Gold Bugs Might Be Wrong…Again

Dear Reader,

On 15 August 1971, ­President Richard Nixon declared…

I have directed the Secretary of the Treasury to take the action necessary to defend the dollar against the speculators.

I have directed Secretary Connally to suspend temporarily the convertibility of the American dollar [into gold] except in amounts and conditions determined to be in the interest of monetary stability and in the best interests of the United States.

And with those words, the gold standard backing the US dollar was temporarily suspended. Proving there is nothing more permanent than a government’s temporary initiative.

The 1970s was a decade of stubbornly high inflation.

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With gold no longer tethered to the dollar, this was the perfect environment for the real money to shine.

The inability of successive US governments to tame the inflationary beast sent the USD price of gold to a previously unimagined level.


Port Phillip Publishing

Source: Macro Trends

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The belief in the permanency of high inflation sent the gold price parabolic.

In 1981 — with US inflation running at 15% — Gary Shilling wrote a book titled Is Inflation Ending: Are you Ready?

To quote from the book…

Inflation is ending and you are not ready. Stocks and bonds are going to do well as inflation unwinds.

Back then, this was a hugely contrarian call. Gold had been the darling of the 1970s, while stocks and bonds had performed terribly.

With 20/20 hindsight we can see Gary Shilling was absolutely correct on all three counts…

High inflation did end.


Port Phillip Publishing

Source: Trading Economics

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And the share and bond markets have posted the greatest bull runs in history.

With the ending of inflation, gold went into a 20-year bear market.

From a peak of US$850/oz in January 1980, gold fell to a low of US$250 in August 1999.

Then gold began a steady resurgence…until 2008.


Port Phillip Publishing

Source: Macro Trends

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When the subprime lending problems started frothing to the surface in early 2008, the price of gold dropped by around 30%.

That price action ran counter to the popular thinking of gold being the safe haven in times of turmoil.

But then gold took off…charging to over US$1,900 in September 2011.

Gold’s newfound popularity was courtesy of this chart…the Fed’s balance sheet.


Port Phillip Publishing

Source: Federal Reserve Economic Data

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After Lehman Brothers went belly up in September 2008, the Fed adopted a ‘print and be damned’ policy.

Over the next three years, the US central bank’s balance sheet went from US$1 trillion to US$3 trillion.

At that time, the word association game went something like this…money printing = Weimar Republic = hyperinflation = BUY gold.

In 2010, Gary Shilling published another book. The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation.

Hark back a decade — in the midst of QE — and there was hardly anyone forecasting slow growth and deflation.

The Federal Reserve Bank of San Francisco’s Economic Letter — published June 2019 — verified the accuracy in Shilling’s 2010 forecast (emphasis is mine):

Before the Great Recession, a GDP growth rate of 3% or higher seemed normal for the United States. For example, annual growth from 1987 to 2007 averaged 3%. In contrast, the pace since the end of the Great Recession in 2009 has been much slower, averaging only 2.3% per year through the end of 2018…

Estimates suggest the new normal pace for U.S. GDP growth remains between 1½% and 1¾%, noticeably slower than the typical pace since World War II.

Money printing didn’t produce hyper or high or even, above-average inflation.

Gold to fall to US$1,000…

When it became evident the hyperinflation genie was not out of the bottle, gold fell more than 40% in value.

In spite of all the newly minted dollars and free-flowing credit, inflation remained stubbornly low.

Why?

In a globalised world, there was more supply (from countries with cheap labour forces) than there was demand.

Low costs were exported and imported around the world.

And now, with the Fed’s latest (over the top) money printing response to the March market meltdown, gold is off again…nudging US$2,000/oz.

Inflation is a comin’…or so we are told.

Don’t bet on it.

This extract is from a Bloomberg article published on 31 July 2020 by Gary Shilling (emphasis added):

The situation is ghastly, with Covid-19 infections accelerating…there are the problems of reopening businesses, re-establishing and reorienting supply chains and encouraging many to return to work who are now paid more by federal and state unemployment benefits than when they were employed.

The recent [US] Treasury bond rally fits with our forecast that the recession has a second, more serious leg that will extend well into 2021, despite massive monetary and fiscal stimulus. Declining business activity saps private credit demand and makes Treasuries shine as havens. A deep recession also breeds deflation to the benefit of Treasuries.

The containment of inflation was due to an excess of supply over demand.

Think about this. With the zombies still being kept alive, supply has not suffered a natural attrition.

However, demand has fallen off a cliff. Savings rates are up. Credit is harder to come by.

Consumers are lacking confidence.

If the supply and demand imbalance was bad before, it’s even worse now.

Deflation is a comin’.

Which, based on past episodes of high and low inflation, you’d expect would not bode well for gold.

For Aussie based gold investors, there’s also the currency — AUD versus USD — factor to consider.

Since late March, the strengthening of our dollar has proved to be a tough headwind for the AUD gold price.


Port Phillip Publishing

Source: goldprice.org

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At present, two of the most crowded trades are…higher gold price and weaker US dollar.

In my experience, when almost everyone thinks things are headed in one direction, invariably the opposite happens.

Here’s my wild prediction for the next 12 months…as a deflationary recession grips the world.

Gold to fall to US$1,000.

AUD versus USD goes to 50 US cents.

Gold in AUD will be $2,000, around 30% lower than the current price.

I think the gold bugs might have it wrong…again.

Regards,

Vern Gowdie Signature

Vern Gowdie,
Editor, The Rum Rebellion


Vern has been involved in financial planning since 1986.

In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners.

His previous firm, Gowdie Financial Planning, was recognised in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top five financial planning firms in Australia.

In 2005, Vern commenced his writing career with the ‘Big Picture’ column for regional newspapers and was a commentator on financial matters for Prime Radio talkback.

In 2008, he sold his financial planning firm due to concerns about an impending economic downturn and the impact this would have on the investment industry.

In 2013, he joined Fat Tail Investment Research as editor of Gowdie Family Wealth. In 2015, his book The End of Australia sold over 20,000 copies and launched his second premium newsletter, The Gowdie Letter.

Vern has since published two other books, A Parents Gift of Knowledge, all about the passing of investing intelligence from father to daughter, and How Much Bull can Investors Bear, an expose on the investment industry’s smoke and mirrors.

His contrarian views often place him at odds with the financial planning profession today, but Vern’s sole motivation is to help investors like you to protect their own and their family’s wealth.

Vern is Founder and Chairman of The Gowdie Advisory and The Gowdie Letter advisory service.


The Rum Rebellion