Gold, Gold, Gold

May 15, 2020

In a world of unlimited printing of fiat currencies, gold looks set to go higher (currently $1,740/oz at time of writing).

The COVID-19 induced recession has arrived. And with it, and with record speed, monetary & fiscal policymakers have responded. Short-term interest rates in the developed world are effecitvely 0%, and long rates are not far behind (US 30yrs are at 1.30%). The US & Canadian federal deficits have exploded, financed by quantitative easing, as policymakers have resorted to sending cheques to millions of households or subsidizing their wages. The world is at the start of a recession, and is going into it in the same indebted position as before the global financial crisis. Given the enormous amount of uncertainty around the virus’ trajectory (recently a a WHO official said it could take 4-5yrs to control) the uncertainty around potential economic outcomes has increased dramatically.

I will do my best to not overcomplicate things with respect to why gold can go higher in USD terms. The US government is, with a few keystrokes, creating trillions of dollars of fiat currency and disbursing it to individuals and firms which deposit it in bank accounts along with the fiat currency they already own. The US government will continue doing this in some form through the multi-year recovery phase we are about to enter into.

Now a reasonable person might ask, “if the government can just ‘do’ this, how much is fiat currency, especially that which pays 0% interest, really worth?”

Now there are all sorts of complicated arguments that can be made about the deflationary effect the recession will have, and we can point to the experience post 2008 to see, at least in CPI terms, we did not get much inflation. Yes one can make those arguments, but I can’t say they satisfactorily answer the aformentioned question. And the honest answer to that question is “well yes most of the time that cash you own is actually worth something, but throughout history in extraordinary circumstances the worth of fiat currency can decline dramatically in a short span of time.” A great chart below which illustrates this from Ray Dalio’s recent piece.

Are we in extraordinary circumstances? Is there the risk that by printing trillions of dollars policymakers ‘get it wrong’ and bring about inflation? Or similarily, has the risk gone up that policymakers try to avoid making hard decisions by inflating away the debts that have been accumulated by individuals, companies, and governments? I think it’s safe to say the answer to all of these questions above is yes.

The hedge which protects against the above risks is gold. I would not be surprised to see the price of gold continue to rise as investors become more sensitive to/aware of these risks. The playbook for this is what happened to gold after the Fed engaged in a variety of QE programs after the GFC. If anything this time-around there is even more reason to fear these risks since policymakers are much further down the rabbithole of unconvential policy (e.g. buying HY bonds, sending cheques directly to individuals, short rates & long rates at or near 0%) then they were in 2008, and Washington no longer cares about the deficit anymore. Gold is at high levels yes, but we are truly in unprecedented times and I think it should be able to break through the all-time high of ~$1,900 set in 2011. Once that happens a speculative fever among retail investors could take hold bringing us through $2,000 and beyond.

This is not investment advice

As of 2020/11/30 with gold moving back to $1770 I have closed my gold position