old is a highly emotional topic. It seems there are only two opposing fronts here: people who love gold (aka gold bugs), and people who hate it. There are only very few shades of grey between these two fronts, and people are extremely hesitant to defect from one to the other. It seems as if we were faced with something like “aurophobia”[1], especially in the financial sector. This pathological fear of, or aggression towards, gold does not seem to exist for any other commodity. After all, we have not heard of such a profound aversion against copper, we do not know “bond haters”, nor are militant property bashers a popular concept. We regard ourselves as analysts rather than psychotherapists, which is why we do not really want to dwell on the reasons for that strong aversion. Instead we would like to continue substantiating with data, historical comparisons, and facts why we believe that gold should be a central module of the portfolio.

+25%, +140%, +460%, +4,322%. These are the performances since the previous Gold Report, since the first Gold Report, since the beginning of the bull market in 2000, and since 1970. Gold set new (nominal) highs last year both in USD and EUR as well as in numerous other currencies. The following chart illustrates the fact that the bull market is intact in both EUR and USD, but also that we have not seen the trend acceleration yet.

Performance of gold in USD vs. gold in EUR since the most recent Gold Report

Sources: Datastream, Erste Group Research

“Gold still represents the ultimate form of payment in the world… Fiat money, in extremis, is accepted by nobody. Gold is always accepted” Alan Greenspan[2]

The past months have shown a clear trend: gold has been more and more regarded as the purest form of money and increasingly less as a commodity. It has an international currency code (XAU[3]), and is still held by the global central banks as a key reserve. This underpins the monetary character of gold. We believe that the current return to a track record of millennia of monetary status indicates that the bull market and its acceptance have entered a new phase.

The possession of gold is tantamount to pure ownership without liabilities. This also explains why it does not pay any ongoing interest: it does not contain any counterpart risk. Along with the International Exchange and the Chicago Mercantile Exchange, JPMorgan now also accepts gold as collateral. The European Commission for Economic and Monetary Affairs has also decided to accept the gold reserves of its member states as additionally lodged collateral. We also regard the most recent initiatives in Utah and in numerous other States as well as in Malaysia, and the planned remonaterisation of silver in Mexico as a clear sign of the times. The foundation of a return to “sound money” seems to have been laid.

Why do people place trust in the yellow metal? Gold looks back on a history of success as the means of retaining value and purchase power that has spanned millennia. In that time span, the market has chosen the optimal currency from a logical and rational perspective. Among the criteria are high liquidity, indestructibility, a high ratio of value per weight and volume unit, negotiability, easy divisibility, global acceptance etc. The slowly but steadily growing supply from the mines (N.B. gold reserves grow at about the same pace as the global population) ensures stability and trust. These unique features make gold one of the best hedges against excessive monetary expansion and black swan events.

The performance of gold was positive in almost all currencies in the past decade as well as last year. The key issue is the relative scarceness in comparison with fiat money[4], which can be expanded at will. Due to the monetary excesses and the global depreciation race in the past years we expect the exchange rate of gold and paper to continue rising.

Gold performance since 2001 in different currencies (%)

Sources: Datastream, Bloomberg, James Turk Goldmoney.com

“Confidence in central bankers’ ability to learn from past inflation is as likely to be misplaced as it was in their ability to learn from past credit booms. Gold remains the cleanest insurance against such overconfidence” Dylan Grice [5]

The gold price and trust in (central bank) policies are negatively correlated. A falling gold price would therefore relate to rising or at least stabilising trust. It is said that “trust is a delicate flower; once destroyed, it will not return easily”[6]. We believe that the trust lost in the past years will not be regained any time soon, and that therefore gold still commands an excellent risk/return profile.

The ECB, the Federal Reserve, and the Bank of England have expanded their balance sheets by more than USD 4.5 trillion since 2007. Only in the year to date the monetary base in the USA has increased by more than 30%. Government bonds had to part with their “risk-free” status last year, and the erosion of trust continues on a daily basis. In this environment investors like to head for the safe haven that is gold more and more often.

The following chart highlights the falling trust of the US citizens in banks and the US Congress.

USA: percentage of citizens trusting the banks (right scale) and the US Congress (left scale)

Source: A. Gary Shillling’s INSIGHT, Gallup


Even though critics will not tire of discrediting gold as the barbarous relic and yesterday’s money that has no place in modern society, we would like to ask the question what timeline they have looked at. “Natural laws” such as “property prices don’t fall”, “US Treasuries are risk-free”, or “The Earth is flat” may have applied in the (recent) past, but if we broaden the (time) horizon, we find that the picture changes. The mere extrapolation of the past leads to disastrous results in the long term. Gold on the other hand has a track record of 6000 years as the currency of last resort and has never turned worthless.

The following chart also shows the clearly intact downward trend of most currencies vis-à-vis gold. The equally weighted currency basket consists of US dollar, euro, Swiss franc, yuan, Indian rupee, British pound, and Australian dollar. The downward trend is intact and is at the moment only marginally above the trend line. We have little reason to believe that the downward trend should subside in the foreseeable future, which is why we stick to our positive assessment of the future gold price development.

Currency basket vs. gold since 1999

Sources: Erste Group Research, Datastream


We underestimated the supply of “digital printing ink” by the Fed and the relentless deficit spending. In June 2010 we had not expected the US central bank to attach as little importance to monetary stability as it ended up doing. We believe that the “Bernanke put” is the main reason for the rising prices in the commodity segment. The Fed has repeatedly referred to the positive effects of higher share prices. Gold also benefits from the decrease in risk aversion, as the following chart clearly illustrates. The higher correlation between the equity market and many commodities can hardly be explained by traditional supply/demand structures; in fact, the monetary policy seems to have turned into the most important determinant of the financial markets.

S&P vs. gold vs. monetary base and QE

Source: Erste Group Research, Datastream

We strongly doubt that the goals of the Quantitative Easing scheme(s) have actually been achieved. However, if a sharp increase in share prices, low volatility, and excessive speculation in agricultural commodities (as confirmed by the CoT reports), energy, and precious metals had been the goal, QE could be called a tremendous success. The Fed may well step up the incentives to lending (low interest rates, bank reserves filled up by the purchase of assets), but it has no influence on where the loans ultimately go.

Performances during QE1 and QE2

 Source: Erste Group Research, Datastream


 “The more capital can be raised by bonds, the better. Resorting to the help of the central bank let alone the option of printing money have to be seen as only temporary financing means for as long as possible ….” Karl Theodor zu Helfferich, member of the central committee of the German Reichsbank, March 1915.


Gold is currently experiencing a renaissance as an investment class

The (financial) world is at the moment long in questions but short in answers. We believe that gold is one of the right answers in times of chronic uncertainty. It is said that “trust is a delicate flower; once destroyed, it will not return easily” [7]. We believe that the trust lost in the past years will not be regained any time soon, and that the situation will actually still get worse. The Eurozone is going through a breaking test, and the US dollar is gradually losing its status as the leading global currency.

The global expansion of monetary supply should continue to provide gold investments with a positive environment. The reaction to the current crisis is already feeding into the next crisis. Trying to resolve a crisis with the very same instruments that caused it (i.e. an expansive monetary policy) would seem to be clutching at straws. The driving forces of wealth are savings and investments, not consumption and debt. The weak US dollar is a logical consequence of the quantitative loosening, which from our point of view is just a euphemism for printing money.

Given that the majority of debt has neither been written off nor paid off but simply transferred, the problem of excessive debt is still waiting to be resolved. There has been no deleveraging, only an adjustment of booking entries from the private to the public sector. The quantitative easing has left monetary stability short on credibility, and it will be very difficult to remedy this situation. In this fragile environment gold will continue to thrive.

Total consumer credit outstanding vs. US gold reserves @ market value

Sources: Fed St. Louis, Datastream, Erste Group Research


A wrong diagnosis of the cause leads to wrong solutions. The systemic issue is not the lack of tax revenue, but excessive spending. Further tax hikes cannot consolidate the public finances on a sustainable basis. Only structural reforms on spending can achieve that. According to Schlesinger[8], saving is tantamount to holding back on consumption in the present in order to be able to consume more in the future. The opposite is true for credit, where today’s benefit is bought with tomorrow’s shortcoming. However, this disadvantage seems to be in general disregard, being passed on to future generations. Although we are faced with the largest public debt in times of peace ever, a comprehensive consolidation of public debt is apparently not up for discussion. The necessary, deep cuts are being postponed, and the policy of “muddling through” continues. A painless therapy does not seem to exist. We believe that gold is an effective medicine.

Both fear trade and love trade[9] are the driving factors of this bull market. The fear component is driven by the negative real interest rates, the excessive government debt, and the rising fear of a collapse of the system. This component is currently regarded as the only reason for the gold bull market. However, this perspective disregards China and India, which are the driving forces on the demand side. The high traditional gold affinity and the rising wealth will support demand in the long run. By 2020 emerging markets will generate 50% of global GDP, up from 19% in 2000. The majority of the emerging countries are significantly keener on gold than the industrial nations are.

“Most great primary bull markets last longer and carry farther than the majority of investors (even the bulls) expect”

Richard Russel

Gold has been ridding itself of its reputation as a “barbarous relic”, emphasized in the 1980s and 1990s, and will ultimately turn into an own investment class again. The paradigm shift definitely has psychological reasons. The unshakeable myths and misunderstandings (gold does not pay interest, the purchase of physical gold is expensive, gold is speculative and volatile…) are currently subject to demystification and reassessment. Given that after the bear market that lasted 20 years many such arguments, defamations, and convictions ended up sticking in people’s minds, achieving a change of mind is tedious and time-consuming. But the same (alleged) killer arguments are still being brought forward, and even Ben Bernanke is “confused” about the rising gold price and does not understand it[10].

The fact that not many market participants actively participated in the last high of the gold price in the 1970s is a positive aspect. This is probably also why the majority of investors still doubt the sustainability and justification of the bull markets although we are in its tenth year. In the 1970s it was an unwritten law to invest at least a fifth of one’s portfolio in gold.

“I prophesy that in 1950 every Treasury in the world will be talking about my ideas, and by that time, of course, the problems will be quite different, and my ideas will be not only obsolete but dangerous.” John Maynard Keynes[11]

Gold, as antagonist of uncovered paper currencies, remains an excellent hedge against worst-case scenarios. Low real interest rates and high counterparty risk provide the perfect environment for gold. Both are clearly the case at the moment, and we expect this scenario to last. At the current real interest rates, gold is an obvious alternative to short-term government bonds, current accounts, or time deposits. After many years of a chronic low-interest-rate policy, we do not believe that interest rates, along the lines of Paul Volcker’s, would be possible without the system collapsing. Therefore this time the gold bull market should end for different reasons than at the beginning of the 1980s.

Average annual performance of gold at varying real interest rates

Sources: Deutsche Bank, Erste Group Research, Datastream

We believe that the saving efforts of the US government constitute lip service of the purest water, given the imminent presidential elections in 2012. Due to the elections and the tepid economic growth a new edition of the Quantitative Easing scheme should not be ruled out (after an “observation period”). In order to deal with the current difficulties in the financial sector but also in the real economy the Fed and the ECB will be forced to keep the interest rates at (historically) extremely low levels. Negative real interest rates and the gold price have traditionally had a very strong correlation. Therefore we believe that gold represents the essential basis of a portfolio, especially in the current fragile environment.

“If you don’t trust gold, do you trust the logic of taking a pine tree, worth $4,000-$5,000, cutting it up, turning it into pulp, putting some ink on it and then calling it one billion dollars?” Kenneth J. Gerbino

Further pros:

- The global reflating policy will continue

- Global USD reserves amount to about USD 5 trillion; the need for diversification is enormous

- De facto zero-interest rate policy in USA, Japan, and Europe

- The central banks have changed their attitude towards gold

- Investment demand will remain high; Wall Street has discovered gold

- Commodity cycle has a long way ahead

- Geopolitical environment still fragile

- Chinese central bank wants to increase its gold reserves



- Gold is often held as ultimate reserve and money of last resort and is thus liquidated in extreme financial situations

- De-hedging has practically come to an end

- Futures positioning (CoT) relatively neutral; open interest indicates negative divergence

- Greece, Portugal, and Italy hold relatively sizeable reserves and may (have to) sell them

- A slump in economic growth would definitely have a negative impact on the gold price

- Double dipping: recessions are generally not a good environment for the gold price (N.B. it is the measures that are taken during the recession that stimulate the gold price later on)

According to Carl Menger’s theory of subjective value, the value of a good is derived from the marginal utility with regard to the set goal. This means that the value of a good or a service is therefore no objective value, but the result of a subjective process of valuation (“Value does not exist outside the consciousness of men”). Therefore the question of price targets is difficult to answer. But given the fact that the majority of debt has neither been written off nor paid off but simply transferred, the problem of excessive debt is still waiting to be resolved. As far as the sentiment is concerned, we definitely do not see any signs of euphoria. Scepticism, fear, and panic never line the final stretch of a bull market. Therefore we believe that our long-term price target of USD 2,300/ounce, as formulated a few years ago, could therefore come out on the conservative side.

In the short term, the seasonality of the gold price seems to suggest the continuation of the sideways movement, followed by the strongest seasonal period in September. In the long run we could see a future where rather than asking for the price of gold, people will much more often ask for the price in gold. Our next 12M target is USD 2,000. We believe that the parabolic trend phase is still ahead of us. This phase should take the gold price to our long-term target of at least USD 2,300 at the end of the cycle.



The above article is formed of the introduction and the conclusions to Ronald Stoeferle’s fifth annual Special Report on Gold for Austria’s Erste Bank.  The full 90-page report is downloadable from Mineweb here

          [1] “Gold: The Currency of FIRST Resort”, Hinde Capital, June 2010

[2] Economic Club of New York, remarks by Chairman Alan Greenspan, December 2002

[3] ISO 4217, International Currency Code List

[4] Fiat money is credit money that involves no obligation of the issuer to exchange it for currency money. The term is derived from the Latin fiat, “let there be”. Fiat money turns into money when the governing bodies of a state declare it such. Today’s central bank money such as euro or US dollar, is fiat money.

[5] “Why this commodity-sceptic value investor likes gold”, Dylan Grice – Popular Delusions, March 2011

[6] Otto von Bismarck

[7] Otto von Bismarck

[8] “Staatsverschuldung ohne Ende? Zur Rationalität und Problematik des öffentlichen Kredits” (Public debt and no end in sight? Of the rationality and problem of public credit), Schlesinger, Weber, Ziebarth

[9] U.S. Global Investors Special Report „Fear Trade and Love Trade”

[10] “Bernanke Puzzled by Gold Rally”, Wall Street Journal, June 2010

[11] “The World will save money in the 1950’s”, J.M. Keynes, Fortune Magazine