As a newcomer to this newsletter business, I face a conundrum.
I believe in gold. I see gold adding several hundred dollars over 2015. In the longer term I believe the yellow metal will go significantly higher, propelled by its unique role as an intrinsic store of value and increasing constraints on its production.
I could talk about gold almost every day…but that would make me a gold bug. And gold bugs can be hard to bear.
It’s hard to listen to anyone tell the same story or make the same argument over and over.
Most gold bugs fit that bill. They cemented their storylines during gold’s bull run, each added dollar creating the confidence to take their tales one step farther. By the time gold peaked in 2011 amidst massive quantitative easing, the bugs were convinced gold’s run to the rafters was unstoppable.
They were wrong, of course. Gold has since lost almost 40%. Now, with consensus growing that we are at the bottom (led by yours truly) or at least very near to it, the gold bug battle cry is again growing loud.
The most vehement cries are easier to dismiss, coming as they usually do from extreme voices: conspiracy theorists, anarchist libertarians, and gold bugs so deeply entrenched they have no choice but to keep digging.
But there are also much more moderate voices in the chorus, armed with information around central bank buying, global currency realignments, and significant tightness in the physical market.
The arguments make a lot of sense. In fact, they render many of the seemingly nonsensical parts of today’s markets coherent.
The bottom line is that we’re in the eye of the storm, the calm before the next financial tempest. When it hits it will involve currency values and oil prices and gold reserves and economic strengths and money velocities and international power dynamics and gold.
It’s a lot to discuss, so I’ve broken it into two chunks. Today, the world’s shifting currency dynamics. Next, the what and why of pressures on gold supplies.
The Decline of the Dollar
Gold bugs tell a very clear tale around gold and currencies: face-saving governments have printed so much money that fiat currencies will inevitably inflate dramatically and then collapse, leaving gold behind as the only true purveyor of wealth.
It’s a dramatic concept and one with some real merit. Many sovereign debts are incomprehensibly high and quantitative easing programs have ballooned the money supply.
Moreover, rampant money printing has destroyed currencies before, in the Weimar Republic (Germany) in the 1920s and more recently in Zimbabwe.
However, these facts don’t mean the dollar or the euro or the yen will collapse anytime soon. Powerful forces support these currencies and their sudden destruction would represent a shift of unimaginable magnitude.
However, currency change is coming. It is happening slowly, but we are seeing the beginning of the end of the US dollar as the world’s reserve currency.
The dollar became dominant because for decades it was the only way to buy oil. Every oil-importing nation in the world – which means most nations – needed greenbacks to buy oil. Then, since everyone had dollars anyway, the greenback became the go-to for all international transactions.
The resulting demand for dollars meant the US could issue bond upon bond without downside. The petrodollar system is inarguably responsible for America’s dominant position in the world.
Now that system is starting to unravel. China, with almost US$4 trillion in its reserves and more than four times the population of the United States, is done dealing in greenbacks. China is pushing its currency, the renminbi or yuan, as an international alternative – and there are good reasons to bet it will work.
The first are currency swap deals that bypass the US dollar. The second is China’s growing pile of gold.
On the first front: China has inked currency swap deals with no fewer than 25 nations. Such deals allow bilateral transactions using direct currency conversions, bypassing the greenback as an intermediary.
The most recent deal was with Canada. The one prior to that was with Qatar, a major oil producer and a nation right in the heart of the petrodollar system. That deal opens the door for the yuan to compete directly with the greenback in the Middle East.
Other examples include the creation of renminbi clearing houses in Kuala Lumpur and an agreement turning Singapore, Asia’s leasing financial center, into a major renminbi hub by enabling direct conversion with the Singapore dollar. As for Russia, in the first nine months of 2014 direct settlements in renminbi and rubles were up ninefold year-over-year.
The renminbi is even becoming important for global debt. Renminbi deposits in South Korea are up 55-fold in a year. The UK government just issued a renminbi bond, making it the first foreign government to issue debt in yuan. The European Central Bank is debating the inclusion of renminbi in its official reserves.
A few years ago all of this would have been unthinkable. China deserves major props for its work advancing the RMB.
International acceptance is one part of establishing a powerful global currency. The second relates to China’s growing stack of gold. As China Gold Association president and Party Secretary Song Xin said in July, to become a global currency the RMB needs stable backing.
“To this end…it is very important to have enough gold as the foundation, raising the ‘gold content’ of the RMB. Therefore, to China, the meaning and mission of gold is to support the RMB to become an internationally accepted currency and to make China an economic powerhouse.”
And so we get to it: gold. China has been buying piles of the stuff, 2,200 tonnes last year and as much or more this year. That is in addition to all the 440-odd tonnes it produces each year domestically, none of which is exported.
In fact, gold never leaves China. Not in any substantial amounts. The world’s largest gold producer is also its largest gold importer. The yellow metal just accumulates there, waiting for China’s turn.
We don’t actually know how much gold China has. The Chinese central bank publishes its gold holdings when it feels like it, which means they last reported in 2009. At that point they claimed 1,054 tonnes in reserve, but there’s little reason to trust that number and no reason to think it means anything five years later. In short, no one knows the current number.
We do know that Song Xin says China’s reserve goal is 8,500 tonnes, which would represent the largest stockpile in the world. How’s that for currency support?
Others inside and outside China are increasingly speaking to the shifting sands of global currencies. For example, in late October former European Central Bank president Jean-Claude Trichet said this in a speech in Beijing:
“The global economy and global finance is at a turning point… New rules have been discussed not only inside the advanced economies, but with all emerging economies, including the most important emerging economies, namely China.”
A few months earlier Zhou Ming, general manager of the Precious Metals Department at China’s largest bank, ICBC, said similar things at the LMBA Forum in Singapore:
“With the status of the US dollar as the international reserve currency is shaky, a new global currency setup is being conceived.”
At the APEC summit a few weeks ago, Vladimir Putin said blatantly that it is his desire to “end the dictatorship of the dollar.”
The dollar is not going to disappear tomorrow. I don’t expect it to disappear at all – but I do expect it to lose importance and value.
That represents a seismic shift for the global economy. And what do investors and funds and central banks do when faced with uncertainty, especially currency uncertainty? They buy gold. That’s the essence of the long gold game.
In the short term: after OPEC’s decision to keep the spigots open hammered the price of oil last week, a wave of attention turned to gold. It stuttered, stumbled…and then put in a solid Monday rally to almost US$1,200. Today it closed above.
Why the rally?
For one, increasingly confident buyers now step in whenever gold falls by more than a few percent. And every time gold finds support, this group grows.
Secondly, there is mounting evidence that the physical gold market is getting very tight.
Tomorrow I’ll delve into that second point. For now, here’s to a slow but steady reset of global currencies, driven by China and supported by gold.
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