Question: Can we ever move back to a gold standard? See the answer at the end of the blog.
This is an excerpt form the book "Investment Strategies that Work" (2015) - by Brett Machtig & Josh Gronholz
Let’s look at the future and see how market conditions impact investment strategies.The factors that are driving the stock market and other investments include: The Federal Reserve and the U.S. Dollar; commodities like oil, gold, metals and crops; and current interest rates. In this blog, we will focus on the gold and commodities.
Oil and Gold Commodities
People act as if that the market conditions will never change, however, they do change. As of June 16, 2015 end of day, Brentwood Oil prices were at $62.63 a barrel. Although it has been above $110 a barrel for about four years in the last 150 years, some experts expect it to happen again, and so do we. All it will take is heightened“uncertainty” in the Middle East. Source: http://oil-price.net/dashboard.php?lang=en#brent_crude_price_large
So let’s talk about the supply-side of oil. Geologist M. King Hubbert famously (and so far) correctly predicted in 1956 that U.S. domestic oil production in the lower 48 states would peak around 1970 and begin to decline. In 1969, Hubbert predicted that world oil production would peak around 2000.
In fact, daily U.S. oil production did “peak” at an average of 9.6 million barrels in 1971 and then began to decline to about five million barrels in 2008.
Since then U.S. oil production had not increased and in January 2015, U.S. production averaged about 9.2 million barrels per day. See Exhibit 3.
Hubbert argued that oil production grows until half the recoverable resources in a field have been extracted, after which production falls off at virtually the same rate at which it expanded. This theory suggests a bell-shaped curve rising from first discovery to peak and descending to depletion.
If Hubbert were right, the increase in production in the last several years should not have happened. The problem with Hubbert’s analysis and his “devotees” is that they overlooked how market prices could change the definitions of “recoverable resources” and “new reserves” of encouraging new technologies. In the current case, fracking has made once unrecoverable resources recoverable. As a consequence, U.S. petroleum production has dramatically ramped up from its low point of five million barrels per day in 2008.
In the meantime, global energy prices have fallen, and many other countries are studying the U.S. example and plan to tap their own shale resources. But analysts, environmental groups, and governments are concerned about the economic costs of fracking and the risks to the environment.
What is fracking, and where is it happening?
Hydraulic fracturing, or fracking, refers to two processes used to extract natural gas trapped in shale formations. The first step is to drill down to the sedimentary rocks, sometimes as far as ten thousand feet, then drill sideways for a mile or more. This horizontal drilling has been widely practiced since the 1980s to extract conventional oil and gas. The second is to inject water, sand and chemicals at high pressure forcing the gas to flow back out the head of the well.
Future production also relates to the future price of oil. The more it costs, the more it opens up expensive oil extraction methods and far-off locations. For example, it is much more expensive to extract a barrel of oil via new deep-sea oil drilling (U.S. deep-sea producers have a break even cost of $60–$80 per barrel) or to extract a barrel out of shale oil (U.S. shale oil producers have a break even price of $60-$70 per barrel), than the traditional means available in 1956. Fracking has reinvigorated oil fields, but only at higher production costs.
Also, production costs for other nations like Russia and Venezuela exceed $100, which puts them losing money until it moves up more. Lastly, pundits believe oil has no more future as energy replacements become more viable.
Gold is one the most manipulated investments over time. In times when the Fed is successful in their currency or “fiat money” policies, gold declines. At some point, the Fed slips up, and the price of gold increases. If the Federal Reserve policy were to stumble and the U.S. economy were to go into a recession, a period of high inflation, or a period of deflation, the price of gold could rise. Other reasons for gold to move up in price:
- A number of countries have quietly been acquiring gold like Russia, China, Italy and France.
- Foreign central banks resumed repatriating gold, with the Netherlands and Germany repatriating a total of 207 tons in 2014.
- The official numbers from the U.S. Federal Reserve report that only 177 tons were repatriated by other countries last year. It is uncertain what is causing the discrepancy, but it could indicate market tightness.
- Goldman Sachs predicts that gold production will decline going forward with the world’s gold reserves falling to zero in approximately twenty years.
- The reduction of new gold production could tighten the gold supply-demand balance and push gold prices up.
- Putin suggested Russia will go toward the gold standard in a March 2015 announcement.
- Fear in other parts of the world about the strength of the dollar.
Most countries have been hoarding gold reserves and have been increasing their gold holdings, as mentioned in James Rickards newest book, The Death of Money: The Coming Collapse of the International Monetary System. Let’s take a look at the ten nations with the largest gold reserves, based on the latest international financial statistics and the WGC.
- United States – Despite ending the gold standard in 1971, the world’s largest economy holds 8,133.5 tons of gold, representing 71% of its reserves. December 31, 2014, 2015, US Gold holdings are 8,044 metric tons. At the May 4, 2015 rate of $1,188.50 an ounce it is worth about $337 billion. Source: Investopedia.com
Germany – Germany holds 3,387.1 tons of gold, which represents 67.1% of reserves. At the beginning of 2013, Germany’s Bundesbank confirmed reports and announced that it will repatriate a portion of its foreign gold reserves. Over the next seven years, the central bank intends to store half of Germany’s gold reserves in its own vaults with the other half in New York and London. Source: Investopedia.com
- Italy – During the depths of the Eurozone crisis, some analysts recommended that Italy use its gold stockpile to raise funds and restore confidence. However, the nation still holds 2,451.8 tons of gold, representing 65.9% of its reserves. Source: Investopedia.com
- France – France holds 2,435.4 tons of gold, which represents about 64.3% of its reserves. The nation has been relatively quiet in the gold market. Source: Investopedia.com
- China – The world’s second-largest economy holds 1,054.1 tons of gold, which represents only 1.1% of its reserves. This underestimates China’s true holdings. In 2009, China announced that it boosted its gold reserves by 454 tons via acquiring gold quietly over the previous five years. It represented a 76% increase in gold reserves, but gold still represents 2 to 3 percent of its reserves. Today, China is estimated to have around 2,000-3,000 tons of gold reserves. Source: Investopedia.com
- Switzerland – The land of international banking holds 1,040.1 tons of gold, which represents 7.8% of its reserves. Some citizens feel very strongly about gold. Last year, the Swiss People’s Party collected enough signatures to force a referendum on a proposal to prevent the nation’s central bank from selling any of its gold reserves and require it to hold at least 20% of its assets in the precious metal. Source: Investopedia.com
- Russia – Russia holds 1,034.7 tons of gold, which represents 8.3% of its reserves. Russia has more than doubled its gold reserves in recent years and is likely to keep buying. In 2011, Russian Prime Minister Vladimir Putin claimed the United States was “like a parasite” on the global economy and said the dominance of the dollar as a world reserve currency is a threat to the financial system. In 2013, Russia’s central bank added 77 tons of gold to its official reserves. Source: Investopedia.com
- Japan – After two decades of low-interest rates, it’s not too surprising that Japan has one of the largest gold reserves in the world. The nation holds 765.2 tons of gold, representing only 2.4% of its reserves. Source: Investopedia.com
- Netherlands – With a large economy in relation to its population, the Netherlands holds 612.5 tons of gold, which represents 52.6% of its reserves. It is estimated that the majority of the nation’s stockpile is held abroad. Source: Investopedia.com
- India – India officially holds 557.7 tons of gold, which represents 7.6% of its reserves. In 2009, the nation purchased 200 tons of gold from the International Monetary Fund for $6.7 billion. India is home to the tenth-largest economy in the world but consumes more silver than any other country. Source: Investopedia.com
Answer to the Question: Can we ever move back to a gold standard?
Although some have speculated that we would be better off on a gold standard, the world economies would have to shrink to make that possible; and players like Japan, China and Russia just do not have enough gold to move in that direction.
Over the years gold has been one of the most manipulated form of currency. FDR took it from citizens and built Fort Knox to house the hoard. Nixon used gold to leverage our position with world partners. And even though countries like China, Russia and India have increased their holdings, their gold represents only a VERY small portion of their reserves. Of the 21 thousand metric tons of gold held by the top 10 nations, the US holds about 38% of it, more than approximately the next top three countries, combined, so any move to a gold economy would help the United States, but we just don’t think it likely.
by: Brett Machtig, & Josh Gronholz
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About the Authors:
Brett Machtig has authored several books and is the founding partner of The Capital Advisory Group, a private asset management and retirement planning services firm located in Bloomington, MN. Their firm manages more than $400 million in assets for 83 institutions and about 850 families as of December 31, 2014. He has been helping affluent investors execute financial strategies, meet income objectives and realize life visions for more than 30 years. Approachable, genuine and down-to-earth, Brett holds himself to a high standard of accountability and seeks to achieve positive financial results on behalf of each client. In this article, Brett shares the effectiveness of each strategy and how to improve it.
Josh Gronholz graduated Summa Cum Laude from the University of Minnesota’s Carlson School of Management and is a Registered Asssitant. He has worked in asset modeling with The Capital Advisory Group Advisory Services and has spent the bulk of his career modeling various investment scenarios and assisting individuals along their way to financial success and personal wealth.
(1)finra.org/web/groups/industry/@ip/@reg/@notice/documents/noticecomments/p118980.pdfas of 8/2014
(2) www.sec.gov/divisions/investment/advoverview.htm as of 8/2014
(3) www.fi360.com/products-services/tools-overview, as of 8/2014, Results not guaranteed.
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