The truth about gold

For thousands of years the glamour of gold has attracted, captivated and even caused the human race to fight. But during the 19th century, the role of gold changed dramatically by becoming the world’s official means of payment – not necessarily via direct trade, but in the form of “promises”. The gold standard basically meant that you could redeem this promise in the form of a note, at any central bank for its weight in gold, which at the time, was linked to a specific currency.

The role of gold in developed economies changed with the outbreak of the Second World War. By the end of the war, the Bretton Woods monetary system was implemented, which came to an end in 1971 when the USA decided to no longer convert Dollars to gold. The FIAT currency has since replaced the gold standard.

Recently however, after nearly 10 years, gold has yet again made headlines by exceeding all-time highs last reached in 2011. With the USA finding themselves in a financial predicament along with the rest of the world during the great recession in 2008, the first economic stimulus (later known as QE) was implemented by President George Bush. The M2 money supply growth (of more than 10% year on year) reached new heights as with the recession of 2001, and as more US Dollars came into circulation, the value of the Dollar started to decline. Despite the fact that the great recession came to an end in the US in 2009, the repercussions of the credit crisis was still noticeable in other countries around the world for years to come.

Various European countries, including Ireland, Greece, Portugal and Cyprus were not able to service their government debt between 2010 and 2014 and this forced the European Union to rush to their aid.  As fears surrounding this crisis mounted, the safety of gold got brought back its shine. This caused the gold price to reach a new high of $1 921/oz on 6 September 2011. And we all know what happened then.

Printing all this new money and lowering taxes and interest rates were not long-term solutions, and while government debt continued to rise, these measures, much like a Panado, only provided short term relief.  Gold was no longer necessary and by 2015, its price declined to just above $1 000/oz.

Graph 1: Euro/US Dollar & Gold ($/oz) (source: PSG Wealth Old Oak & Iress)

One thing that remained clear, was that despite the fact that the Dollar was no longer linked to gold, they still moved hand in hand. For the USA, this was largely successful and it probably would have stayed that way, but then Covid-19 broke out. With economies under lockdown, the USA is yet again forced to borrow trillions of Dollars to fund their stimulus package. As at June this year, the US budget deficit has only experienced a greater shortfall on five prior occasions in history. Now they’re back to printing more money, but that’s not all. For the third month in a row, this money supply growth has reached new heights.

Graph 2: US M2 money supply & Gold ($/oz) (source: PSG Wealth Old Oak & Iress)

Now the M2 money supply isn’t growing by 10.5% year on year as it was during the recession of 2001, nor is it growing by 11% as it was during the credit crisis of 2009. It was growing by more than 24% year on year up until the end of June 2020. As more and more Dollars are being circulated, and as with most things that there’s too much of, the Dollar is yet again starting to lose its value. As much as people would like to point out that the US Dollar is no longer linked to gold, the gold price keeps on running as the Dollar’s value declines.

Where does this leave us? When we look at the gold price relative to the Euro/US Dollar, you will see that similar movements were experienced in 2011, which although the past is never an indicator of the future, those with a more technical approach might tell us that now might is a good time to say goodbye to your gold investments.

Graph 3: Euro/US Dolla relative to gold & gold($/oz) (source: PSG Wealth Old Oak & Iress)

The fact is that Jerome Powell already promised that the US congress will “do whatever we can, for as long as it takes”, and he admitted that they were working on another stimulus package, which will probably see trillions more being borrowed, and will cause even more US Dollars to come into circulation. Do I think that gold is in overbought territory? Definitely. But I also think that it’s dangerous to jump in front of this gold train now and call it a peak. It still has a few more legs to run before it completes the race, and at current levels of around $1 953/oz, it seems that $2 000 might actually be the first psychological target.

But where does this leave South Africans? In terms of worldwide gold production, South Africa was still the eighth largest gold producer in 2018, and accounted for roughly 4% of the world’s total worldwide production. Aside from the US Dollar’s decline (which means a strengthening in the Rand’s value), this environment will be positive for South African gold mines, which will mean further inflows for the country, and which can bring about further strengthening of the Rand. Along with calling the current gold price a peak, investors also have to be careful to call the recent rand strengthening nothing but short-term luck. If gold shines even brighter, it can also cause the Rand to shine. Afterall, as at the end of 2019, 7.25% of the total SA GDP consisted of mining operations in general.

This week, I would like to conclude with a quote by Lord Rees Mogg. If investors are wondering what they should do about gold, or which experts they should believe, always remember that: “Governments lie; bankers lie; even auditors sometimes lie. Gold tells the truth” – Lord Rees Mogg.

The opinions expressed in this blog are the opinions of the writer and not necessarily those of PSG. These opinions do not constitute advice.  This is intended as general information and does not form part of any financial, tax, legal or investment related advice. Although the utmost care has been taken in the research and preparation of this blog, no responsibility can be taken for actions taken based on the information contained in this blog. Since individual needs and risk profiles differ, it is always advisable to consult a qualified financial adviser before taking action.


Schalk Louw

As Portfolio Manager at PSG Wealth Old Oak and with over 20 years’ experience in the investment industry, Schalk has consistently delivered solid returns to his clients and has certainly become one of South Africa’s most well-known strategists. He started his career in 1994 at the stockbroking company, Huysamer Stals (later ABN Amro). He joined SMK Securities in 1997, (later became BoE Personal Stockbrokers) and was later appointed as director and branch manager. In 2001 he co-founded Contego Asset Management and managed the company as CEO up to March 2014, after which he joined PSG Wealth Old Oak. Schalk has also become a regular household name with investors, with his reports being published in many of the national press. He completed his MBA in 2008.

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