Any “Thing” but Paper

In mid-April the EU agreed a 500 billion euro stimulus package at zero percent interest rate to get Europe back on its feet after the Covid-19 pandemic. Two days ago Democrats unveiled a three billion dollar Covid relief stimulus package to be voted on next week. It looks looms large and but really beyond our comprehension. But it is just a drop in the ocean..  By January this year total global debt stood at 250 trillion dollars. With a world population of 7.8 billion that works out at about $32,000 for every man woman and child on in every corner of the planet.  All a bit meaningless really but the world is drowning in debt, debt, unprecedented in scale, to save the world. Even in China the debt to GDP ratio is approaching 310 percent. Central Banks frenzied printing of so much confetti paper-money –  now a biblical-scale locust-swarm of bank notes.  Maybe it will be alright on the night but it might be a good idea to builder a bunker for the financial storm that maybe coming.

What are the consequences of this debt to save the world and the frenzied printing of paper?   Could we be heading for hyper-inflation or deflation and a long deep depression?  Pandemics and talk of a possible global depression has me thinking about possible parallels in history as a guide to what might lie ahead of us. The Roarin’ Twenties or Jazz Age or in France the Années folles or in Germany the Golden Twenties followed the Great War and the Spanish Flu and culminated in the Wall Street Crash in 1929.  It was only then, a decade later that the world economy subsided into widespread bank failures and the Great Depression. Deflation is insidious.  At first it was gently deflation creeping but then accelerated with massive unemployment.

 “I think we’re at the beginning of a long-term period of deflation, falling prices and the loss of pricing power” said Kiril Sokoloff in Lunch with the FT,  2^nd /3^rd  May.  He wryly calls Modern Monetary Theory (MMT)  the Magic Money Tree.  He goes further  “……. the notion that a country which controls its own currency can print it freely to fund deficit spending without worry is in”. 

But did a decade of excess and reckless spending and a soaring stock market result from rampant capitalism and reckless speculation?  I am reading The Bubble that Broke the World by Garet Garrett published in 1931 is a classic.  Garrett is convinced that the crash came but from a pile up of debt made possible by the Federal Reserve printing machine.  The parallels with the present are hiding in plain sight.

Gold and a tale of two presidents

In 1933, two years after The Bubble that Broke the World  was published, banks failed and closed by the thousands, money supply contracted resulting in deflation.  Thousands of people turned to gold to protect their savings.  Every week $20 million was being turned into the U.S. Treasury in demand for gold. Franklin D Roosevelt the 32^nd President of the United States declared a bank holiday and deflated the dollar by raising the gold price from $21.67 to $35 per ounce.  All gold coins and bullion held by American citizens were confiscated under order of the Federal Government.  The Federal Government became the sole buyer of gold from U.S. gold mines.   The gold price remained fixed at $35 an ounce for the next 38 years. Interestingly silver was not fixed and traded in a range around 85 cents an ounce over this period but during World War II it fell as low as 35 cents between March 1940 and December 1941.  The peak for the silver price during the 38 years of the FDR – Nixon gold fix was in June 1968 when the price peaked at $2.50 an ounce. For the most part the ration of the gold price to silver price ratio from 1933 until 1971 was around 40.  With a gold price fixed this ratio is artificial but still aa curious if not useful yardstick.  More on this later.

On August 15^th, 1971 during the Vietnam War the U.S. government under President Richard Nixon completely abandoned the gold standard.  On August 15, 1971 President Richard Nixon announced that the United States would no longer convert dollars to gold at a fixed value of $35 an ounce. The gold price was finally unshackled and like silver was now free to find its own value. I thought I was fairly happy that I knew what happens to gold when it is not fixed to dollar and  there is galloping inflation. Printing too much money over a short time without increase in the supply of “things” would result in inflation maybe even hyper-inflation.  But  what would happen to gold if Sokoloff was right and we were heading into a long period of deflation. It might be instructive to look at what happened during the Great Depression?  There are significant differences between then and now.  The gold price was fixed entering the Great Depression with a substantial revaluation during in 1933. We now have a gold price that is free to find its own value against paper currencies.  It might be more useful to look at the purchasing power of gold rather than the actual price.

Prices slumped 31 percent between 1929 and 1933 including gold.  But the purchasing power of gold rose a staggering 44 percent during this period.  Simply the price of gold was falling slower than “things”.  Whether there is inflation or deflation it is the purchasing power of gold that is crucial to savers and pensioners and their future economic welfare rather than the actual price of the metal. As an exploration geologist I think of gold as being like the African continent  It is stationary, the anchor which holds and it is other continents and “things” that drift around it.  So we are a confluence here:  an unprecedented pile up of global debt, gold is getting harder and harder to find and the demographic in the developed countries is ageing with falling birth-rates and older people living longer. Let’s not even mention climate warming the cost of natural disasters and the breaks on economic growth to achieve sustainable levels.

In the hundred years before the Great Depression of the 1930’s the world’s major currencies were fixed to gold.  The dollar to gold exchange was $20.67.  It was the Gold Standard by which it was decreed that all paper money was legally obligated to be freely convertible into its gold equivalent.  In 1913 before the Great War about three billion dollars, or a quarter of the world’s currencies consisted of gold coins, 15 percent was silver coins and only 60 percent was paper money backed by gold.

The gold standard was very precise: one pound sterling was equivalent to 113 grains of gold and a dollar equivalent to 23.22 grains. There are 15.43 grains if gold in a gram and 31.1 grams in a troy ounce of gold. So the only way to increase money supply was to find more gold.  There was some flexibility.  In those days the U.S. the Federal Reserve was only required to have 40 percent of all currency it issued on hand in gold but with no floor exemption.  The Bank of England could issue Sterling for the equivalent of $75 million without gold backing but anything in excess was required to have 40 percent backed by gold.

If your currency is pegged to gold then the supply of new gold is critical to the growth in money supply and availability of capital. When new gold finds were lean the growth in money supply was stunted. 

During the 19^th century  new gold gushed from great discoveries in Western Australia (1885 -1993) and the Klondike in The Yukon (1896-99). But  by far the biggest new discovery in terms of size and sustained production was Witswatersrand in South Africa in1896.  Over most of the century after the discovery of “The Wits” South Africa produced at least 60 percent of the World’s new gold.  There were minor rushes in Otago, New Zealand (1861-1864)  and Siberia (1830’s and 1840’s) and Tierra del Fuego in Chile (1883 -1906) which spurts to new gold supply. As an exploration geologist I had a cameo role in more recent minor exploration “waves” in sub Saharan Africa.  In Ghana (The Gold Coast) in 1990 and again in the Lake Victoria Goldfields of  Tanzania in the early 1990’s which lead to many big gold discoveries in the wake of a staking rush.  My team discovered Nyanzaga in Tanzania in 1996 https://orecorp.com.au/projects/tanzania/nyanzaga-project. 

In 2000, I was working for a Canadian Junior exploration company with Irish blood which drilled the first deep holes which cut the jewel-box at in the Ntotoroso Gold Deposit in Ghana.  Newmont acquired Ntotoroso in its takeover of Normandy and wanted to exit Africa until they had a more careful look at Ahafo and saw its huge potential.  Newmont renamed  Ntotoroso which  became a keystone deposit of its larger Ahafo Mine complex.  Ahafo began production on 2006 with average production of 450,000 ounces to 500,000 ounces of gold per year.

Johannesburg and Denver were major cities built on the back of gold mining.  San Francisco, Melbourne and Perth became ports and financial centres for a large hinterland of gold camps. Economic growth in the latter part of the 19^thcentury and the first three decades of the twentieth depended on capital and expanding money supply.  This new money supply was inextricably hard-linked to new gold supply from mines.

One might expect that a world war followed by a global pandemic would break all human belief in anything, resilience, endurance and perseverance and lead to the depression of all depressions.  But the Great Depression was on hold and not to happen for another decade.  

One in every three German soldiers between 19 and 22 years old died in the Great War. Eight million men perished in combat during the Great War. A total of 15 million men on both sides were wounded so badly it would be life changing. The United States was for the most part unscathed with 114,000 men dead a toll that was less than half the losses of Romania.  In stark contrast over 50 million souls perished from the Spanish Flu which began in 1918. It was the second-wave that accounted for the bulk of those who died. But yet the Spanish Flu is just a footnote in history.

After the Great War America’s economy grew 42 percent and produced half the world’s output. The U.S. economy’s pituitary gland was in overdrive.  Europe was in tatters after the Great War. America was Europe’s creditor after the Great War. Investing was for the common man  thanks to easy access to credit. It was that hidden weakness that helped cause the Great Depression. The banks borrowed at an interest rate of 6 percent and loaned on to investors at 10 percent. 

The mood after the Great War was more powerful than the reality.  Fear had been drained away from those that had survived  and  not been trampled by the Four Horsemen of the Apocalypse. Risk was on and the champagne and caviar flowed.

“I think we felt that we could do anything we wanted  and that we could have anything we wanted because we knew we had been deprived of so much during the war and we were not going to be bloody well deprived of anything afterwards.”  Although the actress Miriam Margoyles  said this of the general mind-set after World War II but it struck me as most relevant to the “Jazz” decade following Armistice Day .  The fever of the Spanish Flu gave way to a speculation fever.

With the Great Depression the demand for metals and oil slumped and prices fell.  But FDR’s sudden revaluation of gold by 60 percent overnight saved Newmont.  The Magma Copper Mine was one of Newmont’s most important investments for 75 years.  It  was a fabulously rich deposit with veins running 14 percent copper.  In 1929 Magma produced 38 million pounds of copper at a cost of nine cents per pound.  At a selling price of 18.2 cents a pound Magma was making a profit of $3 million and paid out $2 million in dividends of which $300,000 came to Newmont.  By 1932 production of copper at the mine has fallen 44 percent to 21 million and what is more the price of the red metal had fallen to six cents per pound. Without its gold mines and FDR’s revaluation of the metal  Newmont would not have survived.

A combination of high gold prices and cheap oil is great for gold miners.  Energy can account for as much as 25 percent of  operating costs at a gold mine.  Grade is still king.  But these rising gold prices and falling oil prices will have a disproportionate impact on those miners who produce  more ounces at lower margins than those that produce fewer ounces at bigger margins.  One mid-tier producer I am looking at is Iamgold. 

One final comment on the ratio of the gold price to silver price. Historically over the last hundred years the ratio of the gold price to the silver price has been around 53:1 notwithstanding that the gold price was fixed until 1971.  Right now the gold to silver ratio is just touching 109.  This just means that silver is relatively cheap compared  to gold if you believe that long term prices return to the long-term mean.  It does not mean that prices will go up.  The price of both precious metals could fall if  the world economy is not “nearly saved” but rather “nearly drowned” in the ocean of debt.  On the other hand the price of gold and silver could both go up or at the more importantly the purchasing power of these metals.  But if you subscribe to what is written on the US dollar “In God We Trust” then that is commendable as long as it is not “In Governments We Trust”. 

 Nothing you read here should in any way be taken as investment advice. What you read here are just a magpie’s picking of curious historical observations which sparkle (to me) and might shed a little light on what lies ahead.  But then it might all be all so irrelevant.  Most certainly and always do your own due diligence before you make any investment.  

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