EDITOR NOTE: While gold has the capacity to reduce volatility in currencies, the opposite scenario--using currencies to measure gold--can make the yellow metal extremely volatile. The reason for this is that intrinsic value is being measured by artificial value--the “original” evaluated by the “copy”--while the reverse scenario is closer to the “natural” course of things. Given the loss of confidence in the US dollar--the world’s reserve currency--and considering the unsustainable debt load that America holds, what would be the value of gold if central banks were to revert back to the yellow as a benchmark--considering the entire money supply against the shortage in gold production? Jim Rickards estimates that gold would be worth around $15,000 an ounce. Explained below is the rationale behind his calculation. The idea that the dollar is quickly losing favor across the globe may seem surreal to most of us who lived a good portion of our lives with the dollar shining above all sovereign currencies. Times have changed. Gold has seen this process repeat itself throughout history. And in the end, gold always remained the last currency standing.
Gold gained 24.6% last year, while silver gained 47.4%. But what exactly did it gain against?
Gold is historically volatile, except when the world is on a gold standard. This is not because of gold itself, it’s because of the currency used to measure the value of gold. Physical gold is an element, atomic number 79. It doesn’t do much. But, the price of gold is measured in currencies that do a lot.
You can’t look at gold prices without considering the currencies in which they are denominated. You then have to ask, what affects currencies?
Currencies gain strength on higher interest rates and strong economic performance. They weaken in the face of inflation, lower interest rates and recessions. They can move up and down quickly in the middle of currency wars. All of this hyperactivity in currencies is reflected in the price of gold, even though physical gold remains unchanged.
Looking down the road, I expect the dollar price of gold to hit $15,000 per ounce by early 2026. This forecast has three pillars:
The first is a prospective loss of confidence in the U.S. dollar and other reserve currencies due to excessive debt creation and non-sustainable fiscal policy. When confidence is lost, central banks may have to revert to gold as a benchmark or return to the actual gold standard to restore confidence.
A critical step is getting the price right. Using existing money supply, a 40% gold backing, and available gold supplies, the implied non-deflationary price of gold is $14,000 per ounce (and getting higher as money supply expands).
The second pillar is the need for governments to overcome disinflation and deflation. Excessive debt loads are a headwind to growth and cause precautionary savings, both of which are deflationary. The only reliable way to break the back of deflation (and, no, money printing does not work) is to devalue the dollar against gold.
This was done in 1933 and 1971, and it worked to create inflation both times. An 85% devaluation of the dollar (about the devaluation achieved in the 1970s) will inflate away the debt burden, stimulate nominal growth and result in a gold price of $15,000 per ounce.
The third pillar is simply supply and demand. Global gold production has flatlined at around 3,300 metric tonnes over the past five years. Production is declining, partly due to COVID-caused mine shutdowns. Strong hands refuse to sell the gold they own while new demand is surging. Flat supply and surging demand is a recipe for higher prices.
The U.S. Mint has announced that it was not able to keep up with the demand for gold and silver coins through 2020 and into January 2021.
This does not mean there is a global shortage of gold and silver bullion; coins are a relatively small part of the overall bullion markets. Most physical gold and silver transactions are in bars and involve much larger quantities purchased by central banks and ultra-high-net-worth individuals.
But coin sales offer insights into the mindset of everyday citizens and can be a leading indicator of a shift in perceptions about inflation and social unrest. The statistics are striking.
What’s most interesting is that the premiums being paid for gold and silver at the retail level are included in commissions. Dealers quote prices as “spot plus $7.00” or so in silver and “spot plus $90” or so in gold.
These commissions are in the 5% range for gold and the 25% range for silver versus a normal commission closer to 2% to 4%. That reveals the real price of gold and silver is significantly higher than the screen price for paper gold and silver contracts on COMEX.
The expansion of commissions does not reflect dealer operating costs. It reflects scarcity, which does not exist in paper markets because paper contracts can be expanded at zero marginal cost.
The bigger question for investors is, when does scarcity in physical bullion play out in the paper contract world? That may not happen for some time, but when it does, it will be an earthquake.
This makes gold and silver the ultimate asymmetric trade.
Bullion has limited downsides based on scarcity and demand and huge upsides based on an inevitable narrowing of the gap between the real price in the physical market and the manufactured price in paper contracts.
The best entry point of the year is likely to be right now.
Originally posted on The Daily Reckoning