“When a social construct (gold as money) survives for 6,000 years, I would expect curious people to inquire as to whether it is tied to some immutable underlying law, or otherwise investigate if there is something more here than meets the eye. Not so curiously inclined, our court economists prefer to write this off as a 6,000 year delusion. That says a lot about the sorry state of the economics discipline today.” - A Financial Times reader responds to Citigroup economist Willem Buiter’s description of gold as a “6,000 year-old bubble”, July 2012. “I don’t think the question really is what is gold worth, but what are currencies not worth.” - Shayne McGuire, Director of Global Research at the Teacher Retirement System of Texas, October 2009.
“When a social construct (gold as money) survives for 6,000 years, I would expect curious people to inquire as to whether it is tied to some immutable underlying law, or otherwise investigate if there is something more here than meets the eye. Not so curiously inclined, our court economists prefer to write this off as a 6,000 year delusion. That says a lot about the sorry state of the economics discipline today.”
– A Financial Times reader responds to Citigroup economist Willem Buiter’s description of gold as a “6,000 year-old bubble”, July 2012.
“I don’t think the question really is what is gold worth, but what are currencies not worth.”
– Shayne McGuire, Director of Global Research at the Teacher Retirement System of Texas, October 2009.
Money, in whatever form, has uses. Traditional economists assign money three characteristics. It is a unit of account – we can price things with it. It is a medium of exchange – we can use it as a helpful replacement to the barter system, exchanging one good for another. And it is a store of value – it retains its purchasing power over time. Our modern electronic money still retains the first two characteristics. But as for the third.. Since the establishment of the Federal Reserve in 1913, the US dollar, for example, has lost roughly 99% of its purchasing power. The pound sterling has fared no better. Indeed every unbacked paper currency in history has ultimately failed. The dollar will be no different. It is only a question of time.
Gold and silver developed as money in a free market. Throughout human history we have used all kinds of things as money – cattle, shells, nails, tobacco, cotton, even giant stone slabs. But gold and silver always won out over the competition. People tended over time to favour the precious metals as money because of their scarcity, durability, malleability and beauty. Their use arose without coercion. Gold is the money of freedom.
Gold is also scarce. And it is horribly expensive, in both capital and human terms, to dig out of the earth and process. To produce one ounce of fine gold requires 38 man hours, 1400 gallons of water, enough electricity to run a large house for ten days, up to 565 cubic feet of air under straining pressure, and quantities of chemicals including cyanide, acids, lead, borax and lime.
Being chemically inert, gold lasts. Peter L. Bernstein (in his somewhat sceptical treatise The Power of Gold: The History of an Obsession) points out that you can find a tooth bridge made of gold for an Egyptian 4500 years ago. Its condition is good enough that you could pop it into your mouth today.
And it is wonderfully malleable. If you have just an ounce of gold, you can beat it into a sheet covering one hundred square feet. Or if you prefer, you could draw it into a wire 50 miles in length.
Clearly, gold is also a thing of beauty. “Oh, most excellent gold!” said Columbus on his first voyage to America. “Who has gold has a treasure [that] even helps souls to paradise.”
But gold is heavy, dense and impractical to carry around. So using paper certificates to represent gold held safely in reserve was a logical next step. The problem arose when greedy bankers realised that they could print more certificates than they had gold in reserve to back them.
The language associated with gold is invariably derogatory today. Those of us who see any role for gold in the modern world are dismissed as goldbugs. Our response is to label those sceptics paperbugs: they have to believe that unbacked fiat money will last. History, however, is on our side.
In recent monetary history 1971 amounts to Year Zero for gold, because that is when President Nixon finally took the US dollar off the gold standard. This has led to a 50-year experiment in money that remains unprecedented. When Robert Mundell was made a Nobel Laureate in Economics in 1999, he pointed out that the “absence of gold as an intrinsic part of our monetary system today makes our century, the one that has just passed, unique in
several thousand years.”
Robert Mundell could see the way the world was going. In March 1997, two years before receiving his Laureate, Mundell would remark, ominously, “Gold will be part of the international monetary system in the twenty-first century.” The author Nathan Lewis agrees. The title of his 2007 book on the subject? Gold: The Once and Future Money.
Mysteriously, the price of gold has underperformed large cap equities over recent months, despite the relentless money printing that has become a key feature of the Covid crisis. Nevertheless, we continue to focus on real asset-related companies generating impressive cash flow yet with little or no debt. Falls in the share prices of such companies represent buying opportunities provided that their underlying operations remain sound. Examples of some of our current favourite investments include Ramelius Resources, Silver Lake and Perseus. Ramelius has just announced another strong quarter of production, producing 65,868 ounces of gold across their two processing facilities, Mt Magnet and Edna May. The firm produces at a cash cost of AUD 1,445 an ounce, giving it a strong cash margin of c. AUD 850. The disconnect between these operations and their shares translates into a c. 35% CFO yield. The miner carries no debt.
Silver Lake is a similar sized gold miner to Ramelius, and recently announced comparably strong results, producing 64,947 ounces with a margin of 900 AUD. The miner has seen its share price fall over the last twelve months despite continued strong operations. When sentiment to gold mining firms reverses, and we are confident that at some point it will, Silver Lake’s CFO yield of 30% will almost certainly translate into strong share price outperformance.
Perseus, an African based miner, has also just announced an operational update. The firm’s output per quarter rose to 112,786 ounces as it continues to ramp up output from Yaouré, its third mining centre. The firm is guiding to become a 500,000 ounce producer once mining operations are fully ramped up, with current costs of $966 per ounce set to drop slightly. Without factoring future production grown from Yaouré, the firm is generating a c. 20% CFO, with negative net debt. At current commodity prices, these miners offer us a comfortable way to gain exposure to commodities in a period where commodities may well be at the start of a multi-year bull run. Take it away Jeff Currie, Global Head of Commodities Research at Goldman Sachs. Writing in the Financial Times on 22nd October, Mr Currie observed:
..the revenge of the old economy will leave its mark. Periods of commodity price pressure will reoccur as broad-based demand meets inadequate infrastructure. If policymakers’ goals of broad-based prosperity and a massive buildout in green infrastructure are to be met, commodity prices will need to significantly overshoot to the upside to provide the incentive for investment. This is needed to compensate for the growing risks involved in long-cycle capex projects and the inherent complexities surrounding the green energy transition. As we argued a year ago, a new commodity supercycle is upon us.
The chart below, courtesy of Bloomberg LLP, shows the ratio of the CCI Index versus the S&P 500 Index going back to 1956. Intriguingly, commodities – relative to common stocks – haven’t been this cheap for over 60 years.
Our (heightened) exposure to gold, and to commodities-related companies in general, is a function primarily of compelling underlying valuation, but we happen also to agree with Jeff Currie’s view about a new commodity supercycle. Our portfolios are positioned accordingly.
Is yours ?
|cookielawinfo-checkbox-analytics||11 months||This cookie is set by GDPR Cookie Consent plugin. The cookie is used to store the user consent for the cookies in the category "Analytics".|
|cookielawinfo-checkbox-functional||11 months||The cookie is set by GDPR cookie consent to record the user consent for the cookies in the category "Functional".|
|cookielawinfo-checkbox-necessary||11 months||This cookie is set by GDPR Cookie Consent plugin. The cookies is used to store the user consent for the cookies in the category "Necessary".|
|cookielawinfo-checkbox-others||11 months||This cookie is set by GDPR Cookie Consent plugin. The cookie is used to store the user consent for the cookies in the category "Other.|
|cookielawinfo-checkbox-performance||11 months||This cookie is set by GDPR Cookie Consent plugin. The cookie is used to store the user consent for the cookies in the category "Performance".|