Gold has been one of the most boring assets to hold on to over the last four years. (Sam Panthaky/AFP/Getty Images)
  • With 25,000 tonnes of gold in the hands of private citizens, India has a unique opportunity to set the global agenda on monetary policy.

Gold has been one of the most boring assets to hold on to over the last four years. It has traded within a fairly tight band of $1,100-1,400/oz in this period; about a 10 per cent deviation from the median is all that it has exhibited. Not even the most unexpected economic events, for instance, Brexit and the presidential victory of Donald Trump, could take gold beyond this ceiling.

The preceding two years were even worse when gold had more than a 35 per cent correction from its all-time high of $1,900/oz in 2011. Given this background, why do I believe that gold will not only break out of the current trading range, but will become one of the prized asset classes over the next few years?

Most astute investors would always tell you it’s never been really different. A proposition that I would wholeheartedly endorse in the context of the last 46 years’ experiment with an unbacked fiat currency-based monetary system. That has been the de facto monetary standard that we have adopted since 15 August 1971, when Richard Nixon “temporarily suspended” the gold window. It’s my submission here that the temporary phase will come to an end “soon”.

Gold could well be on the cusp of a historic move — not merely from a price action standpoint — but from the perspective of how global monetary policy is conducted. Given the enormous misinformation that is prevalent about gold, it is useful to start with the basics.

Why Gold at all?

An overwhelming majority of the investment community perceives gold as a risk-off investment. Self-fulfilling price actions have possibly reinforced that misperception during times of crises.

I don’t even look at gold as an investment. Gold is just money — has always been money — and if I may add, will always be money. Currencies are just money substitutes that derive their value because of backing by money. Indeed, currencies gained widespread acceptance not only because of backing by money but more importantly due to their fungibility with money.

Under the gold standard, the US dollar was defined as 1/20th an ounce of gold and anybody could have taken a $20 note and exchanged it for an ounce of gold within the US banking system.

Incidentally, an Indian rupee was originally defined as 11.3 grams of silver. So for a bank or a goldsmith to issue a rupee note, he should first have 11.3 grams of silver in their vault.

This system of fungibility of dollar-gold was suspended in 1933 by President Franklin Roosevelt, who went a step further to make ownership of gold illegal. The Great Depression was the pretext for the executive order — as US politician Rahm Emanuel aptly observed, “Never let a serious crisis go to waste.” Ever major disruption in the world has been used to transfer power from the citizens to the government, as citizens ever too willingly surrender their essential liberty to purchase a little temporary safety.

The “demonetisation” of currencies thus happened in measured steps over a four-to-six-decade period. These temporary short-run steps have now established a truly depraved long-run policy. What this paper currency system has allowed is a near infinite expansion of the powers of government through inflation. As American novelist Ernest Hemingway said, “The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin. But both are the refuge of political and economic opportunists.”

What we consider today as money (US dollar, Indian rupee, euro etc.) are mere pieces of paper with nothing backing them other than the misplaced confidence of gullible citizens. A piece of paper printed by US Federal Reserve Chairperson Janet Yellen has pretty much the same intrinsic value as the one printed by Gideon Gono, former central bank governor of Zimbabwe. In the long run, tulips have far greater intrinsic worth than unbacked currencies.

Readers might well be tempted to ponder, “How in the hell did we reach this position today?” For greater insights on the issue, I would recommend one of the best books written on this topic, What Has Government Done To Our Money by Murray Rothbard.

The Current Demand-Supply Situation Of Gold

Going by the price action of the last six years, readers might be tempted into believing that the demand for gold is less than the supply. Nothing could be farther from the truth. Annual demand has been running far ahead of gold mine supplies, and prices have been contained through a deliberate price suppression mechanism orchestrated by the Bank for International Settlements (BIS) through the US Federal Reserve and the Bank of England (BoE).

Through a series of papers titled “Do The Western Central Banks Have Any Gold Left?”, Eric Sprott of Sprott Inc, a global precious metals investor, has shown that annual net consumer demand has been running for the last decade or so at about 4,000 tonnes/annum, whereas the new mines supply has averaged about 2,800 tonnes.

How prices have been contained under such conditions of demand-supply mismatch is a rather technical issue that will need a separate article by itself. Just to provide a one-line summary, it’s done in the futures market by holding concentrated short positions by non-verifiable participants. For interested readers, this issue has been extremely well documented by the Gold Anti-Trust Action Committee (GATA), metals price analyst Ted Butler and several others.

What is more relevant here is how this supply shortfall to the tune of around 1,000 tonnes/annum has been met with year after year. As has been shown by Sprott, this marginal supply could only have come from the Western central banks without disrupting the overall market conditions. A valid question would be: would these sales not reflect as a decrease in gold holdings on their balance sheets? The central banks side-stepped the issue by showing owned and leased holdings of gold as one line item.

So, as happened during Raghuram Rajan’s tenure, the Reserve Bank of India (RBI) swapped/leased a good portion of its 557 -tonne gold reserves with the BoE. The BoE, in turn, would lease this gold to one of the participating banks, which would then sell it on the open market. The gold would then reflect as being owned by both the purchasing individual as well as the RBI. This double counting of gold could well be to the tune of around 20,000 tonnes (around 15 per cent of total supplies above ground), and the chances that the RBI gets this leased gold back is very slim.

Why so? It took Germany more than four years and that too with immense political pressure to get the 300 tonnes of gold that it had kept for safekeeping in a New York vault during the days of the Cold War. The repatriation request that Germany raised in 2013 was completed only a few weeks ago. If gold were indeed as plentiful, why did it take four years for sending just 300 tonnes? That too, this was given to the US Fed for safekeeping, to be made available on demand, and not to be leased into the market.

My guess is that when the time comes for our gold repatriation, we will get worthless printed dollars or pounds instead of the gold.

Rajan’s Role

Would Rajan have been aware of the entire gold price suppressing mechanism when he leased the RBI gold to the BoE? As somebody who later became the vice-chairman of the BIS in 2015, I would suspect that he would be well aware of the extent of demand-supply mismatches and more importantly, about the role of gold itself. Of course, he sugar-coated the gold leasing episode by saying that we will get gold of greater purity when we need it back. Our gullible media swallowed this and even praised him for it. Without a second line in the RBI to question his actions and with a finance minister in P Chidambaram who did not know the difference between gold and copper or glass, he had a free hand to do what he wanted. I can’t really prove that Rajan was aware of all the above, but the alternative hypothesis must be that Rajan was just a “useful idiot” in the hands of his future BIS masters.

Rajan might well do what he does, but in either scenario, what we see is not what we get.

Gold: What has Changed?

If the US Fed and the BoE have been manipulating gold prices for a long time, why can’t they do it forever? A more important question would be if the raison d’etre of central banks is to maintain their monopoly over issuing currencies, why would they ever allow gold to regain its monetary status?

Firstly, I should clarify that this is not a coordinated rigging of gold prices with the knowledge of all the major central banks. To the contrary, GATA has provided ample evidence of the Chinese and Russian central banks surreptitiously adding to their reserves over the last decade. All this gold price suppression scheme has needed is just coordination by the two big ones with the tacit participation of a few banks. In fact, I would go to the extent of saying that very few central bank governors today would even understand the difference between money and currencies.

Having said that, I think two factors are at play that will cause the reversal of the trend — the escalating costs of price suppression and an orange swan in the form of Donald Trump.

The cost of gold price suppression

As explained earlier, there’s a physical demand to the tune of 1,000 tonnes/annum more than the annual mine supply. This necessarily must imply a flow from the vaults of the Western central banks to the East. The US Fed and the BoE must also be nearing the end of its list of gullible central banks, who would lease the gold to them. So, the cost of suppression at this stage could be very high regarding depleting their own physical gold reserves.

The Trump Phenomenon

Candidate Trump was quite correct in his description of the US economy as a “big, fat, ugly bubble”. If anything, Trump was underestimating the structural problems with the borrow-and-consume model of the US economy. But almost everything that President Trump has done in the last nine months has the effect of making that bubble “bigly, fatly, and uglyly”.

A classical “bull in a china shop”, he has managed to create a Republican base for his tax cuts (without an accompanying spending cut) and a Democratic base for entirely repealing the debt ceiling. In what can only be described as the political version of the “art of the deal”, he has converted the standard “guns vs butter” debate to “guns and butter”. With everybody having everything, the casualty must necessarily be the US dollar.

By the end of his first and most likely only term, Trump is going to make Barack Obama look like a fiscal conservative and George Bush II like a Buddha.

Gold Prices: The Road Ahead

Gold is money and currencies have to be backed to anywhere between 40 to 100 per cent by gold for them to have legitimacy as legal tender in the free market.

The one complicating factor would be the unfunded liabilities of all major governments that could dwarf the existing currency in circulation by a factor of 10 or more (US unfunded liabilities, according to academic Lawrence Kotlikoff, could be higher than $250 trillion).

Ignoring all of those complexities, the math after making reasonable assumptions for the reserves of the Western central banks would lead to a five-figure price for gold (in $/ounce) where the first digit need not necessarily be 1.

But readers are more concerned about what “would” happen rather than what “should” happen. Here and now. Living in the moment, if I may say so.

So, despite the rather unpredictable machinations of the Western central banks, I would say that the bottom of the gold price correction of the last six years is behind us. Given that the exploration industry has been in the doldrums for that period, supply reductions are inevitable, going forward. Most independent estimates show that with close to 3,000 tonnes of annual production, the reserve replenishment has been less than 1,000 tonnes. The forecast for annual production predicts a steep 33 per cent decline to 2,000 tonnes by 2025, and given the long cycle times, any price changes, if they happen even today, are unlikely to cause a major change to the 2025 supply forecast.

So we are running into a confluence of factors that could well unravel the fiat currency system as we know it — an inability to suppress gold prices going forward, a steep fall in gold production under conditions of increasing demand, an exploding deficit situation in the US leading to a recognition of the inevitable bankrupt nature of the fiat currency system and a refusal by at least some of the central banks, particularly the Chinese and the Russians, to continue with the existing US dollar standard.

What should India do?

Despite all kinds of dissuading steps, Indians have been buying gold to the tune of 1,000 tonnes/annum for the last several years. This is without accounting for the smuggled gold as well as gold purchases done in Dubai, Singapore and so on due to the price differentials. I am fairly sure government officials will soon take credit for the situation when the fiat currency system blows out.

I will stick to just two crucial items that the government should focus on.

Forget Gold Monetisation

Firstly, it’s a parody of justice for any government to claim that it will monetise gold. It’s the free market that has given the status of money to gold and no government, howsoever powerful or noble-intentioned, can do otherwise. All that the governments have done is to provide temporary monetary status to pieces of paper by their legal tender laws and monopoly use of power within their geographical bailiwick. Therefore, the Indian government should resist all the suggestions or pressures that may come from the West.

Our government’s economic advisers seem to be oblivious to the time-tested Gresham’s law, which states that “bad money will drive good money out of circulation”. They can try whatever they want — enable jewellers to collect the gold, provide tax-free interest on gold deposited, promise equivalent gold at the end of the tenure etc etc — and yet, this scheme will simply not take off.

It’s just a time-honoured monetary variation of not asking the “fox to guard the hen house” that has been wired into the Indian gene that’s at play here.

Central Banking Variations

Central banking, as we know it today, will be at the crossroads in a few years’ time. The so-called capitalist system of the US will go for a confiscation of gold from private hands (to remind the readers, a repeat of what Roosevelt did in 1933) and the so-called communist country of China will launch a gold-backed yuan. A truly peculiar turn of events.

What should India do? In my opinion, neither of the above. We will truly have a unique opportunity to set the global agenda on monetary policy going forward. With close to 25,000 tonnes in the hands of private citizens, no country was ever better positioned to achieve economic glory in a way that we can.

Forget the meaningless demographic dividend which has been talked about widely, but one that technology will lay to waste over time. This monetary dividend that our culture has given us if channelled properly can truly propel India’s economic engine. But how much the myopic advisors that successive governments have surrounded themselves with even understand these issues is the 25,000-tonne question.

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