PIMCO On Gold - The Simple Facts

Tyler Durden's picture

Via Nicholas Johnson and Mihir Worah of PIMCO,

GOLD – The Simple Facts

When it comes to investing in gold, investors often see the world in black and white. Some people have a deep, almost religious conviction that gold is a useless, barbarous relic with no yield; it’s an asset no rational investor would ever want. Others love it, seeing it as the only asset that can offer protection from the coming financial catastrophe, which is always just around the corner.

Our views are more nuanced and, we believe, provide a balanced framework for assessing value. Our bottom line: given current valuations and central bank policies, we see gold as a compelling inflation hedge and store of value that is potentially superior to fiat currencies.

We believe investors should consider allocating gold and other precious metals to a diversified investment portfolio. The supply of gold is constrained, and we see demand increasing consistent with global economic growth on a per capita basis. Regarding inflation in particular, we feel that the Federal Reserve’s decision to begin a third round of quantitative easing makes gold even more attractive.

We see the Fed’s actions in the wake of the financial crisis as a paradigm shift whereby the Fed is attempting to ease financial conditions and encourage risk-taking by increasing inflation expectations. Its policies will likely result in continuous negative real interest rates because nominal rates will be fixed at close to 0% for the foreseeable future.

To be sure, gold isn’t the only asset with the potential to hold its value in inflationary times. For U.S. investors, at least, Treasury Inflation-Protected Securities (TIPS) offer an explicit inflation hedge. What’s more, TIPS tend to be less volatile than gold and, if held to maturity, are guaranteed to receive their principal back – barring a U.S. government default (which we see as incredibly improbable). Still, history shows that gold is highly correlated to inflation and has unique supply and demand characteristics that potentially lead to attractive valuations.

A unique store of value

For more than a millennium, gold has served as a store of value and a medium of exchange. It has broadly managed to maintain its real value, even as various currency regimes have come and gone. The reason is that the supply of gold is not at the whim of any governmental power; it is fundamentally supply constrained. Total outstanding above-ground gold stocks – the amount that has been extracted over the past few millennia – are roughly 155,000 metric tons. Each year mines supply roughly 2,600 additional metric tons, or 1.7% of the outstanding total. This is why gold can be thought of as the currency without a printing press.
The downside of gold is that it generates no interest. One ounce of gold today will still be only one ounce next year and the year after that. Because of this, gold is sometimes referred to as a non-productive financial asset, but we feel this characterization is misleading. Rather, we believe gold should not be thought of as a substitute for equities or corporate bonds. These have equity or default risk and therefore convey risk premiums.

Instead, gold should be thought of as a currency, one which pays no interest. Dollars, euro, yen and other currencies can be deposited to receive interest, and this rate of interest is meant to compensate for the decline in the value of paper currencies via inflation. Gold, in contrast, maintains its real value over time so no interest is necessary.

Today, the forward-looking return on holding U.S. dollars, and most other major currencies, has been artificially lowered by the Fed’s commitment to keep interest rates pegged at near zero for the next few years; real yields on U.S. government bonds are negative out to 20 years. In such a world, we believe the desire and willingness of investors to hold gold relative to other currencies increases dramatically, creating the potential for continued price appreciation.

The real price of gold

Of course, investors must also consider valuation, especially since some believe gold is overpriced. Figure 1 shows the inflation-adjusted value of gold since 1970. There is no doubt that gold prices, which averaged $1,630 in August, are high. However, in inflation-adjusted terms, gold is 12% below its 1980 peak. Inflation in 1980 hit 15% year-over-year, and inflation today is running much lower so some may question the validity of comparisons to 1980. While we believe that inflation over the next several years is likely to be higher, on average, than it has been over the past 20 years and that the tail risks are for much higher inflation, this speaks more to the outlook for the nominal price of gold.

The price of gold in real or inflation-adjusted terms is less affected by the rate of inflation and more impacted by the level of real interest rates because as discussed previously, it is the real interest rate that drives the relative attractiveness of holding gold relative to other currencies. With real interest rates negative on average for the next 20 years, it is of little surprise that gold is trading near its all-time inflation-adjusted high.


Even the inflation-adjusted value of gold doesn’t tell the whole story, however. Thanks to productivity gains and economic growth, per capita GDP is significantly higher today than 30 years ago. Thus, the average person today has more wealth and, all else being equal, can afford to pay relatively more for gold.

To Chinese, gold has never seemed less expensive

Figure 2 shows the ratio of gold prices to per capita GDP in the U.S. and China. In dollar terms, gold is still 34% below its 1980 peak, as U.S. per capita GDP is higher today. Furthermore, this is a relatively U.S. centric view, and considering that China represents the largest source of global gold demand, we believe investors take an overly myopic view at their peril. Chinese per capita GDP has grown at an 18% annualized rate for the past 10 years, compared with just 3% per year in the U.S. Thus, while gold might seem quite expensive to those of us in developed economies, its price seems much less expensive to those in faster-growing emerging economies like China.


Another way to think about the relative value of gold is to consider what a return to the gold standard might look like. In other words, what if the entire world’s gold were used to back the global supply of fiat currency? Globally there are roughly $12.5 trillion in physical and electronic currency reserves. Given that there are 155,000 metric tons of gold above ground, this equals an approximate price of $2,500 per ounce if all of the world’s reserves were to be backed by the entire stock of above-ground physical gold.

Not really so pricey

These points lead us to believe that gold valuations are not as stretched as a naïve look at its nominal price might suggest. Central banks globally are seeking to depreciate their currencies in a beggar-thy-neighbor attempt to stimulate their domestic economies (the Swiss National Bank is a prime example). Therefore, we believe investors should consider owning gold, precious metals and other assets that store value as long as central banks continue to print and maintain negative real interest rates.

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markmotive's picture


Jim Rogers On Gold & Silver: ‘Who Am I To Argue With Thousands Of Years Of Human Stupidity’


kliguy38's picture

Brilliant PIMPERS .......now take a few billion of that Bond toilet paper and buy some physical.....oh wait....you'll own "paper gold"........too bad soo sad......you'll own shit

Bay of Pigs's picture

LOL, Welcome aboard the Gold Train PIMPCO...its only been going up 11 years in a row.

Pinto Currency's picture

Two points:

1) The markets have chosen gold and silver as money over several thousand years.

Over the past 100 years governments have haplessly been fighting the markets and trying to legislate gold and silver money out of existence using paper legal tender laws.  Now their central bank creations are collapsing our economies and gold and silver are reasserting themselves in the market.

2) The real price of gold adjusted for true consumer goods inflation before the Boskin/Greenspan rewrite of CPI calcs in 1992 is something very different than presented above.  See: http://www.fgmr.com/real-gold-price.html

TheSilverJournal's picture

Look at that chart. Especially all you "China Hard Landing" fools. China is set to boom.

Colombian Gringo's picture

Maybe, but rather have physical PM's in my possession over any Chinese stocks. Gamble your money away if it makes you happy, I will stick with what  cant be printed away by banksters, or chinese criminal bureaucrats.

Thomas's picture

i am wildly bullish on silver. Above ground supplies are so damned low.

RockyRacoon's picture

Good news?  We won't know quite yet.  From FT:

CFTC urged to act on position limits
Dr Benway's picture

There is a lot more silver above ground than some silver bulls think. Bullion silver and total silver is commonly conflated, but most silver is not in bullion form.


Regarding PIMCO, do they really think TIPS hedge against inflation, or do they realize TIPS only hedge against a reported statistic that supposedly tracks inflation?


Most telling of all, however, is this: The possibility of total currency collapse is summarily dismissed, as always. So hedging against that scenario is entirely worthless, even if the scenario is disastrous for the non-hedged. It just cannot happen, so no reason to factor it in.

TheSilverJournal's picture

It just can't not happen...soon.

There, fixed it for ya.

CapitalistRock's picture

Not exactly. He dismissed a US treasury default. He did not dismiss a currency collapse. There is little doubt your principal will be returned in the form of US dollars when your treasuries mature. The value of those dollars is the problem, however.

Dr Benway's picture

He implied that real purchasing power can be guaranteed by TIPS as they have an 'inflation hedge', and so he is dismissing both a US treasury default and a currency collapse.

TheSilverJournal's picture

bond bubble credit bubble housing bubble bank bubble deposit bubble fiat bubble government bubble social security bubble medicare bubble medicaid bubble food stamp bubble service sector bubble bond bubble credit bubble housing bubble bank bubble deposit bubble fiat bubble government bubble social security bubble medicare bubble medicaid bubble food stamp bubble service sector bubble bond bubble credit bubble housing bubble bank bubble deposit bubble fiat bubble government bubble social security bubble medicare bubble medicaid bubble food stamp bubble service sector bubble bond bubble credit bubble housing bubble bank bubble deposit bubble fiat bubble government bubble social security bubble medicare bubble medicaid bubble food stamp bubble service sector bubble 

Bear's picture

I had difficulty reading your post ... too bubbly

Urban Redneck's picture

PIMPCO was pimping TIPS.

They have a seat at the table.

Bear's picture

Silver will make more run at 32, then off to the races. It has gone up a little too far too fast, one more selloff to purge weak holders and then on to year-end.

TheSilverJournal's picture

My guess is $40 by Friday. Feels like it's ready to pop. Prob $80 by January.

TheSilverJournal's picture

China will end up with most of the gold.

misnomer00's picture

indian citizens own more gold than the FED's reported numbers. various statistics put the private gold holdings between 15000-25000MT.

you will not believe the amount of gold any middle class family in the southern states of India hold. I was dumbfounded when I accidentally got a look at the safe of one such family (he owed me some cash).

and silver too, mostly in the form of cutlery and utensils.

TheSilverJournal's picture

The purchasing power of silver will increase by at least 30X.

TheSilverJournal's picture

Gold will hit at least $10,000 in real terms.

Al Gorerhythm's picture

" Globally there are roughly $12.5 trillion in physical and electronic currency reserves. Given that there are 155,000 metric tons of gold above ground, this equals an approximate price of $2,500 per ounce if all of the world’s reserves were to be backed by the entire stock of above-ground physical gold."

Your prediction is closer to the mark than what these guys claim. They conveniently ignore the elephant in the room, namely; the yet to be printed $1.4 quadrillion derivative mountain. All that theirs would accomplish is a fractional reprice of their capital base, our money (ouch, for dollar savers).

kreso's picture

Dear Sir,

You're probably correct that $2,500 per ounce corresponds to roughly $12.5 trillion of M0 and M1 aggregate.

And all kind of securities on top of M0 and M1 aggregate will amount to $1.4 quadrillion. The point is that, when money crises starts, money pyramide will have to move from coins/notes/electronic money onto gold. This transition period will increase the value of gold, until the pyramide is moved onto gold. When this gold rush starts, we will enter very geo-politically unstable situation. A rational governments would in this case, try to prolong the transition period... And that is the subject on which most of western think tanks should work on.

Kind Regards,

TheSilverJournal's picture

The silver/gold ratio will shrink to at least 10/1.

TheSilverJournal's picture

How won't it? Fiat's going to collapse. Where do you think all that wealth will flow?

Bear's picture

Understood, but why 10/1 ratio? Gold at 5,000, silver at 500? If so, a silver fork in my pantry is worth $500?

Maybe if bread is $22 / loaf on sale.

MillionDollarBoner_'s picture

When gold and silver were used as money the ratio was somewhere around 16:1

malikai's picture

At 16:1, I convert half my silver to gold.

If by some miraculous catastrophe it goes to 10:1, I convert the rest to gold.

THX 1178's picture

Silver is more rare than gold above ground. I expect the ratio to invert (if only temporarily).

Dr Benway's picture

No it is not. This is a compete furphy. There is several times as much above-ground silver as gold.

TheSilverJournal's picture

Probably about 3X more above ground silver than gold.

TheSilverJournal's picture

About 8B oz of gold and 20B oz of silver is my best guess.

malikai's picture

How much above ground paper silver is there?

TheSilverJournal's picture

Bonds and currency will become worthless, and housing will fall 75%

vato poco's picture

Y'all might be right about the details of this; maybe even the timing too. All *I* know is, I'm gonna follow Bismarck's dictum of "Never believe anything until it has been officially denied". (see: Benghazi attacks, radically "fewer" military absentee ballot requests...) Following that, I'm gonna buy the stuff that western governments are trying hard in ways both loud and subtle to _keep me from buying_: PM's. If they don't want me to have any, I want it. Gold, Freedom, weapons, PGP, videotape of the cops assaulting women, capacity for critical thought......all frowned on by TPTB. So fuck those guys!

DanDaley's picture

I hereby officially deny everything you just wrote.

TheSilverJournal's picture

Equity shares will fall at least 75% in real terms.

AgShaman's picture

Call it a hunch...but I'm guessin' you like silver?

icanhasbailout's picture

I'd call him an obsessive nut but everything he said looks quite reasonable to me.

The Shootist's picture

The Silver Journal's going crazy tonight and I'm loving it!

Oh regional Indian's picture

Gold ONLY works in large concentrations. Like for Nations or banks.

The "true" story of gold is slowly but surely un-folding now, EUphoria aside.

It's not all that. 

For the "physically" minded, it's a strange attractor...



Vlad Tepid's picture

Where I happen to be living right now has a massive collection of working Indians.  The gold markets are literally overflowing with gold accoutraments - some of them, not so much necklaces as breastplates.  I've seen 22k gold crowns.  Is there something the rest of the Indian population knows that you don't?

As an aside, I will buy the first 22k codpiece I come across.

misnomer00's picture

We Indians are born short Gold and have to keep covering our shorts throughout our life.

boatman's picture

more up to date REAL inflation gold price charts


Peter Pan's picture

PIMCO has erred to the downside because the inflation figures it uses are the dumbed down rates used to exaggerate real GDP increases and to rip of social security receipients when the time comes for increases. Therefore the real inflation rate is much higher than the published rate.