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Good afternoon,
it’s a pleasure to speak about gold at this Outlook for 2012.
Today,
I’d like to focus on one important idea: the direct relationship
between the rising price of gold and the rising levels of government debt
that result in currency debasement. Since we measure investment performance
in currencies a clear understanding of the outlook for currencies is
critical.
In order to
understand gold’s relationship, it’s important to understand that
gold is money. It is not simply an industrial commodity like copper, or zinc.
It trades on the currency desks of most major banks – not on their
commodities desks. The turnover at the London Bullion Market Association is
over $37 billion per day, and volume is estimated at five to seven times that
amount – clearly, this is not jewelry demand.
The
world’s central banks know gold is money: after decades of modest sales
they have become net buyers since 2009. This trend strengthened in 2010 and
gained momentum in 2011. They are buying gold as a counterbalance to their
devaluing currencies.
As money, gold
has provided the most stable form of wealth preservation for over three
thousand years – it still does today. Gold has outperformed all other
asset classes since 2002.
 
This chart
clearly shows that US federal debt (purple) and the price of gold (gold) are
now moving in lockstep. This correlation will likely continue for the
foreseeable future. The red line represents the repeatedly violated
government debt ceilings.
Based on
official estimates, America’s debt is projected to reach $23 trillion
in 2015 and, if the correlation remains the same, the indicated gold price
would be $2,600 per ounce. However, if history is any example, it’s a
safe bet that government expenditure estimates will be greatly exceeded, and
the gold price will therefore be much higher.
And it’s
not just the US. Most Western economies have reached unsustainable levels of
debt that will be impossible to pay off. It’s worth noting that the US
Federal Reserve, unlike the European Central Bank, can create currency
without restriction. The US dollar has been the de facto world reserve
currency for over half a century; the rest of the world’s currencies
are essentially its derivatives. Whether global debt is in euros or Special
Drawing Rights issued by the IMF, the Fed, and thus indirectly the US
taxpayer, may become the lender of last resort.
There are four
possible ways to reduce government debt:
One: Grow out
of it through increased productivity and increased exports. This is highly
unlikely, as Western economies, and even China, are poised for recession.
Two: Introduce
strict austerity measures to reduce spending. This has the unwanted
short-term effect of increasing unemployment and reducing GDP, resulting in
even higher deficits.
Three: Default
on the debt. This will make it difficult to raise future bond issues.
Four: Issue
even more debt, and have the central bank in question simply create whatever
amount of currency is needed.
Most
politicians will select option four, since few have the political will to
choose austerity, cutbacks and full economic accountability over simply
creating more and more currency. Almost inevitably, they will choose to
postpone the problem and leave it for someone else to deal with in the
future.
Last August,
the world watched as the US government struggled to come to an agreement on
raising the debt ceiling, and was forced to compromise and delegate the final
solution to a “super committee.” Its lack of political will
earned the country an immediate downgrade from the S&P. Then, the hastily
convened “super-committee” failed to reach a solution.
In Europe,
matters were even worse. Greece did try to write off half its debt, but
Germany and France reminded the Greeks that, if they did, no one would buy
their bonds. The British and Irish implemented austerity measures that raised
unemployment and reduced GDP, resulting in even higher deficits. The Italians
watched their bond yields rise to 7%. While the tsunami and related nuclear
incident deflected attention from Japan’s financial problems, it is a
temporary lull, because Japan has the highest debt to GDP ratio of any of the
developed countries.
In order to
compensate for slowing growth, governments attempt to devalue their
currencies and thus improve export competitiveness. This can lead to a global
currency war that author and Wall Street/Washington insider James Rickards discusses in his bestselling new book, Currency
Wars. This process is now well underway.
A recent
Congressional Budget Office report predicted the US federal
government’s publicly held debt would top an unsustainable 101% of GDP
by 2021. Currently, the official US debt is an astronomical $15 trillion. Yet
this is only the current debt. If the US government used the same accrual
accounting principles that public companies must use, unfunded liabilities
like Social Security and Medicare make the real debt more than $120 trillion.
This represents over $1 million per taxpayer. Obviously, this amount is
impossible to repay.
It’s
interesting to note that in almost every recorded case of hyperinflation, the
point where inflation exceeds 50% a month was caused by governments trying to
compensate for slowing growth through full-throttle currency creation. This
is exactly what we are seeing today.
These events
gave me the confidence to title my new book $10,000 Gold. The book
connects the many trends that will be directly and indirectly responsible for
both the rising debt and the rising gold price over the next five years. It
will be published this year.
To make matters
worse, the irreversible macro trends I discussed in last year’s Empire
Club speech are still very much in place today. These include the added costs
of retiring baby boomers, systemic unemployment due to outsourcing of Western
jobs through globalization and rising oil prices due to peak oil. These
irreversible trends will increase unemployment, lower GDP, reduce tax
revenues, increase deficits further and force governments to borrow even
greater amounts.
Governments
find themselves between the proverbial rock and a hard place, as even
austerity measures tend to negatively impact GDP. As GDP falls and debt
increases, credit downgrades are likely to follow, resulting in higher bond
yields followed by even greater deficits. This becomes an unstoppable descending spiral.
Loss of
purchasing power against gold continued unabated last year. The US dollar and
the British pound have lost over 80% of their purchasing power against gold
over the past decade, and the yen, the euro and the Canadian dollar have lost
over 70%.
As we remind
our clients this is not a typical bull market. Gold is not rising in value,
currencies are losing purchasing power against gold, and therefore gold can
rise as high as currencies can fall. Since currencies are falling because of
increasing debt, gold can rise as high as government debt can grow.
The sovereign
wealth funds as well as the more conservative central banks will have little
choice but to re-allocating to gold in order to outpace currency
depreciation. This is why some central banks, particularly those of China and
India, accelerated their gold buying in 2011, for a third year in a row, to
nearly 500 tonnes – about one-fifth of annual
mine production.
While central
banks have been net purchasers of gold since 2009, the real game changers
will be the pension funds and insurance funds, which at this point hold only
0.3% of their vast assets in gold and mining shares. Continuing losses and
growing pension deficits will make it mandatory for them to eventually
include gold – the one asset class that is negatively correlated to
financial assets such as stocks and bonds. When this happens, there will be a
massive shift from over $200-trillion of global financial assets to the less
than $2 trillion of privately held bullion.
In considering
where gold will be at the end of 2012, I looked back to my first Empire Club
talk of 2005. I said then that it didn’t really matter whether gold
closed the year at $400 or $500 an ounce – the trends were in place to
ensure it had much further to rise. Seven years later, we can say the same
thing. It doesn’t matter whether gold ends 2012 at $2,000 or $2,500,
because gold’s final destination will make today’s price seem
insignificant.
These can be
frightening times, but gold always offers hope. We may not be able to heal
the global economic problems of government debt, but individuals can protect
and even increase their wealth through gold ownership. Gold bullion
ownership, not mining shares, ETFs or other paper proxy forms of ownership,
is an insurance policy against accelerating currency debasement. We use the
analogy that – In the case of fire, would you rather have
a real fire extinguisher or a picture of one?
A number of
people have approached me recently and said they wished they had listened
five years ago. They feel they have missed the boat, that it’s too late
to buy gold. For those who feel that way, let me close with a Chinese proverb
I discovered last year:
The best time
to plant a tree is 20 years ago.
The second best time is today.
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