Goldmoney’s leadership team - Roy Sebag, James Turk, Alasdair Macleod, John Butler and Stefan Wieler were joined by a special guest, Ned Naylor-Leyland of Merian Global Investors at the Royal Society in London on January 28, 2019 to film the annual Goldmoney Roundtable and Outlook video.
A myriad of topics were debated throughout the roundtable. In particular, the discussion revolved around the following topics:
- The state of interest rates and whether they will be the main drivers of the gold price in 2019
- Energy markets and their influence on gold
- Modern Money Theory and the potential reconstruction of the world monetary system
- The U.S. Federal Reserve’s policy and the consequences on the U.S. economy
- The concept of sound money
- 2019 gold outlook
Watch the full video here: https://youtu.be/9fBCOsqzBig
We have highlighted some notable conversations that occurred throughout the roundtable discussion.
Will Interest Rates Be The Main Driver of The Gold Price In 2019?
“I think so! One of two things has to happen, either the rest of the central banks around the world begin to raise and normalize in which case that wont bode well for gold or we will see the Fed stop playing this game of poker that they've been playing and return back to easing and then getting into some of the real problems if we see the deflation continue and the U.S. recession take hold.”
“I don't think interest rates are a negative for gold, history tells us that. You can get there by comparing gold with physical cash. If you’ve got kruger rounds in your pockets they don't earn you anything, if you’ve got pound notes or dollar notes they don't earn anything either. But there is an interest rate on gold if you want to borrow it or if you want to lend it. So in a sense I think with rising interest rates what really matters as far as the gold price is concerned is: Are interest rates rising at a pace which is going to soften the economy and make fiat money more attractive relative to gold? I think that is the issue, its a moving target, it's changing all the time. What we saw in the last months is a global slowdown, almost a stoppage in some markets, and this is going to set the scene for 2019. The big risk is maybe moving into a slump. There are a number of factors that are coming together such as trade policies, the fact that the ECB cannot get out of its monetary dilemma in the face of a downturn, the Fed is being forced to stop reducing its balance sheet. All of these factors tell me the things are coming to a rather nasty stop. The more I look at the comparison with history, I come up with 1929 to 1932 which is extremely worrying and hopefully that won't happen. There are so many similarities in the situation developing today, that any economic historian should be concerned.”
“I always think about the nature of the way gold trades in the cash market, and the fact that it is really the inverse of real interest rates. For the past 6-7 years the Fed has been promising a slightly uphill trajectory in terms of real yields, promising normalization, promising rate hikes and that keeps the cash market away from gold as a hedge against the loss of purchasing power. They have been very clever in the way they have managed that. They have kept it slightly uphill all the way through, and the bond market has bought that narrative, but I think that dramatically changed in December 2018. It's quite clear it tilted into a level playing field and maybe even slightly downhill with the leak last Friday about the pace of QT and central bank growth in the last month as well.
What has been that slight headwind for six and a half years; promising that we can go back to normal interest rate policy and environment seems to have lost its legs lately. The other thing to bear in mind is gold is money. We have all been interested in gold. James Turk maybe back in the raging winter, when no one was interested in gold beyond the odd person at the central bank.
We are in mid to late spring in terms of the gold as money cycle. I think it's warming up quickly, I think people will be surprised how much that can bust out into full view and obviously policy makers comments are supporting that as well. The subject they never wanted to talk about is starting to edge out into view.”
“We developed a model a couple years ago that basically explains the large and small moves in the gold price by practically two factors. One is real interest rates and central bank policies such as QE and the second one is long-dated energy prices. The way I look at the world is there is not one price of lets say oil or gas, but there is an entire curve. You can buy prompt, one month forward or five year forward. The production cost of any of these energy commodities and basically any commodity can only be seen at the back end of the curve, which should be the marginal cost of future supply, which basically should not move much unless you have a massive shift in technology as we have seen with shale oil a couple of year ago, or you have a massive shift in the trajectory of global economic expansion, where you say we might not need anymore of that stuff moving forward.
What we found is gold reacts to the very back end of the curve. In our statistic model we used the long-dated oil prices of five years forward as a proxy for energy prices. We all know mining gold is not just oil, its energy in all kinds of forms. If you followed the oil price over the past year, we saw a tremendous rally going into the third quarter and a total collapse. We went to over $80 in Brent and then collapsed to $50 on Christmas eve. That has very little to do with production costs, because the back end of the curve remained at $60, it doesn't really move much. In order for it to move, we need to see broad based inflation, which we will eventually see because of all the monetary experiments we have been doing over the past 10 years, or the market would realise that at $60 you are not getting enough oil to supply the world in the next 5-10 years, which I think will happen. The reason being, the entire world is relying on the United States to supply the entire production growth over the next 10 years, which is basically currently priced into the market. I think this is very unrealistic, simply because they are not making any money at this price. They produce enough cash flow to service their debt, the banks are now rolling over their debt, as they dont want to write it off. Nobody made money at $80 and people do not make money right now in the U.S. Depending where you are, you may be making $45, not even in some cases. At some point the market will have to realize that by that time it's too late that back end will have to move higher. This is actually the energy driver of the gold price.
It's really hard to predict this stuff, so I dont think this will be the 2019 topic, this will probably be a bit further out. For me the driver of 2019 is what is going to happen with real interest rates. We are back to the whole world buying into the Fed’s narrative, that they will gradually raise interest rates and promised to normalize at 3%, which is not normal! We have always argued with our model that at 3% and 2% inflation the gold price is still going to be $1,300. That's already priced into the market. If the very best they promised us would have happened, the gold price wouldn't have moved lower. But now we have this shift since December and we see it in the Fed’s funds futures market, that the market is now heavily discounting the future rate hikes and it can't because if you look at the world, you look at PMI’s in China and Europe, you look at Chinese car sales are down for the first time in 30 years, we even have an inverted yield curve. With all of these things, it's very unlikely they are getting to the point that they can ever raise it to the promised 3%, which wouldn't have been bad for gold in my argument. Now they are going to have to cut at some point. “
“Where we are today is qualitatively different than any cycle, any recovery that we have ever lived through, because, yes, leading indicators are rolling over and we see all of these typical late end of cycle signals in the data. We’re getting into a slow down, central banks are beginning to acknowledge it, but where did this whole recovery come from? It was all engineered, all artificial, all unconventional. We are in this odd situation, where as financial markets begin to quantitatively reassess their expectations, they also begin to peer behind the curtain again and see the man behind the curtain pulling the levers the whole time, just like Toto and Dorothy in the Wizard of Oz and they need to go through a qualitative assessment. Where did all of this growth come from? What qualitative unconventional factors really kickstarted that recovery that carried us through all the way to the present day? The potential for a reassessment to the downside for growth, risk premia for all kinds of things is unusually high today. We must also not forget that a lot of the debt that was originated through the cycle has been supporting various structured, leveraged and illiquid products for which as long as the price level is still rising in general for assets, then that's OK. But then that sort of liquidity is directional. The moment the prices stop increasing and god forbid they start falling, the liquidity evaporates very quickly, we learned this in 2007-2008. The potential for something similar, yet larger to happen today is actually quite high. Gold is the antidote to all of that, gold is the anti asset in that modern sense in being something that is leveraged, potentially directionally illiquid. I think we are not just going to see a quantitative reassessment of gold that's very positive over the course of this year, but almost some qualitative shock value that will drive some additional demand into gold over the course of the year.”
Modern Monetary Theory (MMT)
“I don't think in a actual fiat money economy it's the actual debt in terms of the dollars that's important, but these days I think there's almost this intellectual balance sheet where a central banker or an academic will put forward a debt in the form of a theory and say look I can do this and I can do that but at some point the theory does get weighed and it gets weighed through either the natural order of things or through basically some competing theory which comes into play. I think what's so special about this moment is that we're sort of all realizing that on this intellectual balance sheet the central bankers and academics have a lot of debt coming due in the form of promises that were made in the form of predictions.
Forget about growth and and things like that, just actual predictions and how they get out of this quandary may only be through an alternate theory and I've personally been seeing a lot of rumblings about MMT which is this Modern Money Theory which essentially just throws everything out the door. If I understand it correctly, it admits that it's a fiat money system which means the government can print as much as it needs, forget about what Keynes says, let's just get the hose at the highest pressure possible but it's okay the government can control where it goes.
For me, QE and TARP’s critical problem was it wasn't an academic theory. It was never flushed out, it was never debated, there was no real literature about it and this is just my intuition but I personally feel that even Keynes if he were alive would be very angry with the way that his views were taken out of context about what Keynesianism is. I can't even imagine what the Austrians would be doing. Keynes himself has really been taken out of context and now you have this chief proponent of MMT and I see a lot of powerful people getting around this theory and I wonder whether what we're going to see isn't just inflation this time in QE but a whole re-architecture of the monetary system.”
“MMT is basically a rehash of Chartalism which was invented by an economist called Georg Friedrich Knapp who wrote about it I think in about 1905-1906. Basically it's the state theory of money. The state should have the right to issue money and the use of money in the private sector is not a matter for the private sector, so you're right to identify it with government control, if you like, over the economy. People are rolling out this rubbish basically because they know that the existing monetary policies are failing. You can see that people who don't understand money let alone sound money are attracted by this sort of wonderful idea that there is a new theory which is going to rescue us from everything. If you go back to before the first world war, Bismarck used MMT then known as Chartalism as the means of financing the state's expansion on military spending. The German historical economic theories had actually been socialist for about sixty or seventy years before the first world war so you know we are talking about socialism, we are talking about taking things away from the private sector in terms of decisions, pricing and everything. What interests me is the the failure of Chartalism (call it MMT nowadays) was actually so profound that it led to two world wars. The destabilizing effect of the first world war led us into the second one so this is no solution at all, it's just an attempt to avoid the reality of sound money. “
“I came up with a new name for MMT which I think is more appropriate, which is not Modern Monetary Theory, but "Old Physical Theory". The idea that back before we even had our modern monetary instruments that central bankers used today, the state in theory could always borrow money, could always engage in deficit spending and this is basically just saying that that's a free lunch. There are no real consequences because you can simply monetize that if the state has full control of the money so it's really not particularly new as Alasdair pointed out. It is based on the idea that fiscal policy management can and should be used, but used so aggressively that you monetize a hundred percent of those deficits if necessary in order to achieve some arbitrary growth target. What it makes it impossible for an economy to do is allocate capital efficiently according to any reasonable capitalist assumption and it also makes it impossible to save and that is simply an arbitrary expropriation of of wealth from the citizens.”
Why Is Gold Sound Money?
“Gold throughout history has been sound money because it has always had a value attributed to it in a non monetary sense. You have only got to go back 3 millennia and see Tutankhamuns mask and just marvel at the gold, which looks as if it was cast yesterday. It's just incredible.
The fact that gold is completely incorruptible makes it useful as money and particularly when you compare it with government source money. The point about it is, it's nobody else’s liability. If you buy dollars you are buying into the full faith and credit of U.S. government. This is the thing that differentiates gold from paper currency, it has a track record, it is incorruptible, it has always been accepted as money and when times get bad, it will come back as money. It is already used as money without interruption in places like India and China.
Sound money is money that is beyond the control of government and is accepted by people as the incorruptible unit of exchange in transactions.”
“Navy seals are dropped into enemy territory with small gold coins in their belts. This brings up all sorts of points, which have to do with recognition. Everybody everywhere knows what gold is. This is what makes it money and beyond the need for a stamp of approval
Most of your transactions require all sort of approval, whereas If you land in Mongolia or the jungle, people will accept gold and probably silver in exchange and that makes gold and silver money.”
“Sound money is money that you own. It doesn’t have counterparty risk. It's a tangible asset. The thing that a lot of people miss is that money comes into creation the same way all goods and services come into creation. Its applying hard work, capital and pulling money out of the ground. It's a productive capacity. The beauty of gold is that it’s timeless, an ounce of gold today, is exactly identical to an ounce of gold a thousand years ago, it doesn’t disintegrate, tarnish or rust. The timelessness makes it an ideal unit for measuring prices and economic calculations.
Silver is a gold substitute in my view, it has got a lot of the attributes that gold has, but it's complicated because it has industrial components whereas the supply and demand for gold is entirely monetary. Silver has an industrial components so I look at the ratio of the two and when the ratio is as high as it is at the moment I see silver as an attractive alternative of a way of diversifying.”
“I would like to emphasize the medium of exchange aspect of it because money is what enables you to get beyond barter, by having some intermediate good that you can use in third-party transactions where direct barter is not possible, and that enables civilization to exist. To get beyond the family and tribal unit, you need to have some means of trading with people who you might never meet, but you do so indirectly through the use of a medium of exchange, that to me is money. However what you see universally the world over is those substances including of course gold that have ever been used as money are ones that are more or less universally accepted and they are universally accepted in large part because, as James says, they don't decay and their storage costs are effectively zero as there is no cost involved in holding on to some of the stuff for your entire life and maybe even potentially handing it on to the next generation. So human societies, the world over have solved for this ideal money which is gold. It has been for an awfully long time the most universal money notwithstanding the very prominent role of silver for more day-to-day transactions as opposed to a store of value for particularly large pools of wealth that has tended to be more the role of gold. “
“There is an energy aspect to the whole thing. If we have a society which is prosperous you generate an energy surplus and you turn that into money. The best way we found through trial-and-error is to turn this into gold. The gold industry is anchored in the primary industries. You are using the same capital, time, labor and machines to mine for commodities we actually consume like oil and copper, to mine for money. Gold simply possesses all of the attributes that are needed to create a great vehicle that allows you to transact and save. The lack of entropy of gold is also very important. Tutankhamuns mask still looks brand new and it will still look the same 10,000 years from now, unless we destroy it. The aspect that you are able to store your energy surplus and use it for savings and transactions is a very important part of why gold is unique. It's not that we chose gold, we just found it in the end. It was there and made the most sense of everything there was. If there wasn't gold, we would have had to invent it actually.”
“Why is it that when you go to Mongolia people value gold? Why is it that when you go everywhere else people value gold? The solution to this question to me came from a deep knowledge of physics and chemistry, where you basically figure out as Newton did that in the corporeal and material world everything follows these laws and principles that are repeatable, observable, omnipresent and don't change through time. All of the stuff known to us is ultimately made up of these simple building blocks called the elements and for whatever reason this element gold has two attributes which are clearly observable, clearly repeatable,clearly omnipresent and clearly transcend time which is that it is rarer than all the other elements so it's always going to take more energy, time and labor to get a physical amount, let's say a sugar cube of gold than a sugar cube of silver or a sugar cube of copper or a sugar cube of oil. This is just natural scarcity enforcing this rule, but then it's got this other trick which is that a sugar cube of everything else begins to react with air almost immediately and gold doesn't, so the result is over cycles of human life we see that everything else is either used up or actually doesn't survive and gold does. Going back to the question of what is money. Money is basically a social tool for us to cooperate with each other once we've decided that we don't want to be a clannish society. If we want to be in clans we don't need money because we can essentially cooperate with each other through familial relationships, kinship, barter. But once we leave the clannish society there becomes different segments of society that depend on other segments. So the primary producers- the farmer, is always going to be producing the food for the rocket scientist. Putting aside who's better today or tomorrow, it is a fact that the rocket scientist, professor and central banker are dependent on the farmer. For them to cooperate they need to have something that intermediates their cooperation, a social contract and that's what money is, it's a tool that allows the farmer to create more crops than he needs today as a surplus which he can then trade on with other counterparts in the society for something that is better than his own crops. This concept allows a software engineer to trade his labor whereby he wrote some lines of code for something that is better than lines of code and it just goes back to that periodic table, how everything is not as good as gold or doesn't last as long as gold and so to me in probably what is a more provocative point, money is gold and gold is money. There is no other system, the laws of nature would have to change.
The other mystery here that we should revel in is there isn't an example of us not using gold as money, there has been great attempts by modern historians to essentially put together anachronistic mishmashes of examples of clannish societies using a big ring in the Island of Yap or clams and shells but these are just examples of clannish societies, just like inmates using cigarettes in jail. All you have to do is take a look at that period of time and zoom out and you'll see a civilization using gold and silver as money. As long as that was taking place throughout written history, the period of history that we can objectively date and back into, gold and silver have always been money which reconciles with our natural understanding of why these elements are so special. To believe that gold wasn't money you have to either take some small clannish society and argue that they were not even using money or you have to believe in anthropological theory that is objectively dated so you're getting into paradigms such as carbon dating. Money is gold, gold is money and that is why we're so focused in this company at promoting this message to the average person.”
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