The essay below, based on conversations with Nick Barisheff, long time gold market commentator, explains why he is in no doubt that we will see a dramatic transfer from paper assets to hard assets, namely gold. He aptly explains why the cogs are slowly coming together to put gold at the forefront of our financial system, making gold bullion investment an attractive idea.
The market for financial assets should be worth approximately $250 trillion. It includes mortgage bonds, equities, treasury bills and related financial instruments. It contains pure paper assets and does not include real estate or derivatives. Against that $250 trillion stands a nominal value of the gold market of around $4 trillion.
Half of the gold market is owned by Central Banks and half is privately owned. Central Banks account for approximately 500 tonnes gold purchases per year (figures are based on the past couple of years). The gold owned by private hands, is held by a relatively small number of very wealthy families (who mostly hold it for generations). The effect of the above situation on the gold market is that both Central Banks (who became net buyers in 2008 and who are not selling their gold) and the vast majority of privately held bullion is not for sale at any price. So all you’ve got is new mine supply to meet the upcoming [investment] demand. Imagine what happens if you get only a few percentage points move out of the $250 trillion paper market in an attempt to buy gold. Indeed, the only adjustable number in such a situation is the price of gold.
Ongoing Currency Destruction
As the driving forces of monetary debasement keep going, you will consequently see an unavoidable shift from the $ 250 trillion. That process has been taking place already for several years, but it’s not visible to most people and market participants because mainstream media is under-reporting the clear trend.
Here are some recent facts supporting that trend: Investment Company Institute (ICI) this week released its latest “Weekly Estimated Long-Term Mutual Fund Flows” that shows retail investors are accelerating redemptions from equity mutual funds. Since the U.S. Federal Reserve’s most recent QE pledge (QE3), outflows from equity mutual funds nearly doubled from the two weeks prior ($12.612 billion for the two weeks ending 9/26/12 versus $6.819 billion for the two weeks ending 9/12/12).
And third quarter equity mutual fund outflows of $19.431 billion were the highest of the year, surpassing August’s $19.195 billion outflow. September also marked the 17th month in a row of outflows from US equity mutual funds and the 26th out of 29. [Source: Seekingalpha.com]
Suppose we will face some kind of crisis or black swan event, then that move will speed up considerably. Now all of this is counted without two huge timebombs:
the derivatives timebomb, which is a question of “when” it will blow up, not “if” it will do
the ETFs, which only a few people see coming.
The ETFs are based on borrowed assets, no matter if it is a gold, bond or equity ETF. So you have a double counting here. As long as the middleman (which is the authorized participant) is acting as a market maker, everything works fine. But when the authorized participant becomes insolvent, someone is going to lose money. When that happens, we will see a scenario that is worse than the subprime crisis.
In addition, recent activities by the Central Banks in the US, Europe and Japan have made the currency debasement worse. Nick Barisheff’s conviction is that the latest QE announcement by the US Fed was another proof that the high returns on financial assets like stocks and bonds are now definitely over. As a natural result, gold is becoming the primary go-to asset for wealth preservation. These two opposite evolutions are simply connected with each other; they are like yin and yang.
Gold Standard And Gold Becoming Zero-Risk Asset
With the ongoing rise in gold, talks about gold backed currencies as a form of a gold standard are heating up. The issue is however that you can’t go back to a pure gold standard without wiping out all the existing debt first. If you want to introduce a gold standard with these debt levels, the gold price would be at astronomical heights. So you first need to clear the debt and what you get in turn is the restructuring of the monetary system. His opinion is that we will not see a gold standard. They did studies during Ronald Reagan’s administration and didn’t find it feasible to introduce a gold standard back then, so it will be unlikely to happen now before a complete restructuring of the present debt.
What’s interesting though is the Basel III framework for banks and in particular the amounts of reserves that banks have to hold. The rules are changing as of the 1st of January 2013. The reserves at the banks go from 4% to 6%. In addition, the Bank for International Settlements (BIS) has proposed to let gold become a tier I asset for commercial banks, which means that it counts as 100% collateral rather than 50% the way it is now. In other words, it’s considered a risk free asset like cash and treasury bills. That’s going to change the picture considerably, in particular for the people who argue that gold is risky. Try to imagine the potential effect of this -- the BIS coming out shortly to confirm that gold is a risk-free asset.
Will this be a game changer? Nick Barisheff believes it will, because the Central Banks which are net buyers of gold currently, clearly understand what the implications associated with holding too much fiat currency reserves. Now with the Basel III rules, the commercial banks will be allowed to do the same thing as the Central Banks. Suppose you are a commercial bank: Would you be willing to hold U.S. treasuries or gold, for purposes of your reserves? The most likely outcome will be an increase in demand from the commercial banks. Right now however holding gold counts as 50% collateral compared to treasuries, so it’s currently unattractive for them.
Gold Confiscation
To which extent is gold confiscation a real threat? There are a couple of important points to make first. The only example of confiscation we can find in history was in the U.S. in 1933. In fact it wasn’t confiscation, it was rather expropriation. The government paid you the market price at the time and then devalued the currency by 50% a couple of years later. All American citizens, anywhere in the world, could not hold gold after the expropriation as from 1933 (till 1974). It wasn’t illegal in Canada, Amercia’s neighbor to the north, however -- an important distinction for North American bullion buyers.
Of course, you can never tell what kind of decisions to expect from desperate governments. There are a couple of complexities you need to deal with. The first question that pops up: what is the timing for government(s) that will chose to do it? It will likely not be at $1,700 gold, but rather at $5,000 or $10,000 gold. At that point it’s likely that we are in a hyperinflation. Additionally, there are more lawyers today than there were in 1933, especially in the U.S., who will undoubtedly argue that it’s illegal for the government to confiscate.
Also in the U.S., Gov. Gary Herbert of Utah and the South Carolina legislature signed bills in March allowing the use of gold and silver coins as legal tender. Missouri, Colorado, Montana, Idaho, Indiana, New Hampshire, and Georgia and Washington states are also deliberating similar bills. It is doubtful these states or their citizens would look kindly on gold confiscation from their Federal government.
But back to the hypothetical case in which the government would expropriate people’s gold like in 1933. Suppose it would happen at $10,000 gold and you own gold. In that kind of (hyper)inflationary environment you should simply convert the $10,000 per ounce you will get immediately to some other tangible asset, like farmland for example. So confiscation or expropriation obviously might happen but you are in any case better off holding gold than worrying if it’s going to get confiscated and not owning it.
The market for financial assets should be worth approximately $250 trillion. It includes mortgage bonds, equities, treasury bills and related financial instruments. It contains pure paper assets and does not include real estate or derivatives. Against that $250 trillion stands a nominal value of the gold market of around $4 trillion.
Half of the gold market is owned by Central Banks and half is privately owned. Central Banks account for approximately 500 tonnes gold purchases per year (figures are based on the past couple of years). The gold owned by private hands, is held by a relatively small number of very wealthy families (who mostly hold it for generations). The effect of the above situation on the gold market is that both Central Banks (who became net buyers in 2008 and who are not selling their gold) and the vast majority of privately held bullion is not for sale at any price. So all you’ve got is new mine supply to meet the upcoming [investment] demand. Imagine what happens if you get only a few percentage points move out of the $250 trillion paper market in an attempt to buy gold. Indeed, the only adjustable number in such a situation is the price of gold.
Ongoing Currency Destruction
As the driving forces of monetary debasement keep going, you will consequently see an unavoidable shift from the $ 250 trillion. That process has been taking place already for several years, but it’s not visible to most people and market participants because mainstream media is under-reporting the clear trend.
Here are some recent facts supporting that trend: Investment Company Institute (ICI) this week released its latest “Weekly Estimated Long-Term Mutual Fund Flows” that shows retail investors are accelerating redemptions from equity mutual funds. Since the U.S. Federal Reserve’s most recent QE pledge (QE3), outflows from equity mutual funds nearly doubled from the two weeks prior ($12.612 billion for the two weeks ending 9/26/12 versus $6.819 billion for the two weeks ending 9/12/12).
And third quarter equity mutual fund outflows of $19.431 billion were the highest of the year, surpassing August’s $19.195 billion outflow. September also marked the 17th month in a row of outflows from US equity mutual funds and the 26th out of 29. [Source: Seekingalpha.com]
Suppose we will face some kind of crisis or black swan event, then that move will speed up considerably. Now all of this is counted without two huge timebombs:
the derivatives timebomb, which is a question of “when” it will blow up, not “if” it will do
the ETFs, which only a few people see coming.
The ETFs are based on borrowed assets, no matter if it is a gold, bond or equity ETF. So you have a double counting here. As long as the middleman (which is the authorized participant) is acting as a market maker, everything works fine. But when the authorized participant becomes insolvent, someone is going to lose money. When that happens, we will see a scenario that is worse than the subprime crisis.
In addition, recent activities by the Central Banks in the US, Europe and Japan have made the currency debasement worse. Nick Barisheff’s conviction is that the latest QE announcement by the US Fed was another proof that the high returns on financial assets like stocks and bonds are now definitely over. As a natural result, gold is becoming the primary go-to asset for wealth preservation. These two opposite evolutions are simply connected with each other; they are like yin and yang.
Gold Standard And Gold Becoming Zero-Risk Asset
With the ongoing rise in gold, talks about gold backed currencies as a form of a gold standard are heating up. The issue is however that you can’t go back to a pure gold standard without wiping out all the existing debt first. If you want to introduce a gold standard with these debt levels, the gold price would be at astronomical heights. So you first need to clear the debt and what you get in turn is the restructuring of the monetary system. His opinion is that we will not see a gold standard. They did studies during Ronald Reagan’s administration and didn’t find it feasible to introduce a gold standard back then, so it will be unlikely to happen now before a complete restructuring of the present debt.
What’s interesting though is the Basel III framework for banks and in particular the amounts of reserves that banks have to hold. The rules are changing as of the 1st of January 2013. The reserves at the banks go from 4% to 6%. In addition, the Bank for International Settlements (BIS) has proposed to let gold become a tier I asset for commercial banks, which means that it counts as 100% collateral rather than 50% the way it is now. In other words, it’s considered a risk free asset like cash and treasury bills. That’s going to change the picture considerably, in particular for the people who argue that gold is risky. Try to imagine the potential effect of this -- the BIS coming out shortly to confirm that gold is a risk-free asset.
Will this be a game changer? Nick Barisheff believes it will, because the Central Banks which are net buyers of gold currently, clearly understand what the implications associated with holding too much fiat currency reserves. Now with the Basel III rules, the commercial banks will be allowed to do the same thing as the Central Banks. Suppose you are a commercial bank: Would you be willing to hold U.S. treasuries or gold, for purposes of your reserves? The most likely outcome will be an increase in demand from the commercial banks. Right now however holding gold counts as 50% collateral compared to treasuries, so it’s currently unattractive for them.
Gold Confiscation
To which extent is gold confiscation a real threat? There are a couple of important points to make first. The only example of confiscation we can find in history was in the U.S. in 1933. In fact it wasn’t confiscation, it was rather expropriation. The government paid you the market price at the time and then devalued the currency by 50% a couple of years later. All American citizens, anywhere in the world, could not hold gold after the expropriation as from 1933 (till 1974). It wasn’t illegal in Canada, Amercia’s neighbor to the north, however -- an important distinction for North American bullion buyers.
Of course, you can never tell what kind of decisions to expect from desperate governments. There are a couple of complexities you need to deal with. The first question that pops up: what is the timing for government(s) that will chose to do it? It will likely not be at $1,700 gold, but rather at $5,000 or $10,000 gold. At that point it’s likely that we are in a hyperinflation. Additionally, there are more lawyers today than there were in 1933, especially in the U.S., who will undoubtedly argue that it’s illegal for the government to confiscate.
Also in the U.S., Gov. Gary Herbert of Utah and the South Carolina legislature signed bills in March allowing the use of gold and silver coins as legal tender. Missouri, Colorado, Montana, Idaho, Indiana, New Hampshire, and Georgia and Washington states are also deliberating similar bills. It is doubtful these states or their citizens would look kindly on gold confiscation from their Federal government.
But back to the hypothetical case in which the government would expropriate people’s gold like in 1933. Suppose it would happen at $10,000 gold and you own gold. In that kind of (hyper)inflationary environment you should simply convert the $10,000 per ounce you will get immediately to some other tangible asset, like farmland for example. So confiscation or expropriation obviously might happen but you are in any case better off holding gold than worrying if it’s going to get confiscated and not owning it.