Why the case against gold is wrong

Molten gold © Getty images
Central banks don’t need to dig to get their hands on more gold

It’s no secret that I am a big believer in gold. But today I want to take a look at the case against gold. Starting from a low of about $250 per ounce in mid-1999, gold staged a spectacular rally of over 600%, to about $1,900 per ounce, by August 2011. Unfortunately, that rally looked increasingly unstable towards the end.

Gold was about $1,400 per ounce as late as January 2011. Almost $500 per ounce of the overall rally occurred in just the last seven months before the peak. That kind of hyperbolic growth is almost always unsustainable.

Sure enough, gold fell sharply from that peak to below $1,100 per ounce by July 2015. It still shows a gain of about 350% over 15 years. But gold’s lost nearly 40% over the past four years. Those who invested during the 2011 rally are underwater, and many have given up on gold in disgust. For long-time observers of gold markets, sentiment has been the worst they’ve ever seen.

Yet it’s in times of extreme bearish sentiment that outstanding investments can be found – if you know how and where to look.

There’s already been a change in the winds for gold so far this year.

A change that, in many ways, I predicted in my most recent book: The New Case for Gold.

But today I want to show you three main arguments mainstream economists make against gold. And why they’re dead wrong.

The questionable case against gold

The first one you may have heard many times. “Experts” say there’s not enough gold to support a global financial system. Gold can’t support the entire world’s paper money, its assets and liabilities, its expanded balance sheets of all the banks, and the financial institutions of the world.

They say there’s not enough gold to support that money supply; that the money supplies are too large. That argument is complete nonsense. It’s true that there’s a limited quantity of gold. But more importantly, there’s always enough gold to support the financial system. But it’s also important to set its price correctly.

It is true that at today’s price of about $1,300 an ounce, if you had to scale down the money supply to equal the physical gold times 1,300 that would be a great reduction of the money supply.

That would indeed lead to deflation. But to avoid that, all we have to do is increase the gold price. In other words, take the amount of existing gold, place it at, say, $10,000 dollars an ounce, and there’s plenty of gold to support the money supply.

In other words, a certain amount of gold can always support any amount of money supply if its price is set properly. There can be a debate about the proper gold price, but there’s no real debate that we have enough gold to support the monetary system.

I’ve done that calculation, and it’s fairly simple. It’s not complicated mathematics.

Just take the amount of money supply in the world, then take the amount of physical gold in the world, divide one by the other, and there’s the gold price.

You do have to make some assumptions, however. For example, do you want the money supply backed 100% by gold, or is 40% sufficient? Or maybe 20%? Those are legitimate policy issues that can be debated. I’ve done the calculations for all of them. I assumed 40% gold backing. Some economists say it should be higher, but I think 40% is reasonable.

That number is $10,000 an ounce. In other words, the amount of money supplied, given the amount of gold if you value the gold at 10,000 dollars an ounce, is enough to back up 40% of the money supply. That is a substantial gold backing.

But if you want to back up 100% of the money supply, that number is $50,000 an ounce. I’m not predicting $50,000 gold. But I am forecasting $10,000 gold, a significant increase from where we are today. But again, it’s important to realise that there’s always enough gold to meet the needs of the financial system. You just need to get the price right.

Regardless, my research has led me to one conclusion – the coming financial crisis will lead to the collapse of the international monetary system. When I say that, I specifically mean a collapse in confidence in paper currencies around the world. It’s not just the death of the US dollar, or the demise of the euro, it’s a collapse in confidence of all paper currencies.

In that case, central banks around the world could turn to gold to restore confidence in the international monetary system. No central banker would ever willingly choose to go back to a gold standard.

But in a scenario where there’s a total loss in confidence, they’ll likely have to go back to a gold standard.

The second argument raised against gold is that it cannot support the growth of world trade and commerce because it doesn’t grow fast enough. The world’s mining output is about 1.6% of total gold stocks. World growth is roughly 3-4% a year. It varies, but let’s assume 3-4%.

Critics say that if world growth is about 3–4% a year and gold is only growing at 1.6%, then gold is not growing fast enough to support world trade. A gold standard therefore gives the system a deflationary bias. But that’s nonsense, because mining output has nothing to do with the ability of central banks to expand the gold supply.

The reason is that official gold – the gold owned by central banks and finance ministries – is about 35,000 tons. Total gold, including privately held gold, is about 180,000 tons. That’s 145,000 tons of private gold outside the official gold supply.

If any central bank wants to expand the money supply, all it has to do is print money and buy some of the private gold. Central banks are not constrained by mining output. They don’t have to wait for the miners to dig up gold if they want to expand the money supply. They simply have to buy some private gold through dealers in the marketplace.

To argue that gold supplies don’t grow enough to support trade is an argument that sounds true on a superficial level. But when you analyse it further, you realise that’s nonsense. That’s because the gold supply added by mining is irrelevant, since central banks can just buy private gold.

The third argument you hear is that gold has no yield. It’s true, but gold isn’t supposed to have a yield. Gold is money. I was on Fox Business with Maria Bartiromo recently. We had a discussion in the live interview when the issue came up. I said, “Maria, pull out a dollar bill, hold it up in front of you and look at it. Does it have a yield? No, of course it has no yield, money has no yield”.

If you want yield, you have to take risk. You can put your money in the bank and get a little bit of yield — maybe half a percent.

Probably not even that. But it’s not money anymore. When you put it in the bank, it’s not money. It’s a bank deposit. That’s an unsecured liability in an occasionally insolvent commercial bank.

You can also buy stocks, bonds, real estate, and many other things with your money. But when you do, it’s not money anymore. It’s some other asset, and they involve varying degrees of risk. The point is this: if you want yield, you have to take risk. Physical gold doesn’t offer an official yield, but it doesn’t carry risk. It’s simply a way of preserving wealth.

I believe the primary way every investor should play the rise in gold is to own the physical metal directly. At least 10% of your investment portfolio should be devoted to physical gold – bars, coins and the like.

• You can discover more about my thoughts on gold by picking up a copy of The New Case for Gold.

  • DemiGod

    Gold will rise as governments (sovereign debt) fail, agree. But gold will rise with other assets too. Will those with gold suddenly get very rich and those without be destitute? That sounds like a spark for revolution to me given the few people holding gold. Gold is not readily convertible to cash for food, Amazon or my local shops won’t take it. I don’t disagree with gold rising to silly numbers, but what good is it if no one takes it, the currency does not exist anymore or every other asset has also risen in line? It is a temporary hedge against government, but I highly doubt it will ever form part of a currency base in percentage you describe.

    • Marcus Sims

      “But Gold will rise with other assets too”.

      Yes, Gold will probably rise with other assets in a period where sovereign debt fails. However, if we enter a great depression or stagnation gold could continue to climb vs. commodity’s like copper, silver, zinc etc as they have immense industrial use cases. If the economy hits the fan, the supply/demand disequilibria will kick in and prices will fall. Now ask yourself what is gold used for? Yes, there is basic applications like dentistry, electronics but it’s relatively slim vs. it’s peers. I am sure we can agree it’s most notable use case is Jewelry. But keep in mind jewelry is interchangeable (fungible) which = wearable wealth. Physical gold is physical gold it will never matter how it’s shaped or the size it’s cut into, the physical properties of gold will never change (timeless, won’t oxidize etc).

      “Will Those with gold suddenly get very rich and those without be destitute?”

      Honestly, I would have thought the same thing a short time ago. However, in unprecedented times usually, innovation is the savior of mass destruction. In this case with money, it seems Goldmoney is emerging to fill this deed. You would think for the ones fortunate enough to catch this looming phenomenon of negative interest rate policy, central banks buying up assets like impulse buyers on the trading floor, the fed’s forward guidance being played like a reality TV would seem to set for a massive explosion in the price of gold. Of course, I agree but Goldmoney through technology has brought divisibility to gold like never before. You can sign up to their platform, buy as little as 0.001 g of gold, so as the price shoots up and the standard sovereign coin and bars become too expensive, you can still buy gold on your terms at an affordable rate. Equalizing & democratizing accessibility.

      “Gold is not readily convertible to cash for food”

      It is now. In fact, I spend gold all the time. Through Goldmoney I buy gold 1% over spot quickly & efficiently redeem it to my prepaid MasterCard almost instantaneously. Once upon a time I had to take my hefty bag of gold eagles to a pawn shop and negotiate the sale price to liquidate. Goldmoney is straight forward, will always be 1% to buy & sell gold bullion. Additionally to your amazon comment, they have a payment button I believe called “Goldmoney Pay” where website owners can embed a piece of code on their site and begin to accept gold as a source of payment. Hopefully, amazon offers this soon so I can directly pay with gold : ).

      “I highly doubt it will ever form part of a currency base in percentage you describe.”

      It slowly is becoming a mainstream currency naturally. Gold always had some sort of link to money, the last 45 years (since the Nixon shock) has been the unprecedented money experiment. The infinity of issuance dilutes fiat’s value while gold requires human energy & capital and equipment to produce. It is pretty evident the credit based economy is on the road to serfdom; which will only add to this emerging shift in mediums.

  • commenter377

    According to the article, with a 40% gold backing, the corresponding gold price is $10,000. But then the article goes on to say that the price for a 100% backing, namely 2.5 times the rate of backing, with the same quantity of gold, is $50,000. You don’t need a PhD in mathematics and a bank of supercomputers to see that 2.5 times $10,000 is $25,000—not $50,000.

  • CumSailAway911

    Jim Rickards article “The Case Against Gold” covered only three arguments against gold, which he dispatched fairly well.

    However, he omitted several other cases against gold. Perhaps because they are NOT so easily dealt with?

    Can we call this omission PROPAGANDA?

    OMISSION 1: Central banks look quite likely to move from paper currency altogether… to digital blockchain-type money that everyone in an economy is constrained to use. i.e. Gold, silver, other metals NOT used as a money base!

    OMISSION 2: Has Jim Rickards actually tried to use gold as money? Has he been into a store with grams of gold to buy food? Was the gold accepted as money?

    OMISSION 3: When famines, earthquakes, storms, floods, and depleted soils end our current food surpluses. How long will Jim Rickards survive on a diet of gold? How much gold will he exchange for a loaf of bread when he’s about to die of starvation?

    It would be ethical of Jim Rickards to state that he’s involved in the gold trading business, when he’s OBVIOUSLY pushing gold investment.

    MONEYWEEK is an interesting commentary on the comical and tragic economic environment we find ourselves in. However, material, financial gain and wealth preservation is NOT the purpose of life on earth!

    Paul Hunt

    • Dave

      I love your last paragraph, well said sir.

    • JC

      “However, material, financial gain and wealth preservation is NOT the purpose of life on earth!”
      To that end you are right but at the end of the day this is a Financial magazine so financial commentary is sort of the order of the day!.

      • CumSailAway911

        The financial commentary order of your day at MoneyWeek needs broader context. The article about gold omitted some important points against gold, thus making it a kind of propaganda for gold. A true assessment of your commentary and articles at MoneyWeek needs broader vision for context, as well as confirmation of figures, facts and details. Financial affairs may be uppermost in some minds. However, for me they are at least secondary. And i’m sure you will agree that political affairs overshadow financial affairs, which can be totally eclipsed by political actions such as regime change and war. What is your financial commentary to help people in Iraq, Syria, Libya,…? Or is it rather that financial interests have played a large part in causing such wars in the first place? Some of your commentary at MoneyWeek i find rather unethical, but that’s just my opinion, as all my other words are too. Thank you for allowing them space.

    • Marcus Sims

      Hi,

      I would like to address some of your ‘omissions’.

      OMISSION 1:

      Jim makes it quite clear in his book that this war on cash (cashless society) has significant repercussions. The digital blockchain is an amazing technology which will totally disrupt the way we all look at central authority, however, if a central bank designed the way it functioned I doubt the privacy constraints would align with the blockchain founder’s ethos (privacy protection.) Personally, I don’t think there is room for an anonymous money system… that’s a debate for another day.

      Digitalization of money requires power (electricity). Sometimes power can be eliminated for days or weeks due to unforeseen circumstances (disaster, weather, etc.). The circulation of physical cash or a future tangible proof of work is imperative because it’s real and not just digital bits.

      OMISSION 2:

      I am unsure with regards to Jim using gold as money, but I have. There is a service called Goldmoney which allows any user to buy (for 1% on the spot price), send/receive, redeem and SPEND gold bullion at traditional points of sale all over the world. So yes, the century’s best performing currency can be spent.

      OMISSION 3:

      LOL, well I will avoid the spastic question. But I recommend you learn about vertical farming or 3d printed food. If things are as catastrophic as this omission let’s pray these technology’s resolve your concern. However, to answer your question my bet is on gold to buy more “loafs of bread” as if was a shortage of food… would probably mean your national currency is in a hyperinflationary state.

      Cheers.

      • CumSailAway911

        Not to avoid your “spastic question” your comments on omissions 2 and 3 contradict your critique of omission 1. Payments using tiny amounts of gold and technological methods of food production you mention require electrical power, which you say is a weakness for using blockchain-like technology! So when power is down you won’t be able to 3d-print food or pay in gold over an online account. All electrical methods of production and payments will be down!
        And IF you wish to quote me, please do it correctly. I did not write “loafs of bread” as you quote! And i’m not at all sure i’d like to eat 3d-printed food. There are other omissions in Rickards’ propaganda for gold: state confiscation, fake gold filled with tungsten etc, and the very tiny amounts to pay for things, especially IF as Rickards thinks gold defies gravity and goes through the roof. Electronic payments based on gold don’t seem any safer or better than blockchain methods not based on gold. By the way, “bread” is a euphemism for “money”! And that’s why i mentioned it. You lay your bet on gold, and i’ll continue with daily bread…

  • commenter377

    “If any central bank wants to expand the money supply, all it has to do is print money and buy some of the private gold.” This will work when people trust the government’s gold pledge and are therefore willing to trade in their clunky and illiquid lumps of gold for the much more convenient, divisible, and transmissible paper or electronic accounting equivalent—money. It won’t work when poeple don’t trust the gold pledge (on which, historically, all governments have reneged). In that case, partial backing of 40% by gold will require the central bank to reduce its gold holding by 250% of the net rate of tendering of the money that the gold is backing. The bank therefore, in addition to holding on to the tendered money, will have to find some way of reducing the money supply 150% beyond the amount tendered, in order to retain the backing ratio.

    This difficult situation would be much relieved if partial backing is replaced by multiple backing (e.g. 400% rather than 40%), so that adjustments to the money supply can be made easily in either direction. Multiple backing would also increase confidence in the gold pledge, so that the normal situation is one where the issuance of fresh currency to buy gold is feasible.

  • dfjkbvdjkf

    Gold only enjoys the status it has because governments choose not to tax it in the same way that purchases of other materials are taxed.

    There is no guarantee that this status as an investment, rather than as a good, will continue. As soon as gold becomes subject to (say) a 20% VAT surcharge on its purchase it’s value as a personal investment or store of value disappears.

    Since there is nothing intrinsic in gold that would prevent this change in opinion, it can’t be considered as anything more than a short-term (some years) and rather volatile alternative to usable assets.

    Although it is said that gold’s lack of practical use is a benefit, that consideration is purely artificial .That lack of use means that the only thing that supports the price of gold, is the investment that people already have in it. A classic bubble.

  • Marcus Sims

    Like always, Mr. Rickards insight on gold is invaluable. I would like to argue a few points made in this comment section though as it seems most have the core framework down of gold, however even Rickards forgets one of the most epochal rebuttals to gold haters. Let me start with @DemiGold.