The True Value of Gold (Part 1)

Most countries in the world have today adopted a paper currency fiat system that we all recognise. Issued by government decree, they are non-convertible forms of payment that are not linked to any underlying value or standard. The continued use of these paper systems relies on a perception of confidence in the value of the particular fiat currency. Historically that confidence would have taken the form of a ‘pegging’ to gold, commonly known as a gold standard.

The application of the gold standard not only had the effect of reinforcing a global fixed rate of exchange for international trade and commerce but more importantly, restricted the ability of governments to print a limitless quantity of paper currency.

The below chart is a snapshot of the growth of the US base money over the last decade vs. the annual supply of new gold produced through mining, scraping / recycling.

Chart 1.1

Source – (1) Federal Reserve Economic Data, St. Louis Adjusted Monetary Base, Billions of Dollars, (2) GFMS Thomson Reuters Gold Survey 2017, (3) ycharts.

(Monetary base is the total amount of a currency that is either circulated in the hands of the public or in the commercial bank deposits held in the central bank’s reserves. This measure of the money supply typically only includes the most liquid currencies; it is also known as the “money base.” – Investopedia)

The acceleration of the printing of money and debt creation by the US Federal Reserve post the global financial crisis (GFC) of 2007/8 is strikingly obvious. This policy not only erodes the core principal of money as a stable medium of exchange, it also has the effect of devaluing the every-day purchasing power of the dollar (refer to Chart 1.2), planting the future seeds of an inflationary time bomb.

Chart 1.2

Source – (1) U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: Purchasing Power of the Consumer Dollar, retrieved from FRED, Federal Reserve Bank of St. Louis, (2) World Gold Council

Gold throughout this period maintained its consistent yearly supply creation, rarely exceeding the 4-tonne mark YoY. The very nature of gold dictates that a finite amount will be available to market, regardless of the demand. A limited and controlled output that both contributes to price discovery as well as maintaining a fundamental level of support.

Considering the above, the prospect of investing in assets to generate fiat based income returns is far from a risk-free proposition, regardless of how diversified your investment portfolio appears.

Here is where the gold doubting friends of ours will usually be chomping at the bit to say, “If gold is priced in dollars then it also has no underlying value”, and to a certain extent that is true. Gold is indeed priced in US dollars and does not generate a yield or a projectable rate of return.

So how do we measure the value of gold and square this to its market USD spot price?

One way to do this is by looking at the relative or fundamental value to attempt to derive gold’s value vs. the perception of confidence. The gold price has been described as the ultimate domestic and geopolitical barometer. Price performance is intrinsically linked to the health of the economy, the actions of those issuing currency and making laws. It is a physical representation, the heartbeat if you will of the ongoing belief (or lack thereof) in the prevailing system.

Take any of the major geopolitical events of the last few decades, and there have been too many to mention. When the prevailing system is remotely tested as a result of a game changing event (war, threat of conflict, financial instability etc.) you will undoubtable see a retreat to gold as the global safe haven.

In our next blog in the series we will be delving deeper into some of those game changing market events. From historical black swans to the recent Trump-trend, we’ll examine how precious metals performed in times of high volatility.

As always, please feel free to reach out to us to discuss anything touched on in the above. You can contact Guardian Gold’s in-house analyst, Patrick O’Connor on +61 2 9283 5570 or patrick@guardianvaults.com.au

 

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