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Is Gold a Bad Investment?
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Gold Coverage Ratio
April 2014
By Nick Barisheff
“Gold is an enemy of central banking—it infringes on
the ability of central bankers to do as they please. It
threatens them with loss of control of the currency
when people flee to the safe haven of precious
metals. Central bankers will do anything to prevent
that—it is the entire basis of their power.”
~ Kelly Mitchell—Gold Wars.
In my recent book, $10,000 Gold: Why Gold’s
Inevitable Rise is the Investor’s Safe Haven, I make
the argument that several long-term, in some cases
irreversible, trends are working simultaneously to
push the price of gold higher. At first glance these
trends may seem unrelated, but all have one thing in
common—they are each forcing the level of
government debt higher by the day. Outsourcing,
movement away from the dollar, tightening supplies
of cheap land-based oil, the aging population—all in
some way are creating a need for more currency,
resulting in debasement that, in turn, contributes
directly to the rising price of gold.
In the book, emphasis is placed on the correlation
between US debt, money supply and the rising gold
price. Since 1973, the United States has enjoyed an
“exorbitant privilege” because the world has been
forced to use the US petrodollar to buy oil, which is
why 61.2 percent of the currency presently in
circulation globally is in US dollars. As well, it is the
United States in particular and Western central
bankers in general that have the most to lose from a
rising gold price, so the dollar and gold are in direct
competition. Short term, this means gold has some
powerful enemies. Long term, the relationship
between gold and US debt will come back into sync
as it was until 2013, when desperate acts of
intervention skewed the relationship.
Therefore, we thought it would be valuable to look
again at the gold coverage ratio and to see where
gold should be trading were it not for the artificial
and temporary price setbacks it experiences as a
result of intervention.
In 2011, Guggenheim’s Chief Investment Officer,
Scott Minerd, presented an important chart showing
three different scenarios for the future price of gold
using the gold coverage ratio. This ratio measures
the amount of gold on deposit in the US Federal
Reserve against the total Monetary Base. Below is an
updated version of the chart (Figure 1).
Figure 1: Gold Conversion Ratio—April 2014
In October 2011, with gold trading 44 percent higher
than today’s price, the gold coverage ratio was at an
all-time low of 17 percent. Today it is at 9 percent.
This is simply unsustainable.
Gold Coverage Ratio
Following Mr. Minard’s example, we have estimated
what the price of gold would be under three
different scenarios: If the ratio is estimated at 19
percent, at 40 percent and at 100 percent of gold to
the money supply.
The ratio was at 19 percent in 1971 when President
Nixon closed the gold window and allowed the price
of gold to float. It was at 40 percent at the time of
the Bretton Woods agreement in 1944. It was at 100
percent in 1934 when President Roosevelt passed
the Gold Reserve Act. It has reached 100 percent
twice in the past century.
Today, at 19 percent, gold would be valued at
$2,800. At 40 percent, it would be at $5,900 and at
100 percent, gold would be priced at $14,800 an
ounce.
Many modern day economists argue the fiat model
makes gold irrelevant. Keynes, the architect of fiat
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deficit spending, claimed gold was a “barbarous
relic” that had no place in today’s economy. Paper
currencies and gold have always been at war and for
paper to retain power, gold must be discredited. Yet
modern economists who see the writing on the wall
know that it is only a matter of time before the US
dollar goes the same route as every other fiat
currency that eventually hyperinflated and then
became worthless. Despite what Keynesian
economists think, gold will almost certainly have to
have a role in the world’s next reserve currency in
order to provide confidence.
Gold may not form a 100 percent relationship to the
monetary base, but even a percentage would give
stability to a new currency and would certainly give it
credibility. When the gold coverage ratio reverts to
fair value, as it always does eventually, today’s prices
will seem unimaginable to most investors—especially
to those who do not own any gold.
Nick Barisheff is the founder, president and CEO of Bullion Management Group Inc., a company
dedicated to providing investors with a secure, cost-effective, transparent way to purchase and hold
physical bullion. BMG is an Associate Member of the London Bullion Market Association (LBMA).
Widely recognized as international bullion expert, Nick has written numerous articles on bullion and
current market trends that have been published on various news and business websites. Nick has
appeared on BNN, CBC, CNBC and Sun Media, and has been interviewed for countless articles by leading business
publications across North America, Europe and Asia. His first book, $10,000 Gold: Why Gold’s Inevitable Rise Is the
Investor’s Safe Haven, was published in the spring of 2013. Every investor who seeks the safety of sound money will
benefit from Nick’s insights into the portfolio-preserving power of gold. www.bmgbullion.com