Scenario Analysis - This article discusses a scenario where gold can be priced at $12,000 an ounce or 10 times the current price of gold.
Gold has regained some momentum and investor interest in 2016 with the precious metal gradually trending higher after prolonged period of sideways movement. I remain bullish on gold and I have written few articles to explain my bullish view.
One of the primary reasons to be bullish on gold for the next 5-10 years is the point that global debt will continue to swell and all fiat currencies will lose in value against gold. This article will discuss how gold can be priced at $12,000 an ounce using global currency reserves and gold reserves as a basis of analysis.
The first data used for analysis is the global currency reserve of all countries and international organization. The chart below gives the global currency reserves from the year 2000 to the third quarter of 2015.
In the last 16 years, total currency reserves have swelled by $10.3 trillion and with debt being money, the increase in global reserves come from increase in global debt.
The second data used for analysis is the amount of gold in tonnes that is held by countries and international organizations. The chart below gives the global gold holdings during the same period as for the above chart on currency reserves.
Therefore, as compared to the year 2000, gold holdings have declined as of 3Q15. However, it is clear that gold reserves have increased steadily for countries after the great financial crisis of 2008-09.
With these two data points, it would be interesting to consider a scenario where all the current reserve were backed by currently held gold with countries and international organizations. In other words, the fiat money system is assumed to be changed to reserves backed by gold without changing currency reserves or gold holdings.
By considering the total currency reserves and dividing it by gold in ounces (there are 32,151 troy ounces in a metric tonne), the value of gold come to $12,000 an ounce in gold backed system.
This is just a scenario analysis and does not imply that gold is surging to $12,000 in the next few years. However, with this analysis, I want to point out the following –
First, Global currency reserves have surged by 5.7 times in the last seven years (backed by debt increase) and during the same period, gold reserves have remained largely stagnant. Therefore, the value of paper money in terms of gold is bound to decline. Even in the coming years, the supply growth of paper money will significantly outpace the supply growth of gold and it implies all fiat currencies losing value against gold. I must mention that the gold data does not represent all mined gold during these 16 years. However, in the fiat system, paper money supply clearly outpaces gold supply.
Second, In the last seven years, central banks have been increasing gold holdings as geo-political tensions and increasing global debt demands currency diversification into an honest currency and gold seems to be the best options. Central bank demand will continue to take gold higher.
Third, Under the fiat money system, the trust on the government is the backing for currency. However, when central banks start trusting gold, individual investors definitely need to have at least 10% to 15% of portfolio in gold.
In conclusion, gold is not heading towards $12,000 an ounce anytime soon, but I would not be surprised if gold trades at those levels in the next 10 years. The financial crisis of 2008-09 was fuelled by leverage and the world is significantly more leveraged in 2016 than it was in 2009. Therefore, in the long-term, there are reasons to be concerned.