitcoin and other cryptocurrencies. But, these are not liquid markets in the same way as are the bond and equity markets. Moreover, it has been the bond market that the central banks have directly stood behind, pushing up prices so as to provide significant, capital gains for speculators. So, all of the money printing went to boost those financial and property assets far more than gold. Only when those assets have looked vulnerable, as in March last year, has gold resurged, but then as soon as central banks stepped in to inflate those asset prices, gold fell back.
In addition, all of the money printing has not led to inflation for the simple reason that the money was directed into the purchase of financial assets and property, and not into financing consumption. On the contrary, by fuelling speculative bubbles, the money printing drove money out of general circulation, and into these asset markets, in the process, thereby, alongside measures of austerity, acting to depress economic growth, and creating disinflationary and even deflationary pressures. A look at the way stock markets have risen is an indication of that. But also, in the latter part of last year, asking prices for houses also rose sharply, egged on by government polices removing stamp duty. All that, despite the fact that lockdowns have created economic chaos, and are likely to lead to widespread unemployment, means that many of those that have gone into debt now, will find themselves homeless, when a combination of unemployment and rising interest rates makes it impossible for them to pay their mortgage, at the same time as the price of their house crashes.
But, those same lockdowns, and the response to them of governments everywhere, by going into astronomical amounts of debt, reverses the situation prevalent in the last thirty years. Over the previous period, austerity restricted debt issuance. Similarly, companies used profits, or borrowed in bond markets, so as to buy back shares, and inflate their prices. Houses sold by homeowners, as rates of owner-occupation tumbled, were bought at inflated prices by Buy-To- Let landlords, and syndicates bought up property, not even to rent, but simply to obtain capital gains. The supply of debt instruments was constrained, whilst the demand for debt instruments was inflated, causing asset price bubbles to inflate incessantly. Now, governments must issue debt on a vast scale to cover their spending to cover furlough schemes, loss of tax revenues, increases in benefits, not to mention the trillions of Dollars of spending they will have to undertake to bail-out of large numbers of big core and strategic industries, laid low by the effects of lock downs. At the same time, those big companies themselves are engaging in large-scale borrowing. They are now issuing shares in rights issues at a third of the current market price of existing shares.
Households have been kept afloat during lockdowns via furlough schemes, and because governments have persuaded landlords and mortgage providers to give payments holidays. They have persuaded banks to make loans to small businesses backed by government guarantees, but which the banks themselves expect to see default. And, as all these schemes end, households and businesses will be faced with making good the debts incurred in the intervening period. They will have to do so, just as many of them face redundancy, and unemployment. Whether it is the government, large businesses, small businesses or households, borrowing and debt is set to soar way above current levels that are already at astronomically high levels. Defaults on debt alone are likely to cause interest rates to rise, but it is the large scale government and corporate borrowing that is going to be most notable in causing asset prices to fall and interest rates to rise.
All of the liquidity that has been pumped into the system, now in conditions where asset prices are crashing, is going to lead to it flooding into general circulation. Much of it, now, has already been pushed in that direction. The borrowing has been directly to fund expenditure, not to finance speculation. Already, lockdown adjusted price indices are showing inflation rising sharply. And, this is significant in relation to gold.
A certain anchor for the gold price must always be the price of production, because if its market price rises substantially, additional production can always be undertaken. The price of production is not currently much above the $1200 an ounce referred to previously. The reason for that is simple. Price of production is cost of production plus average profit. Advances in technology and so productivity act to reduce the cost of production, but in nominal terms, it rises as a result of commodity price inflation. In other words, the cost of production is made up of things such as the wear and tear on all the fixed capital used in mining, as well as the auxiliary materials used, including things like energy costs, and it comprises wage costs. Because, for the reasons set out earlier, commodity price inflation has been constrained, there has been no large increase in the cost of production for gold, so also its price of production has not changed much either.
But, precisely because those conditions have now changed, we are going to see the cost of production of gold, as with other commodities rise. As all of the liquidity pumped into circulation to fund consumption begins to slosh around the global economy, it will fuel inflation. The money prices of machinery, energy, and all of the wage goods bought by workers will rise significantly. There will be an inflation of the cost of production of gold, as with other commodities, and so the price of production of gold will rise too.
In the fourth long wave cycle the price of gold, relative to other commodities, peaked in 1961, about the point at which the Spring Phase of the Cycle turned into the Summer Phase. However, the Dollar price of gold peaked in 1980, having gone from its fixed price of $30 an ounce to $800 an ounce. This latter price move was due entirely to inflation, to the destruction of the value of the Dollar and other currencies. The Spring Phase of the fifth long wave cycle began in 1999. If it had lasted the average for such phases, it would have ended around 2012. However, the 2008 financial crisis, and the actions of states following it, have put it into hibernation. Nevertheless, the gold price moved from $250 in 1999, to just under $2000 in 2011. The big inflation induced rise in the price of gold occurred between 1971 to 1980, i.e. ten years after its peak against other commodities.
We might expect to see a similar thing now. Certainly, we have all the ingredients with an unprecedented amount of liquidity already in circulation, and more planned by every central bank, ready to fuel unproductive consumption and cause inflation to spike higher. We have global trade wars, and currency wars, with a financial crash set to upend global financial and currency systems, much as happened in the 1970's, when Nixon closed the Gold Window, and ended Dollar convertibility to gold, sparking a period of global currency crisis. So, as inflation rises, due to liquidity being pumped now into funding unproductive consumption, that will directly increase the cost of production of gold, and its price of production. In addition, the crash in asset price bubbles, will provide an incentive for speculators, and those seeking a safe haven in a stable store of value to buy gold, creating a new speculative demand.
The combination of a 20% increase in the price of production, plus additional speculative demand, is likely to see gold break sustainably above $2,000 an ounce, and march upwards towards $3,000.
No comments:
Post a Comment