Exactly one year ago, on April 1st, 2024, I published the article “AFTER BITCOIN DID IT, NOW GOLD IS SOUNDING THE ALARM“. At that time, when the gold price stood at ~2,300 USD/oz and Bitcoin at ~69,000 USD/BTC (compared to ~3,100 USD/oz and ~83,000 USD/BTC respectively today), I stated:
“Now, why do you think the US can afford the luxury of keeping such a low amount of “hard” reserves compared to its total debt? Because USD is a reserve currency and is broadly recognized as a reserve currency by everyone in the world. However, similarly to what we discussed above for the supply of gold and Bitcoin, what happens to any asset when its total supply starts to significantly inflate? Fewer and fewer people will consider it as a store of value and move their wealth to more reliable ones. Besides gold and bitcoin, there is hardly any other asset at the moment that can be trusted as a store of wealth. Consequently, the dramatic increase in the price of both of them in USD is a big warning sign that the trust in US monetary policy is starting to quickly erode.”
I added one more important thing in that article: “When the gold standard was abandoned in 1971, the proportion of US gold reserves against its total debt stood at 2.5%. That means that the value of gold and bitcoin combined can quickly increase 46% from here, and no one should be surprised about that”. One year after I wrote these words, gold is up ~35% and Bitcoin up ~20%.
While Bitcoin’s price remains more erratic and still tied to other market dynamics like the correlation to the NASDAQ (the reason for the recent drawdown from the latest all-time highs), it is still set to trade more and more as a commodity “reserve asset” as institutional investors pile up on Bitcoin supply following BlackRock’s lead (“IS THIS BLACKROCK’S MASTER PLAN FOR BITCOIN?“). Meanwhile, gold continues its steady march higher, breaking new all-time high records pretty much every day now. Will gold’s march stop at ~3,300 USD/Oz, aligned with the target we had one year ago? No. Quite the opposite – I believe we will rather soon see this “gold rush” turning into panic buying. Let me explain why.
1 – Central Banks are recalling all physical gold they lent out back to their vaults
On paper, central banks worldwide hold ~35,000 tons of gold, according to the most recent data, with the US accounting for ~8,300 tons. Why “on paper”? Because there aren’t ~35,000 tons of gold stored in central banks’ vaults, far from it. One very important thing to bear in mind is that gold, being a commodity, does not intrinsically pay dividends, and it is quite expensive to store because very large and secure facilities are needed. If gold does not pay dividends and only appreciates in value, then how do central banks (and other institutions holding large amounts of gold) cover the operating costs of the vaults? Simple: they lend out some gold and receive interest in exchange, which is then used to pay for the cost of operating secure gold storage. Furthermore, in the central banks’ case, gold reserves have also been used as a monetary tool to control the amount of liquidity and collateral circulating in the financial system. When a central bank lends gold to a bank, it is effectively lending out collateral that can be used to borrow more liquidity that is then lent for a spread in the financial system in what’s the process that effectively “creates money”.
Currently, the central banks of Russia, India, and China, in particular, are very active buyers of physical gold in the market in an amount that is putting significant stress on the whole re-hypothecation system that stood resilient for so many years in the West. Cracks in the system are already starting to show up, as I described in the two recent articles:
- THE POTENTIAL CONSEQUENCES OF A SHORT SQUEEZE ON BOE GOLD EXPOSURE
- THE CONSEQUENCES OF A GOLD TSUNAMI HITTING THE LBMA
As a matter of fact, the more physical gold is being removed from circulation by central banks, institutions, and retail buying, the greater the ratio of “paper gold” vs “physical gold” in the global financial system. According to several estimates, this ratio already stood at 100:1 before the trend picked up speed, which is why a “paper gold crisis” was always a matter of when, not if (“An Upcoming Paper Gold Crisis?)“) to all those paying attention to this corner of the global financial system. It should be intuitive now why this “gold rush” can suddenly turn into panic buying led by Central Banks (especially those in the Western part of the world) that cannot afford to be caught in the storm of the crisis with their reserves put in question since they don’t hold all of them as physical gold in their vaults but as IOUs.
2 – Physical gold ETFs and funds asking for physical gold delivery
There are trillions of USD worth of ETFs and funds around the world declaring they invest in physical gold; however, this is far from true. Do these funds own and operate gold vaults? Of course, the vast majority of them don’t. However, to be compliant with regulation, all they have to hold to declare they invested in physical gold is IOUs saying there is some gold in a vault somewhere allocated to their account. These funds would incur significant storage costs, undermining their annual performance if they did not allow the vault operator to lend their gold out for interest to cover most of the costs, which is why most funds declaring to hold physical gold instead own a piece of paper. How much is this piece of paper worth? As long as the market believes the piece of paper can be efficiently redeemed for physical gold, then the price will remain fairly aligned with physical gold in the market, but what will happen once uncertainty about this starts to spread? The price of “paper gold” will start trading at a discount equivalent to the amount of gold that can be effectively redeemed. Considering a ratio of paper gold against physical of 100:1, the theoretical price of these IOUs is 1% of the spot gold price of physical, isn’t it?
Then why isn’t the value of these IOUs imploding still? Because in all contracts there is a clause allowing these IOUs to be repaid in cash that the fund manager should then use to repurchase physical from the open market or to pay for investor redemptions in case of withdrawals in fiat currency. Considering the amount of liquidity constantly injected by central banks in the financial system, there is surely no shortage of fiat currency, so rather than seeing the value of these IOUs collapsing, it won’t be shocking to see these funds freeze and start repaying their investors in fiat. At that point, those investors left with amounts of (fast-depreciating) fiat currency will then rush to buy physical gold on their own to maintain their asset allocation, eventually contributing to pushing the price of gold even higher, much higher. Eventually, the financial institutions will be fine, but their investors will be left holding the bags once again with little to no room to sue for damages.
3 – Retail rushing to protect its savings from inflation
Since 2020, the purchasing power of most fiat currencies around the world has significantly decreased. For example, in the US alone, it is about ~20% lower already according to the official, and notoriously under-reported, data. More and more people are starting to realize this, which is why it should not come as a surprise to see gold bars sold at stores like Costco flying off the shelves as soon as they are available (“Costco’s Gold Bars Are Flying Off the Shelves. Demand Is Pushing the Metal to Record Prices“). This trend adds on top of central banks removing physical gold from circulation, exacerbating the pressure on the whole “paper gold” market structure. A trend that, instead of slowing down, is accelerating day by day. Furthermore, many retail investors are redeeming their gold ETFs and fund investments for cash to reinvest in physical gold themselves because the awareness of those financial instruments not being real ownership of physical gold is becoming more and more mainstream.
Conclusion
It is impossible to quantify what will be the point of no return when the whole paper gold system starts to collapse and the panic buying for gold begins. With the price of gold already increasing parabolically and the current inflation environment very similar to the one experienced in the 70s, it should then not come as a surprise to see physical gold prices increasing 5-fold over the next decade in what will ultimately be the failure of the whole modern fiat currency system because by that time no one will trust paper money anymore as a store of wealth and the great reset will be inevitable.
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