By Matthew Gaude & Shawn McGuire
As we entered 2024, one market in particular that we were very bullish on expecting much higher prices is gold and silver. We were early as we started buying our gold and silver positions in 2023, which is why we are not market timers. We would rather be early than miss out on the start of this bull market. As we look at the history of previous bull markets, they have acted like freight trains with little to stop them and not providing many opportunities to “hop on board.”
So why do we believe gold and silver have the potential to go much higher from current levels?
Jared Dillon, a financial writer, author, and former trader at Lehman Brothers from 2001-2008, provided a simple-to-understand rationale as to why gold is going higher this year. The following is from his posts on X:
Gold has been called lots of things, like an inflation hedge. It is an imperfect inflation hedge, at best. It has been called a store of value, a disaster hedge—it has been called all sorts of things. What it really is, is protection against debt monetization.
What is debt monetization? Debt monetization is when the government runs out-of-control deficits, interest rates skyrocket, and the central bank is asked to cap interest rates in response. Rates are capped by the central banks being willing to buy all available bonds at a given price.
With printed money, of course. The money supply explodes, inflation skyrockets, and investors flock to hard assets, like gold, but also pretty much all commodities. There is plenty of historical precedent for this. This is exactly what happened in the hyperinflationary episodes in Weimar Germany, and Zimbabwe. Argentina is fighting it as we speak. Not to say that we’ll get a million percent inflation here, but even 9 percent inflation was pretty painful.
A government bond is a claim. It is a claim on some asset, and that asset is the productive abilities of all the citizens in the country. When the supply of claims exceeds the supply of assets, the result is inflation.
This is the main reason gold is rallying right now—interest expense is spiraling out of control, and if interest rates tick up 1 or 2% higher, we will be in fiscal checkmate. The only path forward will be debt monetization.
So anything that increases the probability that we will monetize makes gold go up, and anything that decreases the probability that we will monetize makes gold go down. You’ve probably noticed that rates and gold are now positively correlated. Why?
Because when interest rates go higher, it actually increases the probability of monetization. In a normal environment, high rates are bad for gold because gold yields nothing in comparison. Now high rates are actually good for gold. Few understand this.
Gold responds to a number of different economic variables, but the one that it has the highest correlation to is budget deficits. When deficits are large (like 2009-2011), gold goes up. When deficits are small (like 2011-2016), gold goes down.
The one thing we know about the 2024 election is that no matter who gets elected, the deficit is likely to get even larger. Outside of some big disinflationary impulse, we are likely to get much higher rates. And if we get a war—Katy, bar the door.
There is historical precedent for that too. The Fed pegged the yield curve during WWII, and after it lifted the peg, inflation went to high double digits. Gold was not freely floating at the time. I have always thought debt monetization was possible since we started quantitative easing (QE) in 2008. And it’s worth talking about QE. How is QE different from monetization? With QE, you set aside a finite amount of money to buy bonds. With monetization, you set aside an infinite amount.
We’ve been inching closer to this for the last 16 years. Things always take longer than you think in finance, but I wouldn’t be surprised if we’re doing full-blown monetization in 2024-2028. That is the endgame.
I’ll expand on several of Jared’s points, but first, let me expand on a couple of other reasons for the bullishness in gold.
Demand
First, let us remind ourselves why it is that central banks hold gold in reserve. The International Monetary Fund published a working paper in January 2023 entitled “Gold as International Reserves: A Barbarous Relic No More?” In this article, the authors, including the renowned economic historian Barry J. Eichengreen, highlight two potential explanations for why central bank gold demand has increased over the last decade:
- First, gold is seen as a safe haven and desirable reserve asset in periods of high economic, financial, and geopolitical uncertainty and when returns on reserves currencies are low.
- Second, gold is perceived as a safe and desirable reserve asset when countries are subject to financial sanctions, and when financial assets are potentially subject to freezes and seizure.
Let me expand briefly on the second point listed above. Central banks in emerging markets cannot rely on U.S. Treasuries for reserves as they once did. They learned, post the invasion of Ukraine by Russia, that their assets may be frozen and that they may have a counterparty risk with the U.S. and Europe. Therefore, they diversify into a store of value without counterparty risk. If you are not aware, the U.S. has frozen Russian assets. According to NBC News:
The House passed a foreign aid package called the REPO Act, which would allow the Biden administration to confiscate billions of dollars’ worth of Russian assets sitting in U.S. banks and transfer them to Ukraine for reconstruction.
The REPO Act, which would authorize Biden to confiscate the frozen Russian assets in U.S. banks and transfer them to a special fund for Ukraine, is part of the foreign aid package that was stalled for months in the House. More than $6 billion of the $300 billion in frozen Russian assets are sitting in U.S. banks. Most of the $300 billion in assets are in Germany, France, and Belgium.
This does not project confidence to central banks around the world.
The weaponization of fiat money has lasting consequences: The confiscation of Russian reserves and assets of Russian oligarchs in 2022 was a wakeup call for numerous states, as well as wealthy private individuals from the Gulf states, Russia, and China. (Luxury) Real estate in London, New York, or Vancouver has always been the preferred destination for savings from emerging markets, but this has changed in 2022.
This can be illustrated in the following graph, showing U.S. Treasury holdings from central banks around the world have been selling their holdings while increasing their holdings in gold:
Central Banks Buying Huge Amounts of Gold
The most recent World Gold Council Annual Central Bank Survey also highlights two key drivers of central banks’ decisions to hold gold: its performance during times of crisis and its role as a long-term store of value. Let’s take a moment to step back and gain a broader perspective on central bank gold holdings before delving into the events of 2022 and Q1 2023. Among all nations, the USA continues to hold the largest quantity of gold, followed by Germany, Italy, France, Russia, and China. While gold holdings constitute a significant portion of the reserves of these Western nations, the percentage of gold reserves relative to the total reserves of Russia and China is only around 24% and 3.5%, respectively. Interestingly, these two nations, in particular, have shown increased demand for gold as a reserve asset in recent years.
Central banks around the world are a decisive factor in the demand for gold: Demand from these institutions is not very price-sensitive. Central banks are likely to have put a floor under the gold price. The chart below shows demand from central banks around the world going back to 1950. Over the last 13 years, we have seen central banks start buying gold, accelerating their purchases over the last several years.
Prior to 2022, there wasn’t a single year with over 1,000 tonnes of central bank gold purchases. In 2022 and 2023, central banks bought 1081 and 1037 tonnes of gold, respectively. China’s central bank alone bought an incredible 225 tonnes of gold in 2023 ALONE. This was China’s single largest annual addition since 1977.
To illustrate central bank buying in more detail, following are the countries where their central banks have been buying gold:
According to the Kobeissi Letter, from their X account:
Global gold demand has never been stronger. Gold demand for the last 7 quarters has reached 40 million troy ounces on average. This is almost 2 million higher than the quarterly average from Q1 2010 to Q2 2022. Over the last 2 years, the gold demand surge has been almost entirely driven by central banks. In 2022 and 2023, central banks bought a record 2,100 tonnes of gold. Why are central banks so aggressively acquiring gold?
The largest purchaser of gold in 2022 was Türkiye, which increased its reserves by 148 tonnes to 542 tonnes. Türkiye has been struggling with high inflation and a weak Turkish lira for a number of years, and has been purchasing gold in order to strengthen the central bank’s foreign currency needs. India added 33 tonnes in 2022, after adding 77 tonnes in 2021.
Not only are central banks around the world buying gold, but so are retail customers:
According to this CNBC.com article:
Gold has turned into money for Costco, where yellow metal sales begun last year have turned into a cash cow for the big-box retailer.
In fact, sales are so brisk that analysts at Wells Fargo expect revenue “may now be running at” $100 million to $200 million a month, a rapid acceleration since bullion hit the warehouse club late in the summer of 2023.
“Our work suggests there has been significant interest given Costco’s aggressive pricing and high level of customer trust,” Edward Kelly, an equity analyst at the bank, said in a note to clients Tuesday. “The accelerating frequency of Reddit posts, quick on-line sell-outs of product, and COST’s robust monthly eComm sales suggests a sharp uptick in momentum since the launch.”
To summarize, the charts are set up quite bullishly for the rest of 2024 and into 2025. Again, I want to make it clear that we are still VERY bullish on the metals complex. We are still looking much higher later this year and into 2025. Following is a recent chart of gold prices over the past 5 years:
Sitting Tight
Jesse Livermore was an American stock trader, pioneered day trading, and was the basis for the main character of Reminiscences of a Stock Operator, a best-selling book by Edwin Lefèvre. At one time, Livermore was one of the richest people in the world until his death in 1940. One of the most meaningful quotes Jesse wrote in his own book was, “After spending many years in Wall Street and after making and losing millions of dollars, I want to tell you this: It never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight! Men who can both be right and sit tight are uncommon.”
This fits the current opportunity in precious metals. As always at Live Oak Wealth Management, we’ll continue to keep you updated. If you’d like to get in touch, call our office at 770-552-5968 or email [email protected]. Or, if you prefer, you can simply click here to schedule an appointment online.
About Matthew
Matthew Gaude is an *investment advisor representative and the co-founder of Live Oak Wealth Management, a financial services firm in Roswell, Georgia. He serves the planning and investment needs of corporate employees, those approaching or in retirement, and 401(k) plan sponsors. Working first as a commodity broker and then as a Business Development Manager for a national broker-dealer in previous jobs, he has the insight and experience to help clients understand the complexities of the market and implement strategies to minimize risk. To learn more about Matthew, connect with him on LinkedIn or visit www.liveoakwm.com.
About Shawn
Shawn McGuire is a financial advisor and the co-founder of Live Oak Wealth Management, a financial services firm in Roswell, Georgia. He serves the planning and investment needs of corporate employees, those approaching or in retirement, and 401(k) plan sponsors. He has worked in financial services since 2002 in positions ranging from financial advisor to stock broker and portfolio manager. As a CERTIFIED FINANCIAL PLANNER™ professional, he is trained to help clients with virtually all their financial needs. To learn more about Shawn, connect with him on LinkedIn or visit www.liveoakwm.com.
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