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is owning gold worth the risk?

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Better than money in the bank


Recently, gold prices have been on a tear. Over the years, like other commodities, gold price has huge run ups followed by big drops. With gyrations like that, why would an “investor” own it if it requires impossibly precise timing, compared to some assets like Walmart stock which has active experts running it and tend to its perpetual growth. Here we show that Gold is in fact more than investment worthy, and indeed it has its own perpetual growth engine built-in. Combined a series of possible extra forces to come for the second half of the decade it can be a major producer for a portfolio and a excellent alternative to absurdly expensive equities.

The Gold price (in USD) is at an all time high in terms of absolute dollars, and near its all time high in terms of its CPI adjusted price.

Gold prices in absolute (left) and inflation adjusted terms(right). US economic recessions are shown in gray.

While western investors have been mainly selling physical gold since 2022 (725 Tonnes over the last 24 months) by liquidating their ETF position. The big buyers have been the central banks world-wide; a very noteworthy change that started back in 2011, with 2022 at an all time high, 2023 a close second. 2024 is well on track to beat both.

This signals important (if not revolutionary) changes may be taking place behind the monetary scenes. Such a possibility of fundamental change in the status of gold to monetary gods is clearly speculative, after-all the “new” trend has barely undone the sell-off in the previous 20 years. However, can we at least find reasons to own gold as a good investment? Any other add-on force will be a bonus to long term holdings of gold.

We have argued (due to unalterable demographic shift) inflation is not going away any time soon, and may in fact be rising considerably into the next 5-7 years ( From the first graph above, we can easily see that gold is at least a good hedge against inflation, beating cash eroding in the typical retail US bank account, handily.

We will show below that the general uptrend in gold prices is easily and largely explainable simply by comparing its (above ground) supply relative to fiat currency. More specifically in terms of the ratio of the supply of gold to the supply of US-Dollars. Hence it is simple scarcity that is driving the majority of long-term rise in the price of gold.

Below, we see both the supply of gold (gold dots) and supply of US-Dollars (green dots) from 1914 through 2023.

Note how amazingly well the supply data (top two curves) fits simple exponential prescriptions as a function of time. Exponential curves look like straight lines on a semi-log plot such as shown. Next note, is that the growth supply of Dollars is much faster than the growth is Gold (steeper green points).

How much of the rise in the price of gold can be explained by this difference in supply growth? We represent the difference in supply growth above by plotting the Ratio of Dollars to Gold using the gray points. Not surprisingly, the ratio (modulo a simple scale factor) also fits an exponential model very well (fine-dotted lines).

Finally we’ve plotted the absolute price of gold in yellow dots. With a simple scaling of the Ratio (included), we can see how closely the two curves are correlated.

Below we will create a simple model that connects the latter two series. Then using the exponential functions (shown above) we will extend the two supply curves (top) into the near future and then compute their implied price for gold as a forecast.

A “power” relation seems to fit the relationship between the supply-ratio and Gold price surprisingly well including pre-Nixon decades, where Gold-price was artificially fixed.

Linear plot of Gold-price v corresponding supply-ratio at the end of that year. Note that there is no time-axis on this plot; it is technically called a phase-space (or more technically a sub-space, as there could be other related variables to describe the dynamics even more fully).

The simple model is of form: gold-price [in $/Oz]=A (supply-ratio [in $Bn/Tonnes] )M. Where A and M are constants resulting from the fitting procedure. After extending the supply ratio into the 2025-2030 range, we can use the model to estimate the expected Gold-price in 2030 at just above $3,000/Oz with a standard deviation of ~$500/Oz. Thus, on the high end (2-sigma) the price can easily be above $4k/Oz in 2030, however, that is only due to the steady growth of Golds scarcity relative to dollars.

The above model does not include potentially large scale biases due to 1. structural monetary shifts (mentioned above) or 2. short-term fluctuations in either of geopolitical or monetary forces, or 3. most potently, a combination of those forces (more on that below). Here is a good example of category 2:

Albeit, keep in mind the US central bank may not be done raising rates.

One potent combination of forces conspiring for much higher price of gold can be the increasingly-feared prospect of “de-Dollarization”. While it is not difficult to convince oneself that there is no good prospect of a sovereign fiat currency to replace the US-Dollar in international exchange, it is not as easy to argue the same for gold, and yes, cryptocurrency as well though it is yet to mature, (assuming the world empires will let it).

2023 saw unprecedented volumes of trades (especially in crude oil and gas, wheat and weapons) carried out using gold flown around the world in jumbo-jets. This is not so hard to believe: with a cargo bay capacity of over 100,000kg (i.e., not even counting the main cabin) at a price of $2,200/troy-ounce. A single full plane can deliver almost $7billion from place to place. This may be one (if not the) factor that is driving the spike in sovereign demand for physical gold over the last 12 years. Russia’s hoarding of gold since 2013 is well publicized.

Keeping gold in a investment portfolio is sane, and offers tremendous safety margins against both uncertainty and inflation, all at a decent rate of return. To boot, as of this writing, gold miners, physical silver and platinum as well as the miners of the latter two have fallen far behind gold (likely,) for the simple reason central bankers are not accumulating them as they do physical gold. All three categories of assets offer potentially explosive returns.

We close with another informative graph from our friends at Incrementum’s monthly report:

For reference, today S&P500 is about 55% higher than MSCI world index.