By NICK GIAMBRUNO – Chief Analyst of Casey Research’s flagship advisory, The Casey Report, and its premium “value investing” advisory, Crisis Investing.
An epic gold bull market is on the menu for 2019.
I’m not talking about a garden-variety cyclical gold bull market, but rather one of the biggest gold manias in history.
This gold mania will be riding the wave of an incredibly powerful trend… the re-monetization of gold.
The last time the international monetary system experienced a paradigm shift of this magnitude was in 1971.
Then, the dollar price of gold skyrocketed over 2,300%.
It shot from $35 per ounce to a high of $850 in 1980. Gold mining stocks did even better.
Today, gold is still bouncing around its lows. Gold mining stocks are still very cheap. I expect returns to be at least as great as they were during the last paradigm shift.
So let’s get right into it, starting with the first four catalysts that will send gold prices higher…
No. 1: Basel III Moves Gold Closer to Officially Being Money Again
The Bank for International Settlements (BIS) is located in Basel, Switzerland. It’s often referred to as “the bank of central banks.” Its members consist of 60 central banks from the world’s largest economies.
It facilitates transactions – notably gold transactions – between central banks, the biggest players in the gold market.
The BIS also issues Basel Accords, or a set of recommendations for regulations that set the standards for the global banking industry.
On April 1, 2019, Basel III went into effect around the world.
Buried among what was mostly confusing jargon was something of huge significance for gold:
A 0% risk weight will apply to (i) cash owned and held at the bank or in transit; and (ii) gold bullion held at the bank or held in another bank on an allocated basis, to the extent the gold bullion assets are backed by gold bullion liabilities.
What this means in plain English is that gold’s official role in the international monetary system has been upgraded for the first time in decades.
Banks can now consider physical gold they hold, in certain circumstances, as a 0% risk asset. Previously, gold was considered riskier and most of the time could not be classified in this way. Basel III rules are making gold more attractive.
Central bankers and mainstream economists have ridiculed gold for going on 50 years now.
They’ve tried to downplay its role in favor of fiat currencies like the U.S. dollar. They’ve tried to trick people into believing it isn’t important.
The fact is gold is real money… a form of money that is far superior to rapidly depreciating paper currencies. This is why central bankers don’t want to acknowledge how important it is.
And this is precisely why Basel III is important. It signifies the start of a reversal in attitude and policy.
Basel III is giving gold more official recognition in the international financial system. It represents a step towards the re-monetization of gold… and the recognition of this powerful trend in motion.
No. 2: Central Banks Are Buying Record Amounts of Gold
Countries are treating gold as money for the first time in generations…
In 2010, something remarkable happened. Central banks changed from being net sellers of gold to net buyers of gold. Remember, central banks are by far the biggest actors in the global gold market.
This trend has only accelerated since…
The World Gold Council reports that in 2018, central banks bought a record 651 tonnes of gold. This is the highest level of net purchases since 1971 when Nixon closed the gold window. And it’s a 75% increase from 2017.
Russia Was the Biggest Buyer
Russia’s gold reserves have quadrupled in the last decade, making it the fifth-largest holder of gold in the world.
Last year, Russia notably dumped nearly $100 billion worth of U.S. Treasuries, and, according to the World Gold Council, replaced much of it with gold.
If this trend continues, and I expect that it will, Russia will soon become the third-largest gold holder in the world.
A major reason for Russia’s gold purchases is to reduce its reliance on the U.S. dollar and exposure to U.S. financial sanctions.
It is providing a template for others to do the same, using gold as money.
For example, in 2016, news broke that Turkey and Iran were engaged in a “gas for gold” plan. Iran is under U.S. sanctions. Through the plan, Turkey can pay for gas imported from Iran with gold.
Russia, Iran, Venezuela, and others are proving they don’t need the U.S. dollar. They are conducting business and settling trade with gold shipments, which aren’t under the control of the U.S. government.
This is how gold will benefit from the U.S. government using the dollar as a financial weapon.
No. 3: Oil for Gold – China’s Golden Alternative
In 2017, when tensions with North Korea were rising, Trump’s Treasury secretary threatened to kick China out of the U.S. dollar system if it didn’t crack down on North Korea.
If the threat had been carried out, it would have been the financial equivalent of dropping a nuclear bomb on Beijing.
Without access to dollars, China would struggle to import oil and engage in international trade. Its economy would come to a grinding halt.
China would rather not depend on an adversary like this. This is one of the main reasons it created what I call the “Golden Alternative.”
Last year, the Shanghai International Energy Exchange launched a crude oil futures contract denominated in Chinese yuan. For the first time in the post-World War II era, it will allow for large oil transactions outside of the U.S. dollar.
Of course, most oil producers don’t want a large reserve of yuan.
That’s why China has explicitly linked the crude futures contract with the ability to convert yuan into physical gold – without touching the Chinese government’s official reserves – through gold exchanges in Shanghai and Hong Kong. (Shanghai is already the world’s largest physical gold market.)
Bottom line, China’s Golden Alternative will allow oil producers to sell oil for gold and completely bypass any restrictions, regulations, or sanctions of the U.S. financial system.
With China’s Golden Alternative, a lot of oil money is going to flow into yuan and gold instead of dollars and Treasuries.
CNBC estimates that the amount of redirected oil money will eventually hit $600-$800 billion. Much of this will flow into the gold market, which itself is only $170 billion.
China is the world’s largest importer of oil.
So far this year, China has imported an average of around 9.8 million barrels of oil per day. This number is expected to grow at least 10% per year.
Right now, oil is hovering around $60 per barrel. That means China is spending around $588 million per day to import oil.
Gold is currently priced around $1,330 an ounce.
That means every day, China is importing oil worth over 442,105 ounces of gold.
If we’re conservative and assume that just half of Chinese imports will be purchased in gold soon, it translates into increased demand of more than 80 million ounces per year – or more than 70% of gold’s annual production.
This shift hasn’t been priced into the gold price. When it happens, the increased demand for gold from China’s Golden Alternative is going to shock the gold market.
The bottom line is, China’s Golden Alternative is a big step towards gold’s re-monetization.
No. 4: The Fed’s Dramatic Capitulation
In the wake of the 2008 crash, the Federal Reserve instituted several emergency measures. The chairman at the time, Bernanke, promised Congress they would be temporary.
This included money-printing programs euphemistically called “quantitative easing” (QE). Through QE, the Fed created $3.7 trillion out of thin air.
That newly created money was used to buy mainly government bonds, which sat on the Fed’s bloated balance sheet.
The Fed also brought interest rates to the lowest levels in U.S. history. The Fed artificially brought rates down to 0% and kept them there for over six years.
Capitalism’s Most Important Price
Remember, interest rates are simply the price of borrowing money (debt). They have an enormous impact on banks, the real estate market, and the auto industry, among others.
In 2016, the Fed began its attempt to “normalize” its monetary policy by raising interest rates and reducing the size of its balance sheet to more historically normal levels. By doing so, the Fed was reversing the emergency measures put in place after the 2008 crisis.
Interest rates have risen from 0% to around 2.5%, and the Fed has drained over $500 billion from its balance sheet, or about 11% from its peak.
But then, the stock market tanked…
The S&P 500 peaked at 2,930 in late September 2018. By late December, it had crashed over 19% and appeared to be headed sharply lower.
It was the worst December in stock market history, except for December 1931, which was during the Great Depression.
That spooked the Fed into its most abrupt change in monetary policy in recent history.
Instead of normalizing monetary policy and removing the so-called “temporary” and “emergency” measures in place since 2008 – as it had long planned to do – the Fed capitulated.
Earlier this year, the Fed announced it would not raise interest rates in 2019.
The Fed also announced it would phase out its balance sheet reduction program in the fall.
Previously, the Fed was slowly winding down its balance sheet by about $30 billion a month. At such a snail’s pace, it would have taken the Fed over 10 years to drain its balance sheet back to its pre-crisis normal level.
Hooked on Easy Money
This whole charade is indicative of how utterly dependent the U.S. economy has become on artificially low interest rates and easy money.
If the Fed couldn’t normalize interest rates when the debt was $22 trillion, how is it ever going to raise rates when the debt is $30 trillion or higher?
The Fed couldn’t shrink a $4.5 trillion balance sheet. How is it going to shrink, say, a $10 trillion balance sheet or higher?
The answer is it can’t and won’t. It’s impossible for the U.S. government to normalize interest rates with an abnormal amount of debt. The Fed is trapped.
After nearly six years of 0% interest rates, the U.S. economy is hooked on the heroin of easy money. It can’t even tolerate a modest reduction in the Fed’s balance sheet and 2.5% interest rates, still far below historical averages.
In other words, this monetary tightening cycle is over. The next move is a return to QE and 0%, and perhaps negative, interest rates. These moves would, of course, weaken the dollar and be good for gold.
By flipping from tightening to signaling future easing, the Fed has turned a major headwind for the gold market into a tailwind.
(Stay tuned for part 2.)
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International Man and Strategic Wealth Preservation
This article was originally posted in the Strategic Wealth Preservation Blog and copied here with the permission of the author.