The finite supply gobbledygook is useless when pricing gold over any realistic timeframe. The finite supply argument just doesn’t hold for a physically non-depreciable asset like gold. Gold’s actual usage (ex-investment) is down by almost a fifth since early 90s. The stock of available gold meanwhile has consistently grown over this period (see Exhibit 1a and 1b). Even assuming that non-investment usage decline stabilizes in the foreseen future, availability will likely continue to outstrip usage, independent of new discoveries or lack thereof. Rapidly dwindling supply just isn’t one of the factors that can support gold’s current price.
Exhibit 1a – Global per capita stock of gold
Exhibit 1b – Per-capita non-investment usage of gold vs. Per-capita stock
Source: Internal Analysis & Estimates; World Gold Council
The father of all decouplings in play. Over the last four decades, gold has comfortably outstripped inflation and currencies of dollar’s biggest trade partners. Over this period, gold is up more than a whopping 17x, well ahead of 5.1x and 1.5x increase in price levels and dollar’s chief trade currencies respectively (see Exhibit 2). Even M2 growth hasn’t kept pace with gold – M2 is up slightly over 10x since the early 70s, including a 5% increase over the last twelve months, comfortably underperforming gold.
Exhibit 2 – Gold vs. CPI and USD’s TWER
Source: WGC; Federal Reserve; BLS
It isn’t a “Chindia consumer” effect either. India and Greater China account for just under 40% of global gold demand, about where they were in the early 90s. For all the hype, India’s per-capita consumer gold consumption hasn’t kept pace with underlying economic growth. Realty and stocks are the new flavors. To put things in perspective, RBI’s recent purchase of 200 tonnes from IMF doesn’t even offset the loss of India’s consumer gold demand this decade.
So, what is gold discounting ?
Demise of the dollar ?. Besides death, few things in the world could be certain. The gradual decline in the dollar is as close as it gets. At some point it'll pass it's global reserve currency baton to another liquid currency, just as it acquired it at the turn of the 19th century from the sterling. The perennial rise in the US trade deficit only necessitates the global need to diversify into new currencies, which is exactly what central banks have been doing this decade. But it’s clearly more than priced in an asset that is up by more than 17x since early 70s, while currencies of US’ largest trading partners have appreciated barely 50% against the greenback over the same period.
…..or perhaps an unprecedented sovereign default ?. Both Greece and Ireland are ticking sovereign debt time bombs (see Exhibit 3). What is surprising however is the magnitude of the after effect that is apparently being priced into gold. It appears that the gold bugs might be working on the hypothesis that central banks will dump Euros in the event of a sovereign EU default and aggressively buy gold - Since most of gold stock is tied in jewelry and central banks hold just about half as much in gold as they do in Euros, Gold has no way to move but up. In my opinion, given underlying liquidity and re-investment challenges, dollar will likely be the prime beneficiary of any weakness in the Euro arising from a prominent EU default, neutralizing the impact from the advertised “rush” into gold, which will nonetheless occur to some extent.
Exhibit 3 – Euro-denominated sovereign debt within euro-transacting economies
Source: IMF; Fitch Ratings
……or maybe a new-found wedlock with central banks. The simplest argument in gold's favor is the growing chorus among certain big emerging market central banks to accelerate their ongoing diversification process. In that context, it's worth noting that emerging market central banks often rush into gold during sluggish growth periods before slowing their purchases down in recovery years. Further, while their aggressive buying may have previously supported strong appreciation in gold, their investment record is suspect, at best - Gold price virtually stagnated for more than a decade following 1988, which incidentally was the biggest year for gold purchases by central banks in almost three decades (see Exhibit 4).
Exhibit 4 – Net central bank gold purchases vs. gold price
Source: GFMS
At these giddying levels, one can’t be blamed for trying to factor in anything and everything to justify the price of gold. Potential payoff in an extreme case however, is unlikely to nearly compensate you for the price you are paying up front. By now, gold bugs are used to such profound levels of malarkey that I suspect that events can unfold in a way that can justify the asset's glittering price tag.
Appendix - Valuation snapshot for global gold miners
Source: Bloomberg; Company Reports
DISCLAIMER: The information, opinions, estimates and projections contained in this post were prepared by me and constitute my current judgment. The information contained herein is believed to be reliable and has been obtained from sources believed to be reliable, but I make no representation or warranty, either expressed or implied, as to the accuracy, completeness or reliability of such information. I do not undertake, and have no duty, to advise you as to any information that comes to my attention after the date of this post or any changes in my opinion, estimates or projections. No part of this post can be reproduced without permission, unless reproduced with due credit provided for the source. Investment research is provided for information purposes only and does not constitute investment advice or an offer or solicitation to buy or sell any designated investments discussed herein. Please discuss with your investment advisor before investing.
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