As we assess government and central bank responses to the global sovereign debt crisis, we remain bullish on gold despite the near-term weakness due to dollar strength. The latest plan from Europe of the LTRO (Long Term Refinancing Operation) is simply more can kicking and quantitative easing.
Global central banks are in a race to debase their currency in order to export their way out of the crisis. The world suffers from an aggregate demand problem, which is being exacerbated by austerity measures in the developed world. While the timing is difficult to pinpoint we believe QE3 is inevitable as the recovery remains weak. Unemployment remains at elevated levels and 2012 will likely be met with reductions in government spending. Our view is that gold remains a strong asset as the U.S. dollar debases long-term.
The chart below highlights that gold and CPI respond to increases in the monetary base.
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Gold is difficult to value as it earns and yields nothing. Many gold bulls point to the U.S. monetary base as a guide post for valuing the inert asset.
In relation to the bubble levels of the 1980s, where the gold price exceeded M0 (U.S. monetary base), today gold is comfortably under the seemingly ever expanding monetary base. Our view is that the monetary base will only grow as the U.S. faces a very weak economy, saddled by large debt loads. This growth in the monetary base will provide tailwinds to gold.
Since severing ties with gold in the early 1970s, the growth in overall financial assets has been significant. Global financial assets have risen 17-fold over the last three decades from $12.3 trillion to nearly $210 trillion. We believe that the investor base is significantly under-weighted to gold.
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Gold Performance During QE1 and QE2
QE1 and QE2 lasted for 15 months and eight months, and gold was up 36% and 21%, respectively, during these periods. During the same timeframe the S&P 500 was up 36% and 24%, respectively.
We own gold and silver in physical and ETF forms (GLD and SLV). We follow a policy of not timing the market, but slowly accumulating these metals, as they are our insurance policy against inflation. Investors interested in vehicles that retain physical metal should look into Sprott Asset Management’s Sprott Physical Gold Trust (PHYS) and Sprott Physical Silver Trust (PSLV).
Additional disclosure: Long physical gold and silver.