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Analysis and outlook for the real assets market
What it may mean for investors
Gold is consistently one of the most asked about assets at Wells Fargo. This makes sense to us because gold has a history like no other contemporary investment asset. Gold was discovered nearly 5,000 years ago and was first coined roughly 3,700 years ago (in the area now known as Turkey). Stocks and bonds, on the other hand, were financial instruments created by the Western world in the last 800 years. Gold also has the unique benefit of literally surviving time. Gold is impervious to both air and water, which means that essentially all of the gold ever mined still sits above ground—even if sunk off the coast of Florida.
Gold's rich history as both a store of value (investments, jewelry, bars, etc.) and money (coins etc.) is something most other major assets cannot claim. Gold's long history, however, has its downside. Gold has been around so long, surviving all types of social and economic turbulence, that it is easy to claim that gold is a cure-all for all kinds of investment scenarios. But it is not. It may surprise some investors to know that gold has not always been a great inflation hedge, it has not always moved opposite the U.S. dollar, it has not always moved higher when stocks have been clobbered, and it has not always reduced investors' exposure against the over-printing of paper currencies.
We say all of this not to take exception with gold as an investment. In fact, we believe that gold holds a place in most investors' portfolios, most of the time. But, as with other investments, timing and position sizes are key. If history is any guide, gold will likely see a period of flat performance in 2017. To help investors better understand gold as an investment, we are releasing one gold publication each day this week (list below). Each publication will revolve around the most frequently asked gold questions.
We'll start today with some history behind gold, and why it is unique.
Why Gold is Special
Durability, density, and radiance have made gold an ideal store of wealth through time. Durability in that gold is impervious to air and water. Unlike any other element on earth, virtually every ounce of gold ever mined still sits above ground somewhere. Density—a cubic foot of gold weighs half a ton. This means that small amounts of gold can function as large money denominations. This comes in particularly handy for, say, refugees trying to cross borders with some wealth in tact to start over. Gold has global value versus the economically and socially torn country that the refugee is fleeing, which likely has a failing paper currency. And then radiance—gold is chemically inert, meaning that it shines forever.
Even though gold has been found on every continent, the earth does not yield gold easily. Chart 1 highlights the total amount of gold mined in its history, roughly 175,000 tonnes (metric tons). (Chart 1 begins in 1900, but it includes mined gold prior to that year as well.) By comparison, the world produces roughly 159,000 tonnes of aluminum each day (as of February 2017).
Chart 1. Gold Above Ground
Sources: Bloomberg, U.S. Geological Survey (USGS), Wells Fargo Investment Institute. Yearly Data: 1900 - 2015. 2015 data includes estimates from USGS. Dates selected to show modern growth of gold above ground
Sources: USGS (2015 estimate), World Steel Association, Bloomberg, Wells Fargo Investment Institute.
Of course, this is reflected in price. Gold trades at roughly $1,200 per ounce, while aluminum trades at more than $1,800 per tonne. A fun way of showing how rare, or precious, gold can be is seen in the soda display below. A 12-ounce soda can contains roughly one-half an ounce of aluminum worth roughly $0.03. If the soda can was made of steel instead, the cost would be roughly $0.01. In great contrast to both aluminum and steel, should that same soda can be made of gold, it would cost roughly $600.
Gold as a Store of Wealth (Investments, Jewelry, Bars, etc.)
Early in its history, as in 4,000-5,000 years ago, gold was primarily used as a store of value or wealth. Most of the available gold was used by priests and monarchs to project power, wealth, and proximity to a god. In ancient Egypt, for example, gold was a royal prerogative, available only to the Pharaohs. Fortunately for the Pharaohs, gold was quite accessible, as most of the gold supplies in biblical times came from mines in southern Egypt and Nubia (today's Sudan, or just south of today's Egypt).
Gold as Money (Coins)
While gold began predominantly as a store of value, it was not long before it was being used as everyday money. Coins were first produced roughly 3,700 years ago in Asia Minor, or what is today's Turkey. Since then, gold has served two purposes, as a store of value or as money for everyday transactions. But although the two uses are related, the second is more problematic than the first.
Businesses and people need money when we want to buy something or want to hire someone. We all use money when we want something today rather than tomorrow. We also borrow from someone willing to wait until later to spend their money (i.e. credit). The main point here is that money seldom sits still. It needs to grow and shrink based on the needs of people, businesses, and economies. And herein lies the struggle with using gold as the world's money, or what we call the base currency—the earth only yields so much gold and unpredictably throughout history. Chart 2 shows yearly global gold production in tonnes (red line) versus the price of gold (blue line). It was not until the mid-1700s that gold production surpassed even 20 tonnes in a given year.
Chart 2. Gold Production vs. Price
Sources: U.S. Geological Survey (USGS), Bloomberg, Prices by G.F. Warren and F.A. Pearson, Wells Fargo Investment Institute. Yearly Data: 1493 - 2015. Data shown in log scale. Dates selected to show all available data. Past performance is no guarantee of future results.
The Gold Standard
When gold was used as a prime source of exchange, a country's economic prospects and flexibility were often tied to how much gold it owned. Countries that held gold could effectively expand credit, while those that did not, could not. To dig out of the Great Depression many western countries were forced to scrap the “gold standard” during the late 1920s and early 1930s in favor of printing paper money with no or little gold backing.
Paper currencies not backed by gold are the prime medium of money exchange today. However, some investors believe that today's Central Banks have gone too far—printing too much paper money not backed by anything other than the full faith and credit of a country or a region such as the Eurozone. They are arguing for a return to gold-back paper currencies, fearing that excessive paper money printing may eventually lead to hyperinflation and the collapse of the currency.
Should world economies return to a gold standard? We're not sold on the idea, at least as it was devised 100 years ago. A gold standard is quite economically inflexible, as the western world learned during the Great Depression. We cannot completely dismiss the fear of excessive money printing, though. Chart 3 emphasizes that global money supplies sit at record highs. Notice the dramatic expansion in money supply, since the 2008 Financial Crisis. The extra money supply, however, has not led to higher-than-normal global inflation. In fact, global inflation rates, in recent years, have been running below historical norms.
Chart 3. Global Money Supply
Source: World Bank, Federal Reserve Economic Data (FRED), Bloomberg, Wells Fargo Investment Institute. Monthly Data: 1/31/1986 - 12/31/2016. Dates selected to show modern increase in money supply across major economies.
While excessive inflation has yet to rear its head, we still advise closely watching global money supply growth. Higher inflation rates could eventually return, which could be bullish for gold prices. Chart 4 is one way to track whether excessive money supply growth could lead to higher gold prices. The dark blue line is the price of gold. The light blue line is the global money supply divided by global above-ground gold supply. A rising light blue line means that paper money supplies are growing faster than gold supplies, which is one way of saying that Central Banks may be overprinting. In recent years, the light blue line has stopped moving higher, which fits well with gold prices sinking (less fear of overprinting paper currencies).
That is it for today. Tomorrow we will go into greater detail on who owns gold and why.
Chart 4. Global Money Supply / Global Gold Supply
Source: Bloomberg, USGS, World Bank, FRED, Wells Fargo Investment Institute. *Global Money Supply estimated by combining M2 Measures for the U.S., UK, China, Japan, Canada, and the Eurozone. Ratio is the global money supply divided by the global gold supply. Monthly Data: 1/31/1987 - 12/31/2015. Dates selected to show how the modern increase in money supply and gold have moved in relation to each other. Past performance is no guarantee of future results.
There is no assurance that any of the target prices or other forward-looking statements mentioned will be attained.
Investing in physical commodities, such as gold, exposes a portfolio to other risk considerations such as potentially severe price fluctuations over short periods of time and storage costs that exceed the custodial and/or brokerage costs associated with the portfolio's other holdings. Products that concentrate their investments in the gold industry increase their vulnerability to international, economic, monetary and political developments affecting the industry.
Investments in gold and gold-related investments tend to be more volatile than investments in traditional equity or debt securities. Such investments increase their vulnerability to international economic, monetary and political developments. They are also exposed to the risk of severe price fluctuations in the price of gold bullion.
Tonne/Metric Ton is unit of weight equal to 1,000 kilograms (2,205 lbs).
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