Source: Li Xunlei Finance and Investment Author: Li Xunlei

Recently, there have been more and more articles discussing gold, but I have always been optimistic about gold and future trends.

I remember that in 2016, when the fluctuation of the RMB increased, and many people were planning to exchange dollars, I wrote an article “Why is it better to buy gold in exchange for dollars”. The logic is simple: the Federal Reserve continues to expand, the dollar is rampant, and the speed of gold mining is far less than the speed at which dollars are printed. I originally thought this article would win everyone's approval, and I didn't think of many opponents, so I wrote another article “On Exchanging dollars is not as good as buying gold”, pointing out that “if the US dollar can also be viewed as an investment product, its increase is insufficient compared to gold.”

Three years ago, my article “Looking at the Allocation Value of Gold as a Strategic Asset from a Long-term Perspective” attempted to explain the long-term investment value of gold from various dimensions, including history. So, where did the main impetus for this round of gold rise since this year come from, and what misconceptions do people still have about the allocation of gold?

Do non-interest-bearing assets have no allocation value?

If you buy bonds, you can get interest income; if you buy stocks, you can get dividends; if you buy a house to rent, you can get rent. What can you get when you buy gold? Therefore, many people still don't approve of investing in gold. It is true that gold cannot survive, but neither can any kind of virtual currency.

For example, since 2019, various virtual currencies have skyrocketed. Bitcoin was only around 3,400 US dollars at the beginning of 2019. By April 2021, it reached a peak of around 64,800, close to 20 times, and then declined sharply. This sharp rise and fall definitely has its share of speculation. Therefore, our country regards Bitcoin and the like as illegal transactions, and must clear them from financial institutions and internet platforms. However, the reason why Bitcoin is recognized by everyone is, firstly, its resistance to the long-term overpayment of national currencies represented by the US dollar. Second, among many virtual currencies, one type of currency will eventually be recognized by everyone and gradually become a type of investment and transaction.

The reason why Bitcoin continues to rise is related to the continuous rise in its “minting” cost, so once everyone has demand for some kind of virtual currency, its scarcity will be revealed. At the stage where the price of gold has declined in the past few years, many people predicted that Bitcoin would replace gold and that gold would lose its monetary properties, but now it seems that the financial status and monetary properties of gold have not changed.

Bitcoin is unlikely to replace gold as a “currency”

Compared to Bitcoin, gold has been a currency for more than 2,000 years. Marx wrote in “The Theory of Capital,” “Money is naturally gold and silver, but gold and silver are not natural currencies.” This is because gold and silver themselves have good stability and rarity.

China has implemented a bank-based system for a long time in history, which is why financial institutions that engage in loans in China are called “banks.” Until 1820, China's economy was the largest in the world; at its peak, it even accounted for one-third of the world's economy. When China had a large export surplus before the Opium War, large amounts of silver flowed to China, so much of it caused a “silver shortage” around the world, and the price of silver rose sharply compared to gold. Therefore, “scarcity” is actually also a relative concept, influenced by the relationship between supply and demand.

In 1850, the gold and silver ratio in Europe ranged from 1:17 to 1:20, and at the end of the 19th century, this value reached over 30; while the gold and silver ratio in the Qing dynasty stabilized between 1:8 and 1:15. Due to the long-standing price difference between China and Europe, even after the Opium War, large amounts of European silver (estimated to be as high as 1 billion yuan) flowed into China in exchange for tea, silk, and gold.

According to a report by the World Gold Council, about 208 thousand tons of gold have been mined, and there are still about 52,000 tons of proven ground gold reserves left. The scarcity is imaginable. Over the past 120 years, the average annual growth rate of gold stocks that have been mined was only 1.5%. Even considering technological advances, the gold stock growth rate in the past 20 years was only 1.6%.

Since the collapse of the silver empire in the Qing Dynasty, the price of silver has depreciated relatively to the price of gold. Although the dollar was decoupled from gold in 1971, the monetary properties of gold are far superior to silver. Therefore, central banks around the world have gold reserves, and the practical significance of allocating gold to households is self-evident. In contrast, although Bitcoin also has monetary properties, its volatility is far greater than that of gold, that is, its asset properties are stronger than monetary attributes, and the future of its valuation is also quite uncertain.

The proliferation of banknotes has boosted the long-term rise in gold prices

In the 180 years before 1971, the price of gold only increased 1.3 times, with an annualized increase of less than 0.5%. The increase in inflation and residents' real income under the gold standard system in 1930-1971 was 1.7 times and 1.4 times, respectively. After the collapse of the Bretton Woods system, the dollar was decoupled from gold, and the dollar began to overrun. Since 1971, the dollar has depreciated 98.6% against gold, that is, gold has risen from 35 US dollars to more than 2,400 US dollars per ounce. Many people think that gold still cannot beat inflation because they have ignored the huge rise in gold prices after the dollar was decoupled from gold.

Since the Federal Reserve raised interest rates, the yield on US bonds has risen sharply, the price of US bonds has fallen, and losses on holding US bonds have been huge, and gold has become a real safe-haven tool. At the same time, under high interest rates, not only is the cost of debt rising, but the US federal government's debt is already close to the upper limit, causing people to worry about the US federal government's credit. As a result, reducing US debt holdings and increasing their gold holdings are increasingly becoming the choice of central banks in many countries.

America's quantitative easing policy has led to heavy debt

Relatively speaking, although the US dollar has greatly surpassed, the US economy has been the leading global economy since World War II, and the US dollar index has strengthened significantly in recent years. Compared to the US dollar, most countries' currencies depreciated against the US dollar. From 1990 to now, the currencies of Brazil, Turkey, Argentina, etc. have depreciated by about 100% against the US dollar. With the exception of Switzerland and Singapore, the currencies of most developed countries also depreciated against the US dollar.

Most national currencies depreciated against the US dollar

The widespread overcirculation and depreciation of global currencies has further deepened people's concerns about the proliferation of banknotes, increasing people's demand for an allocation ratio of natural monetary assets such as gold. Therefore, the long-term logic of gold's rise should hold true.

From a historical perspective, although the trend of gold prices has been short and long, the increase in the bull market is far greater than the decline in the bear market. For example, the bull market rose by 1781.5% in the 1972 to 1979 wave, then fell 69.5% in the next 20 years, and then rose 644.3% in the next 10 years. The most recent round of decline was from July 2011 to December 2015, with a decline of 42%. Since the beginning of 2016, gold has experienced another round of growth. So far, gold has risen 1.26 times. Although the increase was modest, the continued upward trend became more steady.

Central banks' increase in holdings — a marginal driving force for the recent rise in gold

One of the recent hot topics in the market is that central banks are buying gold to increase their gold reserves, such as the central banks of China, Poland, Singapore, India, the Philippines, Iraq, etc. Among them, the central bank of China has been buying gold for 18 consecutive months, ranking first among all countries.

As the second-largest economy in the world, China's central bank does not have many gold reserves. Even though gold reserves have been increased in the last two years, the share is low compared to the size of GDP. In particular, China has the largest foreign exchange reserves in the world. The allocation ratio of US dollars and US dollar assets is relatively high, and there is a need to optimize the structure in the future.

China's gold reserves account for a low share of GDP

The logic for the central bank to increase its gold holdings is more from the perspective of dealing with risk. Because gold is a non-interest-bearing asset, when the price of gold falls for decades, not only will you not earn interest on increasing your gold reserves, but you will also have to endure losses due to a corresponding decrease in the allocation of interest-bearing assets. Therefore, increasing gold reserves is not the right choice for all periods. Historically, there are indeed quite a few central banks that chose to reduce their gold reserves.

However, in the current context where the Federal Reserve is raising interest rates and inflation remains high, and it is not the best time to increase the allocation of gold, why are many central banks still choosing to increase their holdings of gold? The turbulence of the world situation, drastic changes in geopolitics, and the proliferation of global banknotes are the main reasons why safe-haven tools such as gold are popular.

First, the world has experienced a period of peace for nearly 80 years. Peace usually accumulates risks, and wars are usually overthrown and repeated. In other words, today the world's problems are accumulating more and more obvious, conflicts between countries are prominent, and the gap between rich and poor is widening, which has led to a continuous rise in safe-haven demand.

Second, in order to cope with downward pressure on the economy, countries continue to expand their debt levels, which will inevitably lead to currency overruns and high inflation. As mentioned earlier, since the US dollar was decoupled from gold, the US dollar depreciated by nearly 99% against gold, and other currencies depreciated by an average of more than 90% against the US dollar. Therefore, the real hard currency is still gold.

Third, under geopolitics, the Cold War mentality has restarted, the Middle East has been unpeaceful for a long time, and the prolonged Russian-Ukrainian war has made everyone more and more clearly realize that the risk of decoupling between different economies around the world is increasing, so demand for allocation of “neutral assets” such as gold has increased markedly. Looking at the trend of the US dollar index and the RMB index since 2001, it was found that the two currencies of China and the US are still relatively strong. Among them, the US dollar index was lower than in 2001, but the trend was strong after the epidemic. The overall appreciation of the RMB index against a basket of currencies over the past 23 years was only weak after 2016.

The trend of the US dollar index and the RMB index since 2001

For the central bank of China, reducing its holdings of US dollars or US debt while increasing gold reserves should be a wise move to help stabilize the exchange rate. As far as other central banks are concerned, it is likely that they will continue to increase their gold reserves in the future. Central banks around the world bought 300-400 tons of gold every year during the ten years from 2012 to 2021, but they bought 1,135 and 1,100 tons in 2022 and 2023, respectively. At the same time, reducing holdings of dollar assets is also a common practice of central banks.

Although the scale of the increase in gold holdings by central banks is far less than the amount of gold purchased by the global residential sector, they have a stronger marginal impact on the price of gold and have a more exemplary effect. Judging from the time of the 2016 round of gold price increases, it has continued for 8 years, but the trend is relatively smooth, and the upward process has been repeated.

Judging from the absolute increase, it is only 1.26 times, which is far inferior to the 17.8 times increase from 1972 to 1979 and 6.4 times from 2001 to 2011. But this may also mean that the upward process is not over, and there may still be quite a bit of room for the rise.

Significantly undervalued gold investment value

Investment textbooks usually say that gold is not an ideal investment product. For example, looking at the past 100 years, stocks have the highest yield, followed by corporate bonds. Gold's return on investment is not as good as treasury bonds; it just barely outperforms inflation. However, this calculation method is unscientific, because before 1971, the US dollar was linked to gold. Earlier, under the gold standard system, gold itself was currency, and its price lacked a reference frame.

Trends in gold and other assets and inflation since 1971

Note: Real estate is selected from the Freddie Mac Price Index (starting in 1975). The pre-1975 data was obtained by reversing the OECD Housing Price Index

However, after 1971, the dollar was decoupled from gold, and gold was like an unbridled wild horse. Judging from the data, since 1971, the cumulative increase in gold has reached 52 times, surpassing the increase of the US S&P 500 (50 times); the average annual return on gold investment over the past 53 years has reached an astonishing 7.8%. It significantly outperformed the housing price index (11.9 times) and the cumulative increase in the per capita disposable income of US residents (14.9 times).

I also mentioned the allocation value of gold many times in my book “The Power of Trends” published in 2021. This is related to the major trend of global political and economic differentiation and agglomeration. That is, long-term peace causes structural imbalances, and structural imbalances also lead to a decline in efficiency, that is, the return on investment declines. The trend of structural imbalance is difficult to contain. Relative economic and social stability can only be maintained through borrowing and overspending money. As a result, the relatively effective asset for safe haven and counteracting the proliferation of money in the future is still gold that does not live on.

edit/lambor