Gold Report 2012: Erste's Comprehensive Summary Of The Gold Space And Where The Yellow Metal Is Going

Erste Group's Ronald Stoeferle, author of the critical "In gold we trust" report (2011 edition here) has just released the 6th annual edition of this all encompassing report which covers every aspect of the gold space. What follows are 120 pages of fundamental information which are a must read for anyone interested in the yellow metal.

From the report:

The foundation for new all-time-highs is in place. As far as sentiment is concerned, we definitely see no euphoria with respect to gold. Skepticism, fear, and panic are never the final stop of a bull market. In the short run, seasonality seems to argue in favor of a continued sideways movement, but from August onwards gold should enter its seasonally best phase. USD 2,000 is our next 12M price target. We believe that the parabolic trend phase is still ahead of us, and that our long-term price target of USD 2,300/ounce could be on the conservative side.

The study is covering the following topics:

  • Central bank’s monetary inflation supports progressive remonetisation of gold
  • Inflation ? rising prices: confusing terminology with grave consequences
  • The chronology of a hyperinflation – Explanation based on Peter Bernholz’ “Monetary Regimes and Inflation”
  • Gold in an environment of a deflationary loss of confidence
  • The biggest misconception with regard to gold
  • High stock-to-flow ratio is the most important characteristic of gold
  • The advantages of a gold standard
  • Financial repression: the alleged magic formula
  • Why gold remains (dirt) cheap in India and China
  • Excursus on Interventionism - It is a fine line between manipulation and intervention
  • On the search for a “fair value” for Gold
  • Possible price targets for gold
  • Why gold is (still) no bubble
  • Gold improves portfolio characteristics The renaissance of gold in traditional finance
  • Why is gold such a highly emotional topic? Cognitive dissonance and normalcy bias as possible explanation
  • Challenges for the gold miners: Peak Gold and increasing resource nationalism
  • Gold shares (still) with historically low valuations

Some broad observations:

In order to analyse the status quo of the gold bull market, we would like to put the development of the gold price in relation to other asset classes on the following pages. The following chart illustrates that chrysophilites11 still have little to worry about. The left-hand scale shows the ratio of the MSCI World equity index to gold, while the right-hand one depicts the ratio of a total return index of 10Y US Treasuries to gold. The chart clearly highlights the fact that the relative strength of gold (falling ratio) vis-à-vis both asset classes is still intact. Both ratios have been setting lower lows and lower highs and are thus locked in a downward trend. Gold holdings should be reduced only once a significant trend reversal becomes apparent.


We are convinced, that the global monetary expansion should continue to ensure a positive environment for gold investments. The reaction to the current crisis is already feeding into the next crisis. The idea of trying to cure a crisis that was created by an expansive monetary policy and chronically excessive debt with the same poison seems naive. The driving forces of economic health are savings and investment, not consumption and debt.

Central bank balance sheet expansions:

The combined base money supply of the four most important central banks has been growing by 15.2% per year since 2000. According to the Austrian School of Economics, this means inflation. Rising prices are only a logical consequence. From 2007 to April 2012, the balance sheets of the four most important central banks were growing from USD 3,500bn to almost USD 9,000bn. Last year alone, the increase amounted to USD 1,500bn12. The following chart shows the rate of change of central bank balance sheets since the beginning of 2007.


The following chart illustrates the combined base money supply of the ECB and the Federal Reserve. It has increased from USD 1,564bn in December 2002 to currently USD 6,578bn. The gold price more than offset the inflated money supply, increasing from USD 340 to USD 1,600 over the same period.


A chart everyone knows: collapsing purchasing power

The following chart highlights the substantial erosion of purchasing power since 1971. It describes how many units of gold one unit of the respective currency buys. Clearly, purchasing power has been on a gradual slide, i.e. one unit of currency has been worth less and less in terms of gold. The US dollar, the British pound, and the euro13 have lost almost 98% of their purchasing power since 1971. Interestingly, the Swiss franc, which was the last currency to abandon the gold standard, shows relative strength, losing “only” 90% of its purchasing power since 1971. This further confirms the preservation of purchasing power gold provides. We can also see that the downward trends are clearly intact and there is little reason to expect an imminent bottom in the various fiat currencies in relation to gold.


The following chart prompts a similar conclusion. It shows on the one hand the gold/oil ratio (i.e. how many barrels of oil does one ounce of gold buy) and on the other hand the inverted oil price (i.e. how many units of oil do I get for USD 1). For reasons of user-friendliness we have standardised both values at 100 on a logarithmic scale. Whereas the oil price in terms of gold has been stable since 1971, the USD has lost more than 98% of its purchasing power in terms of oil.


And a brief history of the history of global money supply

The following chart illustrates the development of the consolidated global money supply since 1953, expressed in SDRs (i.e. the unit of account of the IMF) and the gold price (red line). According to Peter Millar, a cycle consists of a total of five phases. In phase 1 (1952 to 1968) the money supply was growing at a stable rate of 2.8% p.a. Phase 2 (1968 to 1980) was dominated by monetary inflation and the increase in money supply of 22.7% per year. Phase 3 (1980 to 2000) was again characterised by the fight against inflation and the resulting decrease in monetary expansion (+3.4% p.a.).


We have been in phase 4 since 2001. This phase has been dominated by inflationary instability. In phase 1 and 2, the money supply expanded along economic growth rates. These were phases that provided an unfavourable environment for the gold price, making other asset classes more attractive. Phase 2 and the current phase (due to negative real interest rates, among other things), on the other hand, have created a clearly positive environment for the gold price.


Phase 5 is largely characterised by common Keynesian policies aimed at reducing debt by creating new debt. The Austrian School suggests that the recession will relentlessly uncover flawed investments and misallocations. Even more aggressive monetary expansion is launched against said process. According to Millar in this phase the return to a quantitatively lower monetary inflation is initiated via a monetary reform, the return to a gold standard, or the re-valuation of gold reserves, before a new cycle begins.


Much more in the Full report: