James Rickards contends that the price of gold may reach $11,500 an ounce. Yes, that's right. As of today, April 6, 2021, the ounce of gold trades at around $1,700. His claim arose during a debate on youtube.
Rather than a prediction, James describes a plausible scenario where economic and psychological drivers propel gold to such impressive levels. His claim may sound a kind of random, hit-or-miss forecast; but as you can see below, it's not.
The Case for a Gold Price Explosion
He describes three different methods to estimate future gold levels. They anticipate a price explosion in gold over the coming years. How plausible are they? I believe that each them are, but judge by yourself. These are:
- Technical analysis. Projections of previous long term cycles
- Implied non-deflationary price of gold in a gold standard system
- Targeting debt to GDP ratio
1.) Technical Analysis. Projection of Previous Bull Cycles
From the end of the World War II until 1971 there was no real gold market since the dollar was convertible to gold at the fixed rate of $35 per ounce. The chart above shows that since the 1970s gold has experienced three powerful bull markets:
- First, 2,100% in 9 years. From 1971 to 1980 gold went from $35 to over $800
- Second, 660% in 12 years. From 1999 to 2011. Gold went from $250 to $1,900
- Third, 60% up until now (5 years). From 2016 to ? gold will go from $1,050 to ?
Before continuing, two side notes
- We are using round numbers for clarity and simplicity. For example, the third cycle actually started in December 2015.
- Despite not being relevant with the type of magnitudes we are dealing with here, the highs in 1980 aren't quite correctly displayed on the long term chart up above. By zooming in the FRED chart you can see that the highs in January 1980 were well beyond $800 per ounce.
Now, assuming that:
- We are actually right now in the middle of a third long term bull market of gold (starting in 2016)
- As for estimating future gold prices, we can make an educated guess by using averages of the past values.
The third gold bullish market may unfold as follows:
- Price target: $14,500, i.e., a 1,380% increase (average of 2,100% and 660%) from $1,045 (price at the low in 2015).
- Span: 10-11 years (2025-2026). Average (9 years and 12 years) from 2015.
2.) Implied Non-deflationary Price of Gold in a New Gold Standard
Governments Need to Restore Confidence in Paper Money
Since the financial crisis, liquidity and public debt has been growing at a scale not seen before. Because there is no easy way out, far from slowing down, the deficit spiral seems to be accelerating by the minute.
Eventually consumers and investors will end up losing confidence in paper money. Only if we have confidence that something is money, then it's money. As Jim says, confidence is great as long as it lasts. Once it's lost, it's impossible or at least very difficult to get back.
Sooner or later, a growing loss of confidence in fiat money would evolve into a total collapse of the financial system. You don't have to be a psychic to foretell that central banks will have to react before things go too far. There will be no other choice
Now, how can you rebuild confidence in paper money? Well, by linking it to something that has limited supply and tested value through history, like gold. This monetary system is known as the gold standard.
On several occasions James has explained how a new gold standard monetary system could be implemented by the Fed. Some day in the future, the Federal Reserve may announce that the price of gold is going to be, e.g., $10,000. That's it. If you think that is expensive, sell your gold to the Fed. If you think that is cheap, buy it from the institution.
Implied Non-deflationary Price of Gold
According to James Rickards, as of 2021:
- The global money supply (M1) is about $32.3 trillion. This figure includes all the major economies in the world (US, China, Japan, Europe, Australia, Canada,...) which provide the vast majority of global money supply.
- Global gold amount as of 2021 is about 34,000 tons.
- How much gold backing do we need to support the money supply? $13T. Why? Well, there is no definitive answer to that, but a 40% of money supply has worked well historically. So, 40% of $32.3T of M1 is $12.9T. Therefore you need $12.9T worth of gold.
$12.9T worth of gold divided by 34,000 tons of gold gives you approximately $12,000 an ounce.
3.) Targeting Debt to GDP Ratio
In the previous section we've been adjusting the price of money in relation to gold to restore confidence in paper money. However you can rebuild this very confidence by targeting a different benchmark: an adequate level of debt to GDP ratio.
The Keynesian multiplier
The keynesian multiplier is an economy theory, which basically says that an increase in:
- private spending,
- public spending, or
- investment expenditure
raises the global GDP more than the amount you spend or invest.
Put it simply, if you borrow $1 and spend $1, you can get $1.20 of GDP. Why? We can see this with an example. You buy a book at the bookstore for $20. Then, a few hours later the owner of the bookstore uses a share of it, let's say $2, to buy a pack of gum somewhere else. At the end of the day $10 spending has provided $12 of GDP growth.
Now, there is very good evidence —a ton of research and empirical data to back it up— that when your debt to GDP ratio is above 90%, the keynesian multiplier drops below one. This drop has huge implications on the economy. In other words, with a 130% debt to GDP ratio, we cannot borrow away out of the debt crisis. The more you borrow, the worse it gets since you're digging a deeper hole for yourself.
Reducing the Debt to GDP Ratio
The current US debt to GDP ratio is near 130%, that is, national debt ($32T) divided by GDP ($24T). National debt of the US refers to the total of all debts owed by the government.
What would it take to reduce the debt to GDP ratio?. Basically there are two ways:
- Increasing growth. Because of the keynesian multiplier mentioned above and other factors, it is very difficult to achieve growth in a highly indebted economy.
- Increasing inflation. Since inflation undermines the value of a currency over time, is always beneficial for debtors and detrimental for creditors. As a result, inflation helps improve the debt to GDP ratio.
How to Increase Inflation
How can you get inflation? simply by lowering the value of a currency, the dollar in this case.
Although there is no consensus, a 30% debt to GDP ratio is considered an adequate level to boost growth and restore confidence. It would take a 75% devaluation of the dollar to rebuild the debt to GDP ratio from 130% to 30%. Thus the price of gold would be $8,000 per ounce.
A Simple Average
A simple average of the previous numbers according to each method gives us the following price of gold:
($14,500 + $12,000 + $8,000) divided by 3 = $11,500 per ounce of gold
Far from being "a sure thing", these price projections should be considered as a useful reference.
Being a long term investor in gold doesn't mean that you have to hold the asset forever. Knowing when to sell and when to hold is the only philosopher stone in this game. So how can you differentiate gold price corrections from a long term reversal? While we never know beforehand the answer, the price projections that Jim Rickards reveals may be pivotal.
If I were to be asked about the quintessence of human motivation, the word that would come to my mind is necessity. As suggested above, necessity will be the underlying driver behind the narrative of future gold prices. Humans, including the Federal Reserve members, react primarily and decisively not when they want to, but when they have to.