The trade-off in the risk/reward for gold and gold mining equities is improving, as central banks push the current iteration of the post-World War II Bretton Woods financial order towards its limits.
Bretton Woods began as a gold exchange standard, which pegged the US dollar to gold at $35/oz until 1968. The framework required modification after monetary discipline was jettisoned by the US, and policy coordination between the US and other major economic powers broke down. The peg to the gold price became unsustainable and a bull market in gold, lasting more than a decade, ensued.
The subsequent modification to Bretton Woods, sometimes termed the “Petrodollar”, is a free-floating system built on the US dollar’s dominance in global trade and reserve balances. It requires a framework in which confidence in central banks remains strong, economic policies of major powers are coordinated and debt levels are manageable.
Looking at today’s “big picture”, the current economic expansion is the longest in postWorld War II history. Meanwhile, even the Federal Reserve has scrapped its attempts to normalise monetary policy, with the reversion to rate cuts and QE (sorry Mr Powell, it is QE). Trade tensions between the US and China continue and the debt burden, which is a good place to begin this discussion, is unprecedented.
Our position in the global debt cycle is significant for gold because:
- it performed strongly versus other major asset classes in the final (“Winter”) stages of the three previous debt cycles, which have played out since the Industrial Revolution (see table below);
- gold has no counterparty risk, which increases in loans/credit instruments as the debt carried by the financial system increases; and
- debt has a time function – bringing forward consumption from the future into the present – in a sense “buying time”. Rising debt ultimately acts as a tax on growth.