Gold’s rise to new all-time highs has been a long time coming. Over the past few years, we’ve examined gold’s role as both a strategic asset and a hedge against economic instability. In pieces like Gold Can’t Be Downgraded and It’s No One’s Liability and The Gold Investing Madness is just Getting Started, we’ve highlighted the importance of maximizing gold exposure in portfolios. This stance was reinforced by the breakout of gold from its four-year range to reach new all-time highs above $2,200 per ounce in March 2024. Today, with gold knocking on the $3,000 door, the forces driving this bull market are clearer than ever. The real madness isn’t in the busted brackets, it’s in underestimating gold’s staying power.
The Gold/CPI Fallacy: Why Gold Remains Undervalued
Skeptics often point to the gold-to-CPI ratio as evidence that gold is overpriced. However, this argument hinges on a flawed assumption: that the Consumer Price Index (CPI) accurately reflects inflation. The reality is that CPI has been systematically adjusted over the decades to understate inflation through hedonic adjustments, substitution effects, and owner’s equivalent rent (OER). These adjustments result in an artificially low CPI, making the gold/CPI ratio misleadingly high.
Real-world inflation, particularly in sectors like housing, healthcare, and education, has far outpaced the reported CPI numbers. This discrepancy suggests that gold’s supposed “overvaluation” is merely a byproduct of an artificially depressed denominator. Prominent economists like Larry Summers have also highlighted the potential for inflation to be underestimated. Summers has noted that using pre-1983 methods of measuring inflation, which include housing costs and personal interest rates, could reveal a much higher inflation rate. For instance, in November 2022, Summers suggested that inflation might have been as high as 18%, far above the official 4.1% figure. This discrepancy underscores the complexity of accurately measuring inflation and further supports the argument that CPI may not fully capture the true inflationary pressures [1]
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A Better Barometer: Money Supply and Gold’s Real Price
If CPI is unreliable, what’s a better benchmark? Follow the money – literally. Gold’s long-term value is tethered to monetary debasement. The more dollars in circulation, the more dollars it takes to buy an ounce of gold.
Enter M3, the broadest measure of money supply, which tracks all cash, deposits, and liquid substitutes. The government conveniently stopped publishing M3 in 2006, but independent economists like John Williams of ShadowStats continue to track it [2]
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By this measure, the gold-to-M3 ratio currently sits at 0.3 – well below its long-term average of 0.9. Since early 2020, M3 has ballooned over 250%, while gold has “only” risen 65%. Adjust for this monetary flood, and gold is a bargain.
For further confirmation, the gold-to-CPI-Alt ratio (which calculates CPI using its 1982 methodology, before the government started fiddling with it) sits at just 0.9 – far below its historical average of 2.6. In percentile terms, gold is in the 1st percentile versus M3 and the 11th percentile against CPI-Alt – hardly bubble territory.
The Supply Side: Inelasticity and Central Bank Demand
Gold’s supply is inherently inelastic, unlike fiat currencies that can be created at will. New gold mines take over a decade to develop, and with exploration budgets tightening, supply growth is limited to about 1.5% annually [3]. Central banks have been aggressively acquiring gold, purchasing over 1,000 tons per year for the past three years—a record pace [4]. This demand is driven by geopolitical uncertainty and the desire to diversify reserves away from the US dollar. Central banks hoard gold rather than trading it, which reduces the available supply and amplifies future price movements.
Central Banks: The Whales in the Gold Market
The surge in central bank gold purchases is a significant factor in the ongoing bull market. Countries like China, Poland, Russia, India, and Turkey are leading this trend, driven by concerns over dollar dependency and geopolitical risks. China, in particular, is ramping up its gold reserves but still holds only about 5% of its total assets in gold [5], leaving room for further accumulation. The U.S. government’s freezing of Russian reserves in 2022 underscored the risks of holding dollar-denominated assets, prompting nations to seek safer alternatives like gold. Central banks now acquire approximately 35% of all globally mined gold, up from about 4% in 2010 [6].
The Makings of a Secular Bull Market
The evidence for a sustained gold bull market is compelling:
- CPI is a flawed metric: Alternative measures suggest gold is cheap.
- Money supply growth outpaces gold: The gold-to-M3 ratio indicates gold is undervalued.
- Central banks are hoarding gold: Reducing supply and amplifying price moves.
- North American Gold ETFs are turning around: After selling off approximately 30 million ounces in recent years, these ETFs are now adding gold holdings. They remain well below their peak levels, and with gold at new highs, they may buy well in excess of the 30 million ounces sold, further boosting demand [7].
- The gold market is small: At current prices, the “investable” gold market is worth around $3.9 trillion, which sounds substantial until you compare it to the $124 trillion global equity market or the $140 trillion bond market. With such a relatively tiny market, even a small shift of capital toward gold could create a significant supply/demand imbalance [7].
Conclusion: A Decade of Outperforming Ahead
Looking ahead to the next decade, gold is poised to outshine both stocks and bonds. The United States is grappling with a massive debt load, ever-expanding budget deficits, and a growing reliance on foreign investors to finance its debt. However, foreign investors have been reducing their holdings of U.S. Treasuries, which could exacerbate the challenge of finding buyers for the increasing supply of debt. If the Federal Reserve is forced to reenter the bond market to print more dollars and buy the debt, the implications for gold would be profound. In such a scenario, there simply isn’t enough gold in the world to meet the demand that would arise from a significant devaluation of the dollar.
Holding gold in a well-diversified portfolio will prove brilliant, as it provides a hedge against inflation, currency devaluation, and market volatility. As investors, embracing gold now will position us for success in a future where traditional assets may struggle to keep pace with the evolving economic landscape.
March Madness may end in April, but the gold bull market is far from over. For those still doubting gold’s strength, the real bracket buster is happening in the markets, and gold is cutting down the nets.
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