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The Case for Gold in 2022

Gold’s descent to US$1675 represents a year-to-date performance of – 7%. The short term opportunity is a potential bounce in the gold price as a range…

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This article was originally published by Midas Letter

Gold’s descent to US$1675 represents a year-to-date performance of – 7%. The short term opportunity is a potential bounce in the gold price as a range of geopolitical forces converge to undermine confidence in US dollar-denominated assets.

All this in spite of the US dollar reaching new 20-year highs in the last week.

This might be regarded as a contrarian perspective since traditionally, gold is not expected to perform well in a rising interest rate environment. The logic here is that safe haven assets like government bonds pay a better yield as opposed to gold in such conditions.

But conventional wisdom is no longer applicable in the face of certain emerging geo political and economic realities. Increasing volatility in US-denominated assets and the concern with the gargantuan debasement of the US dollar by the Fed since 2008 are, or should be, foremost among considerations by long term wealth preservation-minded investors.

But significantly for the conventional wisdom, there has been significant erosion of the US dollar share of global foreign reserves, which equates to a reduction in demand for US debt.

Data strongly support the notion that the US dollar’s period of supremacy in global trade may have passed its nadir quite some time ago.

In 2019, the US dollar made up over 60% of all global foreign reserves. But by 2021, that number had fallen to 58%. The total drop in representation of US dollars since the launch of the Euro in 1999 is actually 27%.

Demand for dollars by central banks

When looking for a safe place to store value, you want something that will retain its value in the face of any imaginable calamity. Short of a meteor destroying life on earth as we know it, gold does not need a market to retain its value. There are no historically verifiable reasons for gold to deteriorate in value.

It only becomes more scarce as the mineable depth of the Earth’s crust is depleted. As the grade at which gold can be reached using modern exploration and production methods decreases, the cost of mining an ounce of gold rises.

This is the fundamental difference between a fiat currency – pegged to nothing, and limited only by the restraint or lack thereof by the central bankers who control its proliferation – and gold.

You simply cannot make more gold. And with the mineable inventory decreasing incrementally over time, its value – though not necessarily its price – rises commensurately.

The Fed is an unreliable source

Can we ever forget that the Fed, back in October 2021, stated that the breakout inflation that had appeared in the CPI was “transitory”?

One year later, is it still transitory? Or is it entrenched?

Or who can forget the multiple instances from 2014 – 2016 where the Fed indicated they were going to dial back on stimulus/quantitative easing only to cancel it in response to stock market swooning on the news?

And what of the “redefinition” of the word “recession” stating that it no longer constituted two consecutive quarters of negative GDP growth?

If that’s not Orwellian doublespeak at its finest, I can’t think of a better example.

With such a track record of misleading statements and poor communication, to what extent should we rely on their telegraphing that they will bring inflation under control through aggressive rate hikes.

While we have seen rates raised, it is hardly at a pace that could be considered “aggressive”.

We are not even close to the 18% they reached in the ’80s when inflation reached 15%.

Inflation rate since 1929 in the United States touched 15% in 1980 but was 20% in the late 40’s after the world war.
Inflation rate since 1929 in the United States touched 15% in 1980 but was 20% in the late 40’s after the world war.

Is that where we’re headed?

With declining faith in the US dollar globally, rising inflation and recession impacting stock markets negatively, how long do you think it will be before the Fed reverses course, cuts interest rates, and cranks up the printing presses again?

My bet is that their interest is more aligned with the investor than the consumer.

Federal Debt: Total Public Debt as Percent of Gross Domestic Product

If the Fed does start printing with abandon before the balance sheet has been substantially reduced, the US dollar will likely reach a point where it tanks and sovereign banks start dumping it in favour of gold, such is already happening in places like Russia, Turkey and the Middle East.

Gold Price Dynamics vs Value

The price of gold is most frequently expressed in US dollars. What the US dollar mandarins of the Federal Reserve have realized is that in order to continue the public perception that US dollar bonds are safer than any other reserve asset, they must continue to increase the global inventory of US dollars so that it will always take more of them to calculate the value of any compared asset.

So while the volume of the currency increases exponentially, the volume of gold only increases incrementally. Thus, it appears as though the price of gold is not performing.

My Personal Gold Experience

Let me give you an example of gold’s function as a store of value.

In 2014, I began buying physical gold in the form of 1 ounce wafers from various banks. I used the cash profits from various stock market investments, and in 2019, I cashed in the gold so that I could acquire my current farm for cash.

Not only did I profit from the rising price of gold, which delivered a 25% appreciation in that period, but I was able to buy a piece of food-producing real estate with it that left me mortgage-free. The real estate has doubled in value since I bought it. (Though this is largely from improvements more so than market pricing).

You could argue that I missed out on much upside in the NASDAQ in that period. And while this is true, not having money in the stock market is not having “value at risk”.

US bonds and their yields are often described as a “risk-free rate of return”. But if you consider that the debt to GDP ratio of the United States is now consistently above 120%, how likely is it that the US debt load can realistically be paid?

Especially with the adversarial stance toward China, who holds one third of all foreign owned US Treasuries?

What’s to stop China from dumping its hoard of over a $trillion worth US debt onto the market, just ahead if its invasion of Taiwan, as a way to frustrate US efforts to protect Taiwan?

The term “risk-free rate of return” applied to US Treasuries is nothing short of utterly misleading.

And crypto? The only thing that needs to be noted about crypto is that, at the end of the day, it is just a digital fiat currency. The would-be crypto titans are merely the next generation of wanna-be central bankers.

Gold, as we have maintained since 2008, is the only safe haven asset, and the monetary standard by which all currencies, extant and defunct, have been measured for at least 5,000 years.

Original article: The Case for Gold in 2022

©2022 Midas Letter. All Rights Reserved.

interest rates
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