NEW YORK (Resource Investor Conferences) -- Do you have any idea how difficult it is to come up after Dennis [Gartman] and be introduced as an economist? I’ve got to speak to the organizers here.
Okay. My talk today is on gold, and it’s entitled “Some Bullish Thoughts,” so let’s get right at it because I have 30 minutes and I have 200 slides. So away we go.
The first thing that I want to say is we’ve had a credit market crisis. And that may be new to you, although I did hear some people talking about this. Of course it’s not new to you, but what I want to point out to you is how gold behaved during this credit market crisis. And what you can see is that gold actually started right there when the ECB started pumping money into the system. And the top, at least for this moment, was right there where Bear Stearns was nicely forced into a merger, I think it is – or, how did they do that? I guess the Fed just said move over, here’s $10 billion and do it.
What we have here is how the S&P financials also turned. In fact, that was one of the things that we had noticed all through the credit market crisis, this negative correlation that existed between the financial equities and gold. And that tells you something about what happened here and hopefully this next slide will indicate that.
Okay. My point here is that we are in a major uptrend in the gold price. But within major uptrend prices often go sideways and also go down. I’m going to show you a chart later that has to do with geopolitical impacts on the gold price, and you’ll see that oftentimes you get bumps in a downtrend or bumps in an uptrend. And my point really is that we had a bump in the gold price that is directly related to the credit market crisis.
Now, obviously if the credit market crisis comes back to the fore, if there’s some other financial institution that hits the skids and it’s front page news, it could well be that gold could take another jump upwards. But if you think like I do that the worst of the credit market crisis is now somewhat behind us - there’s other things to come, but the worst of it is behind us - then it is highly likely that gold is going to go into a bit of a sideways, maybe even a bit of a downward pattern and pick up its basic trend. The other thing that this chart shows, and you should remember that, that in May 2006 gold hit $725. It took 16 months thereafter before gold took out that top again. Remember that.
Okay. From a longer-term perspective, we’re quite bullish. So I’m sort of getting our forecast a little bit ahead. What I have here is the price of gold from 1800 to 2007. I’m not actually interested in what the actual price of gold is, and by the way this is inflation adjusted. What I’m really interested in here is in the cycle. So this was a down point, up point, down point, up point, and so forth. What I wanted to look at was how long is any particular cycle. And it turns out that the shortest cycle in the gold price is 10 years, at least historically. Now, that happened to be the up cycle from 1970 until 1980, and it was a heck of cycle, as you remember.
Note, however, that in the middle of that cycle you had a very significant pullback in the price of gold. Now, that was related to the U.S. recession. So that can happen as well. So to sort of introduce my talk, we are in one of these lulls in a very long-term cycle that is upwards. Currently the price of gold has been rising for about 7 years. The shortest cycle is 10 years; I believe we will go much longer than 10 years this time around.
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So what would I like to talk about? Well, some bullish arguments for gold: 1) is monetary reflation, that's easier, monetary policy; 2) the dollar and what I think about what the dollar should do; 3) excessive dollar reserves; 4) gold is relatively cheap according to some metrics; gold supply is constrained, that’s point 5; 6) gold demand is growing. Dennis said it already: we have a whole part of the world where wealth is going from the bottom left, I think he said, to the upper right. 7) Commodities cycles last for many years - well, I just showed you the gold, but I’ll show you some other commodity cycles. And of course, 8) the geopolitical environment favours gold.
So let’s start with the first. This is a picture of monetary reflation. What this is, is the decline in the real interest rate in the United States. This is the treasury bill rate, and we subtract from that the rate of inflation. What you should see here is that when real interest rates are relatively firm in the 2% to 4% range, gold prices tend to stall. When they are below zero, it is very good for gold prices. So what has happened recently is very good for gold prices.
Now, why have interest rates come down? Because of the credit crisis. But the second aspect of that is the U.S. economy. What I have here is the picture of job creation. Now, the last numbers we saw were not that bad, –20,000; the market had expected worse. But when you do a 3-month average, you see that we are now at a point that is starting to mimic past recessions, not past mid-cycle slowdowns. By the way, mid-cycle slowdowns are quite normal; they occur between two recessions because within the cycle interest rates rise and slow an economy, much like what has happened.
Of course, underneath all that is no surprise at all; it’s what’s been happening in the U.S. housing market. So the best way to show that picture is to show the housing starts and the new home sales. And you can see here that these numbers have dropped now to the worst recessions that we have seen since the early ‘70s.
House prices in the United States are coming down, and you may think that this is a U.S. problem - Greenspan did all kinds of bad things and so on and so forth - I am not in that camp. My point here is that house prices are relatively high around the western world, which speaks to the cause of the housing market being a much broader thing than just whether or not Alan Greenspan kept monetary policy easy after the last recession.
What we have here is the hundred line, which is the long-term average within each country of the house price-to-rent ratio. And now the OECD measures the house price-to-rent ratio in each country and says, “Is it above or below that long-term average?” And you can see here Canada is high, U.K. is high, France is high, Spain is high.
I was in Europe recently, opened the paper, house prices in Mallorca - so that would be the Florida, if you will, of Europe - house prices in Mallorca are down 15% since last July. These are problems around the world. In other words, where I’m going with this is we’re going to see easier monetary policy in other countries as well, as those housing markets correct. And this is what the IMF said very recently in their survey. And just note the countries: Ireland, the UK, Netherlands, Denmark, Spain, France. These are all countries that are likely to experience difficulty in the housing market.
Another aspect behind monetary reflation is that we have high debt levels. Now, the easiest numbers to chart are the numbers for the United States. They’re readily available. What we have here is the debt level in the U.S. economy as a percent of GDP, and you see it’s around 220%.
It also tends to go up in stages. Period flat, then a rise. I rather suspect that we’re going to go into a period of flatness. Why? Because savings rates are too low. What that means, however, is that the U.S. economy is going to have to grow without growth in consumer spending. And that’s important. I think that can happen because one of the things that I’m going to say later is that the U.S. dollar is helping. But it isn’t just the U.S. that has high debt levels. In fact, when you start thinking about the baby boomer retirement - and this happens to be a chart culled from The Wall Street Journal where they talked about future payments for Medicare and Medicaid, social security and so forth - we can see that government budgets are going to be stressed.
And this is what the OECD says about what is likely to happen to different countries as we go into this retirement phase. And what they say is that the net financial liabilities as a percent of GDP are going to rise from something like 75% in Japan to over 300% as a case in point.
Now, I’m not the first to say this. In fact, Alan Greenspan said it years ago, David Dodge when he was the governor of the Bank of Canada has been talking about it, indeed every central banker in the world is scared silly about what is likely to happen over time because governments don’t have many choices to deal with this kind of debt that is coming at them. And these are some of the choices that I can think of: governments can renege on promises, although it is apparently a fact that if you renege on too many promises you’re unlikely to be returned to office. You can cut other services. Raise taxes; that’s a good one right? You’re going to vote for the government that’s going to raise your taxes; you’re going to vote for the government that, when you’re in retirement, is going to claw back all the money that they’re paying you? Forget it.
So what’s coming at us is stress in budgets that may have to be solved through printing more money. I don’t mean this in some kind of a sarcastic way, “What the hell, let’s just print money and get through this! Right?” No. It’s going to be in a different sort of fashion, and this may be a bit tough to read, but you can download this presentation from our website in a few days. But this is what the Cato Institute said recently, and basically what they said is that the Fed has always, and then they stress always, been subservient to the treasury. How does a central bank print money? Very simply, the government sells it debt and the central bank is encouraged to buy it. If you don’t believe me, you better study what goes on in Zimbabwe. You think, really, that the president of the Central Bank of Zimbabwe says no when Mugabe says, “You’re going to buy the paper I am now going to give you, and you’re going to give me the money”? Of course not. And that’s how you get 100,000+% inflation.
So this is a problem. What I’m getting at is what is running on the gold market behind the scenes is this pressure to reflate. And this is a way I can express it best is where I look at the global liquidity, that is the brown line, and I look at it on a percent year-over-year change, and you see there also the price of gold on a percent year-over-year change. By the way, the correlation of 0.57 is the highest single correlation we have over a long period of time of one variable against the gold price. So this is a very important variable.
Let’s go through the second point, the U.S. dollar. No surprise here, this is an index of the U.S. dollar; it’s an index we do ourselves. And it has the euro, the yen, the pound and the Canadian dollar in it. It peaked in 2002 and is heading lower. Gold and the dollar move inversely.
Although if I do the dollar only in the euro, so I use the index of the U.S. dollar that is just purely the euro, of course they move together. This correlation is quite high; it’s 0.94 on a daily basis over the last couple of years. Although, from time to time you will see that there is a bit of a breakdown. Then we pay attention to that, so that’s why we looked at the dollar.
What about the dollar? Of course the U.S. has a huge current account deficit, and that is one of the things that has undermined the dollar. It doesn’t always undermine the dollar - sometimes the dollar goes up. But when it goes up, it sets up the current account deficit.
Here’s the trade deficit with China. It’s $260 billion on a 12-month running total, which is just below what the overall U.S. deficit on energy. This is a huge problem, and one way to deal with the problem is to have the RMB rise against the U.S. That would be the nice way to deal with it because a rising RMB also encourages China to consume more, which is actually what we’d like to see. We don’t want China to only be a producer for the world; we also want it to be a consumer in the world.
Of course, the Chinese are fighting it, as you can see. It’s been a relatively hard process to get that RMB from about eight to the dollar up to seven. Of course you can see back here it wasn’t such a problem for China to devalue. And in all my years of watching currencies, I have learned that governments love to devalue their currencies against the U.S. dollar and they hated when times changed and they actually may have to force their currencies up. Then somehow or other it is the U.S. problem.
So, third point: U.S. dollar reserves. What I want - to conclude the second point, the U.S. dollar has to decline against the Asian currencies, which is very important. And that actually is more important than the U.S. dollar declining against the euro because Asia is more important for gold than is Europe.
U.S. dollar reserves are now more than $6 trillion U.S. dollar reserves – or reserves in the world, of which about 75% are U.S. dollars. And here you see some of the countries that have these massive amounts of money: China, Japan, Russia and OPEC. Russia was broke in 1998 and now has $0.5 trillion. These currencies should go up. The ruble should go up against the dollar. OPEC currency should go up against the dollar. The yen should go up, and of course the RMB should go up.
Where I’m going, however, is that this stuff has to be diversified. What you’ve got here in Asia is about $3 trillion foreign exchange reserves and only 1.5% of all their reserves are in gold. There was once upon a time I thought, you know, hey - wouldn’t it be nice if Asia bought some more gold? Well, unfortunately, that didn’t happen. Now, it becomes almost impossible. When you have $1.6 trillion of currency reserves, a $20 billion or $30 billion or $40 billion diversification into gold - that may be important for the gold market, but it’s a pittance to China. So what I’m left with hoping is that China says to the IMF is listen, you guys want to sell 400 tonnes of gold; we’ll buy them. It is spare change to us. And that may happen.
Staying with the dollar reserves, this is OPEC. Now, when OPEC makes money - that is, when OPEC’s current account rises - gold prices tend to do well. Now, there isn’t a direct relationship in the form of, for example, inflation. This is what most people think - oil prices go up, there’s inflation, therefore gold goes up. No. What this chart tells me is that it is really a wealth diversification process. When OPEC gets rich, more money moves to gold. And as you know, there is more heavy trading of gold in the Middle East now than at any other time in recent history.
Gold is cheap, point four. Here we have the real price of gold, and that’s the blue line. And as it turns out today, the real price of gold is a little bit higher than it has been as an average since 1970. So maybe gold is a little expensive at the moment, but obviously for many years it was below the average. The interesting point here, however, is this peak. Now, this is quarterly average data; that’s for the first quarter. If I were to translate the $850 p.m. fix of January 21, 1980, translated into today’s money, it would be $2,300. So that’s what I mean by gold is cheap. It is not near its recent high.
Here’s a chart that is used quite often to indicate that gold is cheap. It is the ratio of gold to oil. Now, I’ll be the first to say that there is nothing - and I have looked; I’ve even done a search on the Bible to see if there is law in the Bible that says oil and gold must trade at 17:1; and it turns out that there isn’t. So don’t hang your hat on this. All I want to say here is that gold is relatively inexpensive compared to oil, which means an oil producer gets more ounces of gold for each barrel of oil he or she sells today. And that reminds me that the Saudis were advised by the ex–prime minister of Malaysia many years ago to invoice oil in gold not in dollars. Keep that in mind.
This is one of my favourite charts in this section: gold is cheap. What I have here is the ratio of gold to the stock market, the S&P. And what I find interesting about this chart is that in the wake of each bubble something very dramatic happens to the gold price. In 1934, as you know, gold was up-valued. And in 1971, gold was cut loose. So in the wake of the two previous bubbles, gold was still highly regulated and regulations changed.
Of course, now we have a floating market. And gold is starting to react much like it did in the past. Now there are many reasons why this occurs that I don’t have time to go through in detail. But what I can indicate to you is that currently we’re at just under 10 in the ratio, and if this ratio were to go back to 1 as it seems to have done historically, and we fix the S&P at 1,350, then the gold price would have to go to 6,600. So you know what I’m going to forecast: 6,600. That’s a joke.
Supply. Supply isn’t growing. In fact, our models say it should be declining, and that’s exactly what it’s doing. This is mine supply. And our models are based on the real prices of gold. It takes years for mine supply to catch up to prices. And that period of time that it takes to catch up is getting longer all the time as governments start to behave the way some governments are behaving these days. It becomes more and more difficult to find new supply.
The second aspect of supply is, of course, central bank sales. Well, most of the central banks that have gold have made an agreement, that’s what we call the Central Bank Gold Agreement, so they’re locked up 500 tonnes a year. That’s good. Then there are some countries that are extremely unlikely to sell gold, and that includes the U.S., Japan, China, Russia and India. In fact, my theory is that some of these will want to buy more gold.
Indeed, Russia is buying a little bit more gold. And then you have some others; the IMF had indicated the 400 tonnes, but the 400 tonnes is going to come underneath that Central Bank Agreement because it turns out that some of the European countries who are in that agreement aren’t selling the amount that they thought they wanted to sell. In fact, that’s what we’re seeing in the central bank side. We’re starting to see little countries that, once sold, like Argentina, are now buying gold again.
Demand. Okay here we have demand for several regions, and it’s a dollar form of demand. This is not in tonnes; this is in dollar terms. So this is for the U.S. Now you notice that there is always a little bit of a decline when there is a recession. That’s what you would expect. Chinese demand, world demand, India demand.
Now, why do I put it in dollar terms? Because if you do it in tonnages you run into a problem. If there are 3,000 tonnes of new gold coming on the market and there is not more demand for the investment side of gold, the jewellery demand component for gold must decline. So it doesn’t make sense to talk about jewellery demand being down in the world. Of course it’s down! Because investment demand is up. And that’s the tradeoff. What I’m more worried about is that gold prices decline in order for the market to suck up 3,000 tonnes.
What you’re getting now is investment demand driving the price of gold, and that higher price of gold is reducing some of the investment demand. And here is, of course, where the investment demand is coming from - at least the part that we can measure, which is the ETF. It’s sold off a little bit, but that’s not so unusual. We’ve seen previous periods where we’ve had some sales.
Another component of demand is commodities and gold are becoming an asset class. Now this is a chart I put together for a talk I gave in Cape Town earlier this year, and what we have here is $123 trillion of financial assets in the world of which $55 trillion are managed assets. How many dollars are in managed commodities? About $200 billion give or take.
If commodities are going to be an asset class, you can reasonably expect to take up about 3% or so of the managed asset class. Three percent of $55 trillion is $1.5 trillion. There is room to grow in terms of commodities as an asset class. And who will be buying? It’s the story for another topic: sovereign wealth funds. That’s where the money is, and that’s where the governments want to enact out their desire to lay claim to future resources. Read the documents for the Chinese Investment Corporation.
The commodities cycle, I showed you the one for gold - here you have the one for copper. The shortest cycle in the copper market turns out to be 16 years. To be sure, when you’re in the middle of it you don’t know whether you’re going up, down or sideways because it’s quite volatile. That’s when you hire an economist like me because you know that I’m really good at looking backwards. I will tell you very clearly with an 80% accuracy where we have been. I make no bones about being an economist. We tend to be better at that. But you see, when I look backwards, you can see that that’s what has happened. And I’m inclined to think that we’re going to get a little repetition.
Dennis mentioned wheat. Here’s a chart of the real wheat price. Same type of thing: long cycles. This chart goes back to 1850 in real terms. Wheat prices are at an all-time low in real money.
The eighth bullish factor? Geopolitical. We’re at a time in the world when gold prices could suddenly bump up because of some geopolitical factor. And this is the chart I referred to earlier. Notice that we were in an uptrend, and in the middle of that uptrend we got a bump. You probably remember this as the peak for gold; I remember this as the peak for gold. That was the end of the cycle. Why was that the end of the cycle? Because that’s when Volcker raised interest rates to 20%, and I guarantee you when interest rates go up to 20%, nothing goes up.
Okay. Are there some negatives? That’s the two-handed economist, right? Of course there are. And we’re in a bit of a lull here. Recession, we may be decoupling a little bit - sorry, we may not be fully as coupled, there should be a word ‘not’ in there - and real interest rates in the U.S. can rise. So let me just briefly show you this.
Here you have gold prices over the long haul; the bars are U.S. recessions. Note that after each, at about the middle and after each recession, gold prices decline, historically. That’s not too surprising. It didn’t there, however. Why not? Because monetary reflation kicked in immediately, and that’s the important thing. But notice the CRB Futures Index. It does decline during recessions. So that raises a caution, a flag. We may be in one of those periods.
I showed you this chart earlier; there’s another side to that. You notice that the hawks on the Federal Reserve are starting to talk a little bit more like maybe we shouldn’t cut rates anymore; food and energy prices are going up, maybe down the road we have to raise rates. That’s a possibility.
And then we have the euro. Now, this chart is a little awkward, but where I have the dark circles is where gold and the euro are in sync. The euro peaks, gold peaks; the euro bottoms, gold bottoms. The square bits are where they are not in sync.
The market is so darn focused on this euro, it scares me a little bit. When the euro goes down, does that mean gold goes down? I said earlier, the more important thing is for the dollar to go down against the Asian currencies because that’s where the gold is being bought - but at this point in time, the market tends to still be focused on the euro, so there is a little bit of a caution there.
Now this is my last slide, when I put all of this together - and I do this once a quarter and I run through our models, et cetera, et cetera. These are the numbers I sort of generate. The probability-weighted average that we’re forecasting for this year is just over $900. To date, the gold price average is $917; our B scenario, our most likely scenario had gold at $907 for the average. That means that we are allowing for gold to be traded in the $800s for a period of time.
And that’s it. Thank you very much for listening.
Dr. Martin Murenbeeld is Chief Economist of DundeeWealth Economics. He has over 28 years of independent consulting experience in the gold, currency and credit markets. Dr. Murenbeeld is often quoted in the financial press on topics related to gold, the Canadian Dollar and economic and financial events abroad.
Please see website, www.dundeewealtheconomics.com, for available reports. Click here to view charts in PDF format.
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