The Case for 3K / oz Gold
Disclaimer: This content is for information only and reflects only my views. I am investment analyst at an investment bank (six years experience).
The case for higher gold is conceptually simple. Gold is a unique asset vs. other financial assets because it is the only asset that is not someone else’s liability. The attractiveness of gold increases when the ability to meet liabilities is at risk.
Gold is another instrument of liquidity similar to currencies which can be exchanged for services. Gold is less liquid vs. the U.S. dollar or the U.S. treasuries with the Fed providing liquidity. For the buyer of gold, the decision therefore considering the liquidity and return of the “risk-free” financial asset, namely sovereign bonds, such as U.S. treasuries vs. gold.
U.S. treasuries 10-years are currently yield real rates of negative -0.8%. Roughly 17% of global currency debt is negative yielding nominally (Europe, Japan). Without any yield in the financial asset, gold becomes marginally more attractive. Especially if one thinks expected real yields will decline (either from deflation or inflation).
From an economic standpoint, global debt is roughly 330% of GDP currently. There have been several episodes in history where debt levels peak around 270% of GDP and then are restructured directly or currencies devalued. The economic rationale is likely that an economy cannot grow incomes to meet required debt obligations at that level (roughly 3% income growth for 1% inflation).
From a behavioral standpoint, institutions have roughly 0.3–0.5% of their asset allocations in gold. A shift to a 1% allocation at roughly $90T in assets requires an incremental $445 billion purchase in gold.
From a supply standpoint, at a price of $2K/oz this implies roughly 222 moz. Gold miners product roughly 110 moz / year. Gold supply is largely fixed and is expected to peak in 2020 at current prices. Hence if this is done over the next two years then the “clearing price” roughly speaking is $4K/oz.
The key questions then are:
Is there an increasingly probable scenario where one will see a loss in “risk-free” liquidity investments?
Will central banks and government policymakers pursue inflation and negative real yields?
Or can current debt levels support a rebound in growth with lower but still positive interest rates?
To be continued…
