‘Gold remains the currency of last resort’ – Jeff Currie, Head of Commodity Research, Goldman Sachs
As a ‘last resort’ it’s not doing too badly.
Since the SPDR Gold Trust ETF [NYSE: GLD] first listed in the US in September 2004, gold has gained 250%.
During the same time the S&P 500 has gained 13.25%.
So we can only imagine what will happen to the gold price when it becomes the currency of first resort.
And that may not be far off if one commodities guru is right…
In Wednesday’s Money Morning, Diggers & Drillers editor, Dr. Alex Cowie revealed what could be the biggest game-changer for gold in recent history.
It’s got nothing to do with China.
It’s got nothing to do with India.
And it’s really not anything to do with the U.S. Federal Reserve.
He wrote:
‘The Basel Committee of Bank supervision, who dream up the rules that govern banks, are looking at turning gold into a “Tier One” asset.
‘This means the banks can carry gold as capital at 100% of its market value – instead of the current 50%.
‘This gives gold a huge increase in status, and effectively turns it back into money at the top level. It would also give the banks a strong reason to hold gold.’
This is about banks carrying gold on their balance sheet. While they can do that now, they can only carry 50% of the metal’s value towards their reserves.
If the proposed Basel plan goes ahead banks could carry gold at 100% of its market value.
If that happens, in one stroke it would put gold at the front of the queue. Gold would be the currency of first resort, rather than the last.
But aside from that, there’s perhaps an even bigger reason to own gold. And if we’re right, it could see the gold price hit $5,000 within the next six years…
Gold Doesn’t Change
One way of measuring the price of gold over time is to compare the gold price with GDP (gross domestic product).
It’s a handy guide because, as Warren Buffett says, gold ‘doesn’t do anything’. You pay someone to dig it from the ground and then you pay someone else to store it in a vault underground.
In other words, a bar of gold produced 200 years ago is no different today to what it was then.
And so, because gold doesn’t change you can measure other things, things that do change, in terms of gold.
One thing that changes all the time, from day to day, month to month and year to year, is GDP.
On a per person (per capita) basis, US GDP has gained from USD$47.61 in 1790 to USD$48,372 in 2011. At the same time, gold has gone from USD$19.39 per troy ounce to USD$1,600 in 2011.
And if you work out how many ounces of gold you could get per capita of GDP, you get the chart below:
In 1791 you got 2.6 ounces of gold per capita of GDP.
From there the ratio hit a peak at 139 in 1970 before falling and peaking again at 132.4 in 2001.
Today, the gold-to-GDP ratio is 30.2. So, where is it heading next?
Stand By For An Inflationary Slowdown
If we accept that we’re living through an end-of-an-era credit bust we need to think about the impact this will have on GDP. In all likelihood it will mean GDP will fall as businesses and consumers borrow and spend less.
Unless you get an inflationary economic slowdown.
To a large degree, this is already happening. Governments have allowed central banks to cut interest rates to record lows. This has caused bond yields to crash (in one case, a 500-year low according to Dr. Cowie in his latest issue of Diggers & Drillers, due out this week).
Central banks have also printed trillions of dollars of new money. Yet none of it has sustained economic growth or kick-started another credit boom.
Proof of an inflationary slowdown is the fact that inflation-adjusted U.S. GDP per person has stood still since 2004.
The same is happening in Europe. Once the final benefits of the resources boom finish flowing through the economy, the same will happen here too.
(Forget yesterday’s bumper GDP number. That’s a lagging indicator from January to March. Remember, the market has only just found out that China and India are slowing faster than most people thought.)
That tells us to expect flat lining GDP worldwide as high taxes strangle the private sector. And that only more government spending on welfare and public works programs will prevent GDP falling.
But, because these aren’t productive spending measures, governments will struggle to meet spending commitments without increasing taxes or raising cash in another way. How?
Why Gold Could Gain 196% in Six Years
By printing more money of course.
And that means bad news for savers who will end up with a negative return on their cash. But it means better news for those with the foresight to buy gold.
So, where could the gold price head?
If we’re right and US GDP flat lines, our bet is you’ll see the gold price-to-GDP ratio fall to pre-credit boom levels of 10 or below.
And if that happens (assuming a US per capita GDP around USD$48,000-USD$50,000), you’re looking at a gold price over USD$4,800 per ounce…or a 196% gain from today’s price.
That’s assuming investors buy gold to protect their wealth against central bank inflation. And based on the long history of gold as the favoured safety spot for investors, we’d say the odds are pretty good.
If you think gold looks expensive at $1,600 an ounce, there’s a good chance that will look cheap compared to where it will be just a few years from now.
Especially when gold reclaims its place as the global currency of first resort.
Cheers,
Kris.
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