The United States led effort to suppress the price of gold in order to preserve the premier status of the U.S. dollar is allowing China and Russia to capitalize by purchasing huge quantities of gold reserves at artificially low prices. In the first quarter of 2018, central bank net purchases rose 42% year over year. Russia has reported the largest gold purchases of late, but China may not be far behind. Central banks have purchased more gold than U.S. Treasuries over the past two years according to John Hathaway of the Tocqueville Funds in his September 2017 interview with Kitco.
China is keenly aware of why the U.S. would prefer to see the price of gold be kept under wraps - the U.S. dollar serves as the reserve currency of the world. China, Russia, India and other countries are accumulating gold to diversify their reserve financial assets away from the U.S. dollar. This anomaly presents a perfect opportunity for investors to buy some gold or shares of gold miners. Unfortunately an artificially low gold price also allows Russia and China a discounted price to accumulate large gold reserves which may threaten the dollar's role as the main "reserve".
An April 28 2009 cable sent by the U.S. embassy from Beijing (released by Wikileaks)-
"According to China's National Foreign Exchanges Administration China's gold reserves have recently increased. The U.S. and Europe have always suppressed the rising price of gold. They intend to weaken gold's function as an international reserve currency. They don't want to see other countries turning to gold reserves instead of the U.S. dollar or euro. Therefore, suppressing the price of gold is very beneficial for the U.S. in maintaining the U.S. dollar's role as the international reserve currency. China's increased gold reserves will thus act as a model and lead other countries toward reserving more gold."
Jim Rickards (author of "Currency Wars") reported that China secretly doubled its gold holdings between 2004 and 2009, by using a sovereign wealth fund "State Administration of Foreign Exchange" to make covert purchases. These purchases were executed outside the China central bank so as to avoid running up the purchase price of gold. This 500 metric ton purchase was then transferred over to the central bank and made public. (page 163)
The unprecedented explosion of U.S. debt caused largely by the 2008 Quantitative Easing by the Federal Reserve has led to a huge rally in U.S. equity prices and in total debt that must be repaid. Some would argue that it has led to a "distortion" in capital allocation when compared to value. This exhibit shows the market value of "Above ground" gold vs. that of U.S. financial assets (including equities and debt).
If the gold price returns to the 5.1% average relative market value ratio-the price would reach $1,918 per ounce. A leap from today's $1,300 price up to $1,918 would be a sizable 48% gain. If another financial crisis were to arrive, one would expect the price of gold would run much higher than just the average over time.
The United States cannot stop other central banks from buying physical gold (or silver) but why would we allow our international competitors to purchase the precious hard "currency" at such a discount to its actual unimpeded value? Surely the U.S. is aware that our rivals are stocking up on gold.
As an investor and a contrarian, one can see the signals to buy gold or gold miners such as McEwen Mining (MUX) are flashing green. McEwen Mining, ($2.16 per share as of 6/11/2018) is particularly attractive to investors looking for a large beta relative to an increase in the price of gold. The stock rocketed from under $1.00 in late 2008 up to $9.58 in April of 2011-a gain of over 900%. The price of gold rose just under 300%, going from about $700 to $1,900 per ounce during the same period.
Hathaway correctly points out that small cap miners (McEwen has a market capitalization of $800 million) who hold established projects, but lack capital-will be prime targets for mergers or potential joint operations. Many larger mining companies are experiencing declining production and have a need to replenish. McEwen recently indicated that he would pursue a merger or acquisition.
In 1966, prior to his appointment as Fed Chairman, Alan Greenspan wrote, "In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value...Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process."
Gold is money that cannot be printed. The full faith and credit of the United States that stands behind the U.S. dollar today, does not hold the same reassurance as it did 50 years ago. Gold will therefore move higher as central banks and investors bid up the price, because there is a limited supply. There are no limits to electronic or printed currencies.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in MUX over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.