In part 4, I had shown that Russia and China have been buying gold. Below is a chart of all global central bank purchases since 1971. The 651 metric tonnes is multi-decade record. In my most simplistic argument, if those that create policy are buying gold, then you should probably have an allocation as well.
I have also laid out fundamental reasons why the dollar will fall. Most people do not think about prices in this way, but the price of gold in the US is effectively the price of gold divided by the price of dollars. With that in mind, if the denominator in the equation was to fall (dollars), then the price of gold will rise. This is demonstrated below. As the dollar rises, gold tends to fall and vice versa. There is a potential scenario where both rise in tandem due to a race to safe and perceived safe haven assets in a time of distress.
Historically, gold was always tied to the US dollar. This meant that for most of history dollars could be exchanged for gold. This forced the government to spend within its means because if too many dollars were ever created, then there was the potential for too many gold redemptions to bankrupt the US. In 1913, $20 would buy an ounce of gold, but the US spent its way out of being able to hold that promise. Then, in 1933, the US said we can no longer allow gold to be redeemable at $20, and gold was revalued to $35 an ounce. This trend continued over time until 1971. The US government in the 1960s was spending too much money on the war in Vietnam and Lyndon B. Johnson’s “Great Society.” The rest of the world was skeptical that the US would be able to repay gold to all dollar holders at $35 an ounce, so there was basically a run on the gold at the United States treasury. In 1971, Nixon basically defaulted on the promise to repay gold at $35, and removed the dollar from the gold standard. Gold in the coming years would rise from $35 to over $800. The brief sequence of events demonstrates that gold has precedent as an insurance asset against government over spending.
During the 2008 financial crisis, the US deficits exploded and so did gold. Below, you can see a different chart showing forecasted deficits exploding going forward. Also, the data is sourced from government sources, and does not forecast a recession in the next 10 years.
Another case for gold is the rising cost to mine it. This is due to inflation and gold becoming harder and harder to find. If gold were to dive below 1000 for a lengthy amount of time, then some miners may need to cease operations due to not being able to produce gold at a profit. If some supply goes offline, then this will be bullish for prices. With this in mind, it is quite likely that there is floor around $1000 an ounce for gold.
Gold also appears to serve as an insurance policy against the inevitable failure of global quantitative easing. Until 2012, gold was rising in tandem with central bank balance sheets. I would speculate that around that time the market basically decided “quantitative easing worked, all is well,” and stopped buying insurance in the form of gold.
The chart below is the gold to dow ratio. This is a historical chart of the amount of ounces it takes to buy the dow jones industrial average. Over time, the ratio tends to revert to below 5. My suspicion is that we were well headed for that reversion prior to “quantitative easing working.” For this chart to revert properly the dow will either need to come down to around 6,000 from 25,000 or gold will need to rise to about $5,000. Some combination or the two is the most likely scenario.
One should not bet the farm on gold or any investment for that matter, but if you do not possess an allocation towards gold it may be unwise. There is a great deal of uncertainty in the world at this moment. By many metrics gold is cheap. If you know that the odds of recession are increasing, which is going to weigh on the dollar in long run, then it makes sense to buy the insurance before the storm hits. Once the economic storm is upon us, then it will be too late. Unfortunately, many individuals do not own gold because conventional wisdom has been brainwashed into hating it. They say, “it doesn’t produce a yield,” “it’s just a dumb rock,” or “it has no uses.” To me this ignorance is the buying opportunity of a lifetime.