There is still time to get tickets to join us at the Gold Symposium (Mon and Tues, 22 – 23 October 0212) and The AEF conference: “The Rational Environmentalist” which David is also speaking at, and I’m attending on Saturday (20 October 2012) this weekend.
Guest post Dr David Evans
The reasons for the gold price to increase are intensifying, not going away.
This is the end-game of the world’s deepest and broadest bubble ever, which began in 1982. In a very real and literal sense, modern money is debt — it’s an IOU you can trade for something you value. So the ratio of all the debt in society to GDP measures the amount of money.
The critical debt-to-GDP ratio is normally around 150%. There have been two significant excursions above this value. The first was in the 1920’s, where it reached 196% in 1929 at the onset of the Great Depression (the GDP crashed harder than the money supply, sending the ratio even higher for a while). The other is since 1982, where it reached 230% by 1987 when we also had a stock market crash. Rather than do nothing like the central banks in 1929, the central banks in 1987 made cheap loans widely available, so there was no shortage of money. The bubble powered on, assisted by changes in banking rules to make money manufacture ever easier, and had soared to 375% in the US in 2008 when the GFC hit. It is now around 350% in the US – in Europe it’s even worse, around 450%. It’s global, so there is no unaffected party with which to trade our way out.
Central banks learned from the Great Depression not to let the money supply decrease. But debt/bank-money/credit creation in the private sector faltered in 2008, due to a lack of ability to pay more interest and due to a lack of unencumbered collateral. This pricked the bubble, and it’s been falling (deleveraging) since. Governments stepped in to keep the money supply up, mistaking the bubble conditions of the previous two decades for “normal”. After four years, governments are increasingly losing their ability to borrow, so are having to resort to the last option—printing new base money directly.
This is the post-bubble normal. Whenever it comes to the crunch, governments and their central banks print: QE1, QE2, QE3, LTRO, OTM, etc. Everyone talks about austerity and deflation, but in a democracy there is no option: there are many borrowers and few lenders, too many votes to buy, and powerful corporates have debt which they would prefer to repay in smaller future dollars. Basically, most of the electorate at this stage thinks it would prefer debt-default via inflation.
Yes, governments today don’t literally print money. Nowadays they type in a number into an account at the central bank (technically they must buy something in doing so — this is called “monetization” — so the size of the central bank’s balance sheet is the amount of base money). The root cause of the bubble was over-manufacture of money by central and commercial banks, because these folk have the ability to create money out of nothing. No matter what the safeguards, that power is always eventually abused.
Gold, on the other hand, is the old currency. It evolved in the marketplace as the preferred money over the last 5,000 years, before the rise of big government. It is honest, because you have to earn it before you can spend it — you cannot just print some up when required. Even digging it out of the ground in the first place costs almost much as it’s worth.
Some people say gold is in a bubble. After all, it’s been going up at 20% pa for 10 years now. However for each of the last 11 years the major financial houses have been predicting the gold price will decrease by 10% over the upcoming year, while still not being able to spot all the real bubbles happening at the time. Uh huh. By chance alone you would expect them to get half their gold predictions right, which suggests there might be vested interests at work. (Banks create paper currency, bank money. Gold is a competitor.)
Gold basically goes up forever against paper currency, simply because paper debases much faster than gold. Due to mining, the amount of above-ground gold increases by about 1.7% each year. Western paper currencies debased at 10 – 25% from 1982 to 2007, and at 5 – 15% pa since then. The differential in debasement rate puts an underlying ~10%+ per year under the gold price as expressed in paper currency, and on top of that there is a catch up for the 1980 – 2001 gold price falls, and a fear of the inflationary collapse of paper currency to factor in. (There have been hundreds of paper currencies over the years, and all except the current crop have failed in default or inflation, usually after one to two generations. The current paper currencies technically stopped using gold as their base currency in 1971, when Nixon closed the gold window, so are now 41 years old.)
Today, globally, there is around 210 trillion USD of debt, but only 150 trillion USD of assets. The banking crisis won’t end until that asset figure climbs above the debts, which gives the central banks another huge incentive to print. The value of all the gold ever mined is just under 10 trillion USD, so obviously if gold ever re-enters the money system in any meaningful way its value has to climb prodigiously.
Gold is literally useless (at least, at the prices that follow from it’s use as a medium of exchange), so it does no harm to the real economy if it goes up or down in value. One day the central banks may even encourage its value to soar, while simultaneously selling their gold to the public, in order to soak up their newly printed money they are dropping into society like confetti (so as to prevent inflation from climbing as high as it otherwise would due to their printing).
Why Gold in the Ground?
If you own physical gold you have a security problem. It costs money to store, and there are trust issues. According to industry expert Jeff Christian of CPM Group, the London “physical market” is leveraged up by a factor of 100: for every ounce of physical gold in London, there are 100 owners out there with a piece of paper to say they own it. It’s a fractional reserve system with a historically unsustainable reserve fraction.
Another way to own gold is to own shares in resource companies that have gold in their mining leases. By buying their shares you own a fraction of the company, and a share of their rights to the gold in the ground. It’s like a long dated option on the gold, because the company has the option of digging it up. It also has decreasing time value, because the company must spend money on exploration or mining to keep the leases alive, and will chew up money in administration. This applies to both mining companies producing gold right now, and to exploration companies that have just have a resource.
This is a convenient way to own gold. Buying and selling shares on the stock exchange is easy and instant, you get a secure paper trail, and you can borrow money against your assets. The gold itself is not completely secure because of company and country risk, but you can mitigate this by diversifying within the sector across several companies and you can choose companies with deposits in countries you prefer.
The big advantage of gold in the ground is the leverage. You can own a lot more gold this way. Most of the cost of producing gold is in the mining, typically $1,200 per ounce (including ongoing capex and administration), so the cost while in the ground is necessarily a lot lower. For gold with a good solid Australian mining operation, you typically pay $150 – $200 per resource ounce, while for gold in an undeveloped deposit you might pay $20 per ounce.
For example, $10,000 buys you about six ounces of gold over the counter, then you have to store it—and if the gold price doubles you make 100%. But by buying the mining company whose gold is $150 per ounce in the ground, you own about 60 ounces of gold—and if the price of gold doubles you might make around 500% (if the price doubled from $1,600 and total mining costs were $1,200, the profit margin moves from $400 to $2,000).
The world’s investors have been fearing deflation since the GFC. This is logical, because without government printing the bubble of debt would collapse as it did in the 1930s. As a result, investors have bid up the prices of deflationary plays, but inflationary plays like gold companies are unpopular. Right now, gold stocks globally are historically cheap compared to the price of gold.
As people increasingly realize that governments will print and that inflation is the real danger, the situation will reverse—the price of inflationary plays like gold will be bid up and the deflation plays will suffer. Predicting when the herd will move is tricky, but very profitable when you get it right.
Cheap Gold on the Australian Stock Exchange (ASX)
There is wide variation in the cost of gold-in-the-ground. The market is somewhat inefficient in this respect, because most gold mining companies are smallish and not well analyzed, but also because investors have been more concerned with cashflow since the GFC, focusing on the value of production rather than on the value of their gold assets.
In 2007 my wife (Jo Nova) and I found it difficult to get in-ground costs for more than a few companies, and impossible to get in-ground costs across the sector. We wanted this information for our own investing, so we started collecting it. We soon found that gathering the basic share structure, financial, resource, and mining information on the 240+ gold companies, and keeping it all accurate and up to date, was too big a task for one or two people.
So we started GoldNerds, a small company that sells information about the gold companies listed on the ASX, to investors, in sophisticated Microsoft Excel spreadsheets. With a team of a dozen part-time researchers, we update our spreadsheet every two weeks. Each spreadsheet shows every gold company, one per line, so the companies are easy to browse, sort, filter, and compare—the sort of things that investors want to do. While GoldNerds has many parameters, it was the cost of gold in the ground that started us off.
On the ASX, you can buy gold in Australian deposits with mining operations for as little as $8 per resource ounce. In one case you can even buy it for less than negative $100 per ounce (this company has more cash and bullion than its market capitalization, a solid, profitable, and relatively trouble-free mining operation, but no one seems to know about it). Or explorers with viable deposits at $2 per ounce.
Or you can pay a $165 per resource ounce for Newcrest, or $200 – $300 for some producers. The Chinese are currently trying to buy Norton, a quality West Australian producer, a bargain at only $30 per ounce. The variation is wide, partly due to factors like cash costs, but partly because the market is simply not paying much attention at the moment.
Disclosure: We own some of the mining companies mentioned.
See you in Sydney, this weekend at The AEF conference (book here), and Mon-Tues at The Gold Symposium
Because these are independent groups targeting independent people, both of these are great value — most conferences targeting government and the financial crowds charge 3 – 4 times the price. There are GALA dinners, boat cruises (AEF), excellent speeches.
You only live once, and we’re looking forward to a chance to be with friends.
Keynote Presentation: David Evans, Editor, GoldNerds,
Gold Begins to Shine Again
* Why we had a bubble, the GFC, and what’s up next
* Gold forecast for the next 15 years, in the best case for the central banks
* Why gold stocks are extremely cheap right now, and why the market is changing its mind.
* How to choose gold stocks.
Other posts on these themes:
- Two dismal sciences (climate and money)
- We are all Austrians now
- The Ground Zero of Global Corruption – it starts with The Currency
- This gold bar is worth its weight in … tungsten — corruption knocks on every door
- Bonds set record on record, stocks down, gold leaps‘
- Murdoch tweets about money printing and inflation, reality won’t be far behind
- Inflation, Money, Money Base