Gold Over Five Years: Substantially Higher
Plot gold across the next 3, 5, or 10 years and the direction is clear. Over five years, gold goes substantially higher. But a five-year answer is not a six-month answer.
In the near term, rising US interest rates are bearish for gold, whether the rise comes from the Fed or the market. Higher US rates relative to other countries' rates make the US dollar more attractive and stronger. A stronger dollar lowers the dollar price of assets priced in dollars, including gold. Higher rates also make yield-paying instruments more attractive. Some investors see the US 10-year Treasury yielding 5% as a good, near-riskless return. I would dispute the "riskless" label, but that view exists and drives money.
I believe the US dollar is losing buying power at 8 to 10% a year. So a 5% nominal yield is not a 5% gain. After losing 8% of buying power, holding that Treasury means losing about 3% in real terms, not earning 5%.
The Real Question: Confidence or Distrust
Nominal yield means little if inflation eats your principal. The issue is whether rising rates signal confidence in the economy or distrust of the currency.
Here is the key point for younger savers. If interest rates rise because savers fear the continued loss of dollar value, then rates and gold can climb together. Both rises share the same root cause: fear of inflation.
The 1970s prove it. Over ten years, interest rates rose about four-fold and the gold price rose 26-fold. Rising rates did not kill gold. Changing inflation expectations changed what those rates meant. Higher yields and stronger gold coexist when currency confidence breaks down.
The 1970s Trajectory in Detail
In 1970, the US came off two very generous decades, the 1950s and 1960s, much like the decades we come off now. That generosity kept investors and savers from seeing inflation building under the surface and the damage it would do to households. As they understood it, they dumped conventional assets like 30-year Treasuries and hoarded gold.
After price controls were removed in 1970 through early 1975, gold ran from $35 to $600, up 600%. That move itself made gold attractive to more people. Momentum validated the story. Perversely, there was more demand for gold at $175 than there had been at $75.
In 1975, inflation became a strong enough political concern that Congress and others forced interest rates higher to fight it. Gold fell from $200 to $100 an ounce, a 50% drop in the middle of a bull market. The people who crowded into gold at $200 hated it and crowded out at $100.
Those higher rates hurt more than gold. They further wrecked the equities market, obliterated the long bond market, hurt housing, and hurt consumer durables. Congress lost its nerve and forced rates back down. That told savers worldwide that short-term US politics mattered more than protecting the dollar. That signal drove gold from a low near $100-$102 to a high of $850.
Somewhere during the five and a half years gold ran from $100 to $850, gold began to reflect momentum rather than utility. People differ on when that shift happened.
Gold's most violent corrections can hit inside a much larger bull market and destroy investors who mistake momentum for certainty. One asset can absorb a shock while another forces selling.
Liquidity Decides the Outcome
There are eerie parallels to today. If we get a replay of the 2008 liquidity-driven crash and you have no liquidity, you will be a victim. If you have liquidity, you will benefit. Ask yourself: would you rather be victimized or benefited? If benefited, ask what you can do now to prepare. Pay less attention to the idiocy of elected officials and more to your own.
Gold should play a fairly major role in the liquidity you build. But gold is only real liquidity if you can actually sell it. In 2009 and 2010, when asset classes I understood became pathologically cheap, I was psychologically ready to sell my gold and use that cash for other things. Other gold bugs could not sell their gold. For them, gold was not liquidity. Ask whether your gold is truly liquid to you.
The real question is not how much gold you own but whether you can deploy it when markets break. One group holds a position; the other converts it into opportunity.
Pricing Life in Gold Instead of Dollars
In the year 2000, I decided to save mostly in gold, keep liquidity in very short-term dollar issuances, but hold the bulk of savings in gold. One exercise from that: pricing the basket of goods and services I consume first in dollars, then in gold. The website priced.com does this easily.
Over the last 26 years, the only period I have personal data for, real estate and rents are dear in dollars but cheap in gold. Food and groceries, a political issue now, are cheap in gold. Energy is cheap in gold. Healthcare and health insurance in the US are expensive in dollars but cheap in gold. That experience is why I will keep storing surplus capital in gold.
The Coming Crowd and the Overpricing Risk
Within the next 10 years, the loss of dollar buying power will likely push the nominal (dollar-quoted) price of gold up fast. When that happens, the gold story will catch the attention of generalist investors and savers. You could see a crowding into gold, and gold could become overpriced relative to its utility. At that point, the smart investor must look across all available opportunities and possibly move money out of gold into other places.
The biggest gold risk may arrive when everyone finally agrees gold is the answer. Watch not just gold's price but who is entering and why.
Set Your Sell Conditions in Advance
Gold buyers need to decide, in advance, what would make them sell. That discipline keeps you from overstaying. My own list of sell conditions:
- A balanced US federal budget.
- Enough political accord to start reducing the debt.
- Political accord to deal with the $120 trillion in unfunded entitlement liabilities.
- A 10-year Treasury yield that carries a premium over the rate of dollar deterioration, meaning a 10-year with a 9, 10, or 11 handle.
Only the fourth condition might be met. It happened in the first year of the Volcker era, when rates rose sharply, cut and then killed inflationary expectations, and delivered a real yield above inflation. Waiting for that set of conditions probably made you wait a couple of years too long. Waiting too long also let you ride the blowoff top of gold, but that is not a prudent strategy.
The danger is waiting for perfect confirmation and selling only after the blowoff.
The Feedback Loop and Failing Confidence
There is a feedback loop: rising interest rates raise interest expense, which raises debt, which raises rates. Debt-to-GDP is high across the world, not just the US. Since 1971, the compounded annual growth rate of the M2 money supply is about 8%.
My suspicion is that confidence will begin to fail, and interest rates are at least partly a function of confidence. Five years ago, audiences hearing my lecture "The Arithmetic of America" stared blankly at numbers like $28 or $30 trillion in aggregate federal debt; the 12 zeros to the left of the decimal did not register. Now the same audiences are far more receptive, which is a good thing.
Not long ago, central bank manipulation happened at the fringe and rates were partly set by markets. President Clinton said if he died he wanted to come back as the bond market, the most powerful entity on Earth; some of his economic goals were blocked by what he called the bond vigilantes. Going back 30 years shows a very different interest rate market, and that is a preview of coming attractions.
Fed Control Ends at the Short End
I expect the Fed to keep control of the 2-year rate, because it is such a dominant player there, but to lose control of the 10-year, 20-year, and 30-year. Markets may tolerate central bank influence at the short end while demanding compensation farther out the curve. That divergence pushes higher borrowing costs into housing, businesses, and government finance. The 10-year may reveal stress the policy rate hides. The implications for society are not good and likely require a reckoning.
The Last Reckoning and the Next
The last reckoning was 1981-1982, the Volcker years, and it was painful: prime rates at 15 to 16%, double-digit unemployment and inflation, housing foreclosures. That reckoning set up the strong reconciliation of the 1980s and 1990s. We took our medicine, reset, and came back stronger. Coming back stronger is the fun part; getting there is less fun, and we will have to deal with it again.
Recovery usually requires surviving the reckoning first. When public finances cannot guarantee liquidity, individuals must build their own reserves before the stress arrives. Investors who entered the 1980s reset without liquidity had fewer choices.
Adding up all these problems tempts you to curl into a corner and whimper. That response guarantees you lose. Instead, look at what is around you and ask what you can do to survive and prosper over the next 10 years. If there are no savings at the national level and liquidity will be a concern, the answer is simple: you need to save and build liquidity.
