The past few months have been an exciting time for gold investors, as the precious metal has seen a spike in demand after serious economic concerns and geopolitical tensions unsettled the markets. Many mainstream analysts have pointed to a number of recent events, from the US-China trade war escalations to the inverted yield curve, to explain the recent gold rally. Although these developments certainly play a part in short-term price moves and are of great interest to speculators, for the long-term investor, who understands the true function of gold and the purpose of their physical precious metals holdings, the bigger picture is much more relevant.
To further examine the implications of this perspective, I turned to Alasdair Macleod, whose insights have long helped sound investors gain clarity and better understand important macro-economic events, the real impact of monetary interventions and the role of precious metals as real money and as a hedge against the inherent risks of fiat currencies.
Alasdair Macleod started his career as a stockbroker in 1970 and became a Member of the London Stock Exchange in 1974. He has accumulated a decades-long and hands-on experience in investment management, fund management, corporate finance and banking in director-level positions and today he serves as Head of Research for GoldMoney. Having worked for forty years in the finance sector, he has developed a very deep and clear understanding of the monetary system, of equity and bond markets and of precious metals, which makes his analyses uniquely insightful and of real value to investors.
Claudio Grass (CG): The last couple of months have been very interesting for gold. The recent price uptick has largely been attributed to stock market volatility and geopolitical developments, like the US-Iran tensions. Do you agree with this assessment or do you see other factors that played a role too?
Alasdair Macleod (AM): Undoubtedly factors such as stock market volatility and geopolitical tensions do have an effect, but for it to be long-lasting it must be deemed to increase the likelihood that the purchasing power of currencies, in this case the US dollar, will be undermined by these events. To me, the real reason for gold’s strength is clear: we face a recession which is likely to be deeper than anything we have seen in recent years.
If I am right in this assumption, then central banks will try to support financial asset prices by reducing interest rates, deeper into negative territory if necessary. We can also expect more quantitative easing, likely to be on a greater scale than seen to date, in an attempt to bolster banks’ balance sheets and encourage them to lend to the private sector. In short, the monetary inflation to deal with an upcoming recession is what both bonds and gold are trying to discount.
CG: What do you make of the significant increase in central bank gold purchases over the last years? What do you think are the motivations and the strategic considerations behind the gold stockpiling activity, especially in Russia and China?
AM: In Russia’s case, it is simple. She wants to eliminate as far as possible American power over her economy through dollar hegemony. Don’t forget that Russia is also the largest energy exporter in the world, so she continually has dollars to sell. Also, from what I have observed, Elvira Nabiullina who heads the Central Bank of Russia is quite “Austrian” in her approach to money, so she values gold as the natural hedge against being dependant on foreign fiat currencies.
In China’s case, I believe she started accumulating gold as a state from 1983 onwards, as a simple hedge against growing dollar inflows. Bear in mind that only a small portion of this gold is declared as national reserves, with unknown quantities stored “off-balance sheet”. Obviously, the Communist Party felt it had enough gold by 2001/02 to then permit her people to buy gold, so the Peoples Bank set up the Shanghai Gold Exchange. At some stage, government strategists must have understood the value of gold as a strategic asset, and we have seen China come to dominate the market for physical gold.
Other central banks, particularly in Asia, Eastern and Central Europe, cognizant of the shift of geopolitical and economic power to the Russian-Chinese partnership, know they must also accumulate gold in order to align their reserve asset policies with this developing power base. I would expect to see this trend continue with more central bank purchases.
CG: We have seen an important shift away from the US dollar. China is trying to internationalize the yuan, Russia adopted a “de-dollarization” plan in response to US sanctions, while European leaders signed an agreement to develop an alternative to SWIFT. Do you believe such moves have an impact on the future of the USD as the world’s reserve currency?
AM: In the longer term, these moves will obviously impact on the dollar’s future as the dominant reserve currency. Even though America continues to abuse its monetary power, it will take something else to undermine it. It will still be used at least for pricing references in all international commodity markets. Given the likely long timescale for the dollar’s demise, I think other factors are more important, particularly the fall in its purchasing power as the Fed battles to protect the US Government, the banks and the US economy in the developing recession.
CG: Staying on the topic of the future of currencies, what is your take on the Libra project that Facebook recently announced? Do you think it has the potential for mass-adoption and if so, what would the wider implications be in your view?
AM: I think Libra is ill-conceived and potentially inflationary. It is a crypto version of a collection of fiat currencies and unnamed assets, but unlike bitcoin, does not have a widely decentralised base beyond the reach of governments and the establishment. It is intended to become a global currency for the world’s unbanked. The assumption is with even nomadic herdsmen using mobile phones, they will use Libra for transactions. If Libra is superior to the weak local currency, Gresham’s law tells us they will use the local currency and save Libra if they can get it. If the local currency has a similar strength to the major currencies, why use it?
Libra is said to be backed by a pool of currencies and assets stored around the world. Putting the assets to one side (are they government bonds? Equities? ETFs?) you have to ask about the origin of the currencies. And here we will almost certainly find it is the expansion of bank credit, unless central banks come on board which is unlikely in my view. I think the concept is ill-conceived by people who do not understand money.
Claudio Grass (CG): After the massive crypto- and blockchain-related advances of 2016-2017 that shone a spotlight on the idea of alternative or private money, what do you think the potential of such concepts is in the future of currencies and payment methods? In this context, what do you expect gold’s role to be?
Alasdair Macleod (AM): In answer to this question I think there is only one cryptocurrency to discuss: bitcoin. To varying degrees, the others are flawed, but bitcoin has a fully distributed ledger and a reward system for miners which cannot be corrupted. So, we are considering bitcoin only.
Bitcoin has the potential to be taken up by the millennial generation as their primary hedge against loss of purchasing power of fiat currencies. They see the relative rates of monetary expansion and fully understand the implications. Furthermore, the process of understanding bitcoin has educated them to the risks of owning bank deposits in state-issued currencies. This is important, because fiat currencies only exist as long as people don’t understand money. There are increasing numbers of people who now see through the fraud.
I’m also told by my contacts that while the Chinese do buy gold as a monetary hedge, if the yuan begins to slide, they will probably buy bitcoin in preference to gold. Obviously, that is yet to be tested.
I don’t see bitcoin as an alternative to gold, but as another way for the ordinary citizen to protect him or herself from monetary inflation of fiat currencies.
CG: Turning our attention to Europe and specifically to the Brexit saga, how do you think this “divorce” will finally be resolved? Will the result of the original referendum be honored, or do you expect a compromise, or even a second referendum?
AM: With the appointment of Boris Johnson as Prime Minister, it is clear that Britain will leave on 31 October. There is not time to do a deal with the EU before that date, so it is likely that the EU and UK will agree to negotiate after Brexit under the terms of GATT Article XXIV. What this means is that if there is a reason for a change in a trade treaty and if they are in agreement, the parties involved can continue to trade on existing terms while the new terms are negotiated.
The new government will not compromise, that much is clear. The Remainers in Parliament are trying everything to stop Brexit, but that is a measure of their desperation. The fact is the laws have been passed.
In the next few months, I expect this reality to force the EU to come to terms with the new situation. Independent estimates suggest the effect on employment in the UK of a so-called “no-deal” Brexit will be relatively minor, yet some 400,000 jobs are likely to be lost in the EU, particularly in Germany and France. Since that estimate was made, Ireland’s central bank has estimated a further 100,000 job losses in Ireland alone. The EU negotiators are likely to come to terms with the reality of their weak position.
CG: The Eurozone economy has long been flashing warning signs of a slowdown, which now are impossible to ignore, especially as Germany continues to lose steam. Given the fact that the ECB has already gone to extremes to support the economy, what tools do you think the central bank has left to fight the next recession?
AM: Central banks, including the ECB, only have two tools at their disposal: interest rates and monetary expansion. Clearly, Germany is sliding into a slump and with the phasing out of the internal combustion engine, the Mittelstand is going to have a very tough time. Furthermore, the premier bank in the strongest EU economy, Deutsche Bank, appears to be in deep trouble. This is a very serious situation that tells us the Eurozone faces the worst combination of economic and systemic risk, particularly given the levels of government debt in the Club Med countries.
Unless it takes the unlikely view it has done everything and it must just stand back and let the whole system collapse, the ECB will have no choice but to impose deeper negative rates, primarily to ensure higher prices for the government bonds every Eurozone bank owns. It will also have to do more asset purchases to keep the Eurozone economy from tanking. The appointment of Christine Lagarde seals the inflationary deal, which is whatever it takes, however extreme.
CG: Given the current geopolitical tensions and economic landscape, what are your expectations for the Euro and the USD in the next 6-12 months?
AM: I don’t make currency forecasts for what measured in gold terms is a race to the bottom.
CG: As economic pressures and geopolitical challenges continue to intensify on a global scale, what are your expectations for gold’s performance in the next 2-3 years?
AM: This is a question always asked by investors who do not understand that gold is not an investment, but money. There are gold-related investments, such as mining stocks, which is a different matter.
It is not a question of gold rising, but of state-issued currencies losing purchasing power. It will be clear from my earlier answers I do not see a positive future for state money.
That said, in real terms the purchasing power of gold can be expected to rise in a deep recession, just as it did in the 1930s Great Depression. In that case, we think of slumping prices in dollar terms, but before January 1934 the dollar was fixed at $20.67 to the ounce. The dollar was then devalued to $35. For this reason, dollar prices were in fact prices in gold before the dollar’s devaluation, and then subsequently in gold at the new dollar rate.
CG: And what of silver? Today, the gold-to-silver ratio hovers near 90, at historically extremely high levels not seen in 26 years. Do you see a buying opportunity at this moment?
AM: Silver is interesting. It was last priced as money in the final quarter of the nineteenth century, when nearly all countries moved from a silver or dual standard to gold. It still has monetary characteristics, which are just not reflected in the price. This is why it has moved from the gold/silver relationship of 15.5:1, which had approximately held for over two centuries since Isaac Newton fixed the exchange standard at the Royal Mint.
Today, it is about 88:1. As fiat currencies lose their credibility, the likelihood of a monetary role for silver increases. This is why when the gold price rises, being the consequence of falling currency, the silver price rises at about double the rate. While it is far too early to think in terms of silver regaining an official monetary role, clearly there will be much catching up to do with silver rising relative to gold as fiat currencies sink.