Could gold hit £10,000 in the long run?

As I started writing today’s Money Morning, gold was plummeting. It had slide by $22 even before New York had opened. It’s now trading at around $1,708 an ounce.

This correction was predictable. (The proof of that is that I predicted it.) I don’t think it’s anything serious, just a normal pullback – normal for the time of year and normal given the up-move gold had over the summer.

I see support, as I said last week, in the mid-to-high $1,600s. Worst case, it may go back to the low for the year at $1,520. I doubt it, though.

That said, in such periods, a little morale boost can be handy. So today I’m going to take a look at some gold chart erotica…

How much gold does it take to buy the FTSE 100?

First, we compare the price of gold to the FTSE 100 – how many ounces of gold it takes to buy the FTSE. The FTSE currently stands at 5,800. An ounce of gold is about £1,080. So it takes just under 5.5 ounces to buy the FTSE.

In the summer of 1999, shortly before Gordon Brown decided to sell, with the FTSE some 10% higher at around 6,500 and gold around £160 an ounce – yes, £160 – it took around 40 ounces of gold to buy the FTSE. The FTSE has fallen by some 85% against gold since then. Here is the chart showing that ratio since 1935.

Gold ratio versus UK stock market 1935 to present

(These charts come courtesy of Thomas Paterson and Gold Made Simple for whom Thomas is chief economist. I recommend his work.)

Fans of long-term cycles – Kondratieff winters and the like – will detect a clear business cycle here. Periods of growth and expansion – the 1950s and ‘60s, the 1980s and ‘90s – followed by periods of contraction – the 1970s and ‘00s.

Such a cycle is not apparent when you look at long-term stock markets measured in government currencies, such as the pound or the dollar. These currencies are routinely debased and so the declines are get hidden by the loss of the currency’s purchasing power. Constancy is one reason I think gold makes a much better unit of account than government money.

It’s interesting that Brown sold our gold shortly after he made that delusional declaration, “no more boom and bust”. An 85% fall is very much the stuff of busts.

Betting that a market which has already fallen by 85% will fall further may not seem a great idea, even if that is the direction of the trend. So should you be rolling out of gold and into stocks?

I don’t have strong views on the equity markets just now. I’m not especially bearish or bullish, just nervous. But the fundamentals for gold are so much better than the fundamentals for stocks, that I can’t help thinking gold is still the place to be. Some kind of monetary crisis seems inevitable, and in such a situation, you want to own gold.

Yes, huge gains have been made by those who rolled out of equities and into gold in 1999. But that’s not to say that further huge gains can’t still be made. For example, what if the gold price were to return to the relative extremes of the 1970s, when its ratio to the FTSE was as low as three, two or even – on one day in January 1980 – 1.2?

If the FTSE stayed flat and the ratio went to two – in other words, it took two ounces of gold to buy the FTSE at today’s level – then the gold price would be £2,900. That’s a near triple on today’s price of £1,080. If it went to 1.2, the gold price would have to be around £4,800, a near-450% gain.

What the Bank of England’s gold holdings say about the gold price

Here are some other interesting statistics to ponder: the Bank of England’s balance sheet, and its gold holdings.

Here’s why I think that some kind of monetary crisis is inevitable. As Patterson notes: “Since the Bank of England started buying up UK debt at the beginning of 2009 the UK has issued about £724bn in new debt. Over that time period the BoE has bought up £365bn. Which means that a staggering 50% of ALL newly issued UK debt has been covered by the BoE.”

At 50%, the BoE has almost become the market for gilts. I can’t see how such artificial intervention can end well for sterling. The BoE is creating an artificial market – a bubble in other words – in government debt. This ability to borrow at artificially low levels means that governments are not being forced to cut spending in the way that they should.

Here’s the BoE balance sheet since 1830, again courtesy of Patterson.

Bank of England balance sheet since 1830

Note the acceleration of the late 1960s and ‘70s. Then the even greater acceleration since 2008, which we see below with the BoE’s balance sheet since 2006. The £400bn threshold has been crossed.

Bank of England balance sheet

The consequences of expanding the balance sheet in that way will be hard to control. I do hope there are contingency plans in place beyond just reacting to events.

My concern is that now this pattern of balance sheet expansion has been set, there is no way back. Should the economy not recover sufficiently, the answer will be even greater stimulus. That’s not good for the currency.

If we look at the percentage of the BoE balance sheet that has been backed by gold since 1830, we can see that we are now at all-time lows.

Percentage of Bank of England balance sheet backed by gold

As Patterson notes on the chart above, the long-term average is for the BoE to have enough gold to back 25% of its balance sheet. Currently 2.7% is backed. (We have 310 tonnes of gold – almost ten million ounces – worth £10.8 bn.)

One way to return to this historical average would be for the bank to buy a heck of a lot of gold: 2,600 tonnes, about 90% of annual global production (2,850 tonnes). That’s not going to happen.

Another option to return to the average is for gold to have a dramatic upward spike – or more likely, sterling a downward one. That would give gold a £10,000 an ounce price tag – almost a ten-bagger from here.

But gold at £10,000? If we hit those numbers, we’d be well into currency crisis territory. I’m not sure sterling would survive that in its current form.

Of course, perhaps talk of these numbers is absurd. Another alternative is that the BoE never returns to the historical average of 25% gold backing. Gold remains, as Ben Bernanke calls it, “a tradition”. And the BoE is able to continue expanding its balance sheet at this rate without any consequence to the holders of the currency.

Me? I’m going with the absurd talk – at least for the time being.

Finally, my book. It’s a simple-to-understand look at the mess the West now finds itself in, and how changing our currency system could help us get out of it. And it’s almost funded now – I’m 87% of the way there. Any help to get me over the line would be much appreciated. If you’re interested in things libertarian, things golden or things economic, please take a look here.

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