The Long-term Bullish Case for Gold
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Audible. There's more to imagine when you listen. Go to audible.com slash imagine and discover all the year's best waiting for you. Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I'm your host, David Stein. Today is episode 431. It's titled, The Long-Term Bullish Case for Gold.

In the past nine years, we have released several Money for the Rest of Us episodes on gold investing. The first was in December 2014, episode 37. At the time, gold was priced at about $1,100 an ounce, down from $1,900 an ounce, its all-time high, in September 2011. That's a 42% decline in three years.

Now, I didn't own gold in December 2014 when I did that episode. On the show, I've talked about investment journeys and how it can take time to learn a new asset class, to get comfortable with it, recognizing we're never sure how things will turn out, we'll make mistakes. And it took me a while, a decade or more, to get comfortable with gold from a

traditional finance background, gold was sort of looked down upon. There was a lack of cash flow. It was just a shiny rock. But...

Over time, as I began to better understand some of the risks with fiat currency, the risk with central banking, and some of the aspects that we'll talk about today, I felt more comfortable investing in gold. So I initiated my first purchase of gold coins in April 2015, the time gold was selling for around $1,180 per ounce.

That same month, April 2015, we released our first episode on Bitcoin, which is sometimes known as digital gold.

The case for owning Bitcoin, some of the elements are similar to gold, but there are definitely some differences. That particular Bitcoin episode was episode 53, Should You Invest in Bitcoin? And I bought my first Bitcoin a couple of months later in June 2015 when Bitcoin was about $250 per coin.

Gold coin investments I did through a company called Appmex, A-P-M-E-X. There are other vendors out there. That was one that was recommended to me and it worked out fine. And then that gold is stored. At this point, it's just all gold coins in a safe deposit box at a credit union. Now, in 2015, gold and Bitcoin combined made up about 1% of my net worth.

I continued to do episodes on both topics. Episode 59 in June 2015 was on gold, is gold money. I did a follow-up episode on Bitcoin. It was a plus episode, episode 59 in August 2015. In that episode, I mentioned that Bitcoin was a lot like the early days of the internet. It was sort of the Wild West.

It was not necessarily easy if you were a cryptocurrency company to even find a traditional bank that was willing to work with you. And one of the few that I mentioned in Plus Episode 59 was Silicon Valley Bank, which we discussed earlier this year because that bank collapsed and was taken over by the FDIC.

Now, I sold most of my Bitcoin in January 2016 at around $430, and that turned out to be a mistake. I continued to research the area, and at the time, there was discussions of a fork in terms of the underlying code, and I just didn't feel comfortable, and I sold it.

It wasn't until about a year and a half that I re-entered Bitcoin at around $3,200 after releasing another Bitcoin episode in August 2017. There was about a four-year gap then between my episode on gold in 2015 and the next one we did, episode 263, Should You Invest in Gold?

Gold was $1,446 an ounce. It never recovered to its high from 2011.

I've had gold and Bitcoin about eight years. And if we look at the returns from June 2015 to May 2023, gold has returned 6.4% annualized. It's currently priced at $2,025 per ounce. It's about $50 below its all-time high of $2,075. And that was reached in August 2020. So a 6.4% annualized return, that's

is much less than Bitcoin, going from $225 to over $28,000. That's an 84% annualized return. If we compare both of those to inflation, inflation was 3%. The rise in prices over time, gold has outpaced inflation, as has Bitcoin, but certainly not every year.

Gold and cryptocurrency, most of which is Bitcoin, each make up about 5% of my net worth for a total of 10%. In this episode, we're going to look at why, particularly why gold, but a lot of the same arguments apply to Bitcoin. The main reason is currency diversification. Money is a unit of account. It's used for calculating the exchange value of goods and services.

What are an apple or a haircut worth in money? What can we buy or sell something for? As we discussed in last week's episode, this exchange value for goods and services differs from its use value. Someone might, let's say for sentimental reasons, hold an item in very high regard. It's qualitative element, an advantage.

The value they put on it in terms of its quality can be very different from its exchange value or its monetary value. So money then is used to exchange. It has exchange value. It's used to keep score, a unit of account. But money also needs to be a store of value.

Will the amount of food $100 can purchase today be the same five years from now? Probably not, but it's a function of how much food is available in five years and how much money is outstanding. When the supply of money grows more quickly than the supply of goods and services, then the prices of those goods and services increase in that market.

monetary unit, that exchange value unit. That's what we know as inflation. And if one type of money, let's say the U.S. dollar, is growing faster, its supply is growing faster than the supply of another type of money. It could be another fiat currency such as the euro. It could be Bitcoin. It

But if one currency's supply is growing faster than the other, the value of that fast-growing money can fall. Its exchange rate can fall relative to the money that is growing more slowly.

That, of course, depends on what money do people trust? What money do they believe will hold its value? That they're willing to exchange this thing, this made-up thing in the case of fiat currency, for something real, a good or service. That's where gold has an advantage. It has been trusted and used for thousands of years as a type of money. But we don't use gold today, though, do we? Because gold has some drawbacks.

It weighs a lot. Its physicality is inconvenient. You just can't conveniently walk around with a satchel of gold. It weighs a lot and you're likely to be robbed, potentially. So we don't use gold. It's also inconvenient because it's not easy to subdivide.

That differs for fiat money, money that's not backed by anything. Digital money, much more convenient, but the main drawback is the supply is potentially unlimited. Fiat money's convenience for exchange can be undermined if the money doesn't hold its value in the short term. It's not trusted, and so there's always that conflict between the convenience of digital money, fiat currency, and the ease which it can be created out of thin air.

Fiat money is not backed by anything. You can't take a dollar bill to a bank or a central bank and get anything in exchange except for some other fiat currency. Could be a different denomination of the $100 you took to the central bank. Could be coin. It could be another country's fiat currency. They won't give you gold for it. But surprisingly, most central banks own

own gold. And this is what caught my eye this year that motivated me to do another episode about gold investing or gold speculating.

The Financial Times reports, and it was in other articles, that the amount of gold bought by central banks rose 152% in 2022. Significantly more purchases of gold by central banks. 1,136 tons. This is according to the World Gold Council. It was the largest addition of gold ever

to central banks' coffers since 1967. Collectively, central banks hold about 32,000 tons of gold. That's about 15% of the total amount of gold outstanding. The World Gold Council estimates that there is about 209,000 tons of gold in the world.

The thing about gold is it just never goes away. It can't really be destroyed, at least not very easily, and because it's so prized that it's all around. About two-thirds of that 209,000 tons of gold has been mined since 1950. Central banks then own about 15% of the outstanding gold. Why do they own gold?

For much of the 1990s and 2000s, central banks were net sellers of gold. They ran into a lot of the same inconveniences of gold. You have to store it. You have to ship it. You need specialized skills to manage it. And it's much easier for central banks to hold dollars in reserves because it's digital. You don't have to be moving it around. And one of the other things that central banks found with gold, it's pretty political. Fairly easy for a central bank to...

Adjust the amount of a foreign currency that it holds in reserves. But once you start selling gold, people take notice. It often requires more permission to be able to do that.

In addition, gold tends to be much more volatile than other reserve currencies like the dollar, and that can cause some consternation among central bankers. And as a result, gold sort of fell out of favor with central banks through much of the 90s and 2000s. They were net sellers. It was a fairly stable time geopolitically in the global economy, and central banks could earn a greater return in other reserve assets.

The interest rate for leasing out gold was very low, and then it was inconvenient. Now that's changed. Gold is typically considered a safe haven. And with Russia's invasion of Ukraine, there's been financial sanctions on Russia, freezing about $300 billion of Russian central bank assets, many of them dollars, euros, and

and other currencies. But the gold that the Russian central bank owned, that couldn't be frozen because Russia had it in their own country. John Reed, who's the chief market strategist at the World Gold Council, said that these sanctions against Russia's central bank, quote, caused many non-aligned central banks to reconsider where they should hold their international reserves.

Countries have recognized that the gold that Russia holds, because it's outside of anybody else's control, is useful in situations where you might not be able to access any other reserves. The gold is separate. It's separate from the paper financial system, the digital financial system.

And so when we're seeing which central banks are purchasing gold, it tends to be those that aren't necessarily aligned politically with the West. The People's Bank of China bought gold. Turkey bought gold. And other countries in the Middle East and Central Asia. If you have gold as reserves, there's the ability to sell that gold, potentially to support your currency, to buy imports, to get around sanctions, potentially.

A survey of central banks, and there were 83 different central banks that participated in this survey, they concluded that two-thirds of those that replied thought that their central banking peers would be increasing their gold holdings in 2023. One exception to that is the U.S. Federal Reserve.

Technically, the U.S. Federal Reserve doesn't actually own any gold. The Gold Reserve Act of 1934 required the Federal Reserve to transfer ownership of its gold to the U.S. Treasury Department. And in exchange, the Federal Reserve got gold certificates.

And those are denominated in U.S. dollars. And if you look at the Federal Reserve balance sheet, it lists $11 billion worth of gold, which is really these gold certificates. And that value never changes. They keep it basically at a constant $42.22. So while it's booked at $11 billion on the Fed's balance sheet as an asset, it's actually worth $528 billion.

That's 6% of the overall Fed's balance sheet because the U.S. Federal Reserve owns more gold than any other central bank, about 8,100 tons. Second is Germany at 3,300 tons.

The U.S. isn't adding to their gold stock, the Federal Reserve, which if you're the reserve currency, you probably don't need to. But other central banks, particularly those that are worried about sanctions, they have been adding gold and that has provided some demand leading to an appreciation in the gold price. Before we continue, let me pause and share some words from this week's sponsors.

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So hire professionals like a professional on LinkedIn. Post your job for free at linkedin.com slash david. That's linkedin.com slash david to post your job for free. Terms and conditions apply. A couple of months ago, I participated on a panel as part of the CFA Society of Tucson's annual dinner. One of the panelists was Trey Reich of Bristol Gold Group.

We sat next to each other at dinner. Trey's been investing and researching gold professionally for decades. Knows more about gold than anyone I know. Invest both in the underlying commodity as well as gold miners. Since then, Trey's been sending his monthly newsletter on gold and he's bullish, but he has been bullish for a long time and he recognizes that it's very difficult to forecast the price of gold. You need a great deal of patience.

Bristol Gold Group does believe gold will exceed its all-time high in 2023. They typically do not make gold forecast. The reason that Reich is bullish on gold is a lot of the reasons that we've discussed so far in this episode.

It's the geopolitical risk, the fact that central banks are adding to their gold. But he adds a couple other reasons. One, he classifies as the natural order. He writes, long before Bitcoin came on the scene, gold provided citizens of organized societies the mean to store significant wealth outside of the reach of confiscatory governments, debased currencies, or corrupted economies. And he pointed out that gold has so amplified

entered the consciousness over millennia that even people that think gold is a terrible idea for investing, we use a lot of idioms such as the golden rule, the gold standard, or it's a gold mine, suggesting that this is valuable. And so in his view, that owning gold as a store value is sort of the natural order just because of its long-term history. Now, Bitcoin has similar properties, but it's much less history.

The big advantage of gold over Bitcoin or other cryptocurrency is gold just sits there. You do not need a community consensus running a network of servers in order to verify transactions. It lives on the server. That's all it is. It's a digital record, a ledger that's very different than gold. Now, there's advantages of Bitcoin in terms of ability to transfer it, to transport it. But

But gold just sits there and doesn't require electricity in order to run. Now, Reich and I agree that a main reason to own gold is due to the potential for less confidence in fiat currencies and central banks.

And it gets to what we talked about, the nature of currency. If the currency supply is growing faster, let's say the U.S. dollar than some other alternative currency, gold or Bitcoin, then if trust remains in those alternative currencies, then their value, they should hold value relative to mutual.

the fiat currency. In other words, they should appreciate, go up in price relative to the fiat currency. And this, in my mind, is the primary reason for owning gold.

Back at the beginning of 2010, there was $8.5 trillion of U.S. dollars, what's known as the money supply, M2. So this would be dollar bills, coins, money stored at banks and retail money market mutual funds, $8.5 trillion. Today it's $21 trillion, 150% increase. Most of that increase occurred since 2020.

Now we can compare that to gold. Since 2010, there's been just about 36,000 new tons of gold mined. That's a 21% increase. The amount of gold outstanding increases about 2% per year. That's about 3 trillion new tons of gold coming online annually. 2% of that 208,000 tons outstanding.

The gold supply isn't increasing as fast as the money supply. Same for Bitcoin, because Bitcoin, the new supply is determined by the algorithm. There is a set amount. Again, though, both require trust. All money requires trust.

If we look at the total transparent gold holdings, and this is from Nick Laird of goldchartsrus.com, and he puts together a graph of all the ETFs that own gold, the other asset managers that own gold, the deposits of vaults where we can store gold. And by his estimates, there is 128 million ounces of gold, what he calls positive.

published repositories of gold, including mutual funds and ETFs. Now that's down from $160 billion in 2020.

Back in August of 2020, when the pandemic hit, people stocked up on gold. Transparent gold holdings went from 100 million ounces up to 160 million ounces, pushing the gold price to an all-time high. But then it fell down to just under 130 million ounces because with the Federal Reserve raising its policy rate, there was an opportunity cost to owning gold because households and businesses can earn 4% on cash.

That has put downward pressure on gold, except now you're seeing it come back. In fact, given the amount that investors and speculators didn't want to hold in ETFs and funds because of the opportunity cost, because there isn't a yield on gold, just owning it, gold actually held up surprisingly well. And now with those central banks purchasing it, that provides some ongoing demand.

But ultimately, the supply of gold is growing less quickly than fiat currency. And over the long term, if people still value gold like they have for thousands of years, that should allow for appreciation of gold relative to the U.S. dollar and other fiat currencies. The other reason to own gold, and this is from TransPayment,

Trey Reich. He writes, in discussions with investors, we are occasionally asked if we could compress our gold thesis into a single sentence. Our answer is always the same. Gold investing is about protecting wealth against the growing mismatch between paper claims, like stocks and bonds, and productive output as measured by GDP.

There are different terms for this. One would be financialization, which economist Gerald Epstein describes as an increasing role of financial motives, financial markets, financial actors, and financial institutions in the operation of domestic and international economies.

Everything is much more about finance. Even Apple in the last few weeks announced you can get a savings account with Apple. At an interest rate of 4.15%, they've raised a billion dollars in four days.

This financialization shows up the most in increased leverage in the system. What Reich refers to as paper claims, debt, relative to what is being produced. And we can look at the total world public and private non-financial debt. So this is government debt, this is household debt, this is corporate debts excluding banks.

Currently, it's 250% of GDP, and GDP is the value of the goods and services produced around the world, the monetary value. 250%. It was as high as 270% back in...

in 2020 when the pandemic hit because GDP collapsed. But if we go back to 1996, it's 210%. And so we are progressively seeing more and more debt. And the debt's getting more complicated. We've done episodes on how money is debt backed by debt backed by debt.

One of the elements of that M2 money supply aggregate are money market mutual funds. Many of us have investments in money market mutual funds. We've got such low yields on our bank deposits, we put it in a money market mutual fund, which is an IOU from the fund sponsor to us. So it's debt that they owe us. Those funds in turn take that money and much of it is now going to the central bank, the

through reverse repurchase agreements, reverse repos. Those are IOUs from the Federal Reserve. So the Federal Reserve takes the money from the money market mutual funds and then gives the money market mutual fund collateral in the form of U.S. Treasury bonds, which in turn is government debt. So we have debt backed by debt backed by debt and the number of products outstanding and the amount of leverage in the system keeps growing, including a third element, the shadow banking system.

Shadow banks are private companies. They could be publicly traded, but they perform some of the functions of traditional banks. But they're much less regulated, include hedge funds. And there are many other. We discussed shadow banks a couple years ago. I'll link to that particular episode in the show notes of this podcast episode. But shadow banks don't have access to central bank funding. So they're not able to turn to the lender of last resort of central bank.

the central bank. As a result of more debt, more financialization, there's a greater risk of contagion and a greater risk in the breakdown of trust. And when that occurs, people want to own something real, something simple, something with history just in case.

And what is that? It's gold. And when there is contagion, typically the gold price, its exchange value in dollars goes up. Gold's interesting as there is no use value other than a small amount is used for jewelry. But mostly it's just there because people think it's worth something because of its history and because it's scarce and rare and beautiful.

So when we think about the long-term bullish case for gold, it's simply that. The financial system, the economy is getting more leveraged, more unstable, greater lack of trust throughout the world.

And so when we think about gold, we don't have a price forecast. We don't have expectations for how it will do other than if things start to fall apart, if geopolitical risk increase, if wars increase, if there's financial contagion, if there's a lack of trust in central banks leading to currency devaluations, it's nice to own a currency diversifier in the form of gold.

I prefer stability. I don't want any of those things to happen. I would be perfectly content if gold stays around $2,000 per ounce for the next decade or more.

because it's only 5% of my net worth. I'm not making a big bet on gold. It's there as a margin of safety. Most of my assets are cash flow generating assets. That's how we build wealth. We're using gold to diversify and protect some of our wealth in case things completely fall apart. Same reason for Bitcoin, but it's only 10% of my net worth. And I think that's a modest, prudent amount for owning currencies that...

that are only likely to do extremely well if traditional fiat currencies hit hard times. And I'm not forecasting that, but it's nice to have that buffer, that margin of safety, just in case. That's episode 431. Thanks for listening.

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