Posted on 28 May 2011 with 7 comments from readers
Doyen of the gold bugs Jim Sinclair has set readers of his popular website a challenge to come up with the price per ounce that gold will reach if the precious metal is fully monetized. He says the correct answer is $13,644.
Mr Sinclair explains his thinking: ‘Because gold is held by many central banks, once as a reserve currency but now as an inventory currency, it functions as a swing asset to balance the International Balance sheet of the US. Central banks are sellers of dollars but still hold, by default, large dollar inventories.
‘China has hedged its dollar position 50 per cent through commitments to long term dollar commercial agreements, pay in, mineral, and energy deals internationally. That is an act of pure genius. We can assume other central banks still hold 90 per cent of their reported dollar positions, on average unhedged by commercial obligation positions.
‘In crisis times, the US dollar price of gold always seeks to balance the International Balance Sheet of the USA. Therefore, take 90 per cent of international US dollar debt less China and then add 50 per cent of the US debt owned by China. Then divide that number by the ounces supposed to be owned by the US Treasury. The result is where gold wants to go.’
Mr Sinclair says that when he did a similar calculation in 1974 that gave him a target of $900 for gold, which actually touched $850 in 1980. Will he be right again this time with $13,644 an ounce or will it be different?
Currency not commodity
What ArabianMoney likes about his approach, aside from being right before, is that it looks at gold from the point of view of an alternative currency, and not a quasi-industrial commodity. Silver should be looked at in the same light (click here). Platinum on the contrary is not and never will be a monetary metal.
You only have to ask why the Chinese authorities are stocking up on precious metals. This is an alternative currency to the faltering dollar, and euro for that matter.
For there is a crisis coming in paper or fiat money. The authorities have been issuing it by the bucketload to offset the global financial crisis. China is as guilty as the US and Europe with its incredible stimulus equal to half-a-year of GDP. It worked to the extent of unfreezing trade and credit and preventing a bigger deflation of assets.
But this nasty medicine has a painful side-effect: inflation and currency devaluation. Investors are always a bit slow to catch on but they are beginning to understand that holding currency of a fixed supply like gold and silver is the way to beat the crisis in paper money.
Gold retains a far better value when compared to cash savings. The reasons for this are that gold is recognized all over the world and is of value internationally. Moreover, gold offers certain amount of protection against credit risk. In addition, gold is never to linked to any lending company’s balance sheet. Find out here more about the gold rush.
Once the general public finally gets it there will be a mad rush into this asset class and a spike in prices to levels now thought completely impossible. That might indeed put gold at $13,644 an ounce, and with the long-term average gold-to-silver ratio back to 16 that would put silver at $853 an ounce, the old high for gold in 1980.
Who knows, of course, what inflation will be by then. Certainly $13,644 will not be worth the same as it is now. You might have $5,000 gold and $300 silver in real terms at today’s purchasing power.
Equally remarkably Mr Sinclair does not expect gold and silver to crash back down from these levels as the adjustment to a new gold and silver standard will be a permanent feature of the global monetary system. And if you look back at the 1970s gold never did return back to its fixed price of $35 at the start of that decade either.
Meanwhile, the June issue of the ArabianMoney newsletter is out (click here) with more ideas on how best to invest in precious metals to capture this remarkable increase in prices. Mind you we were discussing a gold backed currency two years ago (click here).