August 5, 2021
Thesis Portfolio thesis descriptions: Scrooge McBuck

The focus of this thesis is Precious Metals and the expectation that they will rise to reflect the extended money printing regime that central banks have entered worldwide, that is likely to remain for some time.

Let’s start with our belief about money printing. Between 1944 and 1971, the major western powers were on a monetary system known as Bretton Woods, named for the town in New Hampshire, USA, where they got together towards the end of WWII and agreed that the dollar would be backed by gold and that other nations would maintain a fixed exchange rate to the dollar. In 1971, President Nixon ended the dollar convertibility into gold as it was getting harder and harder to maintain the convertibility rate given the inflation stemming from the spending commitments made by the prior Johnson administration. So for the last 50 years, we've been on a worldwide fiat money system for the first time in history. That system was born because of an inability to control spending and since birth it has allowed governments to become progressively more irresponsible. In the wake of the 2008 recession, they took it upon themselves to create money at an even greater rate than before. Following the pandemic of 2020, they simply lost all sense of reason, and now print money with what appears to be no concern of the consequences.

For much of prior history going back many centuries, gold and silver have been used as money. Governments had a degree of control in that they minted the coins and could determine the ratio of the face value of a coin (e.g. 20 Francs) to the gold content, which allowed them, from time to time, to reduce the content and debase the coins. But it was much harder to get away with than modern money printing.

"Since exiting the system of gold and silver money, the price of gold as measured in dollars (and all other currencies) has risen dramatically to reflect the money printing that has taken place. In 1971, the dollar was still pegged at $35 per ounce of gold. At the time of writing the price is $1,815. This more than 50 fold increase in price is really just a 98% drop in the dollar’s general purchasing power. After all, it's not just gold that costs more than it did 50 years ago, almost everything else has gone up similarly. And that is why people continue to own gold. In the old days, currencies were both a medium of exchange and a store value. Now they are just a medium of exchange so you need something else to store value and gold is widely used for that. It is one of the most actively traded forms of money (legacy money, not official money, but it is money in the truest sense) in the world after the dollar and the euro. And it remains a major reserve asset of central banks because, 'If the system collapses, the gold stock can serve as a basis to build it up again. Gold bolsters confidence in the stability of the central bank's balance sheet and creates a sense of security.' as the Dutch central bank said last year.

It has been observed that gold generally rises with inflation over the long term and moves inversely to real (inflation-adjusted) interest rates in the short term. But that is only because money printing leads to negative real rates in the short term and inflation in the longer term. The underlying driver is money printing. Gold does not respond to money printing in a straight line. In the short term, it can be hit when investors become euphoric about risk assets like stocks or cryptos, and then it can soar when they get nervous about the very same assets. Between 1971 and 1980 gold went up 20 fold while stocks fell. Between 1980 and 2000 gold gradually dropped by two-thirds while stocks went up 10 fold. Between 2000 and now, gold is up 7 fold and stocks are up 3 fold. As you can see, gold is no slouch, but it tends to alternate with stocks in performance." according to Mark Borwick, Chief Advisor to the Investment Committee, Thesis Portfolio.

Despite having hit a new high last year, gold is currently dropping while stocks are rising to new highs. A measure of long term relative performance is the Dow/Gold ratio - the former divided by the latter. It tends to cycle at generational frequency between about 1 and 40. At the time of writing (July 2021), we are at about 19, in the middle. It has been gradually falling since 2000, but with ups and downs. So where will it go next?

Money printing is now officially off the charts and the Thesis Portfolio Investment Committee expect this to continue, because as they print money, they create debt, which requires lower interest rates to service it, which can only be achieved with more money printing and more debt. This can eventually create inflation and that is not a mere side effect any longer, that could very well be the plan. Only more inflation will reduce the true value of debt in relation to GDP to a future sustainable level. All of this is gold’s favourite environment, but it isn’t good for stocks. In part because higher inflation will lead to higher nominal interest rates. Gold doesn’t care about nominal rates, only real rates, which are expected to stay negative. In such an environment gold will likely do very well and stocks will not. The last such period was the 1970s and before that the 1940s. In the 1970s gold soared and stocks went nowhere in nominal terms, but literally crashed in real, inflation-adjusted, terms.

"We can’t say whether this will repeat although it sure looks likely. Stocks and gold take turns and it is very much gold’s turn." says Mark Borwick, Chief Advisor to the Investment Committee, Thesis Portfolio.

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Written by
Pouneh Bligaard
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