Gold is glittering; but is it the endgame?

Not long back in global history, aluminum was thought to be more precious than gold. Most powerful kings were served food in aluminum utensils while the lesser knights had to do with gold flatware. The sudden change in the value of aluminum took place when much cheaper means of refining the ore became available. Suddenly, it was disposable – as in aluminum foil or cola cans. In no time it transformed from the most expensive thing in the world to garbage.

Similarly, in the African continent, for a long time, common salt remained a more prominent store of value and medium of exchange than gold. For the past two centuries though, gold has been globally preferred as a store of value over another commodity, primarily for its limited supply and physical traits that make it indestructible.

However, in the past four decades, the demand for gold for storage of value, vanity, social and financial security, and religiously important object has certainly diminished. In my view, there is no reason to believe that this trend will reverse in foreseeable future.

I strongly believe that when economics fails in providing a solution to the problem of livelihood and sustainability, philosophy provides the answer. It is a natural instinct of human beings to look up to the skies for guidance when all our efforts fail. Some even do so without making any effort at all. Religion has therefore been an inextricable part of human life since the beginning of the civilisation and has grown with the growth and expansion of global trade and commerce.

Most ancient civilisations -- Chinese, Egyptian, Mesopotamian and Indus Valley -- have believed in the continuation of life after death. Gold being an indestructible (and therefore sacred) object had always been an important part of their religion, culture, traditions and beliefs, inasmuch as gold formed a key element in the rituals to be performed after the death of a person. Gold has been buried in the graves, implanted in tombs, and donated to the priests in these cultures.

However, the factors such as popularity of technology; rising fascist and communist ideologies due to worsening socio-economic disparities; rise in electronic transactions (personal, social and commercial) and the resultant lower risk (less travel, less physical transactions and deliveries); emergence of new articles of luxury to serve the vanity needs of the affluent; stronger and deeper social security programmes; demise of monarchy; spread of spiritualism; and decadence of church and temples have resulted in a diminution of traditional demand and pre-eminence of gold.

In the modern context, technologically challenging things, e.g., cryptocurrencies, have more potential to attract peoples’ fancy as compared to gold, I feel. The spread of radical forces is the only factor that somewhat weakens my conviction in decline of gold. But the way the global war on radicals is progressing I am sure that in the next decade or so we shall see this concern easing materially and then gold may decline rather precipitously in value.

Gold relevant today...

The demand for gold as a store of value is a deeply complex matter. In the past, gold had been a preferred asset to store value both during economic as well as political (including geopolitical) crises. Gold has served as reserve currency whenever the paper currencies have lost the faith of people due to a variety of reasons, particularly high inflation and/or fiscal profligacy. It has also been used as such during transition periods in global strategic power equilibrium.

However, since the end of the Breton Wood agreement in 1971, gold has not been used as a reserve currency. In the post-Berlin Wall (1989) era the strategic supremacy of the US, and consequent dominance of the US dollar, have remained mostly unchallenged.

In the past five decades post-Breton Wood, there have been two instances of a global financial crisis. In the 1970s, the world faced serious stagflation as the demand generated by post-WWII reconstruction activities faded and the Iranian revolution created a worldwide energy crisis. Gold jumped 10x in real terms during the decade of 1970-1980), to give back most of the gains in the following two decades. Again in the decade of 2000s, as the dotcom bubble hit the global economy, interest rates crashed leading to sub-prime crisis that culminated in a major global financial crisis. The gold jumped 5x in real terms during this decade (2001-2011).

Gold is still to cross its 2011 high. But given the negative rates in large economies like the EU and Japan and near zero in the US; persistent deflationary pressures despite unprecedented and obscene amount of money printed by central bankers; poor economic growth outlook; and the war-like situation in global currency markets, the gold is reemerging as a favourite asset to store value.

...but not the endgame

The socio-economic disparities are rising in the developed world at a pace unprecedented in economic history. The situation in my view is likely to materially worsen in the coming years. Inarguably, the so-called unconventional monetary policies followed by the central bankers are primarily responsible for this phenomenon. An overwhelming $15-17 trillion worth of bonds, many of which are 10-30 year maturity, are yielding negative return at this point in time; and many more promise to return no income to the holders. Poor savers and pensioners who mainly rely on their savings for their livelihood are stressed like never before.

Large economies like Japan and the EU have mostly failed in their vigorous efforts raising inflationary expectations in their respective economies. There is therefore little incentive to invest in these economies. The employment opportunities, therefore, are not likely to rise in any sustainable manner. We have already seen the unsustainability of one decade of job gains in the US. All jobs created in 2009-2019 have evaporated in just one month of lockdown.

There is no dearth of experts who have written about the endgame of the current monetary policy practices. Most of them suffer from historical hindsight and extrapolation of current trends. Being no expert on global economics and monetary system, I can afford to conveniently break from the empirical experience and think freely. I believe the endgame will mark a watershed in global economic history - among other things, many systems will become redundant; many currencies will cease to exist; and monstrous debts will be written off the books. It is difficult to fathom that this task can be achieved under the current democratic system. A new avatar of Karl Marx may, therefore, rise sometime in the next decade. We need to keep a close watch on the horizon to discover the signs of that.

A large number of analysts have forecasted that gold will be a preferred currency of the world amidst all this chaos. I beg to disagree. In my view, presently the interest in gold appears to be more intuitive rather than analytical. It is being presumed that the endgame of the non-conventional monetary policies currently in practice will be prolonged stagflation, complete disintegration (or euphemistically restructuring) of the present monetary systems where the US dollar may no longer be the sole reserve currency and near-complete erosion of savers’ financial wealth.

I find most of the current analysis suffering from some degree of cognitive dissonance. It is trying to dress a trading opportunity into a secular trend. I do not see any reason why gold should ever touch its 1980 high in real terms and why not go below its 1971 lows (in real terms).

-Published on June 27th, 2020