Precious Metals

In the 1940s rising (secular) commodities played a key role in rising inflation. However, the US government maintained an environment of negligible interest rates, surpressed to hold down the costs of excess government debt built up in WW2. It did this by intervening in the money supply, much like today, and the result was debasement of the US dollar. Eventually it had to abandon the policy in 1951 as it had led to an explosion of debt monetization and uncontained inflation. However, the policy was successful in that it provided the sovereign debt support until a new cycle of growth was underway (a new secular stocks bull and the end of the inflationary commodities bull, a transition complete by 1951).

Source: Bianco Research

Fast forward to today and we have a very similar scenario of secular commodities bull, problematic inflation (especially when real undoctored inflation stats are considered), surpressed negligible rates, money supply intervention and currency debasement. Given the historical precedent, we might consider that central banks in the indebted developed nations might be successul in maintaining their manipulation policies until a new cycle of growth and a new secular stocks bull emerges. By solar cycles, that is likely to take hold in late 2014 or in 2015. Recently the Fed extended its commitment to ultra low rates until late 2014, which fits well.

Negative real interest rates are therefore likely to persist for some time yet, not just maintained by the Fed but also by the ECB, BOE and Japanese central bank. Precious metals perform well in an environment of negative real interest rates, but also as all these major currencies are debased simultaneously, hard money becomes a refuge, maintaining value.

Source: Tom McClellan

As the above chart shows, based on the last secular commodities bull finale of the late 1970s, precious metals may cease to do well when we have evidence of real interest rates starting to trend upwards. In other words, the secular uptrends in gold and silver may come to an end when central banks begin to signal an end to low interest rates and inflation starts to ebb.

Marc Faber blames money printing and negligible rates for a series of bubbles in the early 21st century, and expects more bubbles in the next couple of years as this backdrop continues. With currency debasement and negative real returns in cash and bonds, precious metals continue to look an attractive class for bubble-blowing. If precious metals peaked in 2011, as some suggest, then we will print a historic anomaly over the next couple of years whereby hard money performs poorly in an environment of negative real interest rates and currency debasement.

One key factor in the long term secular swinging between hard and paper assets is the supply lag of around in mines and energy fields from plan to production of around 10 years. Since the onset of the current commodities secular bull in 2000, supply in gold stayed flat through to 2010, but grew almost 4% in 2011 as new mines (initiated since 2000) finally started to reach production. However, offsetting that, central banks bought more gold in 2011 than any year since 1964, a net purchase of 440 tonnes. The central banks in question are mainly from the developing world, and they are seeking to diversify their increasing reserves away from one or two main currencies (namely, the ones being debased). Whilst demand for precious metals for technology and jewellery has weakened slightly, it remains robust. So although investment demand is the growth area in demand, it has not become totally dominant, and the situation remains healthy.

Disinvestment in gold is expected to begin around 2015 (again, fitting well with solar cycle predictions). Morgan Stanley estimates show a peak in demand in 2014, and supply increasing each year the next 3 years as more mines come on stream.

Source: Morgan Stanley

In line with the history of secular commodity inversions, that sets us up for lagged supply to be increasing as demand starts to drop, providing a gap between the two that will form the backdrop to a secular commodities bear. This change should occur around 2014-2015, just as a new growth cycle begins supporting a stocks bull, and the central banks drop their negligible interest rate policy.

Comparing previous secular commodity bull conclusions, we have not seen a speculative mania phase in precious metals, and nor have we reached the extremes in stocks:commodities and housing:commodities ratios that we would expect. We might counter that by acknowledging the commodities bull is mature and this asset class is historically relatively expensive to the others now, if not at an abolute extreme. However, looking ahead in 2012 and 2013, negative real interest rates, currency debasement and the demand-supply picture make it probable, in my opinion, that we will see that speculative ascent. The main threat to this scenario would be another major event or deflationary shock. But as we saw in 2008 and 2011, this only had a temporary effect of depressing precious metals, rather than inducing a major trend reversal.


7 thoughts on “Precious Metals

  1. John,

    This all rings perfectly true with me. Negative real interest rates seem to be the common denominator running through it all. I noticed during Bernanke’s testimony on 1 March that he said “it could be argued that interest rates are still too high”. And you mentioned yesterday that Goldman Sachs expect QE3 to be introduced during the first half of 2012 (they are the closest thing in high finance to Govenment itself) – so its hard to imagine monetary tightening anytime soon…

    The recently-increased US Debt Ceiling at $16.394Trillion is due to be reached by 30 September 2012 (if Obama’s 2013 Budget Proposal is accurate), with their presidential election following within a few weeks.

    With debts like these, who would want higher interest rates?!!

    I was thinking that these levels of debt might distinguish the current situation from that around 1951, but the chart on this webpage shows that US Debt as a percentage of GDP was nearly 90% during 1950 – not that different to today’s levels.


    1. Thanks Mark. One thing I pondered was whether max bearish fundamentals for the US dollar could be priced in. The Fed is more trigger-happy with QE and other debt-increasing and currency debasing policies than other nations and it has committed the furthest out to ultra low rates, rates which are already lower than the rest of the world bar Japan. If it can’t get much more currency-debasing then could the dollar start rising on a slight change in this picture? Maybe it could, but it wouldn’t change the overall picture of negative real interest rates and dollar debasement. If the dollar gained ground against other debasing currencies, then I would still expect precious metals to do well – and although it is typically an inverse relationship, there have been periods when both gold and the dollar have risen together, such as in mid-2011.

      1. Yes, I can see what you mean.

        The US dollar was weak during the late 1970’s (similar levels to today in fact), but the low was in late 1978 – a full year before the precious metals mania of late 1979.

      2. I am not waiting for a QE3 in 2012.

        About the interest rate I think the fed will increase it in the 3Q of 2013, the current situation in the interes rate is similar than in1930. Read the book “this time is different”.

  2. Hi John,

    What are your thoughts about a “global reset” along the lines of FOFOA’s thinking and, to a more apocalyptic bent, ZeroHedge’s?

    Both of their theses seem to be based on the idea that there is simply too much fiat currency in the world and either gold needs to rise in price in order to back it (FOFOA’s “Freegold”) or assets need to collapse / fiat currency needs to be printed (ZeroHedge). Both advocate physical possession.

    1. Hi James, I acknowledge that there are parabolic trends in place that could end in some kind of global reset, but as per my Timeline the trends shouldn’t collectively crunch until 2025-2050, which gives us time for another secular stocks bull. And that secular stocks bull should deliver multiple technological paradigm shifts, which may help these parabolic trends turn into S-curves rather than collapse down the other side. So there’s hope, but there’s no guarantee of a happy ending (or a happy postponement). Regarding gold specifically, I refer you to a post I made a year back – history shows people don’t want to hold gold – me included – a new cycle of tech evolution and genuine growth and people will quickly exit gold, IMO.

  3. Hi John!

    wow Gold just took a big hit today actually… Now I know that your analysis and advice tends to be long term but I’m getting a feeling that sometimes your focus on the long term picture makes you miss some short term opportunities. Like the common advice that when the stock market gets a huge blow, gold is just another commodity that investors will sell (at a loss) to cover their open long positions in stocks. So, even if I agree with your long-term picture, one could still make a nice profit (or avoid a small loss) by keeping the short-term in sight IMO.

    That said, many thanks for your advice and that of other contributors on the comments section, I’m really learning a lot in here 🙂

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