Company Descriptions

1

May 24, 2022

Ronald-Peter Stöferle& Mark J. Valek

Introduction: of Wolves and Bears

2

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3

Contents
Introduction: of Wolves and Bears

4

Status Quo of Gold as a Currency

16

Status Quo of Gold Relative to Stocks, Bonds and Commodities

24

Status Quo of Debt Dynamics

43

Status Quo of the Inflation Trend

64

Status Quo of Gold Demand

85

Conclusion: Status Quo95

Stagflation 2.0

104

Stagflation and a New Gold Standard – Exclusive Interview with Alasdair Macleod

130

A New International Order Emerges

145

Energy, War & Inflation – Exclusive Interview with Luke Gromen

168

China – At the Crossroads

184

When Rome Lost Its Reserve Currency

202

Why Does Fiat Money Seemingly Work?

218

Gold Storage: Fact Checking Germany, Canada, and the UK

235

The Synchronous Equity and Gold Price Model251

How to Understand Gold’s Supply and Demand Fundamentals

268

Silver’s Inflation Conundrum

281

Bitcoin: Bull Market in Adoption, Bear Market in Price

294

Mining Shares – Fundamental and Technical Status Quo

305

The Challenges of the Gold Mining Industry

318

Royalty & Streaming Companies: An Excellent Way of Investing in Gold331

The New Low-Emissions Economy: Gold as a Savior

343

Technical Analysis

356

Quo Vadis, Aurum?

366

About Us

386

Disclaimer
This publication is for information purposes only, and represents neither investment advice, nor an investment analysis or an invitation to buy or sell financial
instruments. Specifically, the document does not serve as a substitute for individual investment or other advice. The statements contained in this publication are based on
the knowledge as of the time of preparation and are subject to change at any time without further notice.
The authors have exercised the greatest possible care in the selection of the information sources employed, however, they do not accept any responsibility (and neither does
Incrementum AG) for the correctness, completeness or timeliness of the information, respectively the information sources, made available, as well as any liabilities ordamages, irrespective of their nature, that may result there from (including consequential or indirect damages, loss of prospective profits or the accuracy of prepared
forecasts).
Copyright: 2022 Incrementum AG. All rights reserved.

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4

Introduction: of Wolves
and Bears“To ignore the warning signs andcontinue with the strategies of the past
is to ignore the third, crucial cry ofwolf.”“The Boy Who Cried Wolf: Inflationary Decade Ahead?,” Incrementum Inflation Special,
November 2020

Key Takeaways•

In our special analysis from the fall of 2020, "TheBoy Who Cried Wolf", we warned urgently of theunderestimated danger of high inflation. The wolf is
now here to stay. The war in Ukraine is exacerbating
the inflation dynamic.

•

The intractability of supply chain issues, the cost of
sanctions, tighter monetary policy, anddeglobalization are now bringing the recession bearto the table alongside the wolf.

•

The majority of investors have been caught on thewrong foot by entering the inflationary environment.
Balanced portfolios have been suffering heavy
losses so far this year.

•

In addition to de-globalization and decarbonization,
there are a number of other structural reasons thatargue for a longer-term stagflationary environment
in which multiple waves of inflation are likely tooccur.

•

The freezing of Russian foreign exchange reserves
and the new geopolitical realities make gold
increasingly attractive as a neutral international
reserve asset.

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5

Of Wolves and Bears
Whether the bear beats the wolf,

In the fall of 2020, in the midst of the second Covid-19 wave, we wereor the wolf beats the bear, theprompted to publish a special edition of the In Gold We Trust report. In

rabbit always loses.

our publication entitled “The Boy Who Cried Wolf: Inflationary Decade Ahead?”,Robert Jordan

we used Aesop’s parable to issue an urgent warning about the danger of inflation
creeping up on us. The majority of market participants were no longer familiar
with this predator, which was thought to be extinct, since the last period of highinflation was many decades ago.
Now the wolf is here – and it dominates the headlines. But many investors
are still unaware of the threats it poses to their portfolios. In many cases, people
hide behind the naïve illusion that the wolf will disappear again after a short time
– just like that, and without having feasted on any prey.

The true investment challenge is

Now the next danger is already lurking: sneaking up behind the wolf isto perform well in difficult times.

a bear. This bear symbolizes a striking economic downturn, pushing asset prices

Seth Klarman

down with its paw. Once again, the majority of economists and investors will becaught on the wrong foot.

Monthly Inflation and GDP Polls for 2022, USA and Euro Area,
01/2021-04/2022

01/202104/2021

USA CPI

07/2021

10/2021

Euro Area HICP

01/2022

USA GDP

7.0%

8.5%

6.0%

8.0%

5.0%

7.5%

4.0%

7.0%

3.0%

6.5%

2.0%

6.0%

1.0%

5.5%

0.0%

5.0%

-1.0%

4.5%

-2.0%

4.0%

-3.0%

3.5%

-4.0%

3.0%

-5.0%

2.5%

04/2022

Euro Area GDP

Source: Reuters Eikon, Incrementum AG

After the devastation of the Covid-19 pandemic, everyone hoped foryears of recovery. Last year’s record-high growth figures fueled this fire of hope.
But these figures were mainly due to a return to a certain economic normality
dependent on the base effect.
For those properly prepared, theBut what was the real tinder that caused this growth fire to burn? In thebear market is not only awake of the global lockdowns and the equity market crash, the US economy

calamity but an opportunity.

contracted by an annualized 9.1% in Q2/2020, while global GDP slumped by 3.1%.

John Templeton

An unprecedented flurry of monetary and fiscal policies were implemented in an
attempt to limit the economic damage caused by the lockdowns and prevent thelooming debt-deflation.
The stock markets reacted with delight, deflation was averted, and justa few months later the financial markets were once again in highLinkedIn | twitter | #IGWTreportIntroduction: of Wolves and Bears

6

spirits. The S&P 500 rallied from its Covid-19 low to a new all-time high in just 5
months, and the Nasdaq soared 134% from low to high in just 3 months.
But the inflationary side effects of the brute monetary and fiscal revival measuresmanifested themselves quietly over the course of the past year. The price paid for
rescuing the markets was steadily rising inflation, which broke through the central
banks’ 2% target in both the US and the euro area in mid-2021.
Many of us smile at old-

But central bankers appeased us. Don’t be afraid of the wolf; the howl you

fashioned fortune-tellers. But

think you hear is just your imagination; the surge in inflation is merely transitory.

when the soothsayers work with

Consequently, this appeasement was also to be found in institutions’ inflation

computer algorithms rather thanforecasts. The ECB’s inflation forecast is exemplary for its dramatic misjudgment

tarot cards, we take theirof the situation. In September 2021, an inflation rate of 1.7% was projected forpredictions seriously and are2022; in December 2021, the forecast was raised to 3.2%; and in March it had

prepared to pay for them.

climbed to 5.1%. Even before the outbreak of the Ukraine war, the ECB

Gerd Gigerenzer

almost had to double its inflation forecast within the span of threemonths.
Initially, the gold price reacted disappointingly to the inflation increaseof the previous year. Over the course of 2021, gold holders had to settle for amodest return of +3.6% in EUR or -3.5% in USD.

Gold (lhs), in USD, and CPI (rhs), 01/1970-04/2022
2,100

9.0%
8.0%

1,900

7.0%

6.0%
1,700

5.0%
4.0%

1,500

3.0%
2.0%

1,300

1.0%
1,100

0.0%
2018

2019

2020

Recession

2021

CPI

2022

Gold

Source: Reuters Eikon, Incrementum AG

The reasons why gold temporarily lost its mojo were:•A strong prior performance: 2019: +18.3% (USD), +21% (EUR); 2020:+24.6% (USD), +14.3% (EUR)

Courtesy of Hedgeye•

The extremely firm US dollar•

High opportunity costs because of soaring stock markets•

Crypto assets that stole the show from gold•

Most importantly, market participants believed the transitory
narrative and did not fear that inflation would remain high inthe longer term.

LinkedIn | twitter | #IGWTreportIntroduction: of Wolves and Bears

7

The longer inflation stayed elevated, the more market participants thought that
this must affect the price of gold. It was not until the beginning of 2022 thatthe price gradually began to react to the increased inflation and thegrowing turbulence on the stock and bond markets.

The Russian Bear
February 24, 2022, marks a

It is obvious that Russia’s attack on Ukraine will have a further

historic turning point in theexacerbating effect on the inflation situation. Russia is one of the major

history of our continent.

exporters of raw materials, not only in the energy sector. However, what we believe

Olaf Scholz

is severely underestimated is the disastrous cost to national economies faced withthe substitution of Russian resources. German Minister for Economic Affairs
Robert Habeck put it succinctly in a discussion on a possible EU oil embargo
against Russia: “This cannot be had without any pain!” JP Morgan estimated in
mid-April that an oil embargo would send the price of oil soaring to USD 185. Thatwould be a jump of another 70-80% or so. One does not need to be a great prophet
to predict the impact of such a price jump on the economy and inflation rates. The
sanctions spiral will certainly cause not only the wolf but also the bear
to run rampant.

Russia's Exports, as % of Global Production, 2021
50%

45.6%

45%
40%
35%

30%
25%
20%

15.1%

15%
10%

9.2%

8.4%

6.2%

5%

5.3%

5.0%

4.2%

3.5%

3.3%

2.6%

0%

Source: Bloomberg, JPMorgan, Incrementum AG

Markets usually change when

And that bear can already be seen prowling the capital markets. The

beliefs change, not

S&P 500 dropped more than 15% since the beginning of the year, while the Nasdaq

fundamentals.

is down 25%. The bears have reached the former epicenter of the US bull market:

David Darst

the vaunted technology stocks. But the ursine brute is also loose in thebond markets. In Q1/2022, US Treasury bonds posted their worst performancesince records began in 1973, according to the Bloomberg US Treasury Total Return
Index. And also in the currency markets the bear has appeared, the US Dollar
Index climbed to its highest level since 2002. Gold held up well in thisadverse environment, but lost its strength from mid-April onwards.

LinkedIn | twitter | #IGWTreportIntroduction: of Wolves and Bears

8US Dollar Index, Gold, Bloomberg Global Aggregate Bond Index,
and MSCI-ACWI, in USD, 100 = 31.12.2021, 01/2022-05/2022
115
110
105
100
95
90
85
80
01/2022

02/2022

03/2022

04/202205/2022

US Dollar Index
Gold
Bloomberg Global Aggregate Bond Index
MSCI ACWI
Source: Reuters Eikon, Incrementum AG

The bear is also slowly making its presence felt in economic terms. In
Q1/2022, the USA probably already recorded a decline in economic
output. After annualized quarterly growth of 6.9% in Q4/2021, the economy
contracted by 1.4% in Q1/2022 according to the latest GDP estimate of the Bureau
of Economic Analysis (BEA), even though the initial estimate was for over 3%
Courtesy of Hedgeye

growth. Even if growth in the current quarter is again slightly positive and a(technical) recession can still be avoided for the time being, a recession in the next
12-18 months is much more likely than currently assumed by economists and themarket.

70

US GDP Polls, Annual GDP Growth (x-axis), and Number ofAnalysts (y-axis), 04/2022

60
50
40
30
20
10
0
0.00%

0.50%

1.00%

1.50%

2.00%

2022

2.50%

3.00%

2023

3.50%

4.00%

4.50%

5.00%

2024

Source: Reuters Eikon, Incrementum AG

The Momentous Freeze of Russian Foreign Exchange Reserves
The status of the US dollar as the global reserve and trade currency is
showing unmistakably widening cracks. For many years now, we have been
documenting the process of de-dollarization. We are now eyewitnesses to a
momentous breach of confidence that is preparing the ground for a move away

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9from the US dollar as the world’s reserve currency and, in the medium term,
accelerating the path to a new global monetary order.
If we can’t store [the euro],

The decision of the G7 and the EU on February 26 to freeze the US

acquire it; if the ability to settle

dollar and euro currency reserves of the Russian Central Bank, whichin this currency with our

account for about 60% of its total international reserves, will go down

counterparties, including thosein monetary history. Although there have been sanctions against pariah statesin Western Europe, is violated,such as Venezuela, Iran, or the Taliban’s Afghanistan before, they have neverthen why should we trade for

before been applied against a state with veto power in the UN Security Council, athis currency? For us, thisformer member of the leading economic nations (G8), a nuclear power, and one ofcurrency turns into candy

the world’s most important exporters of raw materials.

wrappers. We have lost allinterest in euros and dollars.

With the weaponization of money, however, the US and the EU are unlikely to

Pavel Zavalny

have done themselves any favors in the medium to long term. The decision
clearly demonstrates to many US-critical nations how quickly US dollar
reserves can transform from a highly liquid asset to useless pieces ofprinted paper. De facto, the US and the euro area have told the worldthat they no longer want to pay their economic quid pro quo fromprevious trade deals.

Composition of Global FX Reserves incl. Gold, 1964-2021
100%
90%
80%
70%
60%
50%
40%
30%
20%

10%
0%
1964

USD

1972

JPY

GBP

1980

DM

1988

FF

EUR

1996

Others

2004

2012

2020

Gold

Source: IMF, World Gold Council, Incrementum AG

It is hard to overstate the

The volume we are talking about is enormous: The global foreign exchange

importance of what the US andreserves of central banks amount to around 12trn USD, of which the US dollar

EU effectively announced: the US

accounts for about 60% and the euro for 20%. China, in particular, will have been

and EU effectively just declaredwatching Russia’s reserve freeze with a wary eye and will be stepping up its efforts

that $12 trillion in FX reserves

toward monetary sovereignty. In addition, the freezing of currency reserves has a

globally that are the result ofpotentially strong deflationary effect.

prior economic surpluses are
subject to political confiscation.

Remarkable countermeasures were taken to support the collapsing

Luke Gromen

ruble. For example, the Russian Central Bank – after doubling its key interest rate
to 20% – announced that it would pay a fixed price of 5,000 rubles per gram ofgold from March 28 until June 30. This is equivalent to about USD 1,940 per
ounce. This establishes a floor for the gold price in rubles, and since gold is tradedin US dollars, it also implicitly establishes a floor for the ruble in US dollars.

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10This weaponization of the US

Some analysts have mistakenly referred to this mechanism as the newdollar was no surprise to anyone

gold standard. However, this is not the case, as the central bank has not– Trump had alreadycommitted itself to redeeming rubles for gold, but only issues rubles and accepts

weaponised it against Iran ingold. Nevertheless, this example illustrates most vividly that gold can beparticular.

used at any time not only as a proverbial but as an actual anchor for a

Russell Napier

fiat currency.
What is extremely impressive is how the external value of the ruble hasdeveloped against the US dollar, which is itself extremely strong. For
example, the ruble is trading firmer against the US dollar than at the beginning of
the year, despite six waves of tough sanctions already in place.

RUB/USD, 01/2022-05/2022
0.016
0.015
0.014
0.013

0.012
0.011
0.010
0.009
0.008

March 25: The Bank of Russia
announces to buy gold for a
temporary fixed price of 5,000
RUB per gram.

February 28: The Bank of Russia
raises its key interest rate to 20%
from 9.5%.

0.007
01/2022

02/2022

03/2022

04/202205/2022

RUB/USD
Source: Reuters Eikon, Incrementum AG

It’s one thing to make life

In addition to the gold price floor, the decision that Russia will nouncomfortable for somelonger accept euros as a means of payment for its exports is likely tooligarchs, but the decision tohave played a significant role in the unexpected strength of the ruble.

freeze central bank assets is in

The chairman of the energy committee in the Russian Duma, Pavel Zavalny,another league all together. With

commented on the Russian decision to no longer accept the euro as a means ofa stroke of a pen, the West took

payment: “Let them pay either in hard currency, and this is gold for us, orRussia’s FX reserves and madepay as it is convenient for us, this is the national currency.” (Our emphasis.)them useless.

From the states classified as unfriendly Russia will in future only accept payment

Kevin Muirin rubles or in gold, and from all others in a freely negotiable currency andpossibly even in Bitcoin.
We are concerned that the West may be overestimating its position
with regard to its de facto monopoly on international currency
reserves. The economic importance of the East – especially Asia – has increased
massively over the past 20 years. This power has been highlighted by Sergey
Glazyev. He is considered one of Russia’s most influential economists and is amember of the National Finance Council and former Minister of Foreign Economic
Relations. He was also an economic advisor to President Putin from 2012-2019.
Glazyev explained the role that commodities will play in the emerging multipolar
monetary order:

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11“The third and the final stage on the new economic order transition will
involve a creation of a new digital payment currency... A currency like thiscan be issued by a pool of currency reserves of BRICS countries... the basket
could contain an index of prices of main exchange-traded commodities: gold
and other precious metals, key industrial metals, hydrocarbons, grains,sugar, as well as water and other natural resources...”We think it is plausible that gold, as a neutral monetary reserve, will
emerge as one of the beneficiaries of the troubling conflict between
East and West. In an increasingly polarized world that is dividing into two blocs,
gold can act as a neutral, nonstate monetary intermediary. Meanwhile, the trend ofgold enjoying increasing popularity among central banks has continued unabatedsince 2008. Thus, while the BRICS countries have significantly increased
their gold reserves in recent years, the West, especially the euro area
and the US, is still well ahead in this ranking.
Country

FX reserves,
in USD mn.

Total reserves,
in USD mn.

Gold reserves,in tonnes

Gold reserves,
in USD mn.

Gold reserves/
total reserves

Gold reserves/
GDP

Euro area

499,850

1,141,117

10,270641,267

56.20%

4.41%

USA

237,182745,0538,133

507,87168.17%

2.00%

Russia497,946

641,665

2,302

143,71922.40%

7.86%

China

3,251,626

3,373,282

1,948

121,656

3.61%

0.61%

Switzerland

1,036,009

1,100,949

1,040

64,940

5.90%

7.71%

Japan

1,303,245

1,356,070

846

52,824

3.90%

1.08%

India

563,471

610,952760

47,481

7.77%

1.44%

Taiwan549,994

576,446

424

26,452

4.59%

3.14%

Saudi Arabia

441,067

461,240

323

20,173

4.37%

1.94%

Singapore

424,839

434,439

154

9,600

2.21%

2.26%

South Korea

455,833

462,355

105

6,522

1.41%

0.36%

Hong Kong

490,956

491,086

2

130

0.03%

0.04%

Source: IMF, World Gold Council, Incrementum AG (data as of Q1/2022).

If reserves can be negatedIn addition to the unique feature that gold has no risk of default orovernight, are they evenconfiscation – provided it is held securely in the country that owns it – central

reserves? How many otherbanks now have another argument in favor of holding reserves in gold. Inflation

countries must hedge against therates, which are markedly beyond their respective inflation targets, are likely topossibility of similar sanctions?

further undermine confidence in government reserve currencies in the coming

Doomberg

years. Gold will probably gain further acceptance as a reserve currency
in many countries and increasingly establish itself as an anchor of
confidence and purchasing power.
Even though Bitcoin was mentioned in passing by Russia in thiscontext – which is remarkable – it does not play a role in the concert ofreserve currencies at present. However, in the oldest of all cryptocurrencies
adaptation continues to progress steadily. Worth mentioning, in addition to theintegration of Bitcoin as an asset into traditional financial markets, is theincreasing use of the protocol for processing payments via the Lightning Network.

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12

Lightning Network Capacity, in Bitcoin (lhs), and USD (rhs),
01/2018/05/2022

4,000

250

3,500
200

3,000
2,500

150

2,000
100

1,500
1,000

50

500
0
2018

0

2019

2020

in Bitcoin

2021

2022

in USD

Source: bitcoinvisuals.com, Incrementum AG

Bitcoin has moved beyond the

Bitcoin is being discovered by a growing part of the population inexperimentation phase. We’redeveloping countries and is also being actively used as a means of

now into the implementation era.

payment. Thus, a bottom-up dynamic can be seen here. Central banks, on theMark E. Jeftovic

other hand, still want nothing to do with the decentralized digital currency. But
even so, there are always interesting initiatives. For example, at the April 2022
general meeting of the SNB, a request was made by some of the bank’s
shareholders that it should shift 1 billion francs of its assets per month from
Eurobonds into Bitcoin. As expected, the request was not favored by the central
bank. Consequently, the initiators will probably confront the SNB with the issue
every year from now on.

I can’t understand why people

But there are also newsworthy developments at the state level withare frightened of new ideas. I’mregard to Bitcoin: Last year, El Salvador introduced Bitcoin as an official means

frightened of the old ones.

of payment alongside the US dollar. The Central African Republic has recently

John Cagefollowed suit. In both cases, the IMF opposed the moves vociferously and warnedof considerable risk. That institution, which forbids its member states from
pegging their currencies to gold, is obviously strongly opposed to Bitcoin becoming
official money. One cannot escape the impression that the IMF is, at its
core, the supreme guardian of the global debt-based monetary system.

From Monetary Climate Change to Stagflation
2.0
Before we turn to our core topic this year, stagflation, allow us to take aquick look in the rearview mirror. In the In Gold We Trust report 2021 wetalked about what we called monetary climate change. With this term, we alluded
to a multilayered paradigm shift triggered by the pandemic and the political
reactions to it, and shaped by the following five developments:

LinkedIn | twitter | #IGWTreportIntroduction: of Wolves and Bears

13•

Budgetary nonchalance•

Merging of monetary and fiscal policy•

New tasks for monetary policy•

Digital central bank currencies vs. decentralized cryptocurrencies•

The new ice age between East and West

These trends are still present and are further reinforced by the Russiancrisis. The budgetary nonchalance continues seamlessly after the Covid-19crisis
has abated. No expense is being spared to develop alternative energy sources, tomassively rearm and to finance the costs of sanctions, but also to cushion the wave
of inflation through transfer payments. Monetary policy will have no choice but tofinance the additional government budget gaps by monetizing public debt.
Relations between East and West have cooled down so much that one can alreadyspeak of a Cold War 2.0. These are all structurally inflationary dynamics, whichhave a braking effect on growth on top of everything else.
From a financial market

Wolf and bear, inflation and economic downturn equals stagflation.

standpoint, the situation remains

This is precisely the insight that is slowly but surely taking hold. No less a person

the inverse of Goldilocks.

than the president of the renowned German ifo Institute, Clemens Fuest, already

Christopher Woodsurprised us at the end of April (!) with the following statement: “We are in the
midst of stagflation, at least in Europe.” In view of the tense geopolitical situationand the dark clouds in the economic sky, we consider stagflation to be very likely inmany parts of the world, especially in the USA and the EU.
Just as we predicted the current wave of inflation in 2020 without going far out ona limb, we are also not going out on a limb with our announcement of persistentstagflation. We will certainly not have to endure a repeat of the
stagflation of the 1970s; rather, we’ll see stagflation 2.0, with its
numerous peculiarities. We will compare some of the importantcharacteristics here with a focus on the US.
FactorStagflation Phases 1970–1983

Stagflation 2.0

Trigger- 1973: Oil embargo Yom Kippur War- 1979: Iranian Revolution

Duration

Several phases between 1970 and 1983

- Covid-19 pandemic & lockdowns/
massive stimulus measures- Supply chain issues- War in Ukraine?

Money overhang

Up to 4.9% (1982)

Up to 21.3% (2020)

Real interest- Partly positive, partly negative, mostly
within a range of +5%/-5%- Strong increase in early 1980s to justunder +10%.

Currently strongly negative Positive real interest rates b.a.w. not conceivable

Budget deficit

Up to 5.7% (1983)

Up to 15.0% (2020)

Debt

Low (data for 1970 and 1982)- State: 35.7%; 35.2%- Company: 47.0%; 53.1%- Private households: 44.0%;47.9%

High (data for 2021)- State: 123.4%- Company: 77.2%- Private households: 76.4

Labor market- High degree of organization;- Growing workforce potential- Low organizational level- Declining workforce potential as aresult of demographic changeInternational
division of labor /geopolitics- Division of Labor Largely Stable- Geopolitics: Cold War- After decades of globalization now
de-globalization- Slipping into Cold War 2.0

Oil price development (WTI)- Jun 1973–Feb 1974: +184%- Dec 1978–May 1980: +166%- Dec 2020–Apr 2022: +116%

Currency regime

Exchange of gold currency standard on
system of flexible exchange rates

End

Interest rate hikes, Volcker shock,recessions

Increasing departure from the unipolar
monetary system with the US dollar as
the anchor currency- Potential debt crises due to high debt
levels- Reorganization of the internationalmonetary order

Source: Incrementum AG

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14

Stagflations and their consequences for the economy, society and financial markets
are probably only known to most people from history books, if at all. Adequate
preparation for the simultaneous appearance of wolf and bear, whichis even rarer to observe than a German victory in the song contest, will
occupy us in all its details in this year’s In Gold We Trust report.

Thank you very much!
Year after year, the In Gold We Trust report strives to be the world’s
most recognized, widely read, and most comprehensive analysis on
gold. We wholeheartedly thank our more than 20 fantastic colleagues on fourcontinents1 for their energetic and tireless efforts!
A strong passion for any object

Our thanks also go to our premium partners, of course.2 Without theirwill ensure success, for the desire

support it would not be possible to make the In Gold We Trust report available freeof the end will point out theof charge and to expand our range of services year after year. In 2022, for example,

means.

we launched our Monthly Gold Compass as well as a Spanish edition of theHenry Hazlittcompact version.
Studying and appreciating the past is crucial to preparing for the future.
Understanding and preparing for the monetary climate change
described last year3 as well as Stagflation 2.0 are, in our opinion, key
analytical challenges of the present. We are pleased to once again
provide you, dear readers, with a comprehensive, informative andentertaining guide to gold.
Now we invite you on our annual parforce ride and hope you enjoy reading our 16th
In Gold We Trust report as much as we enjoyed writing it.
With warm regards from Liechtenstein,

Ronald-Peter Stöferle and Mark J. Valek—

1 All employees are pictured in the employee gallery at the end of the In Gold We Trust report.
2 At the end of the In Gold We Trust report you will find an overview of our Premium Partners, including a brief

description of the companies.
3 “Monetary Climate Change,” In Gold We Trust report 2021

LinkedIn | twitter | #IGWTreportEVEN IF WE
DISCOVER
NEW WORL DS.

T HE F U T UREI S G OL D.

philoro.com

Company Descriptions

16

Status Quo of Gold as aCurrency“Fiat money will be a passing fad in thelong-term history of money. ... Gold isdefinitely a fiat money hedge.”
Jim Reid, Deutsche BankKey Takeaways• In 2020, gold proved itself, yet again, as a recession

hedge, a portfolio stabilizer in times of highly volatile
equity markets, and an early inflation hedge.
• After two years of well above average gains of 18.9%

and 24.6% in USD terms and a new all-time high in
August 2020, in 2021 it was time for consolidation in thegold price.
• Profit-taking, a significantly firmer US dollar, opportunity

costs in the wake of the Bitcoin bull market, and risingbond yields caused significant headwinds for the gold
price in 2021.
• From 2000 to 2022 gold averaged a 9.3% return. During

this period, gold has outperformed virtually every otherasset class and, above all, every other currency.
• Gold is especially effective as an asset protection tool incountries where it has a significantly negative
correlation with local stock markets.
• Gold’s long-term upward trend is clearly intact. The

basis for further price increases seems excellent.

Status Quo of Gold as a Currency

17Your time is precious, and we won’t beat around the bush: 2021 wasdisappointing for gold, especially in view of the sharp rise in inflation
rates.
Take a deep breath, pick yourself

What were the reasons for this frustrating performance? After record

up, dust yourself off, and start all

gains in 2019 and 2020, the gold price had to take a deep breath. After two years ofover again.

well above average gains of 18.9% and 24.6% in USD terms, and a new all-timeFrank Sinatra

high in August 2020, it was time for consolidation. Especially as the impressive
80% rise in the gold price from the August 2018 low to the August 2020 highcorrectly anticipated the rise in the CPI in 2021.

Gold (lhs), in USD, and Silver (rhs), in USD, 01/2016-05/2022
2,200

30

1,900

25

1,600

20

1,300

15

1,000
2016

10
2017

2018

Gold

2019

2020

2021

2022

Silver

Source: Reuters Eikon, Incrementum AG

In 2020, gold did exactly what it should do in a diversified portfolio: It served as areliable hedge against the turmoil in the wake of the Covid-19 pandemic, as arecession hedge, as a portfolio stabilizer in times of highly volatile equity markets,and as an early inflation hedge. In a nutshell, gold has confirmed that it is
the Virgil van Dijk of assets. Always on hand when things get reallyhairy .
I guess you guys aren’t ready for

But now back to the present – and the future. Since the start of this year,that yet. But your kids are gonna

the tide has turned. Gold started superbly. The all-time high of USD 2,075 fromlove it.

August 7, 2020 was almost reached on March 8, 2022 at USD 2,070. Gold posted

Marty McFly

its highest quarterly close ever in Q1/2022. In contrast, the US Treasury index
posted its worst quarter since the data series began in 1973, losing 5.58%, and the
S&P 500 posted its first negative quarterly return since Q1/2020. But from midApril onwards, a correction set in and the gold price had to pay tribute to therallying USD as well as the general risk-off sentiment in markets.

The best bulls in rodeo are

At the outset, let’s look at the development of the gold price in theunpredictable. Trying tomajor currencies. The full year 2021 was divergent for gold in the currencies

outsmart them can lead cowboys

mentioned below. While the gold price in the (former) safe haven currency JPY

to outsmart themselves.

posted a gain of 7.5%, gold in the Chinese yuan fell by 6.1%. In contrast to the US

Ty Murraydollar, the gold price gained 3.6% in euro terms, once again highlighting theglaring weakness of the euro. On average, the gold price lost 0.6%.

LinkedIn | twitter | #IGWTreportStatus Quo of Gold as a Currency

18

As before, the average performance in this secular bull market remains
impressive. The average annual performance from 2000 to 2022 is 9.2%. During
this period, gold has outperformed virtually every other asset class and, above all,every other currency – despite significant corrections in the meantime. Since thebeginning of 2022 the development has been clearly positive, with anaverage gain of 5.4%.

Gold performance since 2000 in various currencies (%)
Year

USD

EUR

GBP

AUD

CAD

CNY

JPY

CHF

INR

Average

2000

-5.3%

1.2%

2.4%

11.2%

-1.9%

-5.4%

5.8%

-4.2%

1.4%

0.6%

2001

2.4%

8.4%

5.3%

12.0%

8.8%

2.4%

18.0%

5.5%

5.8%

7.6%

2002

24.4%

5.5%

12.3%

13.2%

22.9%

24.4%

12.2%

3.5%

23.7%

15.8%

2003

19.6%

-0.2%

8.0%

-10.7%

-1.3%

19.6%

8.1%

7.4%

13.9%

7.2%

2004

5.6%

-2.0%

-1.7%

1.5%

-2.0%

5.6%

0.8%

-3.1%

0.1%

0.5%

2005

18.1%

35.2%

31.6%

25.9%

14.1%

15.1%

35.9%

36.3%

22.8%

26.1%

2006

23.0%

10.4%

8.1%

14.3%

23.3%

19.0%

24.2%

14.1%

20.7%

17.5%

2007

30.9%

18.4%

29.2%

18.0%

12.0%

22.5%

22.5%

21.8%

16.9%

21.4%

2008

5.4%

10.0%

43.0%

30.5%

28.7%

-1.5%

-14.2%

-0.8%

30.0%

14.6%

2009

24.8%

21.8%

13.0%

-1.6%

7.9%

24.8%

27.9%

21.1%

19.2%

17.6%

2010

29.5%

38.6%

34.2%

13.9%

22.8%

25.1%

13.2%

16.8%

24.8%

24.3%

2011

10.2%

13.8%

10.6%

9.9%

12.7%

5.2%

4.5%

10.7%

30.7%

12.0%

2012

7.1%

5.0%

2.4%

5.3%

4.2%

6.0%

20.7%

4.5%

11.1%

7.4%

-19.1%-24.3%

2013-28.0%-30.9%-29.4%-16.1%-23.0%-30.1%-12.6%-29.8%

2014

-1.8%

11.6%

4.4%

7.2%

7.5%

0.7%

11.6%

9.4%

0.2%

5.6%

2015

-10.4%

-0.2%

-5.3%

0.6%

6.8%

-6.2%

-9.9%

-9.7%

-5.9%

-4.4%

2016

8.5%

12.1%

29.7%

9.4%

5.3%

16.1%

5.4%

10.3%

11.4%

12.0%

2017

13.1%

-0.9%

3.3%

4.6%

5.9%

6.0%

9.0%

8.3%

6.3%

6.2%

2018

-1.5%

3.0%

4.3%

9.0%

6.8%

4.1%

-4.2%

-0.8%

7.3%

3.1%

2019

18.3%

21.0%

13.8%

18.7%

12.6%

19.7%

17.2%

16.6%

21.3%

17.7%

2020

25.0%

14.7%

21.2%

14.1%

22.6%

17.2%

18.8%

14.3%

28.0%

19.5%

2021

-3.6%

3.6%

-2.6%

2.2%

-4.3%

-6.1%

7.5%

-0.6%

-1.7%

-0.6%

2022 YTD

-0.7%

7.9%

8.9%

3.7%

1.3%

5.6%

10.6%

7.5%

3.7%

5.4%

Average

9.3%

9.1%

10.7%

8.6%

8.4%

8.3%

10.1%

6.9%

11.9%

9.2%

Source: Reuters Eikon, Incrementum AG, figures as of 05/18/2022

Selling gold because UST yields

Let’s now take a look at the gold price development since the last In

are rising sharply is 100% rightGold We Trust report in US dollars and euros. Shortly after the publicationin the short term but 100%of the last report on May 27, 2021, a consolidation phase of several months set in,wrong in the intermediate term.

which only ended at the beginning of 2022. In addition to profit-taking, aLuke Gromensignificantly firmer US dollar, and opportunity costs in the wake of the
Bitcoin bull market, rising bond yields were a major trigger for the
emerging headwind.

LinkedIn | twitter | #IGWTreportStatus Quo of Gold as a Currency

19Gold, in USD (lhs) and EUR (rhs), 1-Year Performance, 05/202105/2022
2,100

2,000

IGWT 2021

1,900

2,000

1,800
1,900
1,700
1,800
1,600
1,700

1,500

1,600
05/2021

07/2021

09/2021

11/2021

01/2022

Gold in USD

03/20221,400
05/2022

Gold in EUR

Source: Reuters Eikon, Incrementum AG

Long-term consistency trumps

Let’s now flip back even further in the history books. Since the IPO of gold

short-term intensity.

on August 15, 1971, the average annual growth rate of the gold price in US dollars

Bruce Leeamounts to 10.1%. The annualized growth rate (CAGR) is 7.9%. In the previous
year, gold reached an annual average price of USD 1,799, a new all-timehigh. Since the beginning of the year, the average gold price has been USD 1,890.

Annual Average Gold Price (lhs), in USD, and Gold (rhs), yoy%,
1971-05/2022
2,000

120%

1,800

100%

1,600

80%

1,400

60%

1,200
1,000

40%

800

20%

600

0%

400

-20%

200
0
1971

-40%
1976

1981

1986

1991

1996

2001

Average Annual Gold Price

2006

2011

2016

2021

Gold

Source: Reuters Eikon, Incrementum AG

Let us now turn back to the more current “big picture”. The world gold
price, which represents the gold price in the trade-weighted external value of the
US dollar, recently reached new all-time highs again. Here, too, it seems thatthe long-term upward trend is clearly intact.

LinkedIn | twitter | #IGWTreportStatus Quo of Gold as a Currency

20Gold Price, in USD, and World Gold Price, in USD, 01/2008-05/2022
3,000

2,500

2,000

1,500

1,000

500
2008

2009

2010

2011

2012

2013

Recession

2014

2015

2016

2017

Gold in USD

2018

2019

2020

2021

2022

World Gold Price

Source: Reuters Eikon, Incrementum AG

Why do we actually deal so intensively with the gold price development
in different currencies? For years, we have been surprised that the majority ofinvestors primarily focus on the gold price development in US dollars. In our
experience, too few investors ask themselves whether or not they hedge theircurrency risks.
Think about currency allocation,Thus, gold may rise in US dollars during a crisis but much less in Swiss francs,

not just asset allocation.

because the Swiss franc, as a classic safe-haven currency, appreciates against theBridgewater Associates

US dollar and thus retains some of the gains that gold makes in US dollars. For
investors from Switzerland, it might therefore be advisable to own gold hedged in
Swiss francs in order to also fully benefit from gold’s safe-haven properties. For aeuro investor, on the other hand, there is no need to hedge gold investments, in
our opinion, as the euro tends to weaken in stress and crisis scenarios.
In a study worth reading, Prof. Dirk Baur of the University of Western
Australia analyzed the correlation of gold with the local stock market
in 68 countries.4 For this purpose, he applied the gold price in US dollars andthe gold price in the respective local currency. The table below shows thecorrelations between the local stock markets and the gold price in local currency.
Note that Venezuela has the highest positive correlation. This is certainly due tohyperinflation in Venezuela, which led to a devaluation of the Venezuelan bolivar
and thus a significant appreciation of gold. Stocks rise sharply in times ofhyperinflation, not because companies are doing so well, but because there is aflight to real assets.

—

4 Baur, Dirk G.: “Is Gold a Safe Haven in all Currencies?,” October 21, 2021

LinkedIn | twitter | #IGWTreportStatus Quo of Gold as a Currency

21

Correlation stock market in local currency with gold in USD

Source: Baur (2021), p. 14

It can be seen from the chart that for all countries up to Oman and theUS, the protective effect of gold is significantly lower, as gold tends tohave a positive correlation with the local stock markets. In countries from
Oman to Israel or Taiwan, gold has essentially zero correlation with the local
equity market, making it quite suitable for diversification. Residents of thecountries at the bottom of the list – which include almost all eurozone countries,
Sweden, Norway and Australia – should use gold as asset protection due to its
significantly negative correlation with the local stock market.

Conclusion
The primary trend is a law unto

Our assessment of the previous year, according to which gold is in aitself. It will continue until it

new bull market, has proved accurate. Even though the gold pricedies of exhaustion.

performed weaker than expected in the past weeks, the broad, long-

Richard Russellterm upward trend still seems to be intact.
A look at the Sprott Gold Bullion Sentiment Index5 shows that sentiment hadreached an absolute low in March 2021. The indicator had fallen even beyond thesecond standard deviation in the short term. Since then, the index and the gold
price have recovered but are still far from the euphoric levels that prevailed inAugust 2020, for example. In this respect, the basis for further priceincreases seems excellent.

—

5 The data was kindly provided by our premium partner Sprott Asset Management.

LinkedIn | twitter | #IGWTreportStatus Quo of Gold as a Currency

22

Sprott Gold Bullion Sentiment Indicator Index (lhs), and Gold(rhs), in USD, 01/2014-05/2022

100

2,200

90
80

2,000

+2σ

70

1,800

60
50

1,600

40
1,400

30
20

1,200
-2σ

10
0
2014

1,000
2015

2016

Recession

2017

2018

2019

2020

Sentiment Index

2021

2022

Gold

Source: Sprott Asset Management LP, Incrementum AG

LinkedIn | twitter | #IGWTreportInterested insecure storagefor your gold?

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Company Descriptions

24

Status Quo of Gold
Relative to Stocks, Bonds
and Commodities“Perfect storms begin when overvalued
assets meet unanticipated surprises
which are difficult to price.”
Larry Jeddeloh

Key Takeaways• After 2020, gold has once again proved its essential

character as a defensive and stabilizing portfolio
component, and particlarly in 2022 in the course of the
Ukraine conflict.
• In the last 90 years, there have been only four years

when both US stocks and bonds had negative annual
performance in the same year. 2022 could be the fifth
year.
• If the joint downward trend in the equity and bondmarkets that has been underway since the beginning of
the year continues, a brash counter-reaction by theFederal Reserve seems to be only a matter of time.
• From surplus to scarcity is how one could summarize

the situation in the commodity market. As we predictedlast year, the commodity sector has risen like a phoenix
from the ashes.
• The lack of investment in the raw materials sector,

especially in the oil and gas industry, could lead to a
supply shortage in the medium and long term. This will
have a significant impact on inflationary pressures.

Status Quo of Gold Relative to Stocks, Bonds and Commodities

25

The deeply negative correlation

Robert F. Kennedy said in his “Day of Affirmation” speech in 1966,of stocks and bonds that has“There is a Chinese curse which says ‘May he live in interesting times.’persisted for most of the last two

Like it or not, we live in interesting times.” Today, 56 years later, many

decades is not a permanent

investors may be experiencing first-hand that this Chinese saying is indeed a curse.

feature of markets but in fact is

The status quo that investors have come to love as a matter of course over the past

contingent on a certain macro

few decades is undergoing fundamental change. Old certainties are being lost, andregime of low and not volatile

new ones have yet to emerge.

inflation.
Inigo Fraser Jenkins

It is no different when it comes to the strengths and weaknesses of the various
asset classes and how they interact with each other. The last few months haveshown inflation to be the Achilles heel of many portfolios. Yes, times
are getting interesting for investors.
With this in mind, in the following pages we will examine the relative valuation
and relative trend strength of gold compared to other asset classes to better
understand the opportunity cost of investing in gold.

Gold Compared to Stocks“The Fed is launching a triple-faced policy
agenda of simultaneously ending QE4,
commencing QT balance sheet runoff, and hiking
rates 25 or 50 basis points at seven consecutive
FOMC meetings? And equity investors remain
unconcerned? We have never observed a strong
disconnect between indisputable liquidity
fundamentals and detached market sentiment.”
Trey Reik
Last year we pointed out that the markets were in a hysterical mania
phase, fed by ultra-loose monetary and fiscal policy.6 Confidence amongmarket participants seemed as boundless as liquidity just a few weeks after thehistoric Covid-19 crash in February/March 2020.
The fundamentals and market data already gradually clouded over in
2021, and the air was becoming increasingly thin. Even if many market
participants were surprised by the downturn on the markets, similar to the way car
drivers are surprised year after year by “unexpected” onset of winter in December,the signals towards the end of 2021 were clear:• A Shiller P/E of almost 40 (vs. 34 currently) meant a 3-standard-deviation
event. In the last 100 years, the Shiller P/E ratio has been higher only 2% of thetime, most recently in November 2000, when the market fell 18% in thefollowing year.

• In 2021 only 5 stocks were responsible for half of the total return of the
S&P 500. Market concentration was thus even higher than in 1969 and 1999.

—

6 See “The Status Quo of Gold,” In Gold We Trust report 2021

LinkedIn | twitter | #IGWTreportStatus Quo of Gold Relative to Stocks, Bonds and Commodities

26

The subsequent years were difficult in both cases. In those years, the S&P 500
posted annual performances of -0.1% and -10.1%, respectively.

• In the case of corporate bonds, spreads of just over 300 basis points were well
below the historical norm of 530 basis points and had only been this low in
10% of cases in the past. This low yield spread only seems plausible in thecontext of an accelerating economic boom. However, the flat yield curve, which
recently inverted in some segments, speaks against this.

• Midterm election years are often demanding and have often been accompanied
by a monetary policy reversal. 2010: termination of QE1 in March 2010; 2014:
termination of QE3 in October 2014; 2018: QT.

• The next chart illustrates that the total market capitalization of all companies
trading at 10 or 20 times sales per share or more rose from a negligible size toalmost USD 13trn (10x P/S) and to USD 5trn (20x P/S) recently. These arelevels that make the dotcom bubble look like a deep-value party.

Market Cap of Stocks with P/S > 10x and P/S > 20x, in USD trn,
01/1995-03/2022
16
14

12
10
8
6
4
2
0
1995

2000

Recession

2005

2010

P/S > 10x

2015

2020

P/S > 20x

Source: Kailash Capital, LLC, Reuters Eikon, Incrementum AG

The vacuum is nothing more

Looking at this fantastic chart from Kailash Concepts reminded us of the legendary

than a space full of energy, andstatement of Scott McNealy, the former CEO of Sun Microsystems, who describedeven if we empty it and there isin his inimitable way why it is hare-brained to pay 10 times sales for a share:

nothing left, according to the
Heisenberg uncertainty“At 10 times revenues, to give you a 10-year payback, I have to pay you 100%principle, that nothing has aof revenues for 10 straight years in dividends. That assumes I can get that byweight.

my shareholders. That assumes I have zero cost of goods sold, which is very

Salvatore Garau

hard for a computer company. That assumes zero expenses, which is reallyhard with 39,000 employees. That assumes I pay no taxes, which is very
hard. And that assumes you pay no taxes on your dividends, which is kind ofillegal. And that assumes with zero R&D for the next 10 years, I can maintainthe current revenue run rate. Now, having done that, would any of you like tobuy my stock at $64? Do you realize how ridiculous those basic assumptions
are? You don’t need any transparency. You don’t need any footnotes. What
were you thinking?”
And the wind has indeed changed (very) quickly. Around the turn of theyear, market behavior gradually changed from buy the dip to sell the rally. Former

LinkedIn | twitter | #IGWTreportStatus Quo of Gold Relative to Stocks, Bonds and Commodities

27

highflyers such as Peloton, Robinhood, and also Cathie Wood’s highly successful
ARK Innovation ETF, whose tech stocks are also referred to as Wood stocks, fellquickly and deeply from their highs. The most telling anecdote for us regarding the
speculative bonanza in the US stock market, however, came from Rivian
Automotive, a car manufacturer and purported Tesla rival that had delivered just156 cars by the time it went public in November – and these were distributed
exclusively to its own employees. Yet Rivian was temporarily the US automakerwith the second-highest stock market value. With a capitalization of USD 100bn,
the company was at times valued higher than Ford or General Motors.
The art market was also affected by monetary insanity, so we rubbed our eyes
at the sale of the invisible sculpture Io Sono by Salvatore Garau for an
unbelievable EUR 15,000. As a special service to you, dear reader, we
present the sculpture on the left.
The starting position for stocks at the beginning of the year was
therefore already fragile. And it came as it had to come. In Q1/2022, theS&P 500 lost 4.9%, the MSCI World 5.5%, the Nasdaq 9.0% and the Euro Stoxx 50
9.2%. And the slump in stock markets continued unabated in April and May. Thereis no doubt that valuations of many markets, sectors and individual stocks remain
Courtesy of Hedgeye

far from bargain levels. In an environment of low interest rates and strong growth,
this would not be a problem. But the headwind on the equity markets is no longer alukewarm breeze but a stiff one. We would like to point out the following risk
factors:• “Don’t fight the Fed” – The Federal Reserve is no longer an investor’s friend.
• The fiscal tailwind has turned into a headwind.
• The firm US dollar is putting pressure on US corporations’ earnings abroad.
• Geopolitical risks justify higher risk premiums.
• Households and portfolio managers remain fully invested.
• Inflation is reducing consumers’ real incomes and squeezing corporate profit
margins.
In this respect, we doubt that the macroeconomic and political environment and,in particular, the earnings growth outlook justify such high valuation levels –especially in US markets.

LinkedIn | twitter | #IGWTreportStatus Quo of Gold Relative to Stocks, Bonds and Commodities

28

Wilshire 5000/US GDP, in %, 01/1971-05/2022
220%
200%
180%
160%
140%
120%
100%

Average: 82%

80%
60%
40%
20%
0%
1971

1976

1981

1986

1991

1996

2001

Recession

2006

2011

2016

2021

Wilshire 5000/US GDP

Source: Reuters Eikon, Incrementum AG

A significant and recent recovery

Now what does this market environment mean for gold? We view theof equity inflows also is boosting

stock market performance as a key opportunity cost of gold. In 2021, theshares due to ‘fomo’ (fear ofopportunity costs of being invested in gold were still enormously high due to themissing out), and forbullish equity markets. Gold competed with a rapid 28% rise in the S&P 500. The

professional asset allocators

record run was so pronounced that the S&P 500 set a new all-time high on 70 of‘fomu’ (fear of meaningfully

the 252 trading days. This was second only to the 77 daily highs in 1995. We thinkunderperforming).

it is understandable that gold is little sought after when the world’s most important

Tobias Levkovich

stock index reaches a new all-time high on average every 3.5 days.
But the opportunity cost has vanished into thin air since the beginningof the year. After 2020, gold in 2022 has once again proven its essential
character as a defensive and stabilizing portfolio component in the course of the
Ukraine conflict; gold is, so to speak, the Robert Pecl7 of the portfolio.
Confidence arises from the repeated fulfillment of expectations.

Gold in Local Currency, and Domestic Stock Index, Annual
Performance in %, 2022
60%
46.3%

40%

20%

8.1%

5.7%

1.3%

11.1%

3.8%

0%
-1.0%
-20%

-15.7%

-5.0%

-5.3%
-11.7%-6.7%-19.3%-40%-39.1%-60%

Gold in Local Currency

Domestic Stock Index

Source: Reuters Eikon (as of 12th of May 2022), Incrementum AG—

7 Robert Pecl was an Austrian footballer who played exclusively for SK Rapid Wien. His playing style is aptly

characterized on Wikipedia as follows: “The defender held the nicknames ‘Ironfoot’ and ‘Red Robert’ due to hisrelentless style of play towards himself and opponents.” Wikipedia: Robert Pecl, our translation

LinkedIn | twitter | #IGWTreportStatus Quo of Gold Relative to Stocks, Bonds and Commodities

29

The following chart shows the gold/S&P 500 ratio since 2008. The
downward trend, whereby one ounce of gold buys fewer and fewer shares of the
S&P 500, was broken in 2018, and since then the ratio has been bottoming out.
Currently, it appears that gold is slowly building relative strength again. The ratio
is now slightly above the 90-day and the 1-year moving averages.
Courtesy of Hedgeye

Gold/S&P 500 Ratio, 01/2008-05/2022
2.0
1.8
1.6
1.4
1.2
1.0
0.8
0.6
0.4
0.2
2008

2010

2012

2014

2016

Gold/S&P 500 Ratio

2018

2020

90d MA

2022

1y MA

Source: Reuters Eikon, Incrementum AG

The reality is that

Let’s now look at the relationship over the longer term – since 1900.

diversification has not been aGold looks attractive compared to US equities and may have made a secular

good risk strategy, because

turnaround. The gold/S&P 500 ratio is trending to a mean of 1.67. The downtrend

correlations tend to spike justappears to have been broken, and the moving average has stabilized and is now

when you least want them to.

pointing slightly upward again. Based on the previous counter-trend rallies, gold

Mark Spitznagel

could more than triple against the S&P 500 if it reaches its 122-year median overthe next ten years.

Gold/S&P 500 Ratio, 01/1900-05/2022
7
6
5
4
3
2

Average: 1.67

1
0
1900

1910

1920

1930

1940

1950

1960

1970

1980

1990

2000

2010

2020

Gold/S&P 500 Ratio
Source: Reuters Eikon, Incrementum AG

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Gold Compared to Bonds“Oil is the wrecking ball that will crush every
CUSIP, because the Fed will eventually panic.
Look at bonds. They’re getting smashed alongwith equities today. This will blow up the risk
parity boys. Their model says that bonds aresupposed to hedge out risk-off periods in equities.
As expected, their model stops working when
inflation explodes.”Harris Kupperman (Kuppy)
Over the past four decades,

Gold also faced headwinds from bond market yields last year. The yieldbonds have been a naturalon 10-year Treasuries increased 65.07% in 2021, from 0.92% (12/31/20) to 1.51%

ballast to a stock portfolio. In the(12/31/21). Perhaps more importantly, the average 10-year Treasury yield in 2021

coming decade(s), bonds will nowas 1.44%, up 62.49% from the 2020 average of 0.88%. This contributed, among

longer be negatively correlated

other things, to the DXY Index posting a gain of 6.37% in 2021. Since theto stocks and save your portfolio

beginning of the year, the US dollar has appreciated by a further 8.95% against thein times of stress, but will instead

DXY currency basket. However, the gold price showed increasing

become the anchor that drags

resilience to rising yields and the rallying US dollar.

your portfolio lower.
Kevin Muir

The chart below shows the ratio between the gold price and the price of
10-year Treasuries. It can be seen that gold recently broke out of a 10year consolidation phase.

Gold/UST10Y Futures Ratio, 01/1985-05/2022
18
16
14
12
10
8
6
4
2
0
1985

1990

1995

2000

Recession

2005

2010

2015

2020

Gold/UST10Y Futures Ratio

Source: Reuters Eikon, Incrementum AG

Has the great bond bear market now begun? The signs have been
pointing to a storm since the beginning of the new year. According to thealways readable Jim Bianco, the bond markets experienced a Waterloo in the firstweek of January. The 10-year US Treasuries ended their worst week in 42 (!) years
with a total loss of 4.24%. Only in the wake of the Volcker Shock and the February
1980 hike in the federal funds rate to 20% was the loss in a calendar week greater.
The 30-year bond lost 9.35%, which meant the worst weekly performance in thelast 49 (!) years. Currently, 30-year US Treasuries are already 35.8% below their2020 peak, the 10-year 17.5% below. Also, the German Bunds, which have fallen

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31

14.9% from their peak. One of our central theses of past years is now likely
to come true: (government) bonds are no longer the antifragile
portfolio foundation they have been over the past 30 years.

Gold, UST10Y, UST30Y and Bund10Y, indexed 100 = 01/2022,
01/2022-05/2022
115
110
105
100

95
90
85
80
75
70
01/2022

02/2022Gold

03/2022

04/2022

UST10Y

UST30Y

05/2022

Bund10Y

Source: Reuters Eikon, Incrementum AG

The decoupling between gold and bonds that we anticipated has taken place inrecent months. The bond market and the gold market are sending thesame message: Deflation or disinflation are no longer the biggest
threat to portfolios; inflation is the new reality.

Gold (lhs), in USD, and UST10Y (inverted, rhs), in %, 01/200605/2022

2,200

0.0%

2,000

0.5%
1.0%

1,800

1.5%

1,600

2.0%

1,400

2.5%

1,200

3.0%
3.5%

1,000

4.0%

800

4.5%

600
400
2006

5.0%
5.5%
2008

2010

2012

Recession

2014

2016

2018

Gold

2020

2022

UST10Y

Source: Reuters Eikon, Incrementum AG

Bonds have never performed

One underappreciated reason for the acceleration of the sell-off inwell in inflationary times, but itbonds with long maturities may be investors’ realization thatwill become even morepolicymakers’ proposals to address price pressures are fuelingproblematic if bonds are held as

inflation rather than reining it in.8 Whether in Italy, France, Germany oran equity hedge.

California, the most common proposal to combat high energy prices is fuelPaul Wongsubsidies or tax cuts to cushion the shock voters feel in their wallets. To fund thesesubsidies and tax cuts, some politicians are calling for a tax on energy companies’
windfall profits or special dividends – all measures unlikely to encourage
investment in future production. The market recognizes that the measures—

8 See “The Fixed Income Market Meltdown,” GaveKal Research, March 28, 2022

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32

adopted to combat inflation – whether fiscal, monetary, regulatory, or
geopolitical – guarantee that the inflationary environment willcontinue.
One day, central banks will

But what would the consequences be, e.g. for mixed portfolios

decide that they need to support

or risk-parity investment strategies, if the positive correlation between

their currencies instead ofstocks and bonds continues? As discussed last year, correlation regimes aresupporting their bond markets.

stable for long periods of time, but can quickly reverse. The majority of today’s

In this scenario, bond markets

market participants can hardly imagine the impact of a possible reversal of thewill implode.

correlation, because many investment concepts are built on low or negative

Gavekalcorrelation between the two main asset classes.
However, the negative correlation is the exception rather than the rule
when viewed over the long term. For example, the correlation between stocks
and bonds in the USA has been slightly positive in 70 of the last 100 years.9 The
decisive factor for the negative correlation in the last 30 years was primarily the
low inflationary pressure or the decreasing inflation volatility in the course of theGreat Moderation.

Increasing inflation volatility

The following chart shows the one-year rolling correlation between 10-

simply means inflation going up

year US Treasury bonds and the S&P 500, as well as the average yieldand down more sharply, moreof 10-year Treasuries. It can be clearly seen that the 1-year correlation has

often. If inflation volatility is therecently turned into positive territory. Since 1955, the correlation coefficient

future, bond volatility won’t be

between stocks and bonds in the US has been around 0.075, which, when looking

far behind. And bond volatility

at the entire period, indicates that there is virtually no correlation between the two

will have severe implications for

asset classes. However, between 1960 and 2000, when high (nominal) interest

portfolios built around a mean-

rates influenced market activity for long periods, the correlation coefficient was

variance framework.

mostly above 0.2, while in an environment of low inflation and interest rates it was

Henry Maxey

mostly below -0.2. Currently, inflation is thus again positively influencing
correlation, which is probably causing heated discussions at asset
allocation committees and sleepless nights for portfolio managers.

1-Year Correlation of UST10Y and S&P 500 (lhs), and UST10Y
Average Yield (rhs), 01/1955-05/2022

1.0

8%

1962-2000: 7.5%

0.8

7%

0.6
0.4

6%

0.2
0.0

5%
Long-term
Correlation: 7.5%

-0.2

4%

-0.4
-0.6

1955-1961: 3.6%

3%

-0.8
-1.0
1955

2001 until now: 3.0%
1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

2%

2020

Recession
1-Year Correlation of UST10Y and S&P 500
UST10Y Average Yield
Source: FRB, S&P, BofA Merrill Lynch US Equity & US Quant Strategy, Reuters Eikon, Incrementum AG—

9 See “Portfolio for the high seas,” Variant Perception, July 2020

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33

In inflationary periods such as

Let us now take a closer look at the development of gold relative to

the US in the 1970s, the 60/40

Treasuries. In the Covid-19 crisis, the biggest economic shock since World War

portfolio suffered greatly.

2, both asset classes were among the few reliable safe havens. Both gold and US

Nominal returns optically lookedbonds reached their interim highs for the year on March 9, 2020, then sold off

good, but real returns werebriefly in the general panic and rallied soon after. On August 4, 2020, US 10-year

abysmal. Commodities and cash

Treasuries bottomed at a yield of 0.52%, and gold followed with its all-time higheasily outperformed equities andjust four days later. So, both have fulfilled their antifragile role inbonds, representing a failure ofexemplary fashion – at least superficially.

standard portfolio
diversification over this period.
Variant Perception

But if we look a little deeper beneath the surface, we see that
Treasuries suddenly became strongly positively correlated to equities
in the darkest days of March 2020.10 This represents a significant difference
from past cycles, when bonds compensated for losses on the equity side andsmoothed out volatility. The chart also shows that the red bars are
becoming more frequent. If the relationship is now actually reversed, the basisof the 60/40 portfolio – namely a negative correlation between equities and bonds– will be removed. Will Treasuries then have to hand over the scepter togold?

S&P 500, and ICE US Treasury 20+ Year TR Index, indexed 100 =01/2020, 01/2020-05/2022

150

S&P 500 and
US Treasuries
fall

140
130
120
110
100
90
80
70
60
01/2020

04/2020

07/2020

10/2020

01/2021

S&P 500

04/2021

07/2021

10/2021

01/2022

04/2022

ICE US Treasury 20+ Year TR Index

Source: Reuters Eikon, Incrementum AG

Gold and Commodities“I’ve been doing this [for] 30 years and I’ve neverseen markets like this. This is a molecule crisis.
We’re out of everything, I don’t care if it’s oil, gas,coal, copper, aluminum, you name it – we’re outof it.”
Jeff Currie, Head of Commodities Research, Goldman Sachs
From surplus to scarcity – is how one could summarize the situationin the commodity market. As predicted in the In Gold We Trust report 2020,
the commodity sector has risen like a phoenix from the ashes.11 It is amazing how—

10 See “Desperately Seeking Anti-Fragility: Part I,” GaveKal Research, August 28, 2020
11 See “The Status Quo of Gold,” In Gold We Trust report 2021

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34

firm the commodity bull market has been, even though the Chinese economic
engine is sputtering, and the US dollar is so prone to strength. The main reason isthat this bull market is not so much driven by rapid demand as by a lack of supply,
which has been further exacerbated by the Russian crisis.
Bloomberg
Industrial Metals Subindex

Bloomberg
Precious Metals
Subindex

Bloomberg
Agriculture
Subindex

Bloomberg
EnergySubindex

Bloomberg
Livestock
Subindex

ATH

266.76306.85143.33516.66131.99Date ATH

05/04/07

08/22/11

05/29/97

09/29/05

10/04/93-83.4%

Low-32.9%-30.6%-45.7%-89.4%

Date Low

53.90

49.66

34.15

15.47

16.21

YTD

11/07/01

04/02/01

06/26/20

04/27/20

04/13/20% Above Low

232.1%

329.0%

128.0%

254.2%

34.8%

YTD

3.5%

-2.8%

28.1%

77.4%

-2.5%

2021 Performance

30.3%

-6.1%

26.6%

52.1%

8.6%

Source: Reuters Eikon, Incrementum AG, figures as of 05/18/2022

Those who know it best, love it

The tide now seems to have really turned in favor of commodities. The

least, because they have beenquestion arises: Are we now on the threshold of a new commodity

hurt the worst.

supercycle? A number of factors speak in favor of this:Don Coxe• For ten years, commodities were in a bear market, resulting in a significant
lack of investment activity and declining production volumes.

• The increasing focus on fiscal stimulus and the energy transition(infrastructure projects, ...) will stimulate the commodity sector much morethan was the case in the pure QE paradigm.

• Russia and Ukraine are significant commodity producers and exporters.
• (Institutional) investors are still underweighted or not invested in commodities
at all. We firmly believe that commodities – and real assets in general – will
resume their historical role as a safe haven.

• Growing inflation concerns will continue to provide a tailwind forcommodities.

• Geopolitical tensions will encourage resource nationalism and demandgeopolitical risk premiums.

• In our view, the US dollar could be facing a secular bear market as its reserve
currency status gradually fades. Historically, the US dollar and commodity
prices have been strongly negatively correlated (-0.86). However, in 2021,
commodities were able to decouple from the strength of the US dollar, which
we believe is a clear sign of the forcefulness of the commodity bull market.
But isn’t the commodity boom possibly already overdone in the shortterm? Attention should also be focused on China, which is now responsible foralmost half of commodity consumption. China’s stubborn adherence to its zeroCovid policy, weak stock market performance, sluggish credit growth, and Beijing’s
increasing deleveraging efforts should by no means be disregarded, despite all the
Courtesy of Hedgeye

euphoria over the commodity supercycle.

Fortunes are made by buying

Positioning has also shifted in favor of the commodity sector recently.

low and selling too soon.

According to a Bank of America survey, the commodity weighting of global fundNathan Rothschildmanagers recently reached its highest level since the survey began in 2006.
Moreover, the futures market, various sentiment indices, and the year-on-year rate

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35

of change of the GSCI, shown below, confirm this hypothesis. In this respect, astrong breather of the commodity segment would not be surprising inour opinion.

GSCI, yoy%, 01/1972-05/2022
120%
100%
80%
60%
40%

+1σ

20%

Average

0%
-20%

-1σ

-40%
-60%
1972

1977

1982

1987

1992

1997

2002

2007

2012

2017

2022

GSCI
Source: Reuters Eikon, Incrementum AG

In bull markets, people haveLet’s now look at the performance of commodities relative to the stockfaith; in bear markets, doubt.

market. Loyal readers know the following chart, which has been by far

The other way around might be

the most cited chart of the In Gold We Trust report in recent years.12 It

more profitable.

impressively shows that the relative valuation of commodities compared to

Jim Grant

equities remains historically extremely cheap and has just stabilized. Compared to
the S&P 500, the GSCI Commodity Index (TR) has since April 2020 been near its
lowest level in 50 years. The ratio is currently 0.87, much lower than the long-term
median of 4.02 and miles away from the highs.

S&P GSCI Total Return Index/S&P 500 Ratio, 01/1971-05/2022
Gulf War 1990

10

GFC 2008

9
Oil Crisis 1973/74

8
7
6
5

Median: 4.02

4Everything(except
commodities)
Bubble3
2

1

Dot-Com Bubble

0
1971

1978

1985

1992

1999

2006

2013

2020

S&P GSCI Total Return Index/S&P Ratio
Source: Lynkeus Capital LLC, Dr. Torsten Dennin, Reuters Eikon, Incrementum AG

But even in absolute terms, it seems that the commodity cycle still has
further potential. According to long-term analysis of commodity bull markets,the average price gain is 202% and the average duration is 13.9 years. In thisrespect, we would only be at the beginning of the development.
—

12 We would like to take this opportunity to again thank Prof. Dr. Torsten Dennin, who came up with the idea for thischart.

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36

Commodity Bull Markets (NDR Commodity Composite)
Percentage gain

Duration (years)

1802-1814

68.5%

12.0

1843-1864

200.0%

21.4

1896-1920

267.6%

23.9

1933-1951

329.9%

18.0

1972-1980

168.4%

7.9

1999-2011

270.0%

12.1

2020-2022

125.0%

2.0

Average202.9%

13.9

Source: Ned Davis Research Group, Incrementum AG, as of March 2022.

Lack of capital expenditure in the resource sector
As a man sow, shall he reap.

The saying goes that you must sow before you can reap, while another

Bob Marley

adage reads that you can reap only what you sow. There has been a severelack of capital expenditure, or sowing, in the resources sector over the last few
years. This is especially true for the oil and gas sector. In a report published in
December 2021, the International Energy Forum warns that capital
expenditure in the oil and gas sector was depressed for the second
consecutive year at nearly 25% below 2019 levels. This while oil and gas
demand is back to pre-pandemic highs, with demand expected to rise in the next
several years, particularly in developing countries.

Global Upstream Oil and Gas Capex, in USD bn, 2015-2030e
550

500

523
484

481
450

450

441

410
400
348

341

350
309
300

250
2015

2016

2017

2018

2019

2020

2021

2025e

2030e

Source: IEF, IHS Markit, Incrementum AG

Hope is not a strategy. Luck is

The next two years (2022 and 2023) will be critical for allocating

not a factor. Fear is not an

capital toward new projects to ensure that adequate oil and gas supply

option.

comes online in the next 5–6 years. As this lack of capex becomes evident,

James Cameron

concerns about lower future output and increased uncertainty surrounding sourcesof supply could add a premium to prices. Even if demand stays flat over the coming
decade, a steady stream of investment is needed to offset declines in existing oil
and gas fields.

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Projected Declines in Non-OPEC Production Assuming No
Additional Drilling, in mn. barrels per day, 2020-2030e
60

50

49
-41% by 2030
42

40

38

-33% by 2030
36

29

30

28

20
-86% by 2030
7

10

2

1

0
Total Non-OPEC

Total Non-OPEC conventional

2020

US unconventional

2025e

2030e

Source: IEF, IHS Markit, Incrementum AG

Rystad Energy announced that in 2021 the world had the lowest level of new oil
and gas discoveries in 75 years. Analysts at Moody’s said that global annual
upstream spending needs to increase by as much as 54% to USD 542bn if the oilmarket is to avert a supply crunch in the medium term. Greg Hill, president of US
oil producer Hess Corp, said the oil industry is “massively underinvesting” insupply to meet growing demand.
Why is the rum gone?

This while Saudi Aramco sees healthy demand growth as spare capacity shrinks.

Jack Sparrow

Aramco CEO Amin Nasser said that the geopolitical situation, a lack of investmentin the hydrocarbons sector, and a “totally unrealistic energy transition plan” ismaking for a tight market.

Copper and other base metals
Similar situations are being observed in other parts of the resource sector. In an
April 2022 report, analysts at Goldman Sachs warned that copper is heading
towards a major supply shortage. The report states that:“ESG, geopolitics and chronic underinvestment (are) all driving copper
fundamentals far more than overall global growth”, and “while the near-term
supply outlook may be weakening, more concerning is the near total absenceof new investment in long-run mine supply”.

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Green Copper Demand by Technology, in Kilotonnes
Green Demand

2021

2022e

2023e

2024e

2025e

2026e

2027e

2028e

2029e

2030e

Solar

459

586

651

757

828

863

938

993

1,045

1,094

27%

11%

16%

9%

4%

9%

6%

5%

5%

497

514

584

664

634

707

760

751

810

21%

3%

13%

14%

-4%

11%

8%

-1%

8%

15

21

27

32

39

47

55

64

75

39%

42%

30%

19%

22%

20%

18%

17%

16%

816

1,046

1,270

1,518

1,832

2,158

2,458

2,729

3,044

75%

28%

21%

20%

21%

18%

14%

11%

12%

29

40

53

68

86

106

128

153

180

49%

40%

33%

28%

26%

24%

21%

19%

18%

1,942

2,272

2,691

3,110

3,454

3,956

4,395

4,743

5,203

42%

17%

18%

16%

11%

15%

11%

8%

10%

yoy%
Wind

409

yoy%
Stationary Energy Storage

10

yoy%
Electric vehicles

465

yoy%
Charging Infrastructure

19

yoy%
Total
yoy%

1,364

Source: BNEF, ICA, Goldman Sachs Global Investment Research

The report goes on to state that they have observed no new greenfield projectapprovals in the last year, that the current situation will leave thecopper market in deficits for the next decade, and that the only meaningful
outcome would be a substantially higher copper price in order to stifle demand andentice greater production. Goldman put price targets for copper at USD 13,000 per
tonne in 12 months’ time, compared to the current price of USD 9,000.

ESG, geopolitics, and popular opinion
I’m trying to be as green as I can.

The UN-convened Net Zero Banking Alliance brings together banks worldwide,

As an airline pilot, I have a

representing over 40% of global banking assets, which are committed to aligningcarbon footprint that’s a size 10,

their lending and investment portfolios with net-zero emissions by 2050 by

so it’s pretty hard.

combining near-term action with accountability. Members include JP Morgan

Bruce Dickinson,

Chase, Wells Fargo, Bank of America, Morgan Stanley, Goldman Sachs, and in

Iron Maiden

total 93 global institutions controlling USD 66trn, each of which signed acommitment to “reinforce, accelerate and support the implementation of
decarbonization strategies”. They aim to provide an international framework andguidelines by which to operate, and they recognize the vital role of banks insupporting the global transition of the real economy to net-zero emissions. To put
it bluntly, these financial institutions committed themselves to attempt to reduce
emissions by starving oil and gas producers of capital. The International Energy
Association (IEA) released their Net Zero by 2050 report last year. One of therecommendations reads: “No new oil and gas fields approved for development
after 2021”.

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Bank Issued Bonds and Loans, in USD bn, 2014-2021
1,000
900
800
700
600
500
400
300
200
100
0
2014

2015

2016

2017

Fossil Fuel Industry

2018

2019

2020

2021

Green Projects

Source: IEF, Bloomberg, Incrementum AG

It seems that the true end goal of these institutions is to raise the price of fossil
fuels high enough to encourage the transformation to other forms ofenergy. Society seems to be trying to resolve climate change by focusing on
supply, rather than demand. Ignoring economic consequences in favor ofsocial and environmental goals will have a far-reaching impact on global energy
markets.

Knock-on effects
The true cost of ignoring economic reality often lies in the unintended
consequences. Global fertilizer prices have skyrocketed amidst shortages, with
farmers in Kenya, Nigeria, Cameroon, Ghana, Senegal, Mexico, Guatemala, Peru
and Greece, to name a few, reporting price increases of as much as 500%, if supply
can be found. This in turn will have severe effects on food prices in those nations.
Fertilizer is in part a byproduct of fossil fuels, and many countries are dependenton phosphorus and other fertilizer components from Russia, Ukraine and Belarus.
This dependency is, at least partially, caused by longer-term lack of capital
investment in other parts of the world. Current economic policies in the West willdefinitely not help to alleviate the situation.

Resource investment cycle
Now, this is not the end. It is not

The extraction of raw materials is an extremely cyclical business,even the beginning of the end.

characterized by a long-term investment cycle. Tight energy markets lead

But it is, perhaps, the end of theto a price rally, and companies then generate above-average profits and attract

beginning.

investor capital. The market rewards growth and incentivizes companies to use

Winston Churchill

their newfound capital to drill more wells or develop new mines. Supply begins togrow and eventually exceeds demand. The cycle reverses when resource prices fall,company profitability collapses, stock prices decline, and capital flees the industry.
Over time, depletion occurs, supply inexorably falls, and the cycle repeats.
Messing with this carefully choreographed cycle has consequences.

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The world is going to end in

The exodus of capital in the energy sector exemplifies what is occurring

twelve years if we don’t addressin the entire commodities sector. Exploration and production (E&P)

climate change.

spending in the U.S. peaked in 2014 at USD 140bn. From there it successively fell.

Alexandria Ocasio-Cortez

Before the Covid-19 pandemic this figure stood at only USD 70bn, and in 2020 it

January 22, 2019

went down further to only USD 30bn, the lowest level in decades and a drop of
80% from the peak. US E&P companies are budgeting to spend only USD 45bn in
2022. To put this in perspective, the oil price averaged USD 90 in 2014, and thatyear E&P capital spending amounted to USD 140bn, almost four times the amount
expected this year.

The cure for high prices is high prices
From our point of view, the resource sector faces a significant triple
challenge. The multi-year bear market in commodities has caused severe
underinvestment and a lack of capex. This needs to be offset by increased
upstream investment, especially in exploration and the development of new
greenfield projects sectorwide. The market needs more supply, but the normal
market mechanism is being blocked by ESG policy.
Worldwide focus on ESG – especially by governments and the banking sector –supply chain issues and the supply crunch caused by the unfolding situation in
Ukraine and Russia, exacerbated by sanctions and export bans, have ushered in
unprecedented uncertainty and risk. This makes it difficult for resource companies
to access the capital required for development.
Lack of appetite from large banks and governments will force
producers to find alternate sources of funding, resulting in higher
costs of capital, which in turn will lead to higher commodities prices.

Conclusion
Pessimism sells. For reasons I

Last year we concluded: “The grueling bear market in commodities

have never understood, people

may have come to an end last year. Not only are we facing a renaissance inlike to hear that the world isthe sector, but we are also already in the midst of one.”13 With a clear conscience,going to hell, and become huffy

we can now reaffirm this statement and emphasize that the Ukraine crisis isand scornful when some idiotic

merely an accelerant of a fundamental trend reversal. Even if the war ends soon

optimist intrudes on theirand sanctions are lifted, this would by no means mean an end to the bull market inpleasure.

commodities.

Deirdre McCloskey
Global efforts to increase the security of supply of raw materials as wellas to decarbonize continue to gain momentum and will definitely
increase the demand for raw materials. The IMF has published, in theWorld Economic Outlook – October 2021, an estimate of how the prices ofimportant raw materials will develop, both based on projects already adopted andon the implementation of “net zero” by the year 2050.

—

13 “The Status Quo of Gold,” In Gold We Trust report 2021, p. 38

LinkedIn | twitter | #IGWTreportStatus Quo of Gold Relative to Stocks, Bonds and Commodities

41

Copper, Nickel, Cobalt and Lithium Price for the IEA's Net Zero by2050 Emission Scenario, 100 = 2020, 1970-2040e

800
700

600
500
400
300
200
100
0
1970

1980

1990

Copper2000

2010

Nickel

2020

Cobalt2030

2040

Lithium

Source: IEA, Schwerhoff & Stuermer, BLS, USGS, Incrementum AG

In a world of ongoing pressure

According to the IMF, the price of cobalt is expected to increase almost sevenfold,for policymakers across thepeaking in 2027. The price of nickel is not anticipated to peak until 2039 but may

globe to print and spend, zero

more than triple by then. Lithium is forecast to nearly triple in price, with 2031 asinterest rates, tectonic shifts inthe peak year. The price of copper is projected to increase at a much slower rate

where global power lies, andand to be 65% higher by 2030. These price estimates assume that demand

conflict, gold has a unique role infor these essential elements will increase drastically: copper willprotecting portfolios. It’s wise toalmost double, nickel will almost quadruple, cobalt will more thanhold some gold.

quadruple, and lithium will nearly quadruple.

Ray Dalio

Demand for Battery Materials, 2020-2030e
16
14
12
10
8
6
4
2
0
2020

Lithium
Iron

CobaltPhosphorus

2030e

NickelAluminium

Graphite
CopperManganese

Source: IRENA, Incrementum AG

There is no training, classroom

In our opinion, decarbonization and ESG-compliant investing willor otherwise, that can prepare

become structural drivers for the supply and demand of many green

for trading the last third of acommodities. We see positive impacts especially for copper, nickel, and battery

move, whether it’s the end of ametals but also for silver.

bull market or the end of a bearmarket.

The green wave is not the central reason for our positive outlook on thePaul Tudor Jones

commodity sector. There is no doubt that this trend is an additional
factor that is now swinging the pendulum in favor of commodities (andinflation).

LinkedIn | twitter | #IGWTreportSilver & Goldpromise freedom

gold value
80

60

40

1900

20

0
1910

Mark

1920
1930

Build your personal gold standard with yourprofessional all-in-one asset protection partner!

Yen

1940

Pfund Sterling

Yen

Mark

ECU

40

1990

ECU

20

Euro

…

1920

1930

1940

1950

1960

1970

1980

1990

Euro

1910

2019

1900

Deutschmark

US-Dollar…

2019

data: Bloomberg, Reuters

THE TOXINE

THE ANTIDOTE

In order to destroy thebourgeoisie, one has to wreak
havoc on its monetary system.

In the absence of the gold
standard, there is no way toprotect savings from confiscation through inflation.

Vladimir Ilyich Lenin

Time to act. For more information, go to:www.goforgold.de
www.solit-kapital.desolit-kapital.de/google

solit-kapital.de/apple

Alan Greenspan, Chairman of the Federal
Reserve 1987-2006 (“Gold and Economic
Freedom”, 1966)

data: Bloomberg, Reuters

Deutschmark

60

1980

gold value

1970

Reichsmark

Pfund Sterling

1960

80

Gold

US-Dollar

Richard Nixon shock

100

0

Reichsmark

1950

120

Company Descriptions

43

Status Quo of Debt
Dynamics“The fragile wants tranquility, theantifragile grows from disorder, andthe robust doesn’t care. Debt always
fragilizes economic systems.”
Nassim Taleb

Key Takeaways• At first glance, it might seem as if the global debt

situation has taken a turn for the better, but this islargely due to exceptionally high nominal economic
growth last year.
• The base effect in economic growth makes things look

much better in the short term than they actually are.
Because in reality, economic output has barely
recovered to pre-pandemic levels.
• All these factors, combined with low real growth rates

and government budgets continually running at large
deficits, lead us to conclude that it is highly unlikely wewill see significant interest rate hikes in the coming
decade.
• It is likely that more central banks will engage in yield

curve control in addition to classic interest rate policy
as a way of indirectly managing debt levels.
• Especially for highly indebted countries, higher inflation

rates are a means of debt reduction. This is at theexpense of existing bondholders and the population,
especially recipients of transfer payments.

Status Quo of Debt Dynamics

44

Debt has a time function –“Appearances are deceptive” – this is how the development of thebringing forward consumption

public debt ratio in 2021 can be summarized. According to data from thefrom the future into the present –Institute of International Finance (IIF), the global debt-to-GDP ratio fell by aroundin a sense “buying time”. Rising

10 percentage points to 351%, having jumped by 13.3% of global GDP in 2020. And

debt ultimately acts as a tax onjust as in 2020, the striking economic slump in global GDP of 3.3% further fueled

growth.

the increase in the public debt ratio due to the extraordinary reduction in thePaul Mylchreest

denominator, last year the effect was reversed due to the exceptionally highnominal economic growth of 13.0%.
This effect was also seen in government debt in 2021. In advanced economies, thepublic debt ratio fell from 123.2% to 119.8% in 2021 and is expected to fall further
to 115.5% in 2022.

Government Debt, as % of GDP, 1980-2027e
300%
250%
200%
150%
100%
50%
0%
1980

1985

1990

Japan

1995

Greece

2000

USA

2005

2010

Euro Area

2015

2020

EU

2025

Germany

Source: IMF, Incrementum AG

But this decline is not due to sustained savings in government budgets.
It is largely due to above-average nominal GDP growth last year. In the US,
nominal GDP grew by 10.1% in 2021, the highest increase since 1984. But thisexceptional growth is also not the result of structural reforms, but can be explained
almost exclusively by the gradual (with some setbacks) return to ordinary life after
the sharp Covid-19 restrictions.
Due to countless other pandemic-related support measures, government deficits
were still extremely high in 2021. For example, the US again posted a double-digit
deficit of 12.4% in fiscal year 2021, down from 14.9% in fiscal year 2020. In
absolute terms, the deficit decreased from USD 3.1trn to USD 2.8trn. The
corresponding figures before Covid-19 were around two-thirds lower at “only”
Courtesy of Hedgeye

4.7% or USD 984bn.

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45

US Total Public Debt (lhs), as % of GDP, and US Budget Balance(rhs), in USD bn, 1960-2021

140

500

0

120

-500
100

-1,00080-1,500-2,00060-2,50040-3,00020
1960-3,500
1965

1970

1975

1980

1985

1990

1995

2000

US Total Public Debt

2005

2010

2015

2020

US Budget Balance

Source: Reuters Eikon, Incrementum AG

It’s clearly a budget. It’s got a lot

In absolute terms, nominal total global debt of all economic sectorsof numbers in it.

rose even further in 2021. The USD 300trn mark was breached for the firstGeorge W. Bushtime last year.

The – Largely Ignored – Base Effect in
Economic Growth
Facts are stubborn things, but

The economic growth of last year and also this year is largely due to the base effectstatistics are pliable.

in growth figures; after all, many sales simply could not be made due to lockdowns,

Mark Twain

contact restrictions, event cancellations, and similar non-pharmaceutical measures
to contain the Covid-19 pandemic. This particularly affected the service sector. The
easing and, even more so, the withdrawal of these measures allow the industries
affected by the measures to operate more or less normally, which has naturally
increased economic output. However, this economic growth is not new, additional
prosperity but is largely due only to the reopening of the economy, i.e., the returnto the status quo ante. The negative supply shock of forced closings wasfollowed by the positive supply shock of reopenings. However, boththese shocks were only temporary in nature.

There’s no trick to being a

But because politicians like to bask in high growth figures and sellhumorist when you have thethem as their own successes, the influence of the base effect onwhole government working for

economic growth has been largely ignored, in contrast to the baseyou.

effect on inflation figures. This may be considered successful PR, but that’s all

Will Rogers

it is. In other words, if you have an accident with your car, your car will not be in
better condition after repairs than it was before the accident. With the Ukraine war
caused by Russia and the resulting spiral of sanctions, the next "accident" hasalready occurred on the supply side.
How much the base effect has distorted growth figures upward since March 2021 isshown in the next chart for Austria.

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46

Real GDP Compared to Pre-Crisis Levels, and Real GDP
Compared to Previous Year's Levels, in %, 03/2020-03/2022

40%
30%
20%
10%
0%
-10%
-20%

-30%
03/2020

06/2020

09/2020

12/2020

03/202106/2021

09/2021

12/2021

03/2022

Real GDP Compared to Pre-Crisis Levels
Real GDP Compared to Previous Year's Levels
Source: OeNB, Incrementum AG

A realistic view of economic developments is therefore sobering. For
example, despite real growth of 3.7% year-on-year (Q1/2022), the German
economy is still 0.9% below its pre-crisis level (Q4/2019). The auto sector has been
particularly hard hit by supply chain problems in chips, and since Russia’s attack
on Ukraine, more key supplier factories have had to close. Since 2017, domestic car
production has been falling, and at just over 3 million units in 2021 was almost
50% below the 2017 level.
Italy, and the spring and first

It is therefore no surprise that Italy, which was highly acclaimed in 2021 – thelove all together should suffice toEconomist even voted Italy Country of the Year – will fall back again significantly

make the gloomiest person

in 2022. According to the current forecast of the World Economic Outlook, Spain

happy.

and Portugal will overtake Italy this year, whose growth of 2.3% is expected to be

Bertrand Russell

significantly lower than the 2.8% forecast for the euro area. In 2021, by contrast,
Italy was still a (statistical) growth locomotive, with growth of 6.6%, while the euroarea stood at 5.5%.

Debt Relief Through Inflation?
The most important thing is to

In addition to the short-term effect of strong nominal economic growth (owed tounderstand that inflation is not

the base effect) on reducing the debt burden, the marked rise in inflation will also

an act of God, it is not a naturalcontribute to the real deleveraging of sovereigns, indeed of all debtors, for as longdisaster, and it is not a disease.

as nominal economic growth – or nominal corporate and household incomes –Inflation is a political strategy.

grows faster than existing or new debt. Increases in transfer payments by less than

Ludwig von Mises

the rate of inflation is therefore a simple and obvious method, but at the expense of
the weaker members of society. To put it bluntly, transfer recipients
restructure the national budget by being forced to forego consumption
as a result of a real decline in transfer payments.
However, this automatism is not as strong as it may seem at first glance. Statutory
inflation adjustments of expenditures diminish this effect. In the US, for example,
the automatic increase in payments from Old-Age, Survivors and Disability

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47

Insurance (OASDI, Social Security) to remain in line with the CPI, is prescribed bylaw.
Above a certain level of inflation rates, the debt-relief effect of inflation on
government budgets is even reversed. This is because real tax revenues erode as
inflation rises, since the time at which tax liabilities are established and the time atwhich they are paid can differ significantly in the case of some high-yielding typesof tax, such as income tax. This fiscally significant effect is known as theTanzi effect.14
Calculations by DZ Bank show that, using the GDP deflator as a measure of
inflation, inflation of 3% per year would significantly reduce the debt ratio in thosecountries with a low primary deficit or possibly even a primary surplus and acomparatively high debt ratio. Italian government debt could thus fall by 20
percentage points to 136% of GDP by 2026. At an inflation rate of 5%, which ismore in line with current reality, the decline would amount to 32 percentage
points. The corresponding figures for Germany show a decline from 69% to 58% in
2026 in the 3% scenario and to 53% in the 5% scenario. This would put German
government debt well below the 60% debt ceiling again.
I have tried to lift France out of

The problem child in the euro area, however, is France. Because unlike

the mud. But she will return tomuch-maligned Greece and no less heavily criticized Italy, France has been

her errors and vomitings. I

running stubborn primary deficits, i.e. a current deficit even excluding debt service

cannot prevent the French fromexpenses (interest payments and net borrowing), even before the Covid-19

being French.

pandemic. The 6% decline in the 3% scenario can be described as insignificant inCharles de Gaulle

view of France’s public debt of 117.8% (2021).
For the US, whose national debt swelled from 105.2% to 124.8% in the 2020 and
2021 Covid-19years, the CRFB calculates that inflation would have to be 12% fornearly a decade to cut US national debt in half, as it did after World War 2.
Alternatively, real economic growth of 6% or cumulative spending savings of morethan USD 20trn would be required, i.e. 61% of GDP.
Another key tool for achieving debt relief through inflation is keeping
interest rates artificially low, as central banks around the globe havedone in recent years. This has allowed interest expenditures on government
debt to be steadily reduced, even during periods of rising government debt ratios.

—

14 See “Hyperinflation: Much Talked About, Little Understood,” In Gold We Trust report 2019

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48

Advanced Economies, Government Debt (lhs), as % of GDP, andInterest Expense (rhs), as % of GDP, 2007-2021
130%

2.8%

120%

2.6%

110%

2.4%

100%

2.2%

90%

2.0%

80%

1.8%

70%

1.6%

60%

1.4%
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

Government Debt

Interest Expense

Source: IMF, Incrementum AG

Blessed are the young, for they

The following long-term chart shows the historically low level ofshall inherit the national debt.

interest rates. It is worth noting that until the mid-1930s, interest rates andHerbert Hoover

government debt were positively correlated. Since then, there has been a negative
correlation, which supports the thesis that artificially low interest rates are an
invitation to create debt. Indeed, while long-term interest rates have been in free
fall since the Volcker shock in the early 1980s, government debt in industrializedcountries has been rising steeply. In the US, the previous record of 126.1% from1946 was surpassed in 2020 at 127.1%, this despite the fact that we are living in
relatively peaceful times, whereas in 1946 industrialized countries were badly
affected by the devastation of World War 2, with high military spending and a
post-war recession.

Advanced Economies, Government Debt (lhs), as % of GDP, andLong-Term Interest Rate (rhs), in %, 1880-2020

140%

COVID 19Great
Depression

120%

0.14
0.12

GFC
100%

0.1

80%

0.08

60%

0.06

40%

0.04

20%

0.02

0%
0
1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020

Government Debt

Long-Term Interest Rate

Source: IMF, Incrementum AG

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49

Yield Curve Control as a New Central Bank
Tool?
The US is as far from a balanced

One tool the Federal Reserve used to facilitate wartime financing wasbudget as Joe Biden is fromyield curve control (YCC). After World War 2, this policy was continued until

puberty.

the Treasury-Fed Accord of 1951, which greatly facilitated the reduction of national
debt.15 Actively supporting the Federal Reserve’s financially repressive monetary
policy at the time were nearly balanced budgets and strong economic growth. But
the US is as far from a balanced budget as Joe Biden is from puberty.
Even before the outbreak of the coronavirus pandemic, the CBO’s forecast for the
US budget deficit from 2022 onward was more than USD 1trn each year, or at least
4.4% of GDP.

The QT timebomb is ticking.

However, the central banks’ interest rate capping policy to limit the

When it goes off there will be

nominal interest rate level means that, as a result of an inflation

emergency liquidity operations,premium that is too low, demand on the market for bonds isand we will move to the Yield

correspondingly restrained. Therefore, significant bond purchases by central

Curve Control (YCC) end game.

banks are inevitable in such a scenario, with the corresponding impact on total

Joseph Wangassets. Capping bond rates was the explicit goal of the Federal Reserve in the
1940s; it has been the goal of the Bank of Japan (BoJ) since September 2016. Inlate March, the BoJ reaffirmed its YCC policy. This was prompted by the fact thaton March 28, yields on the 10-year Japanese government bond (JGB) threatened
to breach the 0.25% level that the BoJ had issued as a ceiling. In response, theBoJ announced that it would buy JGBs in unlimited quantities.

The faster interest rates rise

Given Japan’s national debt of more than 250%, this decision comes astoday, the more financial

no surprise. However, the attempt to protect the Japanese budget from higher

repression will be required in theinterest payments by capping the debt comes at a price. On the inflation front, thecoming decades and the more therisk is still manageable. At 2.5% (April 2022), the inflation rate in Japan has

United States will come tosurpassed the BoJ’s inflation target of 2% for the first time in 7 years. To achieve

resemble Japan.

this, the BoJ had introduced YCC 2016 in addition to quantitative and qualitative

Joachim Klement

easing (QQE). Unsurprisingly, the YCC policy is weakening the external value ofthe yen, and dramatically so. In March and April alone, the yen lost morethan 10% against the US dollar. In mid-April, as yields again scratched
the 0.25% ceiling, the BoJ reiterated that it was ready to buy unlimited
amounts of JGBs in defense of the interest rate ceiling.

Don’t worry about the world

In contrast, the Reserve Bank of Australia (RBA), Australia’s central

ending today, it’s alreadybank, capitulated to market pressure. At the end of October 2021, it

tomorrow in Australia.

abandoned the YCC introduced at the beginning of the Covid-19 pandemic.

Charles M. Schulz

Initially, it capped the yield on the 3-year Australian government bond at 0.25%,
and on November 3, 2020, it lowered the cap to 0.10%. By the time the RBA ended
its YCC policy on November 2, 2021, it had already lost control over yields. At theend of October 2021, the yield rallied to 0.775%, and by mid-April it had alreadyexceeded the 3% mark. As could be expected, the YCC caused the RBA’s total assets
to explode. Within less than two years, total assets more than tripled, and the shareof Australian government bonds held by the RBA increased more than 15-fold toover 35%.
—

15 “The Status Quo of Gold,” In Gold We Trust report 2019, pp. 43–45

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50

Australian Bond (2.75%, 04/21/2024), and RBA 3 Year Bond Target
Rate, in %, 01/2020-05/2022

3.00%

2.50%

2.00%

1.50%

1.00%

03/19/2020:
Start of Yield Curve
Control 0.25%
11/03/2020:
New Target 0.1%

0.50%

0.00%
01/2020

07/2020

11/02/2021:
End of Yield
Curve Control

01/2021

07/2021

Australian Bond (2.75%, 04/21/2024)

01/2022

RBA 3 Year Bond Target Rate

Source: Bianco Research, Reuters Eikon, Incrementum AG

The ECB engages in a special form of interest rate capping bypromising all euro member states, which have varying levels of debt
and highly divergent ambitions in terms of debt reduction, “favorable
financing conditions”.
I’m not in the business of reading

The question of whether the ECB should keep spreads within a certain

tea leaves. I don’t have a crystal

range came up in March 2020, i.e. at the beginning of theCovid-19

ball.

pandemic. In the Q&A-session following the announcement of the results of theChristine Lagarde

March 12, 2020 Governing Council meeting, ECB President Christine Lagarde
caused an uproar. She stated – correctly in terms of content – that “to close
spreads” is not the task of the ECB. Italian politicians reacted indignantly to thisstatement. After all, following Lagarde’s statement, the already high spread
between German and Italian 10-year government bonds shot up from 191 bps to252 bps, or by 32%. To make matters worse, this discussion took place against the
backdrop of the first Covid-19 wave, in which Italy was hit early and particularly
hard.

10-Year Government Bond Spread Relativ to Germany, in %,01/2020-05/2022

4.5%
4.0%

3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
01/2020

04/2020

07/2020

10/2020

France01/2021

Spain

04/2021

07/2021Italy

10/2021

01/2022

04/2022

GreeceSource: Reuters Eikon, Incrementum AG

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51

In an interview for CNBC following the press conference, however, Lagarde
immediately made a 180-degree turn:“I am fully committed to avoid any fragmentation in a difficult moment for
the euro area. High spreads due to the coronavirus impair the transmissionof monetary policy. We will use the flexibility embedded in the asset purchaseprogram, including within the public sector purchase program. The package
approved today can be used flexibly to avoid dislocations in bond markets,
and we are ready to use the necessary determination and strength.”Markets love volatility.

With this, Lagarde publicly stated that the ECB wanted to exercise

Christine Lagarde

control over spreads. Only a few days after this regular Governing Council
meeting, the introduction of the Pandemic Emergency Purchase Program (PEPP)
was decided and presented to the public in an emergency Governing Council
meeting on March 18, 2020. Both in the presentation of the PEPP and in countlessother press conferences and speeches, the special flexibility of the PEPP wasemphasized, which allows the ECB to conduct bond purchases not strictly
according to the capital key, but to deviate from it – temporarily.

Many economists (including Fed

The fact that controlling bond spreads has become a central target ofVice-Chairman Lael Brainard)

monetary policy is confirmed by a project leaked to Bloomberg at thepromote yield curve control as abeginning of April 2022. According to information from an ECB

legitimate policy tool. The

employee who wished to remain anonymous, the ECB is said to be

problem is it works until it blows

working on a crisis instrument that would be activated in the event of aup.

sharp rise in bond spreads. This emergency instrument is to be used in the

Jim Bianco

event of an exogenous shock that is beyond the control of national governments.
If this information is correct, three conclusions follow:• The ECB is flirting with the idea of an open YCC.
• Only (ultra-)lax monetary policy is holding the eurozone together.
• The ECB will use the next crisis to further strengthen, i.e. centralize, theinstitutional architecture of the euro area.

Not Only Governments Are Highly Indebted
The borrower is servant to theInterest rate hikes affect not only governments but all overindebted

lender.

economic entities. For a country’s economic stability, therefore, it is not only

The Bible

government debt that is relevant but also the debt ratios of the corporate sector
and private households. The relative debt levels of these sectors vary markedly
from country to country. In the next chart, countries are ranked by government
debt. Corporate and household debt are added on top of the government debt.

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52

Total Debt (Government, Corporations, Households), as % of GDP,
Q3/2021
400
350
300
250
200
150

100
50
0

Government

Corporations

Households

Source: BIS, Incrementum AG

If we now classify the countries listed above according to their total debt, thepicture is clearly different.

Total Debt (Government, Corporations, Households), as % of GDP,
Q3/2021
400
350
300
250
200
150
100
50
0

Total Debt
Source: BIS, Incrementum AG

To understand Europe, you have

Not insignificant for the euro area and the interpretation of the ECB’s monetary

to be a genius - or French.

policy is the fact that France has the highest level of debt in society as a whole, in

Madeleine Albrightparticular due to the high indebtedness of the corporate sector. Italy, which is often
criticized, is in a relatively good position in this overall view, and even has a lower
level of debt than Sweden or Switzerland, which are often presented as role models
in the public debate, with their strong focus on government debt. But in these twocountries, the other two sectors of the economy are far more indebted than
average, with the result that the level of debt in society as a whole is over 300% ofGDP, while that of Italy is significantly lower.

The greatest deception men

With regard to the debt ratios in the EU, it should be noted that they have been

suffer is from their own opinions.

distorted downward since the decision to take on EUR 750 billion in EU

Leonardo da Vinci

community debt as part of "Next Generation EU". This is because the government
debt ratios do not include the respective governments’ shares of the community
debt. Clemens Fuest, President of the Munich-based ifo Institute and Florian Dorn

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53

estimate that NextGen EU will increase the government debt ratio by 5.5
percentage points.
The German Bundesbank, which has been headed since January 1 by Joachim
Nagel, nominated by the new German “traffic light coalition”, following thesurprise departure of Jens Weidmann, has also been extremely critical of thestatistical treatment of EU debt. As early as December 2020, it called for the new
debt not to be removed from national debt statistics. But the Bundesbank will
not be left with much more than the role of an admonishing voice inthe wilderness.
Christian Lindner is the David

Yet, unsurprisingly, circumvention strategies seem to be gaining in

Copperfield of German financial

importance again. When the Maastricht criteria were introduced, many a state-policy. He juggles the national

owned enterprise was formally privatized, with the state as sole or majority owner.

debt with such virtuosity that theThis formal privatization also "privatized" the debt and no longer burdened the

public can hardly distinguish

Maastricht debt ratio. The German government now wants to resort to a similar

between reality and appearance.

trick in order to address the ailing Bundeswehr in the face of the Russian attack on

Gabor Steingart

Ukraine and the commitment to achieve the NATO target of a defense budget of
2% of GDP. An “extra budget Bundeswehr” (Sondervermögen) of EUR 100bn is tobe established. The previous 27 special funds have a combined volume of
EUR 132bn. For Finance Minister Lindner (FDP) it is politically very convenient
that, subject to the appropriate legal structure, this extra budget would not becovered by either the Maastricht criteria or the German debt brake. New borrowing
without officially incurring new debt – fiscal policy alchemy, for which, in the end,
the taxpayer has to take the rap.

Maastricht Rules on the Verge of Softening?
Efforts to ease the debt and deficit rules of the Stability and Growth
Pact (SGP) have picked up again in recent months. After all, in 2020 the
EU Commission had set itself the goal of working out a reform of the now
extremely complex rules by 2023. Oliver Blanchard et al., for example, propose
replacing the rigid fiscal rules with fiscal standards. These should enable member
states to react more flexibly to their respective economic situations.
The enormous debts that now

In the course of this discussion, high-ranking representatives of the ESM,

oppress all the great nations ofincluding its managing director, Klaus Regling, have publicly pleaded for an

Europe will, probably in the longincrease in the debt ceiling to 100% of GDP. After all, according to an argument

run, ruin all these great nations.

strongly reminiscent of Larry Summers’ in the fall of 2020,16 because of the sharp

Adam Smith, 1776

drop in real interest rates, debt service would be lower today at 100% of GDP thanat 60% in earlier times. The fact that Regling and his colleagues assume thatinterest rates will remain so low in the long term is – to put it mildly – somewhat
naive.

—

16 Furman, Jason and Summers, Lawrence: “A Reconsideration of Fiscal Policy in the Era of Low Interest Rates,”

discussion draft, November 30, 2020; see also “The Status Quo of Gold,” In Gold We Trust report 2021

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54

It’s not easy being green.

A major, probably even unmanageable fiscal challenge for the EU

Kermit the Frog

member states is the political goal of a green and digitaltransformation of the economy. This would require enormous investments ofat least EUR 650bn. These should, according to another suggestion, be excluded
from the deficit calculation. The renowned economist Barry Eichengreen also
argues in favor of this in an article with the telling title “Greening Europe’s Fiscal
Rules”. He points out that in some countries it is permissible to disregard
investments when calculating deficits. A green investment should be treated thesame way because “[e]ven if it does not boost economic growth, it could avert aclimate-related disaster in which GDP plummets and the debt burden becomes
unmanageable”.

Politics is the art of looking for

It is obvious that this and similar proposals are political shell games. In

trouble, finding it everywhere,

economic terms, it makes no difference whether debts or deficits are included indiagnosing it incorrectly andstatistics that are embellished according to political guidelines. Either way, theapplying the wrong remedies.

debts have to be serviced, and that alone counts. In any case, the concealment

Groucho Marx

tactics used by the EU will lead to an underestimation of future debt and deficit
dynamics.

The EU reached an agreement –It is still a completely open question how the Maastricht criteria will

except it was the kindactually be reformed. In any case, a tightening of the criteria canof agreement only the EU candefinitely be ruled out. Whether there will be a softening disguised as a reform

reach; an agreement about

depends largely on the positioning of Germany, the political heavyweight among

which everybody involved

the frugal states of the former D-mark bloc. In the current year, 2022, the Stability

disagrees.

and Growth Pact is still suspended anyway because of the Covid-19 pandemic. In

Grant Williams

view of the massive economic upheavals to be expected as a result of the Ukraine
war and the spiral of sanctions, an extension of the suspension in 2023 is within
the realm of possibility, if not now even probable.

Why the Comparison with the 1970s Is (Partly)
Misleading
The current situation is often compared with the 1970s. But there is asignificant divergence on one crucial point. For example, the total of three
inflation waves – 1967-1972, 1972-1976, 1976-1983 – with year-on-year peaks inannual CPI inflation of 5.8%, 11.0% and 13.5%, respectively – were each counteredwith significant interest rate hikes. Interest rates rose from 2.00% to 10.50%, from
3.25% to 13.60%, and from 4.20% to 20.60%, respectively. Such interest rate hikes
are completely unthinkable nowadays; after all, the US government debt ratio iscurrently around four times its level in the 1970s.

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US Total Public Debt , in % of GDP, Q1/1970-Q1/2022
140%

120%

100%

80%

60%

40%

20%
1970

1975

1980

1985

1990

1995

2000

Recession

2005

2010

2015

2020

US Total Public Debt

Source: Reuters Eikon, Incrementum AG

It is therefore not surprising that real interest rates are currently strongly negative,
whereas in the 1970s real interest rates initially moved within a range of -5% to 5%
and in the early 1980s broke out upward to just below +10%.

Real Effective Federal Funds Rate, in %, 01/1970-05/2022
12%
10%
8%
6%
4%
2%
0%
-2%

-4%
-6%
-8%
-10%
1970

1975

1980

1985

1990

Recession

1995

2000

2005

2010

2015

2020

Real Effective Federal Funds Rate

Source: Reuters Eikon, Incrementum AG

The truly unique power of a

A Powell moment as a contemporary counterpart to the historic Volcker moment,

central bank, after all, is thei.e. a radical cycle of interest rate hikes to fight inflation, is extremely unlikely

power to create money, andgiven the high level of US public debt, even if Jerome Powell expressed his

ultimately the power to create isadmiration for his predecessor in mid-March with these words: “I think he was

the power to destroy.

one of the great public servants of the era – the greatest economic public servant

Paul Volckerof the era.” After all, a 5% increase in interest rates would increase US interest
service by about USD 1.5trn annually, which is pretty much twice the current
defense budget.

Talk is cheap, except when

The US Congressional Budget Office (CBO) has once again confirmed

Congress does it.

the impossibility of a significant increase in interest rates. In response to

Cullen Hightower

a question from Congressman Jason Smith, the CBO calculated how a stronger
increase in the interest rate level than forecast in “The 2021 Long-Term Budget
Outlook” would affect the debt ratio of the United States. In this scenario, CBO
assumes an increase in the interest rate on the national debt of 5 basis points each

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56

year. Instead of 4.6%, the average interest rate on the national debt in 2051 would
thus be 6.6%. This would be accompanied by an increase in government debt to260% of GDP, compared with 202% of GDP in the extended baseline scenario.
Currently, federal debt held by the public (excluding debt held by federal
authorities and the Federal Reserve) is just below 100%.

Government Debt (x-axis), as % of GDP, and its 10-Year Change(y-axis), in %, 2021
80%

Spain

70%
Italy

60%

Japan

50%
Australia

40%
30%

UK
BrazilCanadaChina
South Korea

20%

USA

Russia10%

FranceIndia

Mexico0%Germany

-10%
-20%
0%

25%

50%

75%

100%

125%

150%

175%

200%

225%

250%

Source: BIS, Incrementum AG

Demographic Change as a Massive
Expenditure Driver
The significant demographic change taking place in all parts of theworld, with the exception of Africa and some Asian countries, will havea major impact on debt development. One effect of an upside-down
population pyramid is that the number of working people will decline. This is thepart of the population that, through its productivity, creates the resources fromwhich debt can be repaid. To put it another way: Debt per capita, especially per
employed person, will increase in the coming years simply because of the constantrise in the average age of the population.17
Everyone wants to live at theAgeing will cause significant additional costs. In a comprehensive study entitledexpense of the state. They forget“The 2021 Ageing Report”, the EU Commission has calculated the increase in age-that the state wants to live at therelated expenditures in the EU and the individual member states. The cost

expense of everyone.

increases vary greatly between the states. For the EU as a whole, the baseline

Frédéric Bastiat

scenario forecasts an increase in age-related expenditure as a share of GDP of 1.9
percentage points, to 25.9% by 2070. However, the development diverges strongly
between the individual states. At one end, Slovakia, Luxembourg and Slovenia areprojected to see an increase in age-related expenditures of 10.8%, 10.4% and 8.9%,
respectively, while at the other end, Greece, Estonia and Portugal may show adecrease of 3.7%, 1.6% and 1.3%, respectively.

—

17 See “Global Demographics Turn Inflationary,” In Gold We Trust report 2021

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An increase of 1.9 percentage points sounds very small at first glance.
But calculated from the current level of 24.0%, the increase amounts to almost 8%.
With a government spending ratio of 50%, in terms of tax revenues this means thatage-related spending would increase by around 16% compared with today.
Moreover, over the same period, the economic dependency ratio (inactive
population/employees) would increase significantly from 125.5% today to 142.2%
by 2070. If today one employed person has to finance 1.26 economicallydependent persons, i.e. young and old, in fifty years it will be 1.42.
Governments are likely to

A recent study by the OECD comes to similarly worrying conclusions.

continue printing money to pay

Most OECD countries would have to increase their taxes significantly just to

their debts with devalued money.

prevent government debt from rising until 2060. The median country would haveThat’s the easiest and least

to increase its structural primary revenues (i.e., excluding special cyclical effects

controversial way to reduce theand other one-off revenues) by almost 8 percentage points of GDP between 2021

debt burdens and without

and 2060, and in 11 countries the effort would have to exceed 10 percentage points.

raising taxes.

Again, it is Greece that is in the best position and could even cut taxes; and again,

Ray Dalio

it is Slovakia that is in the worst position and would have to raise taxes by morethan 15 percentage points.

The Future: Financial Repression as a
Permanent Condition?
International investors will be

To finance debt reduction, governments have a rich repertoire ofcollateral damage as the free

instruments. The choice and relative weighting of instruments will vary frommovement of capital ends acrosscountry to country, but no state in the world will manage without increasing thethe eurozone.

tax burden and intensifying financial repression.18

Russell Napier
Major instruments of financial repression are:
Relative favoritism of government bonds: The decisive return on an investment forinvestors is the real after-tax return. Therefore, the government can significantly
influence the attractiveness of an asset class through the design of its tax
treatment. Regulatory treatment favors government bonds, for example, in thatcommercial banks do not have to hold equity capital to hold government bonds. It
is thus conceivable that demand for government bonds could be artificiallystimulated by tax benefits for the purchase of government bonds or by tax
deterioration for other asset classes.
We do not merely destroy our

Ban on private wallets: For several years, the institutions of the EU have beenenemies; we change them.

dealing with the question of how the crypto sector should be regulated. The

George Orwell, 1984

legislative process of the Transfer of Funds Regulation (TFR) is still at an earlystage. However, a vote in the relevant committee at the end of March shows where
the journey is likely to go. Unhosted wallets are in fact threatened with extinction.
In addition, a strict interpretation of the planned regulation would de facto
prohibit the transfer of funds from one unhosted wallet to another. This would—
18 See “Financial Repression – Economic Reasons Come to the Fore,” In Gold We Trust report 2020; “Financial Re-

pression – Slowly But Surely, the Screws Are Tightened Further,” In Gold We Trust report 2018; “Financial
Repression: When the Grasping Hand of the State Runs Rampant,” In Gold We Trust report 2016

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58

ultimately be as if cash payments between private individuals were unlawful or atleast subject to reporting requirements. This bill still requires the approval of theplenary of the EU Parliament, as well as the European Council.
In the post Covid-19 world theWealth levy/wealth tax: A one-time wealth levy, as opposed to a permanent wealthprobability of a financial crisis

tax, is a profound encroachment by the state on citizens’ property rights.

does not mean that there will be

Historically, such encroachments have occurred time and again. Examples include

a financial crisis. What it means

the German house interest tax of the Weimar Republic and the German Burden

is that there will be a financial

Equalization Act of 1952.

repression with public support
for private institutions, highThe official registration of assets is indispensable for the collection of a property

inflation and yield curve control.

levy or a property tax. Real estate and land ownership are already recorded by the

Russell Napier

land register and are therefore easily taxable.
The EU now apparently wants to move into completely new dimensions
with the possible introduction of an EU-wide asset register. A feasibility
study in this regard was commissioned in December 2021. The EU Commission
tasked the Centre for European Policy Studies (CEPS); a Brussels-based thinktank, VVA; a consulting company based in Milan and Brussels; and Infeurope SA, aservice provider based in Luxembourg, to produce the feasibility study, under theunwieldy title “Feasibility Study for a European Assets Register with regard to thefight against money laundering and tax evasion”. The feasibility study is expected
to be published in early 2023.
The tender for the feasibility study reads like a total assault on thefinancial privacy of EU citizens:“This project will explore various options for collecting information toestablish an asset registry that can subsequently inform a future policy
initiative. It will explore how information available from different asset
ownership sources (e.g., land registers, business registers, trust andfoundation registers, central securities depositories, etc.) can be collected andlinked, and analyze the design, scope, and challenges for such a Union asset
register. The possibility of including data on ownership of other assets such as
cryptocurrencies, works of art, real estate, and gold in the register should
also be considered.”
Even at the national level, an asset register would be a highly
problematic matter. If, however, such a wealth register were to be establishedat the EU level, this would significantly reduce the opportunities for ordinary
investors to evade taxation and would consolidate the EU’s path to becoming ahigh-tax prison.
Moreover, one cannot help suspecting that money laundering (AML), which iscommitted by a few criminals and needs to be fought, is once again being used as amere pretext to gain access to the financial assets of the entire population. Putanother way: The EU is placing the entire population under general suspicion inorder to obtain the data necessary for broad taxation.

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We have not overthrown the

The mention of combating tax evasion also pronounces a generaldivine right of kings to fall down

suspicion, so that citizens must prove their compliance with the law.

for the divine right of experts.

This reversal of the burden of proof was also the basis of various legal regulations

Harold MacMillan

to combat the Covid-19 pandemic; namely, when citizens without any symptoms of
illness had to prove that they were healthy in order to be allowed to participate insocial life. Ultimately, the asset register is intended to give the EU access toeverything and everyone, which is more reminiscent of the dystopia of a total
surveillance state made up of helplessly regulated people than a democracy of freecitizens based on mutual trust.

I’m kind of in a position that FDR

Gold ban: The terms of reference for the feasibility study on a possible EU-wide

was (...) What in fact FDR did

asset register also explicitly name gold as one of the assets whose regulatory

was not ideological, it wasrecording is to be examined. This brings back memories of a gold ban. In the Incompletely practical.

Gold We Trust report 2021, we dealt in detail with historical gold bans.19 We

Joe Bidenconsider a gold ban unlikely, if only because of the enormous bureaucracy
involved. However, in recent years the screws have been tightened considerably on
the buying and selling of gold, even in the more liberal countries such as
Switzerland and Austria, by lowering the maximum limit for anonymous sales. In
Germany, this has for some time now been set at only EUR 1,999.99, which justabout allows the anonymous purchase of an ounce.20

Cash combined with courage in a

Cash ban: Digital central bank currencies are still dreams of the future, but theirtime of crisis is priceless.

implementation is being driven forward with increasing intensity. 21 In an article

Warren Buffett

published by the ECB in January 2020 entitled “Tiered CBDC and the financial

20F

system,” the following features are mentioned with surprising candor as
advantages of the introduction of a digital central bank currency:22• Better control of illegal payment and savings activities, money laundering andterrorist financing, with banknotes (in high denominations) being banned as apossible further prerequisite and the digital central bank not being madeanonymous• Allows overcoming the nominal interest rate floor (ZLB), as negative interest
rates can be applied to CBDC, provided banknotes (in high denominations) areprohibited• An easier way to provide helicopter money• Higher seigniorage revenues for the government (and citizens) as thegovernment takes back money creation from banks
A non-anonymous digital central bank money would be the end of financial
privacy, especially if cash were additionally banned.
In view of the recurring sovereign debt miseries, it is time to raise thefollowing fundamental idea of Milton Friedman:“There are four ways in which you can spend money. You can spend yourown money on yourself. When you do that, why, then, you really watch out
what you’re doing, and you try to get the most for your money. Then you can—

19 See “A Brief History of Gold Confiscations,” In Gold We Trust report 2021
20 See “A Brief History of Gold Confiscations,” In Gold We Trust report 2021
21 See “De-Dollarization 2021: Europe Buys Gold, China Opens a Digital Front,” In Gold We Trust report 2021
22 Bindseil, Ulrich: “Tiered BCDC and the financial system,” ECB Working Paper Series, No. 2351/January 2020, p. 5

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60

spend your own money on somebody else. For example, I buy a birthday
present for someone. Well, then I’m not so careful about the content of thepresent, but I’m very careful about the cost. Then, I can spend somebody else’s
money on myself. And if I spend somebody else’s money on myself, then I’msure going to have a good lunch! Finally, I can spend somebody else’s money
on somebody else. And if I spend somebody else’s money on somebody else,
I’m not concerned about how much it is, and I’m not concerned about what I
get. And that’s government. And that’s close to 40 percent of our national
income.”Admittedly, Friedman’s views on gift spending can and probably should bequestioned. But it is hard to deny that politicians tend to be particularly generous
with taxpayer money, especially for their own constituencies.

Conclusion
The economic shambles of the Covid pandemic have not even begun to
be cleared away, and already two more crises are on the scene, theenergy crisis and the Ukraine war, which have the potential to makethe distortions of the pandemic appear trifling.
What is important that will

Due to the historically low and almost constantly falling interest rate level, the highconstrain how far the Fed can golevel of debt for society as a whole has hardly been a problem so far, apart from ais the extreme level of debt. At a

few exceptional cases among the industrialized nations, such as Greece. In 2021,

record $83 trillion of public andaccording to calculations by Janus Henderson Investors, the debt-service

private debt, if the Fed goes as

expenditures of all countries fell to a record low of USD 1.0trn. This corresponds tomuch as what is priced in, we arean effective interest rate of only 1.6%. The extremely low level of interest rates istalking about $330 billion being

also reflected in the fact that in 2021 the global government bond markets

drained out of the economy forachieved a total return of -1.9%. Investing in government bonds was therefore adebt servicing charges or aboutsure loss business.

1.5% out of GDP.
Dave Rosenberg

These low-interest-rate times are over because of the strong rise ininflation. But because hardly any state can afford a marked rise in the interest
rate level, financial repression will increase; indeed it will have to increase.
Likewise, the state’s demand for higher tax revenues will grow, putting theremaining vestiges of financial freedom under pressure. The possibility that thiswill be merely a temporary episode can be ruled out in view of the spending
dreams of politicians (key words: energy turnaround, green transformation of theeconomy), the loss of the peace dividend as a result of the Russian invasion of
Ukraine, and the profound demographic change.
Moreover, it should be borne in mind that many countries were already running
substantial structural deficits before the outbreak of the Covid-19 pandemic andbefore the severe impact of the Ukraine war, the sanctions against Russia, and thecounter-sanctions. That is, even without the exogenous negative shocks of thepandemic and the Ukraine war, the fiscal situation in many notable countries was
highly problematic, especially in the medium and long term. Deep, painful
structural reforms are particularly difficult to implement politicallyand come as rarely as Halley’s Comet.
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General Government Structural Balance, as % of Potential GDP,
2019-2020
2%
0%
-2%
-4%
-6%
-8%
-10%
-12%
-14%
USA

Japan

France

UK

2020

Italy

Germany

2019

Source: OECD, Incrementum AG

We have to win, everything else

A sustained turnaround in interest rates is therefore less likely thanis primary.

ever. It is probably even more likely that Austria will be soccer world champion

Hans Krankl

one day than that real interest rates will be in clear positive territory in the next
decade. This is also due to the fact that central bankers increasingly see themselves
as financiers of governments rather than guardians of the currency. In the euroarea in particular, the politicization of the central bank is clearly visible. This is not
surprising, given that the ECB is headed by Christine Lagarde, a politician.

In an ideal state of society

Substantial increases in real interest rates would also hit the other two

perhaps the intrinsic quality of

sectors of the economy, companies and private households, hard. The

money might entirely disappear

already long-delayed wave of corporate bankruptcies would be exacerbated byand be replaced by the valueinterest rate hikes. In those countries with high levels of household debt, such asderived from the control of the

Scandinavia and Switzerland, the financial solvency of households with variable-

state. But for that to occur therate mortgages in particular would be seriously jeopardized. In the US, as

control of the state would need toelsewhere, the absolute level of the 30-year fixed-rate mortgage is still manageable

be perfect in authority and god-at around 5.50% – it averaged 6.97% annually in 2001, more than 9% in 1991, andlike in intelligence.

16.64% in 1981 at the height of the third wave of inflation – but the increase since

Aristotle

summer 2021 has been rapid. At the interim low in early August, it stood at just
2.77%. This is an increase of more than 90%.

US 30-Year Fixed Rate Mortgage, in %, 01/1991-05/2022
10%
9%
8%
7%
6%
5%
4%
3%
2%
1991

1994

1997

2000

2003

Recession

2006

2009

2012

2015

2018

2021

US 30-Year Fixed Rate Mortgage

Source: Reuters Eikon, Incrementum AG

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Appearances are deceptive, as we cautioned at the beginning of thischapter. There is no reason to believe that the (government) debt
momentum has been broken as a result of last year’s decline in the(government) debt ratio. The prospects for rapid consolidation, especially of
government debt, are poor. In contrast to the huge debt reduction after World War
2, two basic conditions are no longer met in many countries today: balanced
budgets (at minimum) and high real growth rates. We therefore firmly believethat a return to sustained positive real interest rates is as likely as aremarriage between Johnny Depp and Amber Heard.

US Total Public Debt (lhs), in % of GDP, and Real Interest Rates(rhs), 1940-2021

140%

10%

120%

5%

100%

0%

80%

-5%

60%

-10%

40%

-15%

20%
1940

-20%
1950

1960

1970

US Total Public Debt

1980

1990

2000

2010

2020

Real Interest Rate

Source: Federal Reserve St. Louis, Nick Laird, Reuters Eikon, Incrementum AG

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64

Status Quo of the Inflation
Trend“The characterization of inflation astransitory is probably the worst
inflation call in the history of theFederal Reserve, and it results in a highprobability of a policy mistake.”
Mohamed El-Erian

Key Takeaways• Price trends of rigidly priced goods, such as rents,

medical treatment, and public transport, indicate that
inflation will not remain transitory. The fairy tale oftransitory inflation should therefore be shelved for good.
• The increase in M2 money supply correlates well

historically with increased inflation. This, combined with
low interest rates, provided the foundation for highinflation.
• This is accelerated by supply chain issues caused by

the Covid-19 pandemic, the Ukraine war, and theattempted energy transition.
• We are witnessing a price-increase supply-shrinkage

spiral and seem to be in the early stages of a price-wagespiral.
• Structural deflationary or disinflationary factors are

currently rare.
• This leads us to conclude that, even if inflation rates

come back down due to the temporary expiry of thebase effect, the level of inflation will remain elevated far
above the target level of central banks for some time tocome.

Status Quo of the Inflation Trend

65

In my 24 years in the business,

In the summer of 2021, a rally began in the USA that is not giving rise

I’ve never seen anything like it,to any jubilation. On the contrary, this rally is making people sweat

not even close. Across the board

harder, the more it continues. In the euro area there was a rally, too, starting

we are faced with crazyfrom a somewhat lower level and somewhat more restrained (as it is still). In a very

increases. There’s no model thatshort time, this rally led to a series of multi-decade highs, but highs that pleased no

can handle this kind of inflation.

one. You have probably already guessed: We’re talking about theIt’s kind of off the charts.

inflation rally.

Dolf van den Brink,
CEO, Heineken

Now, inflation rates are significantly closer to the double-digit
threshold than to central banks’ inflation targets. In the US, the CPI in
March stood at 8.6%, the highest since January 1982. In April, the CPI easedslightly to 8.3%, which was less than expected. To put this in perspective: The lasttime inflation was at this level, in 1982, Steven Spielberg’s E.T. The ExtraTerrestrial premiered in US cinemas.
In Germany, the inflation rate of 7.4% (CPI) is at its highest level since1981. At that time Helmut Schmidt was chancellor, heading a social-liberalcoalition. However, there was one serious difference compared withtoday: The key interest rate in Germany was 7.5%, while in the USA it
averaged 16.5%.

The Transitory Inflation
Transitory – that was the word most often used by central bankers for
many, many months. The tenor of the term was that the rise in the inflation
rate was merely temporary and that there was no cause for alarm. However, themost famous temporarily was uttered by US President Richard Nixon on August
15, 1971, when he “temporarily” suspended the gold redemption obligation of the
Courtesy of Hedgeye

US dollar. This suspension has now been “temporary” for more than 50 years.

First it was ‘transitory,’ thenStubborn – this is how to describe the denial of reality that took place‘inflation is good,’ then we wentin the second half of 2021 when inflation rates really started to pick up.

to ‘corporate greed,’ now we’reCentral bankers on both sides of the Atlantic initially practiced appeasement, theirat ‘Putin.’prayerful repetitions increasingly taking on a tragicomic quality. On November 29,

Rick Santelli

2021, Isabel Schnabel, a member of the ECB’s Executive Board, expressed thefollowing position in an interview on German television:“But we believe that the inflation rate will peak in November and graduallysubside next year, towards our inflation target of 2%. Indeed, most forecasts
expect inflation to fall even below that 2% level. So, there is no indication that
inflation is getting out of control.”

Forecasting is not a strong side

While it was clear to central bankers in the US – at least by the end ofof economics.

2021 – that the increase in inflation would not be merely transitory, by

Jan Tinbergenspring 2022 the euro’s monetary watchdogs still saw no reason to turnthe interest rate screw. At the ECB meeting on March 9/10, however, a “large
number of members” were of the opinion that the persistence of high inflation
rates demanded immediate further steps toward normalization. After much delay,

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the ECB finally abandoned what can only be described as a stubborn defense of thenarrative of merely temporary high inflation. To date, though, the ECB has
still not taken any significant action.
In spite of the cost of living, it's

One indication that inflation will not remain temporary is the pricestill popular.

trend of rigidly priced goods. In the US, the Federal Reserve of Atlanta’s

Kathleen Norris

Sticky-Price CPI shows a sharp rise in the prices of these goods. These include, forexample, rents, medical treatment, and public transport. The prices of fuel, rental
cars, and fresh fruit and vegetables are particularly volatile. On a year-on-yearbasis, this subindex rose by 4.9% in April, the strongest increase in 30 years.

Sticky-Price CPI, yoy%, 01/1970-04/2022
18%
16%
14%
12%
10%
8%

6%
4%
2%
0%
1970

1975

1980

1985

1990

1995

Recession

2000

2005

2010

2015

2020

Sticky-Price CPI

Source: Federal Reserve Atlanta, Incrementum AG

The 20.0% increase in volatile prices marks an all-time high since calculations
began in 1967, meaning that these prices are currently rising morestrongly than during the high-inflation phase at the beginning of the
1980s.

Monetary and Psychological Dimensions ofInflation
In our past two publications, we had already emphasized thatnumerous structural reasons point to an end of the era of low inflation.
In the fall of 2020, we felt called upon to publish our first special publication on
the inflation threat, entitled “The Boy Who Cried Wolf: Inflationary Decade
Ahead?”The title of the In Gold We Trust report 2021, “Monetary Climate Change”, also
points to this serious change, which was initiated by the political reactions to the
Covid-19 crisis and is now accelerated by the war in Ukraine. We already pointed
out last year that the claims, repeated mantra-like, that inflation would only betemporarily elevated, were inaccurate from the outset. Thus, we wrote:“... contrary to the statements of central bankers, the current risein inflation is not a temporary phenomenon. Last year, for example,

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the 5-year rolling growth rate of M2 per capita picked up strongly. As thenext long-term chart shows, inflation could follow suit in the near future.”23
However, a sustained easing on the inflation front remains highly unlikely from amonetary perspective:

CPI, and M2/Capita (5-year rolling growth rate), 1905-2022
150%
125%
100%
75%
50%
25%
0%
-25%
-50%
1905

1915

1925

1935

1945

CPI

1955

1965

1975

1985

1995

2005

2015

M2/Capita

Source: Lyn Alden, Nick Laird, goldchartsrus.com, Reuters Eikon, Incrementum AG

In many cases, however, central banks have succeeded in focusing
attention on the goods side of the inflation debate and ignoring themonetary dimension of the upward price trend. While the Federal Reserve, byinitiating the turnaround in interest rates, has, belatedly, begun to takeresponsibility for the monetary dimension of the inflation rally, the ECB persists in
its tunnel vision of supply shocks and blames the Ukraine war and Russian
President Vladimir Putin personally for the inflation spike.
Continued inflation inevitably

But without the ultra-loose monetary policy of the past two years, andleads to catastrophe.

the broadly loose monetary policy since the Great Financial Crisis, theLudwig von Mises

supply shocks could not have driven the general price level up so sharply. After all,the additional spending on energy and food would mean that less money would beavailable for other expenditures. Accordingly, prices would fall in these sectors,
thereby dampening the general upward pressure on prices. In support of the claimthat the rise in inflation was only temporary, the argument was put forward thatthe surge in inflation was mainly due to the base effect in energy prices anddisrupted supply chains.

The herd instinct among

This view has been shared by major institutions. Therefore, the following

forecasters makes sheep look like

list of inflation forecasts for Q4/2021 is a testimony to the failure of the forecasting

independent thinkers.

models of all major institutions.

Edgar Fiedler—

23 See “The Status Quo of Gold,” In Gold We Trust report 2021, p. 66

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2021 (Q4/Q4) Inflation forecasts

Value

Q1

Q2

Q3

ActualSurvey of Professional Forecasters

Core PCE

1.8%

2.3%

3.7%

4.6%

Federal Open Market CommitteeCore PCE

2.2%

3.0%

3.7%

4.6%

Congressional Budget OfficeCore PCE

1.5%

2.4%

4.6%

Federal Reserve Bank of New York GSGE

Core PCE

1.4%

3.8%

4.6%

OECD

Core CPI

IMF

CPI

Market-based

CPI

2.7%

2.2%
3.0%

5.0%

2.3%

7.0%

2.9%

6.7%

Source: Furman, Jason: “Why Did (Almost) No One See the Inflation Coming?”, Intereconomics, Vol 57 (2), 2022, pp.
79-86, Incrementum AG.

Even if, at root, it is monetary reasons without which there can be nosustained inflation and no general rise in consumer prices,
psychological factors also play a significant role in the actual inflation
phase. If people expect prices to be noticeably higher tomorrow than they aretoday, i.e. that their purchasing power will be noticeably lower tomorrow, they willbe less willing to hold money. The velocity of money in circulation then increases,
Courtesy of Hedgeye

which in turn drives up prices. Once this self-fulfilling, self-reinforcing inflationary
spiral is set in motion, it can only be stopped by tough intervention, i.e. significant
interest rate hikes. To make matters worse, interest rate hikes initially haveinflationary effects, as the price of financing is mandated upward.
At present, however, the velocity of monetary circulation in the USA
remains at a historically low level. If the velocity of circulation accelerates,
there is still considerable additional potential for inflation.

M2 Velocity, 1900-Q1/2022
2.4
2.2
2.0
Average: 1.75

1.8
1.6
1.4
1.2
1.0
1900

1910

1920

1930

1940

Recession

1950

1960

1970

1980

1990

2000

2010

2020

M2 Velocity

Source: Reuters Eikon, Incrementum AG

Finally, we would like to take a look at inflation expectations.
Unsurprisingly, they have risen significantly. Short-term inflation
expectations fluctuate much more strongly than long-term expectations, which is
why they should be treated with a certain degree of caution. We therefore look at
longer-term inflation expectations, which are elevated but still not dramaticallyhigh.

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Michigan 5y Inflation Expectations, in %, 01/1980-05/2022
10%
9%
8%
7%
6%
5%
4%
3%
2%
1980

1985

1990

1995

2000

Recession

2005

2010

2015

2020

Michigan 5y Inflation Expectations

Source: Reuters Eikon, Incrementum AG

The way prices are rising, theWhich prices have a particularly strong influence on the formation ofgood old days are last week.

inflation expectations? The recently published study “Determinants of

Les Dawson

Inflation Expectations in the Euro Area”24 examines this question. Food, oil andglobal commodity prices have a major influence, as does any currency
depreciation. A 10% increase in food prices raises short-term inflation expectations
by around 0.5%. Thus, due to the announced and in some cases already realized
sharp food price increases, there is a serious risk that inflation expectations, whichhave been very low for a long time, will be torn from their moorings.

Russia’s Attack and Its Consequences
Russia’s invasion of Ukraine has the potential to further unhinge a global economy
already battered by the pandemic measures – cue supply chains, energy price hikes– and the impact on Europe will be far more consequential than on the US. The
war itself is driving inflation through lost production, difficulties in exporting, andthe destruction of production facilities.
After the countless Covid-19 lockdowns and the 2021 blockage of theSuez Canal, the world is now facing the next serious inflation-fueled
supply shock. Unlike with the lockdowns, however, it will now be not the service
sector that is primarily affected but the industrial sector and agriculture. Putanother way: If the Covid-19 measures mainly impacted normal activities andCourtesy of Hedgeye

pleasures, there is now the veritable threat of price surges and supply shortages infood and the value-adding sectors of the economy.
The first and immediate effects have been felt in gas and oil prices.
These have continued their strong upward movement since the Covid-19 crash in
spring 2020. In the meantime, prices have settled at a very high level and withhigh volatility.

—

24 Moessner, Richhild: “Determinants of Inflation Expectations in the Euro Area,” Intereconomics, Vol. 57 (2), 2022,

pp. 99–102

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Food is an essential part of a

Depending on the duration of the hostilities, the consequences for thebalanced diet.

global economy will be significant. For example, Russia and Ukraine are

Frank Lebowitz

among the world’s top grain exporters, particularly of wheat, oats, and corn, as
well as sunflower oil, of which Ukraine is the top exporter. Ukraine also ranks firstin the export of rye. For those states, especially in North Africa, that are dependent
on grain supplies from Russia and Ukraine, there is the threat of a significant
tightening of supply. As a result of the failure of these two producers, whether due
to the acts of war themselves, sanctions or export restrictions, further price jumps
can be expected in the coming months. These will spill over into other areas ofagriculture, since meat production requires large quantities of grain andagriculture requires large quantities of fertilizer.

FAO Food Price Index, 01/1990-04/2022
160

140

120

100

80

60

40
1990

1995

2000

Recession

2005

2010

2015

2020

FAO Food Price Index

Source: FAO, Incrementum AG

To what extent the currently emerging bloc formation – a Cold War 2.0 – between
the West on the one hand and a China-India-Russia-Arabian Peninsula axis on theother, will be reflected not only in words but also in tangible deeds, is still open. In
any case, the votes of the UN General Assembly on the resolution against Russia
already give an idea of the two blocs. While the absolute number of statesthat voted against the resolution or abstained from voting is quite
small, it is remarkable that extraordinarily populous and geostrategically highly relevant countries are among the abstentions.

Source: Tagesschau

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More intensive work is also continuing on alternatives to the establishment of nonWestern payment systems and settlement platforms.25 In any case, increased
drifting apart and the accompanying attempt to reduce imports fromthe respective “enemy” bloc will further increase inflationarypressures.
When goods are not allowed to

On the other hand, there are interdependencies that make a complete

cross borders, armies will.

breakup of the global economy unlikely. The economic structure of both

Frédéric Bastiat

countries with a structural current account deficit and those with a structural
current account surplus is geared to brisk trade flows. Reshaping these takes a lotof time and even more money. Moreover, even in Cold War times, the Soviet Union
and Western Europe traded, and both the Soviet Union and Russia have always
honored oil and gas supply contracts.
Thus, the EU’s attempt to reduce dependence on Russian oil and gas
through the green transformation involves, in a sense, an inherent
paradox. Russia exports significant amounts of raw materials such as nickel,
which are essential for the green transformation. And in the absence of its own raw
material reserves, the Union would become increasingly dependent on otherstates, especially on China.
In any case, one thing is certain: The era of globalization now seems to
be over for a long time to come. And just as globalization has had adisinflationary effect for a long time, deglobalization will have an inflationary
effect.

The Price-Increase Supply-Shrinkage SpiralHigh energy prices and the extreme volatility of prices have already prompted
some companies to limit their production or even temporarily cease it altogether,as it is no longer possible to operate profitably. Currently, this is specificallyaffecting energy-intensive sectors, with companies that cannot pass on the priceincreases being particularly hard hit. Some examples:• Lech steel mills stop production – due to high electricity prices• U.K. factories halt some production as energy prices surge• Norske Skog paper mill must stop production• Spanish industry halts production over sky-high energy prices• Farmers’ association: many greenhouses remain empty• Germany’s largest aluminum manufacturer has to halve production
This phenomenon can be described as a price-increase supplyshrinkage spiral. The (sharp) rise in production costs forces companies out of
the market, causing supply to shrink, which further fuels the upward pressure on
prices. A general halt to energy imports from Russia would have a devastating
effect, especially in the euro area, given the lack of alternatives available in the
short term.
—

25 See chapter “A New International Order Emerges” in this In Gold We Trust report

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The same effect is threatening to occur as a result of the rise in theprice and shortage of fertilizers for growing food. Even before theoutbreak of the Ukraine war, the development of prices on the fertilizer market
was worrying. The sharp rise in gas prices and the sanctions against the Belarusianfertilizer producer, Belaruskali, had driven up fertilizer prices significantly. And
higher fertilizer prices ultimately mean higher food prices, but also food shortages.
In response to the threat of food shortages, some states have already
imposed export restrictions or even export bans.
We´re moving from a world that

The supply shortage has been exacerbated by supply chain problems,

was constantly globalizing to one

some of which have been intractable. These have increased, in some cases

breaking up into three different

significantly, since the outbreak of the Covid-19 pandemic. Strict quarantine

empires, each with their own

measures, particularly in China; the shortage of containers as a result of self-currency, reference bond market,

aggravating delays; and a lack of unloading and transport capacity at destination

supply chains. There are massive

ports have been causing delays and cancellations in international trade for many

investment implications.

months. The days-long blockade of the Suez Canal in March 2021 had in theLouis Gavemeantime further worsened the situation and brought the vulnerability of supply
chains to the attention of a broad public.

Global Supply Chain Pressure Index, 01/1998-02/2022
5

4
3
2
1
0
-1
-2
1998

2000

2002

2004

2006

Recession

2008

2010

2012

2014

2016

2018

2020

2022

Global Supply Chain Pressure Index

Source: Reuters Eikon, Incrementum AG

Going forward, companies will

There has been talk since the fall of 2020 that the supply chain

be thinking less “just in time” anddisruptions will ease. At that time, there was a clear temporary easing of themore “just in case”.

situation, but this was quickly reversed with the new wave of lockdowns. All in all,Paul Singer

a return to undisturbed supply chains is not to be expected any time soon; thedistortions are too great and the geopolitical tensions and uncertainties are
increasing too much. Thus, in view of the unusability of Ukrainian ports, theexport of Ukrainian wheat is becoming a Herculean task.

The Upcoming Wave of Price Increases
I see deflation in the things you

For Germany, the ifo Institute regularly surveys whether companies

own and inflation in the things

intend to raise, lower, or leave their prices unchanged. As of April, theyou need.

number of companies in Germany intending to raise their prices in the coming

Kyle Bass

three months reached a new high with a balance value of 62.0, after a new record

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value of 55.0 points in March and 47.6 in February. This value is calculated bytaking the difference between companies planning to increase their prices andthose planning to reduce them. If all companies intend to increase prices, thebalance is 100 points. In the food sector, price expectations almost
reached this extreme value in March, at 94.0 points.
In general, prices in consumer-related sectors are expected to rise in the coming
weeks and months. This means that precisely those prices covered by the
consumer price index will be particularly hard hit. However, the fact thatthe need for price increases is so widespread also means that companies see a
realistic chance of pushing through higher prices on the market. This new
Courtesy of Hedgeye

record level is not surprising in view of the rapid rise in producer
prices.

PPI, yoy%, 01/1996-04/2022
50%

40%

30%

20%

10%

0%

-10%
1996

1998

2000

Spain
Austria

2002

2004

2006

Italy
USA

2008

2010

2012

2014

Germany
Switzerland

2016

2018

2020

2022

FranceSource: Reuters Eikon, Incrementum AG

Wholesale prices in the euro area are rising at a rate not seen for half acentury. Costs and inflationary pressures will therefore remain enormously high.
This is because if prices cannot be passed on in the production chain and thus
ultimately to consumers, companies will come under considerable pressure on
margins. In the USA, producer price increases are also at multi-decadehighs:
Upward pressure on consumer price inflation will remain elevated for theforeseeable future, even if fluctuations in producer prices have had a much milder
impact on consumer prices since the 1990s, partly due to globalization. Our
calculations suggest that a 1% increase in the PPI raises the CPI byaround 0.6%.

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PPI (Commodities), and CPI, yoy%, 01/1970-04/2022
30%
25%
20%
15%
10%
5%
0%
-5%
-10%
-15%
-20%
1970

1980

Recession

1990

2000

2010

PPI (Commodities)

2020

CPI

Source: Federal Reserve St. Louis, Incrementum AG

The Price-Wage Spiral Will Inevitably Begin toSpin
A specter from the 1970s is now suddenly back: the price-wage spiral.
How realistic is it that we will fall into this vicious economic spiral?
The early signs of a wage-priceFirst, we address the question of whether it is more economicallyspiral are all present… And wecorrect to speak of a wage-price or a price-wage spiral. Is it higher wages

could see much higher inflationthat fuel price inflation, which only subsequently raises wages further? Or does areadings over the next few

pickup in inflation and the accompanying real wage loss cause workers to heighten

quarters.

their wage demands to compensate, which raises wage costs and, subsequently,

David Elfrig

production costs? A study by Moody’s suggests that causality runs in only one
direction, from consumer prices to wages.
It should be noted that a price-wage spiral as a typical second-roundeffect is only possible if the money supply has been or is being
significantly expanded. If the money supply were (relatively) constant, asignificant increase in the price of a good as an expression of its increased relative
scarcity would lead to a decline in nominal demand for all other goods. The generalprice level would remain unaffected. But with their ultra-expansive monetary
policy, central banks have laid the foundation for the erosion of the purchasing
power of money and thus provided fodder for the looming price-wage spiral.

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Average Hourly Earnings, yoy%, and PCE Core Inflation, yoy%,
01/1965-03/2022

12%

10%

8%

6%

4%

2%

0%
1965

1970

1975

1980

1985

Recession

1990

1995

2000

2005

Average Hourly Earnings

2010

2015

2020

PCE Core Inflation

Source: Reuters Eikon, Incrementum AG

When union membership goes

Labor’s significantly lower degree of organization – in the USA it has

down, so do wages.

been cut in half to around 10% in recent decades – reduces its

Ed Schultzbargaining power, which in turn makes substantial wage increases highly
unlikely in the current situation. Thus, those who argue that there is no threat of aprice-wage spiral presently. In the 1970s, Europe unions did push through theirhigh wage demands, in some cases by means of strikes. The strikes of ÖTV, thepowerful union for public employees in Germany during the early-1970s inflation
not only brought workers an 11% wage increase in 1974 but also ushered in the endof Chancellor Willy Brandt (SPD), who repeatedly spoke out against such a highwage settlement. He resigned a few months after the strike. The autonomy ofcollective bargaining was defended against the state’s attempt to intervene, and sowage negotiations were opened over Swabian pockets, soup and buttered pretzels.
But one important factor argues against the weakening of thebargaining power of labor: demographic change, which is causing the supplyof labor to decline. For the first time, even in the USA with its relatively young
population, the number of working-age people (15-64 years) fell in 2019.

US Working Age Population (Aged 15-64), yoy%, 01/1960-04/2022
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
-0.5%
-1.0%
1960

1965

1970

1975

1980

Recession

1985

1990

1995

2000

2005

2010

2015

2020

US Working Age Population

Source: Reuters Eikon, Incrementum AG

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Demography and the reversal of

In this respect, the trade unions are no longer as important inglobalization mean that a great

enforcing higher wages as they were in times when the supply of labordeal of [inflation] is likely to be

increased year after year. The demographically induced shortage on the labor

permanent – clearly not all.

market increases the bargaining power of employees by itself, as it were. It cannot

There will be structural forces

therefore be assumed that the decline in the degree of employee organization willraising inflation for probably theprevent the price-wage spiral. In large parts of Europe, the demographicallynext two to three decades.

induced decline in the working-age population is much more pronounced than inCharles Goodhart

the US, which should increase the bargaining power of employees even moreforcefully.
This aging-related trend toward a decline in labor supply can beobserved in large parts of the world, with particularly strong manifestationsin China, Japan, Russia and large parts of Europe.26 In the meantime, there arealso more and more examples of initial wage agreements or wage demands thattake into account the sharp rise in inflation rates, and thus very much point to arenewed price-wage spiral:• John Deere Workers End Month-Long Strike After Approving To New Contract
Offering 10% Raise• New GM union in Mexico seeks 19.2% wage hike in historic talks• ‘You cannot treat us like this’: Austin ISD employees demand higher pay raises• Record demand: Electrical industry wants six percent wage increase• Restaurants and hotels must pay significantly higher wages• IG Metall demands 8.2 percent pay rise for steelworkers
The Wage Growth Tracker of the Federal Reserve Bank of Atlanta also
impressively shows that nominal wages in the USA are already risingstrongly. However, consumer price inflation is now so high that, despite record
nominal wage increases, the loss of purchasing power due to inflation cannot be
fully compensated.

US Median Wage Growth (Weighted 3 Month MA), in %, 01/199804/2022

7.0%

6.0%

5.0%

4.0%

3.0%

2.0%

1.0%
1997

2002

Recession

2007

2012

2017

2022

US Median Wage Growth

Source: Reuters Eikon, Incrementum AG

Looking at the bigger picture, there is additional reason to worry that
inflation will be further fueled due to structural labor shortages. After—

26 See “Global Demographics Turn Inflationary,” In Gold We Trust report 2021

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all, in much of the Western world, an excessive focus on academization – andwithin academization, an emphasis on dubious fields of study while neglecting
STEM subjects – has exacerbated this shortage of skilled workers.
In conclusion, central banks should have known long in advance that the labormarket would recover rapidly as the economy reopened with the end of the
lockdowns. The fact that this was obviously ignored is a serious omission
on the part of the central banks, which thus reinforced the dynamics ofinflation.

Weak Currency, Rising Inflation
Price stability belongs to the

The most important currencies have depreciated by around 9% againstsocial contract. We givethe US dollar since the beginning of the year (DXY Index). This

government the right to print

devaluation is adding to inflationary pressures in the rest of the world, as

money because we trust electedcommodities are (at least still) generally priced in US dollars. As can be seen in theofficials not to abuse that right,

next chart for Germany, import prices are rising much faster than export prices,not to debase that currency by

precisely because of the weakening euro. Against the US dollar, the euro has lost

inflating.

more than 8% since the beginning of the year.

Paul Vocker

Import Price Index, and Export Price Index, Germany, 01/201503/2022
130
125
120
115
110
105
100
95
90
2015

2016

2017

2018

Import Price Index

2019

2020

2021

2022

Export Price Index

Source: Reuters Eikon, Incrementum AG

The weakness of the euro is mainly due to the growing interest rate
differential. This fundamental economic relationship seems to have beenforgotten in Frankfurt. For example, at the annual hearing before the EU
Parliament in early February, Christine Lagarde began by asking the rhetoricalquestion, “Now, if we were to take monetary policy action by way of gradually
putting an end to asset purchase prices and rapidly hiking interest rates, wouldthat have an impact on energy prices right away?” To which she replied, “I don’t
think so.” The well-known German economist and former director of the ifo
Institute, Hans-Werner Sinn, commented sharply on this statement at a lecture in
Vienna: “How can the president of the ECB spout such nonsense?” After all, aninterest rate hike would cause the euro to appreciate, making imports cheaper andeasing inflationary pressures.

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Greenflation – the Energy Transition as an
Inflation Driver
The merging of climate and

The conversion of the economy to environmentally and climate-friendly

monetary policy strengthens thetechnologies, which is being pursued by more and more governments in the West,

political power of central

will also structurally increase inflationary pressure. Especially since the mottobankers and provides them with"sustainably expensive" seems to prevail among many governments, with therelief for the foreseeable failureemphasis on "expensive," while sustainability is often treated ideologically. Thus,of their low-interest-rate policy.

the massive human rights remonstrances against the Emirate of Qatar have given

Thomas Mayer

way overnight to a flurry of visits. Just a few months ago, political parties, nationalsoccer associations and NGOs from the West wanted to deprive Qatar of the World
Cup, which will be held in December; now, high-ranking delegations are travelingto the Gulf to buy Qatari liquefied natural gas. “Food first, then morality.” –this is how Bertolt Brecht put it in a nutshell in The Threepenny Opera.
In any case, the raw materials needed for the energy transition areusually not available in abundance, especially if many countries wantto accomplish this green transformation in a very short time. It is
doubtful whether such an increase in the supply of raw materials can be achievedat all. The managing director of the Institut der deutschen Wirtschaft (IW), Karl
Lichtblau, recently noted that the energy turnaround could fail due to a lack of raw
materials. He sees serious supply problems for 22 chemical elements,
especially copper, platinum and lithium.
In addition, the construction of new mining sites often leads to protests
by environmentalists on site, which further prolongs the necessary approval
procedures, which already take many years, or even brings projects to a halt. For
example, after ongoing protests, the Serbian government denied approval for Rio
Tinto’s Jadar project in early January. Lithium for up to 1 million electric cars wasto have been mined there. Such shortages of supply naturally also have an
inflationary effect. The shortage of skilled workers, especially in the European andNorth American mining sector, is a further obstacle to the expansion of supply.

You should be attacking theCO2 certificates are a key instrument for implementing the green

carbon emissions, period, andtransformation of the economy. In the EU, these were introduced in 2005 towhether it’s cap-and-trade or

put a price on CO2 emissions that are blamed for manmade climate change.

carbon tax or whatever, that’sCertificates are currently required for around 11,000 companies such as power

the realm in which we should beplant operators, cement factories, refineries, steel mills and, since 2012, intra-

playing.

European air traffic, for every ton of CO2 emitted.

Joe Biden

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EU Carbon Permits, in EUR, 01/2010-05/2022
100
90
80
70
60
50
40
30
20
10
0
2010

2012

2014

2016

2018

2020

2022

EU Carbon Permits
Source: Reuters Eikon, Incrementum AG

In order not to jeopardize the competitiveness of the countries covered byemissions trading – the 27 EU member states plus Norway, Iceland andLiechtenstein – the EU finance ministers agreed in principle in mid-March on the
introduction of a Carbon Border Adjustment Mechanism. Negotiations with the
EU Parliament are now pending. This climate tariff is intended to prevent a shift toimported goods that are not subject to emissions trading and can therefore be
produced more cheaply. Initially, cement, iron, steel, aluminum, fertilizers andelectricity are to be covered. This first stage of a climate tariff is to apply from2026.
Unless we take action on climate

Given the increasing prioritization of the fight against climate change by more andchange, future generations willmore institutions, it would be anything but a surprise if in the near future thebe roasted, toasted, fried anddemand were to be made to exclude various “green” price increases from thegrilled.

inflation rate in order to prevent too high official inflation rates from jeopardizing

Christine Lagarde

the fight against climate change. Increased inflation rates would compromise
political enforceability of climate measures, because voters would be told monthafter month how vigorously the purchasing power of their incomes and assets was
melting. The higher inflation rates and interest rates to be expected as a result ofsuch “green” measures would also make the financing costs of the transformation
to a climate-friendly economy more expensive.
A demand to exclude climate-mitigation price increases from theinflation rate would lead to a rehash of the capital mistake that thenFederal Reserve Chairman Arthur F. Burns made twice in the 1970s.
Burns, the father of the concept of core inflation, removed oil and other energy
costs from inflation calculations after the first oil price shock in the wake of the1973 Yom Kippur War. When food prices also rose sharply that same year, he
excised them too from the inflation calculation. Burns’ argument was that bothprice phenomena were external shocks that could not have been influenced by theFederal Reserve and its monetary policy. Such exogenous, i.e. uninfluenceable,
noise said nothing about the trend, he maintained.
For citizens and their dwindling purchasing power, such reasoning isof course irrelevant. The same would apply to the possible exclusion of the

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price effects of the green transformation. Just because official statistics do not take
into account certain price increases does not mean that these increases do notdiminish the prosperity of the population. To put it differently and lessdiplomatically, walking through the city with your eyes closed does not protect you
from getting run over; in fact, the exact opposite is true. If such a measure weretaken, it would also be tantamount to further politicizing central
banks.

CPI, and Core CPI, yoy%, 01/1966-12/1984
16%
14%
12%
10%
8%
6%
4%
2%
0%
-2%

-4%
1966

1968

1970

1972

Recession

1974

1976

1978

CPI

1980

1982

1984

Core CPI

Source: Reuters Eikon, Incrementum AG

Isabel Schnabel, a member of the ECB’s Executive Board, did somepreliminary intellectual work on the possible elimination of green
transformation costs. In a speech to the ECB and Its Watchers Conference in
mid-March, which she introduced by pointing out that Europe and the world were
facing a "turning point," she distinguished between climateflation, price increases
caused by climate change; fossilflation, price increases caused by dependence on
fossil fuels, which have risen sharply in price; and greenflation, price increases
caused by the switch to so-called “green” technologies.
In the past couple of decades, theThis distinction is still somehow plausible – with the use of a fair amount of mental

2% inflation target behaved likeacrobatics. But given the ECB’s open endorsement of the green transformation, ita ceiling. In the next twenty

prepares the ground for future “green” adjustments to inflation calculations. This

years, the 2% inflation target

is not altered by the fact that this advocacy is outside the ECB’s

will become a floor.

mandate. Rather, it reflects the increasing politicization of the ECB, which is

Kevin Muir

hardly surprising given that Christine Lagarde, a politician, is at the helm.
Last but not least, newly introduced CO2 levies, which are also usuallyraised gradually over many years, increase price inflation. This upward
pressure on inflation is entirely independent of the additional price surges
triggered by the Ukraine war.

Current Trend of Inflation Development
As we have extensively argued, we believe that the data clearly point toa protracted inflationary environment. In retrospect, disinflationary forces

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81such as globalization and digitalization have contributed in recent decades to thefact that inflation has so far been reflected mainly in asset price inflation. We havereferred to the so-called "everything bubble" on several occasions. Now it looks as
if this asset price inflation will be slowed down or reversed and financial capitalwill increasingly be shifted into real assets.

Everything Bubble, Q1/1970-Q4/2021
Everything Bubble
7.0
6.5

Housing Bubble

6.0

Dot-Com-Bubble

5.5
5.0
4.5
4.0
3.5
3.0
1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

2020

Recession
Financial Assets of Households/Disposable Personal Income
Source: Reuters Eikon, Incrementum AG

Is there a risk of inflation? I

Typically, there is a correlation between the gold price and inflation-

think there’s a small risk and I

linked bond yields. Comparing the gold price with the real yields of 5-year US

think it’s manageable... I don’t

Treasury inflation-protected bonds (TIPS), we see that the breakout of the gold

think it’s a significant risk, and if

price in early 2016 was accompanied by a pricing in of rising inflation expectations.

it materializes, we’ll certainly

From early 2019, the yields on TIPS and gold moved in tandem, but since mid-monitor for it, but we have theAugust 2020 they have diverged. The expected real yield rose recently and is now

tools to address it.

even slightly positive in the 10-year range.

Janet Yellen

Gold (lhs), in USD, and US 5y TIPS (rhs, inverted), 01/2012-05/2022
2,200

-2.5%
-2.0%

2,000

-1.5%
1,800

-1.0%

1,600

-0.5%
0.0%

1,400

0.5%
1,200

1,000
2012

1.0%
1.5%
2013

2014

2015

2016

Recession

2017

2018

Gold

2019

2020

2021

2022

US 5y TIPS

Source: Reuters Eikon, Incrementum AG

Since its low of 0.14% on March 19, the break-even rate, i.e. the yield differential
between nominal government bonds and inflation-linked bonds (TIPS), has rallied
to almost 3% – its highest level in two decades. The momentum of theincrease was enormous, which is why we would not be surprised to see
a breather phase.

LinkedIn | twitter | #IGWTreportStatus Quo of the Inflation Trend82

US 10-Year Breakeven Rate (lhs), in %, and US Dollar Index (rhs,inverted), 01/2000-05/2022

3.5%

60

3.0%

70

2.5%

80

2.0%
90
1.5%
100

1.0%

110

0.5%
0.0%
2003

120
2005

2007

Recession

2009

2011

2013

2015

2017

US 10-Year Breakeven Rate

2019

2021

US Dollar Index

Source: Reuters Eikon, Incrementum AG

The Incrementum inflation signal
Central banks are fighting a

In an elevated-inflation environment, inflation has historically often

deflation boogie man that does

occurred in waves. In financial markets, too, inflation is not priced in and out

not even exist, creating a debt

steadily but is subject to corresponding market fluctuations. To better read the

deflation monster in the process.

tides of inflation, we have, as our loyal readers already know, developed a

The tail risk is the Fed goes too

proprietary inflation signal. With the help of this, we have been monitoring thefar down the rabbit hole,market action of inflation-sensitive assets for many years.

unleashing a different kind of
monster.

The Incrementum inflation signal is also a key input factor for our"Tyler Durden"

inflation-protection strategies.27 According to the signal, theturnaround in inflationary movement probably took place during thecourse of the Covid-19 crisis. After the brief but strong deflationary movementin H1/2020, the signal has predominantly indicated rising inflation.

Inflation Sensitive Assets (lhs), 100 = 01/1997, and Incrementum
Inflation Signal (rhs), 01/1997-05/2022
1,000

1

900
0.75

800
700

0.5

600
500

0.25

400
0

300
200

-0.25

100
0
1997

-0.5
2000

2003

2006

Gold

2009

2012

Silver

2015

BCOM

2018

2021

HUI

Source: Reuters Eikon, Incrementum AG—

27 See “The Fruits of Our Seed. Our investment funds,” Incrementum AG

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83

In the near future, the markets could see a brief cooling-off phase in
the inflationary trend. Commodity prices, which are included in our signal as a
subindicator, appear to be forming a temporary high. The gold/silver ratio, which
is important for our model, rose sharply, which also suggests a slightly weakening
inflation trend. It is quite possible that it will take the Federal Reserve pricing out
its hawkish stance to trigger the next wave of inflation.

Conclusion
Last year we wrote:“The current rise in inflation rates heralds a fundamental
turnaround. Although one swallow does not make a summer, there are now
countless swallows in the sky. They herald a change, a monetaryclimate change.”28
The arithmetic makes it plain

After this violent inflationary storm, we will no longer be returning tothat inflation is a far more

the disinflationary, fair-weather equilibrium that has been

devastating tax than anything

characterized over the past 40 years by globalization, free trade, athat has been enacted by ourdemographic dividend, the development of international supply

legislatures... If you feel you canchains, and the reduction of stockholding (just-in-time delivery). We aredance in and out of securities in aentering a phase of establishing a new equilibrium that will be characterized by

way that defeats the inflation

deglobalization, i.e. self-sufficiency efforts, the retrieval of production sites andtax, I would like to be yourbuildup of stockpiles of critical food and raw materials, and the safeguarding of

broker – but not your partner.

existing supply chains, including through military intervention. All this has a

Warren Buffett

fundamental price-driving effect.
Structural deflationary or disinflationary factors are currently few andfar between. First and foremost, there would be a marked tightening ofmonetary policy. However, we do not expect central banks to be able to sustain thisfor long. The pioneers of monetary tightening are emerging economies, but also
developed European economies such as the UK, Norway, Poland and Hungary andof course the US. These will be the first to feel the inevitable impact of tightermonetary policy on the real and financial economy, and their central banks will
have to pass a credibility test.
Technological progress is an influential disinflationary, if not
deflationary, factor that will continue to exert its dampening effect on
inflation for a long time. In the short term, however, the technology sector isalso likely to have a rather price-driving effect. For example, factories in China arehaving to close time and again as a result of the country’s zero-Covid policy.

Courtesy of Hedgeye

China’s manufacturing purchasing managers’ index (PMI) continued to fall in
April. At 46 points, it is lower than ever before apart from the Covid-19 shock inlate winter 2020 and is thus now well below the 50-point mark separating growthand contraction. The purchasing managers’ index for services slipped further with
an April reading of just 36.2, down from 42.0 in March. That’s the second-lowest
reading since this index was introduced in November 2005, and the overall index—

28 “The Status Quo of Gold,” In Gold We Trust report 2021, p. 54

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84

also fell below the 40-point mark at 37.2. And because around half of the neon
needed for chip production comes from Ukraine and production there had to behalted due to the war, the technology sector is also facing difficult times.
Our baseline scenario is that the present inflation upswing will not be
the last wave in this high-inflation period. In the last such period there werea total of three inflation waves, with each subsequent one marking a higher highthan the previous one: 6.4% in February 1970, 12.2% in November 1974, 14.6% in
March 1980. Oil price shocks reinforced the already existing inflation momentum
then, and may be doing so again now.
Central banks are starting to

It should not go unmentioned that the first wave of inflation occurred

question whether reliance on thein the 1970s at a time of considerable change in the world monetary

US dollar is a good idea, sincesystem. The Bretton Woods system, with its rudimentary gold peg, went down in

the United States has been

several stages, as pure fiat money in combination with a system of flexible

extremely trigger-happy when it

exchange rates with the US dollar as fiat anchor currency prevailed. Such ancomes to the use of sanctions andepochal change is again beginning to take place before our eyes. The end of theother economic punishments.

global US dollar fiat standard has been announced for quite some time, even

Institute for the Analysis ofthough the US dollar has remained firmly in the saddle for lack of serious

Global Security

alternatives. With the sanctioning of Russia’s currency reserves by theWest, the first major transformation of the global monetary system in
50 years has now been officially heralded.29

Inflation is not a bug. Inflation is

We are convinced that even if inflation rates will come back down due to thethe feature.

temporary expiry of the base effect and the absence of special factors, the level ofLouis Gaveinflation will remain elevated, i.e. (far) above the target level of the central banks,
for some time to come. The narrative of “transitory” inflation should now
finally be laid to rest.

—

29 See chapter “A New International Order Emerges” in this In Gold We Trust report

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85

Status Quo of Gold
Demand“Money is the most universal and mostefficient system of mutual trust everdevised. Even people who do not believein the same god or obey the same kingare more than willing to use the samemoney.”
Yuval Harari

Key Takeaways• The renaissance of gold as a reserve asset of central

banks continued last year, and it seems to be picking up
pace.
• More and more central banks are choosing to custody

their gold domestically. This points to a breakdown intrust between central banks.
• Investor demand for gold has picked up considerably in

Q1 2022. We even saw companies holding gold on theirbalance sheets. This comes as no surprise considering
the current world economic outlook.
• Going forward, central banks and institutional investors

will see greater demand for gold. Due to soaring
inflation rates, pension funds and insurance companies,
which normally have a high proportion of (government)
bonds, will have to fundamentally rethink theirinvestment policy. Gold could play a major role in this.
• Catch-up effects in jewelry demand, once the Covid

pandemic has been pushed back – especially in China –should also support gold demand.

Status Quo of Gold Demand86

We will now turn to the most important developments on the demandside, with our focus on central bank gold demand and investor
demand. For further insights, we recommend the World Gold Council’s Gold
Demand Trends, which is always worth studying.

Central Bank Gold Demand
The seizure of Russia’s FX

Before we start, let us remind ourselves why central banks hold gold. The following(foreign currency) reserves will

has been adapted from the website of Banca d’Italia (our emphasis):

likely be a wake-up call for FX
reserve managers at all central“Gold has traditionally been used to measure the value of goods and as abanks. Gold as "outside money"means of payment in almost every ancient society. It serves as an excellent

in the global central banking

hedge against adversity. Its price tends to rise when operators

system will become more

perceive the level of risk to be high, for instance during military

attractive to almost any central

escalation or in times of financial crisis. Holding large positions in goldbank but especially for any

is an excellent hedge against high inflation. Unlike foreign currencies,

country with an adversarial

gold cannot depreciate or be devalued as a result of a loss inrelationship with the US or theconfidence. When a foreign exchange crisis erupts, central banks are able toEU.

use gold as an official foreign exchange reserve in order to shore up

Paul Wong

confidence in their currency by using gold as collateral for loans or selling it
to buy national currency and uphold the latter’s value. Gold gives a central
bank room to maneuver to preserve confidence in the national
finance system.”
The renaissance of gold as a reserve asset of central banks continued
last year, and it seems to be picking up pace. In 2021, the net inflows ofcentral banks amounted to 463 tonnes, according to the World Gold Council. Thisis up 82% from 2020 net inflows of 255 tonnes. Note that this is in comparison to
the record year 2019, with 668 tonnes. Total global reserves are now near a
30-year high.
Key developments in 2021:•

Thailand was the largest buyer, with 90 tonnes, followed by India (77tonnes), Hungary (63 tonnes) and Brazil (62 tonnes).

•

15 central banks made purchases of one ton or more.

•

Only six central banks reduced their holdings last year, most notably thePhilippines (31 tonnes). This was the largest sale from a central bank since2016, when Venezuela sold 86 tonnes.

•

Kyrgyz Republic (7 tonnes), Sri Lanka (4 tonnes), Germany (3 tonnes), andUAE (2 tonnes) were the only other notable sellers.

•

Official gold reserves now stand at 35,600 tonnes, the highest level since
1992.

The largest purchaser of gold in 2021 was Thailand, increasing theirreserves by 90.2 tonnes, or 60%. This puts Thailand’s total gold reserves at
224 tonnes, or 6% of total reserves, the highest level on record. The Governor of
the Central Bank of Thailand said that gold addresses their key reserves
management objectives of security, return, diversification and tail-risk hedging.

LinkedIn | twitter | #IGWTreportStatus Quo of Gold Demand87

India was the second largest purchaser, adding 77 tonnes to its
reserves, the biggest increase since they bought 200 tonnes from the
IMF in 2009.
Managing new risks arising

Hungary increased its holdings by 63 tonnes in 2021, tripling its gold

from the coronavirus pandemic

reserves. In a statement, the Hungarian National Bank (MNB) referred to thealso played a key role in the

exploding global public debt in the wake of the Covid-19 pandemic, which is why

decision. The appearance of

Hungary is increasing its gold holdings for hedging reasons. As a result, Hungary’s

global spikes in government

gold reserves per capita increased from 0.1 ounces to 0.31 ounces. Thus,

debts or inflation concerns

Hungary currently has the highest gold reserves per capita in Central

further increase the importanceand Eastern Europe. Hungary’s monetary history, like Germany’s, is marked byof gold in national strategy as a

hyperinflation. Indeed, Hungary leads the inglorious hit parade of hyperinflations.

safe-haven asset and as a store

At the height of the hyperinflation of 1946, the monthly inflation rate of the pengő

of value.

was 4.2 quadrillion percent and prices doubled every 15 hours.30

Hungarian National Bank
Brazil added 62 tonnes, its first sizable purchase since 2012. This took
its total gold reserves to 130 tonnes. Uzbekistan and Kazakhstan added
30 tonnes and 15 tonnes, respectively.
Trust is like a mirror, you can fix

It seems that domestic gold storage is enjoying increasing popularity.

it if it’s broken, but you can still

The Bank of England’s vaults remain unchallenged in the rankings of the mostsee the crack in that

popular storage locations, with 63% of central banks surveyed storing at least somemother****r’s reflection.

of their gold reserves in London, according to the 2021 Central Bank Gold Reserves

Lady Gaga

Survey. This indicates a significant increase over last year and may indicate
growing importance attached to keeping gold in liquid trading centers. Domestic
storage is now preferred by 39% of respondents. This is also higher than inprevious years.

I think I’ve seen this film before.

It is worth noting that there has been an increasing trend over the last

And I didn’t like the ending.

decade for central banks to repatriate and store their gold

You’re not my homeland

domestically. We have discussed this trend numerous times in the In Gold We

anymore, so what am I defendin’

Trust report from as early as 2012.31 Most notably, France repatriated 221

now?

tonnes of gold between 2013 and 2016, and all its monetary gold is now

Taylor Swift, “Exile”

stored in La Souterraine in Paris. This after the German Central Bank
announced that they would repatriate gold from the Bank of France and theFederal Reserve Bank of New York. Germany would eventually hold 50% of its goldin German vaults. Poland also repatriated 100 tonnes from London, roughly half of
its total reserves. Other countries with notable repatriations over the last decade
include Belgium, Switzerland, Austria, India, Mexico, Thailand, Sri Lanka, Bolivia
and Bangladesh. Also worth noting is that China and Russia vault all their gold
locally.
And lastly, the Australian Reserve Bank sent an official to London to conduct anaudit on their reserves that are kept in the vaults of the Bank of England in April
this year. This further demonstrates the lack of trust between central banks withregards to the storage of their gold reserves.
—

30 See “Hyperinflation: Much Talked About, Little Understood,” In Gold We Trust report 2019; Grossman, Peter Z.

and Horváth, János: “The Dynamics of the Hungarian Hyperinflation, 1945-6: A New Perspective,” Scholarship andProfessional Work – Business. 29, Butler University, 2000
31 See Archive of the In Gold We Trust report

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88Gold is scarce. It’s independent.

The number of central banks buying gold is expected to remain high.

It’s not anybody’s obligation. It’s

21% of central banks intend to increase their gold reserves in the next 12 months.

not anybody’s liability. It’s not

This compares with 20% in 2020 and 8% in 2019. This is particularly notable given

drawn on anybody. It doesn’tthat central bank purchases have already been at record levels in recent years. In

require anybody’s imprimatur toparticular, demand for gold from central banks in emerging and developing

say whether it’s good, bad, orcountries is likely to continue to rise: 31% of the total of 155 emerging markets andindifferent, or to refuse to pay. It

developing economy (EMDE) central banks said they intended to increase theiris what it is, and it’s in yourgold reserves, compared with 21% in 2020 and just 11% in 2019.

hand.
Simon Mikhailovich

In March the Central Bank of Russia announced that it would be resuming its
gold buying from the domestic market. It has been two years since Russia
suspended its gold buying after accumulating 1,900 tonnes between 2006 and2020. Russia’s gold reserves stood at just under 2,300 tonnes at the end ofJanuary, accounting for 21% of its total reserves. Given the fact that Russia’s US
dollar and euro FX reserves were essentially rendered worthless – at least
temporarily – by sanctions imposed by the West, it is worth noting that gold makes
up more than 20% of Russia’s FX reserves.

Gold Reserves of the Top 10 Gold Reserve Countries, as % of GDP,
2000 vs. 2021
10%

9.0%
8.0% 8.0%

7.5%

8%

6%

5.4%

5.1%
3.9%

4%

1.9%
2%

1.6%

1.6%

0.8%
0.3%
0%

China

2.3%

1.9%

1.9%

1.2%

1.0%

0.7%

0.7%

0.1%
FranceGermany

India

Italy

Japan

2000

Netherlands

RussiaSwitzerland

USA

2021

Source: IMF, World Bank, World Gold Council, Incrementum AG

From 1989 to 2008, central banks were net sellers of gold andrepresented an important part of the global gold supply, averaging 400
tonnes per year. Since the Great Financial Crisis of 2008/2009 central
banks have become a reliable factor on the demand side and look toremain as such. This shift indicates a reassessment of gold’s role amid ongoing
financial and economic uncertainty and reflect long-term concerns about fiscal
sustainability.
Current geopolitical turmoil and global financial uncertainty should
further fuel central bankers’ appetite for gold. By freezing Russia’s gold
reserves, the West has essentially signaled to the rest of the world that roughly
80% of global FX reserves are in danger of being frozen or even confiscated.
Today, reported official gold reserves are only 8% below the all-timehigh of 38,491 tonnes in 1966.

LinkedIn | twitter | #IGWTreportStatus Quo of Gold Demand

89

Global Central Bank Gold Reserves, in Tonnes, Q4/2000-Q1/2022
36,00034,00032,00030,00028,00026,00024,000
2000

2002

2004

2006

2008

2010

2012

Developed Markets

2014

2016

2018

2020

2022

Rest of the World

Source: World Gold Council, Incrementum AG

Investor Demand for GoldO Gold! I still prefer thee unto

We now take a closer look at investor demand. We will particularly

paper, which makes bank credit

focus on private investment demand and ETF demand. ETFs saw outflows

like a bark of vapour.

of 173 tonnes in 2021, compared to a record 874 tonnes of inflows in 2020. This

Lord Byron

caused total investor demand for 2021 to decrease 43% compared to the previous
year. We published a report in January 2022, outlining the various possible
reasons for this interim slump.
In contrast, bar and coin demand reached an eight-year high of 1180
tonnes in 2021. Bar demand was 50% higher, at 804 tonnes, while official coinand medal demand slipped marginally to 376 tonnes.
China accounted for 285 tonnes of bar and coin purchases, a 44%
increase from the 2020 numbers, helped along by exceptionally strong demand in
Q4/2021. India’s investment climbed 43% to 186 tonnes, while US
investors bought a total of 117 tonnes, a 69% increase from 2020. Germany
led the strong demand for bar and coin purchased in Europe, with European
investors buying 264 tonnes, 6% higher than the previous year. This is asignificant demand increase from previous years and roughly 20% more than the
average demand for bar and coin since 2014.

All that is gold does not glitter,

It is interesting to note that not only central banks and consumers but

not all those who wander are

also companies are buying gold to hedge against crises. Software

lost; the old that is strong does

company Palantir Technologies announced in 2021 that they bought USD 50.7mn

not wither, deep roots are not

worth of gold bars, saying that they are “preparing for a future with more black

reached by the frost.

swan events”. The word Palantir means “seeing stone” and is part of the J.R.R.

J. R. R. Tolkien

Tolkien fantasy universe that includes The Lord of the Rings. Palantir’s clients
include the CIA, FBI, NSA, various other government agencies, and numerous
private-sector clients including Chrysler, Airbus and JP Morgan Chase. We mightsee more companies follow suit in 2022 if financial uncertainty intensifies.

LinkedIn | twitter | #IGWTreportStatus Quo of Gold Demand

90

ETFs aren’t just having a

The outflows seen in the ETF market were heavily concentrated in

moment. They’re creating a

Q1/2021, coinciding with a rise in risk-on investor appetite as newly

movement.

developed Covid-19 vaccines were rolled out. Looking at these outflows

Martin Small, BlackRockfrom a longer-term perspective provides useful insights. During the previous five
years, ETFs saw cumulative inflows of more than 2,200 tonnes, more thandoubling the global total to almost 4,000 tonnes. The 2021 outflows of 173 tonnes
are therefore relatively small in comparison. Global ETF holdings remain
significantly above pre-pandemic levels.

Cumulated ETF Holdings by Region (lhs), in Tonnes, and Gold (rhs),
in USD, 01/2004-04/2022
4,500

2,500

4,000
2,000

3,500
3,000

1,500

2,500
2,000

1,000

1,500
1,000

500

500
0
2004

0
2006

2008

2010

North America

2012

Europe

2014

2016

2018

Asia

2020

2022

Other

Gold

Source: World Gold Council, Incrementum AG

Gold is the inverse of paper,

ETF outflows in 2021 were driven by North American funds, which neverunlimited to the upside, limited

recovered the losses accrued in Q1/2021. European ETF holdings wereto the downside. It’s not the total

considerably more stable, recovering from the Q1/2021 outflows and fully

stock of gold that matters, but

reinvesting the 44 tonnes lost over the remainder of the year. Asian ETFs

the flow from those that alreadyoutperformed again, with the region accounting for the majority of the inflows

hold it.

during the year. Total holdings in the region grew by more than 20%, adding 25

FOFOA

tonnes over the course of the year. Thus, Asia once again confirmed its preference
for gold purchases in times of a weakening gold price. The assets invested ingold ETFs remain tiny compared to the overall US equity market. At the
moment, this allocation is a mere 0.5%

Gold ETFs, as % of US Equities (Wilshire 5000), 01/2008-04/2022
1.2%
1.0%
0.8%
0.6%

0.4%
0.2%
0.0%
2008

2010

2012

2014

2016

2018

2020

2022

Gold ETFs
Source: Atlas Pulse, World Gold Council, Reuters Eikon, Incrementum AG

LinkedIn | twitter | #IGWTreportStatus Quo of Gold Demand91

The first quarter of 2022 has seen significant inflows, with the North American
market adding 170 tonnes or 10%. Europe added 110 tonnes or 7.5%. Asia saw
outflows of 14.8 tonnes or 10.5%. Combined this adds up to total inflows of 8% for
the first quarter.

Jewelry demand for gold
All you need is love . But a little

Worldwide jewelry demand grew 52% to total 2,124 tonnes, recovering

Jewelry never hurt anybody.

the losses sustained in 2020 due to the Covid-19 pandemic. Recovery in

Abby Lowery

the first three quarters was largely due to base effects – extreme weakness in 2020
– but Q4/2021 saw strong demand growth, led by India, which saw a newquarterly record in the fourth quarter. In value terms, annual demandreached USD 123bn to virtually match the 2013 record.

Gold goes where the money is,

Last year, China’s gold jewelry demand increased 63% to 675 tonnes.

and it came to the United States

This should be compared to the pre-pandemic level of 2019, from which it is a 6%

between World Wars I and II,

increase. India’s jewelry demand doubled from 2020 levels to 611

and it was transferred to Europe

tonnes, a six-year high. US demand was the strongest in 12 years at 149

in the postwar period. It thentonnes. European demand rose by 21% to 69 tonnes, but still fell short ofwent to Japan and to the Middle

pre-pandemic levels. Global jewelry demand is expected to remain strong

East in the 1970s and 1980s, andin 2022 as post-pandemic pent-up demand unwinds.

currently it is going to China andalso to India.

Let us now look at the developments in the Chinese market. The ChineseJames Steeleconomy saw a significant downturn in growth rates in H2 2021, coupled withhigher inflation. With stagflationary pressure mounting and real rates remaining
low, analysts at the World Gold Council believe that Chinese investors will look togold in order to protect their wealth and purchasing power.
A China-wide gold jewelry market survey in 2021 found that gold jewelry products
have become a major sales focus in local jewelry stores in China. Increasing focus
on the financial aspect of gold jewelry products among the young and greater
pricing transparency under the new “per-gram” pricing model should encourage
further growth. Current restrictions on retail gold products will ensure that
Chinese demand for physical gold in the form of bars and coins will remain high.
Gold plays a unique cultural and economic role in India. Indians readily
use gold as a store of wealth and as a financing vehicle through “pledging” gold ascollateral. This means the price of gold has a unique effect on the Indian economy.
A recent study looked into the habits of Indian gold-holding consumers. It
concluded that if the price of gold increases, Indians tend to use their increased
wealth to consume more. This further corroborates earlier findings that gold’s
status has hardly changed in India, despite changes in demographics and theadvent of new technologies and innovations, including digital assets such as
Bitcoin.

Emergence of a new delivery standard for gold in the UAE?
On November 18, 2021 the United Arab Emirates announced at the Dubai Precious
Metals Conference that they would soon launch the UAE Good Delivery Standard
for gold. This new standard will be similar to the LMBA Good Delivery Standard.

LinkedIn | twitter | #IGWTreportStatus Quo of Gold Demand

92This announcement is significant, as the LMBA Good Delivery Standard dictates
the rules considering what refineries fall within the scope of Good Delivery Lists.
There has been an ongoing struggle between Dubai-UAE and the LondonSwitzerland axis as the Middle East vies for more independence. In November
2020 the LMBA threatened to blacklist the UAE if they failed to meet new
regulatory standards. The UAE’s response, expanding on their own standard forgold delivery, could have a significant impact on world gold trade. Dubai claims
that 25% of world trade in gold is conducted within the Dubai Multi Commodities
Centre (DMCC) free trade zone. The launch of the UAE Good Delivery Standard
was announced on November 18, 2021. As of the time of writing, further details
outlining the standard have not yet been published.

NSFR – Announced disasters rarely take place
As we expected in last year’s In Gold We Trust report,32 the mandatory
introduction of the net stable funding ratio (NSFR) has not led to any major
disruptions in the gold market. The regulations were introduced in the EU on June
28, 2021; in the USA on July 1, 2021; and in the UK on January 1, 2022, after
expiry of the six-month deferral period. Financial institutions had alreadycomplied with this regulatory requirement to reduce liquidity risk.
Liquidity is a coward, it

Therefore, the European Banking Authority (EBA) report published on June 28,

disappears at the first sign of2021 with the somewhat unwieldy title “EBA report on the impact of the NSFR on

trouble.

the functioning of the precious metals market under the mandate in Article 510

Barton Biggs(11) of Regulation (EU) No 2019/876” was able to draw an initial, interim
conclusion. No significant impairment of the functioning of the precious metals
markets was found. A reduction of the RSF factor for gold from the current 85%
was therefore not considered necessary. (The RSF factor determines thepercentage by which an asset must be stably financed.)

The crisis of today is the joke of

The LBMA, on the other hand, continues to maintain its call for the RSF factor for

tomorrow.

gold to be reduced to 0%, thereby placing unallocated gold on an equal footing

H. G. Wells

with banknotes, coins and central bank deposits, and for gold to be classified as a"high-quality liquid asset" (HQLA).

Conclusion
According to the World Gold Council, Q1/2022 saw a strong start to the year on
the gold demand side, with demand (excluding OTC) increasing 34% compared tothe same period last year. This while the price of gold in USD rose by 8%. Total
demand of 1,234 tonnes is the highest since Q4 2018 and 19% above the five-year
average of 1,039 tonnes.
Overall investment demand more than trebled. from 182t in Q1’21, to 551t
in Q1’22. This was mainly fueled by ETF purchases of 269 tonnes, more thanreversing the outflows from 2021, and central banks adding 84 tonnes, more thandouble the previous quarter.
—

32 See “The Status Quo of Gold,” In Gold We Trust report 2021

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Bar and coin investment remained high relative to long term trends at 282 tonnes,
11% above its five-year quarterly average, this relative strength is exceptional
considering the lockdowns in China and historically high prices in Turkey had an
adverse negative effect.
Denial aint just a river in Egypt.

Egypt was the biggest central bank buyer in Q1, reporting a 44t (+54%)

Mark Twain

increase in its gold reserves in February. This took total gold reserves to
125t, or 19% of total reserves, which is on the high end when compared to thecountry’s regional peers. Turkey was the other major purchaser in the quarter,
increasing its gold reserves by 37t. This pushed total gold reserves to over 430t,
accounting for 28% of total reserves.
Jewelry demand lost momentum in Q1 and is down 7% to 474 tonnes compared tolast year, with higher prices and a drop in consumption by China and India.

Global Gold Demand by Sector, in Tonnes, Q1/2021-Q1/2022
1,400
1,200
1,000
800

600
400
200
0
-200
-400
Q1/2021

Jewelry
ETFs & Similar Products

Q2/2021

Q3/2021

Q4/2021

Technology
Central Bank Net Purchases

Q1/2022

Total Bar & Coin

Source: Metals Focus, World Gold Council, Incrementum AG

An interesting trend that we already mentioned last year is the strong
increase in physical deliveries on the COMEX. Over the last 24 months,
deliveries have averaged 1.93mn ounces, miles above the long-term average of
673,000 ounces. Similar developments can be observed in the silver futures
market.

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94

Comex Gold Deliveries, in Troy Ounces, 01/2006-04/2022
6,000,000

5,000,000

4,000,000

3,000,000

2,000,000

1,000,000

02005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
Source: CME Group, Goldchartsrus.com, Incrementum AG

What could be the reasons for this increasing desire for physicaldelivery?33•

In view of temporary supply shortages, the futures market was “converted”
for the purchase of physical gold.

•

A growing number of market players have preferred physical gold to “papergold” after confidence in institutions and the gold supply chain weakened in
the wake of the lockdown crisis.

One may say that, apart from

Going forward, central banks and institutional investors in particularwars and revolutions, there is

will see greater demand for gold. Pension funds and insurance companies,

nothing in our modern

which normally have a high proportion of (government) bonds, will have tocivilizations which compares infundamentally rethink their investment policy. Gold could play a major role in this.

importance to inflation.

Catch-up effects in jewelry demand, once the coronavirus pandemic has been

Elias Canetti

pushed back – especially in China - should also support gold demand.

—

33 See Polleit, Thorsten: “Auf physisches Gold und Silber setzen. Dazu ist es noch nicht zu spät,” (“Going for

Physical Gold and Silver. It’s Not Too Late”), Degussa Marktreport, July 30, 2020

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95

Conclusion: Status Quo“All roads lead to gold.”
Kiril Sokoloff

Key Takeaways• As we predicted in last year’s report, inflation is runningrampant, but we have not seen the high returns that we
expected for gold.
• Gold is becoming increasingly important on thesovereign level, with central banks continuallypurchasing large amounts. We expect new all-time highs
in worldwide central bank demand in 2022.
• The commodity bull market is now in full swing, spurred

on by lack of capital expenditure, the war in Ukraine, andwarlike conditions caused by the Covid-19 crisis.
• Substantial interest rate hikes are not expected. This is

primarily because of a looming debt crisis and theeasing effect inflation brings to the burden of
government budgets.
• In the stagflationary environment of the 1970s, investors

were able to profit from their gold exposure. This is ofparticular relevance now, given the current slide ofmany economies into Stagflation 2.0.
• The positive correlation between equities and bondsmeans that a reliable portfolio diversifier is needed. Goldwill fulfill this role.
• Despite massive price increases for Oktoberfest beer,

the popular gold/Oktoberfest beer ratio has remained
constant at 121 measures of beer per ounce of gold. Soeven in times of inflation, beer lovers with an affinity forgold are not left high and dry.

Conclusion: Status Quo

96

After our tour de force through the gold universe, let’s conclude bysummarizing the most important thoughts. Last year we wrote in thischapter:“We feel confirmed in this forecast, whereby we are currently still within the
inflation comfort zone – but the emphasis is on ‘still’. In view of the inflation
data for April, which show a rise in US inflation to 4.2%, the ‘still’ has to berevised to ‘just’.”34
It’s been 40 years since inflation

A solidification of inflation has definitely taken place. Inflation is no

was on radars. Most boomers

longer an exotic, much less a “transitory”, topic but has arrived in the

only experienced the raging

mainstream. This part of our last year’s forecast was therefore correct, but the

inflation of the 70s through thegold price developed rather disappointingly in view of the strong increase inlens of their struggling parents.

inflation. Towards the beginning of the year, frustration was still high among gold

Dave Collum

investors, with many gold bulls questioning their confidence in gold. But as we
wrote in our article “Why Gold Lost Its Mojo”, there were valid reasons for thisbreather. After all, as recently as May 2019 gold was trading at a mere USD 1,300.
The subsequent record run to USD 2,063, up almost 60% in 15 months, was rapid.
In addition, the strong US dollar, the U-turn toward tighter monetary policy, andalso competition from digital gold, i.e., cryptocurrencies, weighed on the gold
price. These headwinds turned into tailwinds at the start of this year, driven byvolatile equity and bond markets reacting nervously to the increasingly
stagflationary environment. In the last few weeks, the tailwind has shifted again.

There is a difference between

In the In Gold We Trust report 2019, we took an in-depth look at thegold and tin as commodities. The

topic of trust. Trust reduces complexity and makes portfolios more antifragile. It

difference is that central banks

grows and thrives by expectations repeatedly being met. Gold met those

don’t hold tin in their reserves.

expectations in the wake of the Covid-19 crisis and during theGeoffrey Bellescalation of the crisis in Ukraine, following the outbreak of war on
February 24. Since the beginning of this year, gold has been one of the
few assets with a positive performance. With their reluctance to fightinflation, central banks risk exhausting their trust capital for good. This isparticularly true of the ECB, but also to a lesser extent of the Federal Reserve andmany other central banks.
The renaissance of gold as a central bank reserve currency continued
last year, with net central bank inflows of 463 tonnes. This is up 82% from255 tonnes in 2020, and total global reserves are now near a 30-year high.
Extensive purchases were made by India, Brazil and Thailand.

China has just been sent soft

The freezing of Russian central bank reserves will have considerable

notice that their $3 trillion may

consequences for the gold market. We believe it is quite possible that theor may not be there when they

Russian gold production of around 370 tonnes per year will be largely bought upneed it.

by the central bank or state-related institutions. In addition, numerous otherDouglas Pollitt

central banks from countries that harbor certain disagreements with the US will
also prefer to increase their gold reserves over dollar-denominated assets.

—

34 “The Status Quo of Gold,” In Gold We Trust report 2021, p. 81

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Conclusion: Status Quo

97

The mining industry has been a

We therefore expect central bank gold demand to reach its all-time

hard industry to operate in forhigh in the second half of 2022, as central banks around the world havethe last 30 years. And the aura ofboth strong diversification and geopolitical reasons to shift theirrespect surrounding mining isreserves into gold.

somewhere below thatsurrounding garbage collection.

Demand for bars and coins increased in 2021, with bar demand up 54% at year-

And the consequence of that isend, mainly due to increased demand in China and India. Jewelry demandthat many competent people

increased 52%, recovering from the Covid-19 slump. We expect consumer

would choose a job in any career

demand in emerging markets to be boosted by a lack of alternative

other than mining.

investment opportunities. In China, property prices are falling and equities

Rick Ruleare in a bear market. At the same time, interest rates in both China and India
remain at historically low levels in an environment of high inflation.
ETFs saw outflows of 45% in 2021, mainly due to an exceptionallystrong 2020. Since the beginning of the year, gold ETF demand has
been clearly on the upswing. We expect investor demand to tip the scales
toward further price development.

Monthly Gold ETF Flows by Region (lhs), in Tonnes, and Gold(rhs), in USD, 01/2004-04/2022
250

2,500

200
2,000

150
100

1,500

50
0

1,000

-50
-100

500

-150
-200
2004

0
2006

2008

North America

2010

2012

Europe

2014

2016

Asia

2018

2020

Other

Gold

Source: World Gold Council, Incrementum AG

The rapid surge in price levels

We were already growing in confidence about a renaissance in thesince 2021 fits the classic profile

commodities sector in 2019. The commodity bull market is now in fullof a war-related bull run inswing. A look at the history books shows that wars are a frequent catalyst

commodity prices.

for commodity cycles. There are numerous reasons for this. On the one hand, as a

Alpine Macroconsequence of a pick-up in aggregate demand driven by the defense industry; on
the other hand, due to supply chain disruptions, the general perception ofdemonetization and, in extreme cases, a flight into real assets.
Since the onset of the Covid-19 pandemic in late winter 2020, the world has faced
warlike disruptions. The supply side has been constrained by lockdowns, and there
have also been temporary, sometimes structural, shortages of materials,
transportation, and labor, while demand has been quickened by monetary andfiscal stimulus. In this respect, the rapid rise in commodities
corresponds to a war-induced bull market.

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Conclusion: Status Quo

98

One argument that we think is not discussed enough is thedisinvestment cycle and capacity reduction in the raw materials sector,
which is now manifesting itself in the form of supply shortages. Total
investment in the mining sector as a share of global GDP remains low,less than half of what it was in the early 2010s.35 Trends in other majorcommodity-producing countries are similar. In both Canada and the US, mining
investment has fallen dramatically since 2015, reaching its lowest level in nearly 30
years, when the secular bear market in commodities was near its bottom. Mining
supply is characterized by a long-term investment cycle, while demand depends on
shorter, cyclical fluctuations. This is the main reason why boom-bust cycles
are so pronounced in the commodity sector.

Commodity/Dow Jones Ratio, 01/1900-04/2022
1.4
1.2

1.0
Commodities overvalued

0.8
0.6

Median: 0.45
0.4
0.2

Commodities undervalued

0.0
1900

1910

1920

1930

1940

1950

1960

1970

1980

1990

2000

2010

2020

Commodity/Dow Jones Ratio
Source: http://blog.gorozen.com/blog/commodities-at-a-100-year-low-valuation, Reuters Eikon,
Incrementum AG

The last rate hike in a cycle isTotal global debt fell by around 10 percentage points to 351% in 2021.

much like the last kiss in aThis was primarily due to exceptionally high nominal economic growth and thus torelationship: You rarely think it

the base effect. Finally, the Covid-19 pandemic response was much milder in 2021

is going to be the last one while itthan in 2020. In absolute terms, however, the upward trend continued. For theis actually happening.

first time, the USD 300trn mark was broken through. High economic growth has

Alex Gurevichalso caused government debt ratios to fall, despite deficits remaining excessive insome cases. The USA in particular stands out negatively with a second deficit
above the 10% mark. Substantial interest rate hikes are therefore virtuallyout of the question, as otherwise a veritable debt crisis threatens.

You must only be patient.

Given the current turbulent mixed situation, it is hard for us to

Because on your side you haveimagine that we are at the end of a gold bull market. This assessment isreason... and against you, youcorroborated when we compare various macro and market indicators at the time ofhave just a vague, fat, blindthe last two secular all-time highs in 1980 and 2011 with the current situation.

inertia.

From this perspective, it becomes clear that the gold price still has a lot of room to

Ayn Randmove up.

—

35 See “Commodity Surge: Secular or Cyclical,” Alpine Macro, April 25,2022

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Conclusion: Status Quo

99

Comparison of various Makro- and Market Key Figures at Gold ATH in 1980,
2011 and Currently
1980

2011

Current

Gold Price in USD

835

1,900

1,811

Monetary Base in USD bn

157

2,637

6,135

1,483

9,526

21,810863

14,79030,382GDP per capita

12,30350,05673,277US Median House Price in USD

63,700228,100

428,700

S&P 500

111

1,174

4,023

US Unemployment Rate

6.3%

9.0%

3.6%

USD Index

86.1

75.2

104.6

M3 Supply in USD bn
US Federal Debt in USD bn

Source: treasury.gov, Federal Reserve St. Louis, Reuters Eikon, Incrementum AG, as of 05/13/2022

Is gold the be all and end all, the solution to all of our problems? No,
definitely not. But gold has unique portfolio characteristics, and it will
experience a renaissance as a key portfolio component under the new inflation
regime. Let’s recap the key benefits of gold:36• Increased portfolio diversification: The correlation of gold with other assets is
0.1 on average.

• Effective hedge against tail-risk events• Highly liquid investment: The liquidity of gold is significantly higher than thatof German bunds, British gilts, US Treasuries, and the most liquid equities.

• Portfolio hedge in times of rising price inflation rates as well as in strongly
deflationary times, but not in times of disinflation!

• Currency hedge: Gold correlates negatively with fiat currencies, especially the
US dollar.
Nothing ventured, nothing

Especially in the stagflationary 1970s, investors were able to profit

gained, sometimes you've got tofrom their gold exposure. This is of particular relevance given the current slidego against the grain.

of many economies into Stagflation 2.0. This is shown in the next chart, which

Garth Brooks

compares the Sharpe ratio of a classic portfolio with different gold weightings as an
admixture in the 1970s and since the 1970s. Thus, although the marginal benefit ofgold up to a portfolio addition of 10% is steadily positive in both observed time
periods, the increase was much steeper in the 1970s, indicating a relatively higher
marginal benefit.

—

36 On the special portfolio characteristics of gold, see “Gold in the Context of Portfolio Diversification,” In Gold We

Trust classic

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Conclusion: Status Quo

1.4

100

Sharpe Ratio of Classic Balanced Portfolio* with Various Gold
Admixture, Gold Exposure (x-axis), and Sharpe Ratio (y-axis),
1970-2021

1.3
1.2

1.1
1.0
0.9
0.8
0%

1%

2%

3%

4%

5%

6%

since the 1970s

7%

8%

9%

10%

in the 1970s

Source: Reuters Eikon, goldchartsrus.com, Incrementum AG
60% Stocks (S&P 500 TR)/ 40% IG Bonds

Based on the table below, it can be seen that gold shows acountercyclical effect when the stock market falls by more than 20%.
Both the absolute and relative performance of gold to the S&P 500 is positive inmost cases. Only in the period between 1980 and 1982 did gold underperform the
S&P 500. This outperformance during periods of market weakness demonstrates
the supportive role of gold as part of a portfolio.
Date of theMarket High

Date of theMarket Low

S&P 500
ReturnGold
ReturnGold Relative to
S&P50009/16/1929

06/01/1932-86.19%0.29%

86.48%

08/02/1956

10/22/1957-21.63%-0.11%

21.52%

12/12/1961

06/26/1962-27.97%-0.06%

27.91%

02/09/1966

10/07/1966-22.18%0.00%

22.18%

11/29/1968

05/26/1970-36.06%-10.50%25.56%

01/11/1973

10/03/1974-48.20%137.47%185.67%

11/28/1980

08/09/1982-27.27%-45.78%-18.51%

08/25/1987

10/20/1987-35.94%1.38%

37.32%

07/16/1990

10/11/1990-20.36%

6.81%

27.17%

07/17/1998

10/08/1998-22.29%1.71%

24.00%

03/24/2000

10/10/2002-50.50%11.18%

61.68%

10/11/2007

03/06/2009-57.69%25.61%

83.30%

09/21/2018

12/26/2018-20.21%

5.59%

25.80%

02/19/2020

03/23/2020-35.41%-3.63%

31.78%

01/03/2022

05/12/2022*-18.07%1.36%

19.43%

Mean-35.33%8.75%

44.09%Median-27.97%1.38%

27.17%

Source: Cornerstone Macro, Bloomberg, Reuters Eikon (*Lowest closing price since 01/03/2022), Incrementum AG

A return to the Great Moderation period, with four decades ofsuccessively falling inflation rates, seems out of the question. In view of
the increasing risks of stagflation, which we will discuss in detail in the following
chapter, a sustained tightening of monetary policy is likely to be virtually out of thequestion. The correlation between equities and government bonds will remain
positive and could catch many portfolio managers on the wrong foot. According

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Conclusion: Status Quo

101

to the next chart, we could imagine outperformance of gold and theWTI vs. the S&P over the next couple of years.

10

S&P 500/Gold Ratio (lhs), and S&P 500/WTI Ratio (rhs), 01/195005/2022
100

1
10

0
1950

1
1960

1970

1980

1990

2000

S&P 500/Gold Ratio

2010

2020

S&P 500/WTI Ratio

Source: Reuters Eikon, goldchartsrus.com, Incrementum AG

Is gold now already too “expensive”? We hear this question frequently, fromclients, journalists and private investors. Despite the significant nominal priceincrease in the previous years, it should not be forgotten that in an inflationadjusted view, the real all-time high from 1980 of USD 2,427 is still far away.

Gold (Nominal), and Gold (Inflation Adjusted - April 2022), in USD
01/1971-04/2022
3,000

2,500

2,427 USD

2,000

1,500

1,000

500

0
1971

1981

Recession

1991

Gold (Nominal)

2001

2011

2021

Gold (Inflation Adjusted - April 2022)

Source: Reuters Eikon, Incrementum AG

Gold continues to be massively

We therefore firmly believe – more than ever – that gold is a multi-

underrepresented in mostdimensional portfolio component with antifragile properties that will

individual, andplay to its strengths in the golden decade that has now dawned – andinstitutional, portfolios.

even more so in Stagflation 2.0.

Charles Gave

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102

In Gold We Trust Extra: The Gold/Oktoberfest
Beer Ratio37
Beer is the proof that God loves

The traditional Oktoberfest will take place again, after it had to be canceled in the

man and wants to see him

past two years due to the Covid-19 pandemic. On September 17, it will be “O’zapft

happy.

is” again.

Benjamin Franklin
But the consequences of inflation will also be felt at the Wies’n. Due tothe sharp rise in commodity prices and the expected additional expenditure for
Covid-19 security measures – in Germany, a next Covid-19 wave is firmly expectedin the fall – the Maß is likely to cost EUR 14.90 this year. That would be anincrease of 25% (!) over 2019. Massive price increases are also to be expected forother drinks and for the food, which could deter even the guests made thirsty by
two cancellations from a visit.
To alcohol! The cause of – andBy our calculation, however, the price of the Maß will “only” rise by 20.2% thissolution – to all of life’syear. In the past two years, we extrapolated the price increase from 2018 to 2019problems.

by 2.6% p.a. to calculate the gold/Oktoberfest beer ratio for 2020 and 2021. This

Homer Simpson

resulted in a price for the virtual Oktoberfest 2021 of EUR 12.40 for the Maß.

24 hours in a day, 24 beers in a

But the gold price has absorbed the massive price increase in its

case. Coincidence?

entirety. Just like last year, one ounce of gold buys 121 Maß of beer. So

I think not.

beer lovers with an affinity for gold are not left high and dry, even in times ofPaul Newman

inflation.

Gold/Oktoberfest Beer Ratio, 1950-2022
250

200

2012:
137 Maß/Ounce

1980:
227 Maß/Ounce

2022:
121 Maß/Ounce

Average:
90 Maß/Ounce

150
1971:
48 Maß/Ounce
100

50

0
1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

2020

Gold/Oktoberfest Beer Ratio
Source: Reuters Eikon, Statista, Incrementum AG—

37 We take a more detailed look at the gold/Oktoberfest beer ratio every fall in an In Gold We Trust special, when the

Theresienwiese is abuzz with activity; see “O’zapft is! The gold/Oktoberfest beer ratio 2021,” In Gold We Trust
special, October 2021

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DISCOVERING THE NEXT
MAJOR GOLD CAMP
www.aurionresources.com

Company Descriptions

104

Stagflation 2.0“It was the biggest inflation and themost sustained inflation that theUnited States had ever had.”
Paul Volcker

Key Takeaways• In this chapter, we take an in-depth look at the topic ofstagflation, provide an outline of precedents from therecent past, venture a look into the future, and thenanalyze the concrete consequences for portfolio
construction.
• Historically, the last pronounced stagflation phases

occurred between 1970 and 1983. These were madepossible by a liquidity overhang, which had its origins in
an excessively loose monetary policy, and were
triggered by oil shocks caused by geopolitical tensions.
• While some parallels exist today with the environment ofthat time in terms of monetary and geopolitical policy,
certain circumstances are significantly different. In
particular, high indebtedness makes a rigorousmonetary policy to combat inflation virtually impossible.
• Our baseline scenario is that we will experience several

waves of inflation in the coming years, which will
significantly change the investment environment.
• The disinflationary environment that prevailed for

decades has strongly shaped investors’ asset
allocation. Stagflation is the blind spot for mostbalanced portfolios. Precious metals and commodities
investments can be excellent additions to portfolios inthis environment, although there are some pitfalls to
consider.

Stagflation 2.0

105

We are more worried about theIn the middle of the year 2021, the time had come. The monetary policy

inflation rate being too low in the

Elysium, an inflation rate of 2%, was finally achieved on both sides of

medium term rather than too

the Atlantic. But inflation rates did not stop at the 2% mark. Without pause, one

high.

percentage mark after another was broken and numerous new decade highs in

Isabel Schnabel,

inflation rates were reached. The ketchup was out of the bottle.

Member of the ECB’s
Executive Board,

However, central bankers initially dismissed the trend, saying at theAugust 2021

top of their voices that inflation was merely transitory. Anyone who took
a different view was dismissed as a crash prophet. But the narrative of merely
temporarily elevated inflation inevitably began to crumble the longer this“transitory” lasted. Only in Frankfurt has it not yet been possible to completely
break away from this narrative, especially not in practice.
In order to give the rising inflation a positive connotation after all, reference wasrecently made to the strong economic growth, which is supposed to be partly
responsible for the inflation. However, while the growth figures were above
average, mainly due to the Covid-19 induced base effect, they have now alreadyclouded over noticeably, while inflation rates continue to soar.
The Russian invasion of Ukraine now represents the next fundamental
game changer after the Covid-19 crisis. It seems as if the world is slipping
seamlessly from one exceptional situation into the next. Is the war now threatening
a stagnant economy with rising inflation? As the frequency of Google
searches for the term “stagflation” suggests, more and more people
fear precisely this scenario.

Google Trends (USA): Stagflation, 01/2004-05/2022
120

100

80

60

40

20

0
2004

2007

2010

2013

2016

2019

2022

Google Trends (USA): Stagflation
Source: Google, Incrementum AG

In this chapter, we will therefore take an in-depth look at the topic of stagflation,
provide an outline of precedents from the recent past, venture a look into the
future and then analyze the concrete consequences for portfolio construction.

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106

Stagflation – Definition and Economic Policy
Views
We now have the worst of both

The term stagflation refers to the economic state in which economic

worlds – not just inflation on thestagnation and noticeable inflation coincide. The term was coined by theone side or stagnation on the

British Member of Parliament and later Secretary to the Treasury Iain Macleod,

other, but both of them together.

who first used it in 1965. He employed it again in the summer of 1970, when

We have a sort of ‘stagflation’inflation in Great Britain had reached the 6% mark and the economy shrank bysituation. And history, in modern

0.9% in Q1/1970. During the stagflationary 1970s, the term entered common

terms, is indeed being made.

usage.38

Iain Macleod
The classic stagflation definition is based on four pillars:• High inflation• Low or negative economic growth• High unemployment• Growth below potential growth
The coincidence of economic stagnation with increased inflation was considered
impossible according to the prevailing theory in the 1960s, which clung to asimplistic view of the Philips curve, which postulates an opposite dependence
between unemployment and inflation. This was because a cooling economy would
release workers, causing wages and inflation to begin to fall. By contrast, only abooming economy would be accompanied by rising wages and permanently highinflation, according to the generally accepted thesis at the time.
Criticism of this Keynesian view was voiced as early as the late 1960s by
Edmund Phelps39 and Milton Friedman40. They argued that there is no longterm trade-off between inflation and unemployment. Rather, over time, loose
central bank policies create the conditions for lower real economic growth andhigher inflation, i.e., stagflation. This is because a low-interest-rate policy would
make it more difficult to build up the capital stock and thus weaken economic
growth.
Those who know that they are

Representatives of the Austrian School of Economics saw the

profound strive for clarity. Those

expansionary monetary policy – in the 1960s, the annual growth rate of M2

who would like to seem profoundincreased from 3.7% in 1961 to 8.3% in 1968 – as the main reason why the boom

to the crowd strive for obscurity

triggered by it must inevitably end in a bust. The positive discrepancy between

Friedrich Nietzsche

money supply growth and real economic growth caused a monetary overhang
which unloaded in several waves of inflation in the 1970s and early 1980s.

—

38 See our interview with Iain Macleod’s nephew, Alasdair Macleod, titled “Stagflation and a New Gold Standard” inthis In Gold We Trust report.
39 Phelps, Edmund S.: “PCs, Expectations of Inflation, and Optimal Unemployment Over Time,” Economica, Vol. 34,
August 1967, pp. 254-81; Phelps, Edmund S.: “Money-wage Dynamics and Labor-Market Equilbirum,” Journal of
Political Economy, Vol. 76, July-August 1968, pp. 678-711
40 Friedman, Milton: “The Role of Monetary Policy,” American Economic Review, 58, May 1968, pp. 1-17

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M2 Growth minus GDP Growth, in %, 1960-2021
25

20

15

10

5

0

-5
1960

1970

1980

Recession

1990

2000

2010

2020

M2 Growth minus GDP Growth

Source: Reuters Eikon, Incrementum AG

Inflation is always and

The stagflation of the 1970s heralded the triumph of monetarism at the

everywhere a monetarylevel of economic theory. One of the key insights of the Chicago School aroundphenomenon.

the charismatic economist Milton Friedman, who was awarded the Nobel Prize in

Milton Friedman

Economics in 1976, was that central banks must exercise rigorous control overmoney supply growth in order to prevent inflation or tame high inflation. It was
only on the basis of this quantity theory of money with the well-known equation
MV = PQ that the Federal Reserve under Paul Volcker succeeded in bringing highinflation under control in the early 1980s, thus laying the foundation for the
resurgence of the US economy.
The slowdown in money supply growth was not painless, however. As aresult of the sharp rise in interest rates, the US economy plunged into two
successive severe recessions in the early 1980s. The high interest rates, which were
the prerequisite for curbing money supply growth, were so unpopular that Paul
Volcker was even threatened with death. Nevertheless, he stuck to his tough course
and was later celebrated for it by investors and is revered by monetary policy
hawks to this day.

Paul Volcker was the greatest

Despite this success, monetarist ideas fell behind over the years. A

American hero that I havenotable example is the evolution of the ECB’s monetary policy strategy. At the

known.

instigation of the Deutsche Bundesbank, the ECB was given a two-pillar strategy,

Ray Dalio

one pillar of which was the inflation target and the other a money supply target.
The M3 money supply was to grow by no more than 4.5% p.a., it said. But thismoney supply focus became less and less important over time.

Un-anchoring is the loss ofKeynesian economists also partially turned away from the Phillips

central bank credibility and acurve after the 1970s. Instead, the inflation expectations of theloss of control of the yield curve.

population were given a high priority. The widespread view today is that as

Pascal Blanqué

long as inflation expectations are anchored in the low range, there is no danger of
employees triggering a price-wage spiral by demanding high wages to compensate
for their expected real wage losses.
Low inflation rates thus become a self-fulfilling prophecy. To put it bluntly: Aslong as no one believes that prices will rise across the board, they will

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not rise. The monetary side of the inflation equation thus becomes almost
irrelevant; expectations are (almost) everything.
The academic debate on the appropriate mix of fiscal and monetary policy
measures to combat stagflation also began early. The later-Nobel laureate Robert
A. Mundell presented his proposal as early as 1971 (!) , i.e. immediately after theend of the first stagflation period in 1970: “The correct policy mix was a reductionin the rate of monetary expansion (perhaps best achieved by a credit ceiling)combined with a tax reduction. This would have stopped the inflation rate
without causing a depression”41. At least in terms of monetary policy, however, thereins were kept too loose for far too long.
In the present, the application of this mix of measures – interest rate
hikes and budget deficits – is hardly feasible due to significantly higher
levels of debt. In the 1970s, for example, total debt (government + companies +
private households) in relation to economic output was not even half as high in the
USA as it is today. Significant interest rate hikes today would therefore not only
cause a sharp recession but also a veritable debt crisis.

Stagflation 2.0 – A Proprietary Definition
The classic definitions of stagflation are largely qualitative and thus
vague. To make it easier to operationalize, we want to provide our own objectively
measurable, quantitative definition, which we also keep deliberately lean byincluding the two main factors, economic growth and inflation.

Courtesy of Hedgeye

We define an economy as stagnant if real economic growth is less than
1% year-on-year. We consider inflation to be elevated if it exceeds 3%
year-on-year. We collect these data on a quarterly basis. Both conditions must be
met for at least two consecutive quarters in order to declare stagflation.
In addition, we have calculated stagflation strength, which we define as
the sum of the deviation of the two variables inflation and GDP growth from theirrespective targets, assuming that our proprietary stagflation definition holds. The
scale is then normalized so that the maximum value of stagflation strength is 1.

—

41 Mundell, Robert A.: “The Dollar and the Policy Mix,” Essays in International Finance, No. 85, May 1971, p. 4

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US GDP, US CPI, and Projections, yoy%, and Stagflation Periods,
Q1/1962-Q4/2022e

20
15
10
5
0
-5
-10

-15
1962

1972

1982

1992

2002

2012

Stagflation

Stagflation Strength

CPI

GDP

CPI Projection

GDP Projection

2022

Source: Reuters Eikon, Incrementum AG

Based on this definition, there have been a total of five stagflationary
phases in the USA over the past 60 years. Four of them took place over a
period of 14 years between 1970 and 1983, and another weak stagflation occurredin the early 1990s.
The picture is quite similar within today’s euro area (EA-19). We register
three phases of stagflation between 1974 and 1983, and the euro area also fell intoa weak stagflation in the early 1990s.

Euro Area GDP, Euro Area HICP*, and Projections, yoy%, andStagflation Periods, Q1/1962-Q4/2022e

20
15
10
5
0

-5
-10
-15
1962

1972

1982

1992

2002

2012

Stagflation

Stagflation Strength

HICP

GDP

HICP Projection

GDP Projection

2022

Source: Reuters Eikon, Incrementum AG*Quarterly data available since 1991

Those who are easily shocked

The pronounced periods of stagflation in the 1970s and early 1980s

should be shocked more often.

were triggered by supply shocks. As a result of geopolitical tensions that were

Mae West

obvious to everyone, the public debate initially focused exclusively on supply
shocks as the cause of stagflation. Little attention was paid to the monetarydimension. The fact is, however, that without a marked monetary overhang as aresult of a previous excessive expansion of the money supply, a rise in the generalprice level to such an extreme extent would have been inconceivable. The
stagflation phase of 1991/1992 also follows this pattern, because it was preceded by
the oil price shock in 1990 resulting from the Iraqi invasion of Kuwait.

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Stagflation vs. Stagflation 2.0 – A Comparison
Most people currently involved“History does not repeat itself, but it rhymes!” Into these words Mark Twainin economic life do not know

poured the insight that many things repeat themselves in the course of history, butwhat inflation is and have notnever exactly one to one. Every era has its own peculiarities, despite somebeen faced with any sustained

similarities. What the stagflation phases of the 1970s and the early 1980s have inperiod of rising prices andcommon with the emerging Stagflation 2.0, apart from the coincidence of ainterest rates. This is a process of

weakening economy and an elevated inflation rate, and what separates thememory awakening andhistorical original from the new edition fifty years later, we contrast in theadaptive expectations.

following table for the US:

Pascal Blanqué
FactorStagflation Phases 1970 - 1983

Trigger

Oil embargo 1973
Yom Kippur War
1979 Iranian Revolution

Stagflation 2.0

4 phases between 1970 and 1983

Covid-19 pandemic & lockdowns/massive stimulus measures.
Supply chain issues
War in Ukraine?

Up to 4.9% (1982)

Up to 21.3% (2020)

Real interest
rate

Partly positive, partly negative, mostly
within a range of +5%/-5%;
Strong increase in early 1980s to justunder +10%.

Currently, strongly negative
Positive real interest rates not conceivable

Budget deficit

Max. 5.7% (1983)

Max. 15.0% (2020)

Debt

Low (data 1970 and 1982)- State: 35.7%; 35.2%- Company: 47.0%; 53.1%- Private households: 44.0%;47.9%

High (data 2021)- State: 123.4%- Company: 77.2%- Private households: 76.4

Labor market

High degree of organization;
Growing workforce potential

Low degree of organization
Declining workforce potential as a resultof demographic changeInternational division of labor /geopolitics

Division of labor largely stable
Geopolitics: Cold War

After decades of globalization now deglobalization
Slipping into Cold War 2.0

Food prices

Poor harvest in 1972 led to a sharp risein food prices in the US

Fertilizer crisis due to price increase
Sanctions against Belarus and Russia.
Impending food crisis due to the
Ukraine war.

Oil price development (WTI)

Jun 1973–Feb 1974: +184%
Dec 1978–May 1980: +166%

Dec 2020–Apr 2022: 116%

Price controls

Wage and price controls
ended in 1974 and triggered catch-up
effects

Currency regime

Exchange of gold currency standard on
system of flexible exchange rates

End

Interest rate hikes, Volcker shock recessions

Duration
Annual monetary overhang

In some countries, introduction of pricecontrols, especially for energy, but also
for food prices, as well as massive subsidies to compensate for inflation
Increasing departure from the unipolar
monetary system with the US dollar as
an anchor currency
Potential debt crises due to high debt
levels

Source: Incrementum AG

Where Do the US and the Eurozone Stand?
Let us recapitulate: According to our definition, for stagflation to occur, the two
criteria of an inflation rate above 3.0% and economic growth below 1.0% over a
period of two quarters must be met simultaneously.
The latest growth rates continue to be strongly influenced by the Covid19-related base effect, which distorted both inflation rates andeconomic growth upward in 2021. In the case of inflation rates, the baseeffect, which was mainly due to the marked drop in energy prices in the first threequarters of 2020, has largely been overcome. The base effect on economic growth,

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111

on the other hand, was barely addressed and is still having an impact in 2021 dueto the numerous lockdowns.
Let’s now take a closer look at the current stagflation situation in the
US and the euro area.

USA
Inflation at 8.3% (CPI, April 2022) is significantly above our 3% mark, and has
been consistently so since April 2021, meeting the minimum 2-quarter length
requirement. Even the core rate for the PCE Index, the Federal Reserve’s preferredinflation indicator, is well above this mark at 5.2%, also since April 2021.
Moreover, one-year inflation expectations have climbed from 3.4% to 5.4% in a
year, and the much less volatile five-year inflation expectations have risen to 3.0%.
A rapid abatement of inflationary pressure is thus not to be expected.
It’s all too much.

If the official inflation rates are already high, the price increases experienced by

George Harrison

many citizens in their everyday lives could deviate significantly upwards from theofficial data. Truflation, a provider that calculates inflation based on real-time
data, shows significantly higher inflation rates. In mid-April, the Truflationinflation rate stood at 12.7% year-on-year, with a serious 26.4% yearon-year increase in food prices.

Truflation Rate, Q2/2021-Q2/2022e
15%12.65%
11.60%
9.63%
10%

5%

8.67%

4.56%

0%
Q2/2021

Q3/2021

Q4/2021

Q1/2022

Q2/2022

Truflation Rate
Source: Truflation, Incrementum AG

Given the eroding purchasing power, it is hardly surprising that
consumer confidence has been on a downward spiral for several
months. The high inflation rates are making themselves felt in people’s wallets.
When asked about their financial outlook for the coming year, more households in
March than at any time in the history of the University of Michigan Consumer
Sentiment Survey said they expected their finances to deteriorate. Given the highimportance of consumption for US GDP, the economic outlook is anything but
rosy.

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US Consumer Sentiment Michigan University, Q1/1960-Q1/2022
110
100
90

80
70
60

?

50
1960

1970

1980

Recession

1990

2000

2010

2020

US Consumer Sentiment Michigan University

Source: Reuters Eikon, Incrementum AG

The reverse wealth effect is also likely to dampen consumer spending.
The ordinary wealth effect occurs when investors believe they are wealthy as aresult of rising share prices and real estate prices due to the book gains achieved,
and increase their consumer spending accordingly. When prices fall, the reverse
wealth effect has a correspondingly negative impact on consumer spending. In thecurrent calendar year, US equities have already lost more than USD 10trn inmarket capitalization, while bonds suffer their worst losses in decades. And thefirst cracks can already be seen in the real estate market.
None of us has the luxury of

Jerome Powell has recently reminded us that the Federal Reserve’s

choosing our challenges; fatefocus is currently on fighting inflation. If his pronouncements are followed

and history provide them forby corresponding actions, this would implicitly mean the end of the Fed put. The

us…Our job is to meet the tests

first time the Federal Reserve’s then-chairman Maestro Alan Greenspan invoked

we are presented.

this practice was in the wake of the 1987 stock market crash. Now it appears theJerome Powell

Federal Reserve is removing the safety net from the market, at least temporarily.
Bill Dudley, former FOMC member, goes much further. He calls for the Federal
Reserve to “force” the stock markets to correct, should they not correct on theirown.

The situation right now is the

In any case, stagflation confronts monetary policymakers who

most difficult that Jay Powell has

continue to trust the Philips curve with the greatest possible dilemma.

seen, or any Fed chair in a while,

They are faced with the uncomfortable question of whether to stimulate thebecause the stock market isweakening economy with monetary easing or to curb inflation with tighterbasically in a bear market. And

monetary policy. Lacy Hunt argues that with respect to the question of higher

yet the inflation rate is going up,

inflation with lower unemployment or lower inflation with higher unemployment,

and the economy is likely to slow

the Federal Reserve would have no choice at all, since it is a Hobson’s choice.

down with all of these priceIndeed, without containing inflation, economic recovery and thus a low

increases curtailing demand.

unemployment rate are not even possible. However, the Federal Reserve’s decision

Jeff Gundlach

will probably depend heavily on day-to-day political sentiment. As long as asset
markets remain at high levels and growth is not disastrous, a more restrictive
monetary policy stance could prevail. However, the matter will become moredifficult if equity and credit markets come under further pressure and growthsuffers accordingly.

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113

Historically, oil shocks have led

One small consolation from the perspective of monetary policy is that,to demand destruction thatas far as the cause of the bleak situation is concerned, the Ukraine

causes recessions. We’re going toconflict can be comfortably blamed for inflation. The following chart

start hearing the wordshows how high the probability of recession is as a result of oil price spikes. We

stagflation a lot more.

would not be surprised if the next recession were to go down in the US

Jeff Gundlach

history books as the "Putin Recession".

Real WTI Oil Price, Deviation from Trend*, 01/1980-04/2022
150%

100%

50%

0%

-50%

-100%
1980

1985

1990

1995

2000

Recession

2005

2010

2015

2020

Real WTI Oil Price

Source: Reuters Eikon, Incrementum AG*Trend is based on 2-year MA

I can’t see a recession! Where’s

In the meantime, the economic situation in the US has alreadythe recession? I can’t tell you how

deteriorated sharply. The estimate of the Bureau of Economic Analysis (BEA)

much I hear this every single

for annualized growth in Q1/2022 turned out unexpectedly low for many at -1.4%.

day. It’s like saying ‘I can’t smell

This means that expected growth for this quarter is already well below ourthe carbon monoxide. By the time

stagflation threshold of + 1 %. At 1.9%, the Federal Reserve Bank of Atlanta’s

you see the recession, your head’s

current forecast for Q2/2022 is also not promising and is well below the 3.0%

sliced off.

calculated as the initial forecast for Q1/2022.

Dave Rosenberg

In its most recent forecast, the IMF also made a significant downward
revision to its figures for the USA. While the IMF forecast growth of 5.2% for
the calendar year 2022 in October 2021 and 4.0% in January, the figure has now

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114

been reduced to 3.7%. In 2023, growth is expected to be only 2.3%. However, thepersistent inflationary pressure could lead to a negative surprise in terms ofgrowth, as higher prices lead to lower growth in a highly indebted society.

ISM (lhs), and PPI (18 Months Lead, rhs, inverted), 01/1960-04/2022
80

-10%

70

-5%

60

0%

50

5%

?
40

10%

30

15%

20
1960

20%
1965

1970

1975

1980

1985

1990

Recession

1995

2000

ISM

2005

2010

2015

2020

2025

PPI (18 Months Lead)

Source: Reuters Eikon, Incrementum AG

Liquidity is oxygen for a

The announced interest rate hikes and the equally announced QT – i.e. thefinancial system.

reduction of the central bank’s balance sheet by selling securities – will also have a

Ruth Porat

strong dampening effect on economic growth. The previously seemingly limitless
liquidity is now slowly drying up. According to Richard Duncan, the US
economy needs annual credit growth of at least 2% in real terms toescape recession.42 In all nine instances between 1952 and 2009 in whichinflation-adjusted total credit grew by less than 2%, the US entered a recession.
Currently, it looks as if this mark could be reached this year.

Real Total Credit Growth, and Real GDP Growth, 1952-2021
14%
12%
10%
8%
6%
4%
2%
0%
-2%
-4%
-6%
1952

1962

1972

1982

1992

Real Total Credit Growth

2002

2012

2022

Real GDP Growth

Source: Federal Reserve St. Louis, Incrementum AG

The shape of the US yield curve also points to a marked slowdown in US economic
growth. A study published by the San Francisco Federal Reserve in 2018shows that inverted yield curves have presaged most recessions sincethe 1950s. From an empirical perspective, narrowing interest rate spreads are—

42 See Duncan, Richard: “Stormy Weather Ahead,” October 15, 2021

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115

followed by economic downturns and then gold appreciation. This chronologicalsequence has been particularly evident since the Nixon shock in 1971.

Gold (lhs, log), in USD, and US Treasury Yield Spreads (rhs),
01/1970-04/2022

5,120

4%

2,560

3%

1,280

2%

640

1%

320

0%

160

-1%

80

-2%

40

-3%

20
1970

1975

1980

1985

Recession

1990

Gold

1995

2000

2005

TY10-T5Y

2010

2015

T10Y-T3Y

-4%
2025

2020

T10Y-T1Y

Source: Federal Reserve St. Louis, Robert J. Shiller, Reuters Eikon, Incrementum AG

Euro area
We are in the middle ofEven more so than in the US, growth rates in the euro area continue to be distorted

stagflation, at least in Europe.

upward by the base effect. Nevertheless, the IMF’s latest World Economic Outlook

Clemens Fuest,

forecasts growth of only 2.8% for the euro area in 2022, compared with 4.3%

President, ifo instituteprojected in October 2021 and 3.9% in January, with the IMF noting considerable
downward risks.

Effects on EU Real GDP, 2021-2027e
0.0%

1

-0.5%

1

-1.0%

1

-1.5%

1

-2.0%

1

-2.5%

0

-3.0%

0

-3.5%

0
2021

2022

2023

2024

2025

2026

2027

Commodity prices and supply chain disruptions
Plus higher inflation rates
Plus tightening of global financial conditions

Source: IMF, Incrementum AG

Moreover, the war in Ukraine has had a large impact on the European
economies, both as regards the direct consequences and the knock-on
effects caused by the incessantly spiraling sanctions. In its Monthly
Report – April 2022, the German Bundesbank calculates the impact of an EUenergy embargo on Russia on euro area GDP. The negative effects are fed by threesources: higher commodity prices, lower foreign demand, and higher uncertainty.
For 2022 and 2023, GDP in the euro area would be around 1.75% lower in eachcase, and for 2024 the GDP losses would be only marginally lower. For Germany inisolation, the GDP losses would be considerably higher at around 2% in the current

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116

year and around 3.5% in each of the next two years. A drop in the growth rate
below the 1% mark would be unavoidable in these scenarios for the three years
2022-2024.
Trade protection accumulates

The potential impact on GDP is even worse if, in addition to priceupon a single point the goodeffects, the impact of volume restrictions resulting from an embargo iswhich it effects, while the eviltaken into account. German GDP could slump by up to 5% compared with the

inflicted is infused throughout

baseline scenario. In this case, German economic output would fall by around 2%

the mass.

in 2022. The Gemeinschaftsdiagnose (Joint Economic Forecast) publishedFrédéric Bastiat

somewhat earlier by leading German economic research institutes arrives atsimilar dramatically negative consequences of an oil and gas embargo for theGerman economy. For 2023, this alternative scenario deviates by 5.3 percentage
points downward from the baseline scenario, with growth of 3.1% forecast for2023. For the current year, however, the 0.8 percentage point drag on GDP causedby an embargo would still be manageable.
We are certainly not going out on a limb with our assessment that these
forecasts are all on the optimistic side. At present, it looks as if theescalating spiral that has been set in motion will be continued by all parties
involved. In the event that the war escalates further or, even worse, spreads toother states, the effects on the economy could be catastrophic.

There is a fairly strong bias that

A telling risk assessment was made by Christine Lagarde at the press conference

stagflation of some kind is more

following the ECB Governing Council meeting on April 14: “The downside risks tolikely than not over the next 12

the growth outlook have increased substantially as a result of the war inmonths.

Ukraine.... The upside risks surrounding the inflation outlook have also

Deutsche Bank

intensified, especially in the near term.” In this context, the HICP for the euro area
has already been above the 3.0% mark since August 2021 and is now at 7.5% (April
2022). If the ECB were to take its own statements seriously, it would
have to assume that a stagflation scenario is extremely likely. In any
case, consumer confidence has rattled to an all-time low since theoutbreak of war.

Economic Sentiment and Consumer Confidence in the Euro Area,
01/2002-04/2022

120
100
80
60
40
20
0
-20

-40
2002

2004

2006

2008

2010

Economic Sentiment

2012

2014

2016

Consumer Confidence

2018

2020

2022

Long-Term Average

Source: Reuters Eikon, Incrementum AG

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117

True ignorance is not the absence

Once again, we would like to draw attention to the development ofof knowledge but the refusal tosentiment in the years before the Covid-19 breakout. Since the beginningacquire it.

of 2018, the economic sentiment barometer had been on a continuous downward

Karl Popper

trend. The brief recovery immediately before the Covid-19 crash was not a trend
break that could now be followed up. This upswing was solely due to theanticipation of certain sales that could not be completed because of circumstancesno one could foresee at the time.

The odds that we’ll have a global

Despite all the (purposefully) optimistic forecasts, a number of factors

recession are rising by the day.

currently point to increasingly recessionary trends in large parts of the

Kenneth Rogoff

world:• Rising interest rates, quantitative tightening (QT)• Strongly flattening yield curve, which is already partially inverted• Falling stock markets• Sharp rise in oil, gas and electricity prices• Sharp drop in consumer confidence• Slowly rising loan default rates• Weakening of economy due to lockdowns to combat Covid-19 pandemic• Persistence of supply chain issues• Threat of fertilizer and food crises due to war in Ukraine• An increasingly fragile Chinese economy stubbornly adhering to the zero-Covid
policy.

• Sharp rise in geopolitical tensions

Stagflation-Proof Portfolios“I think that most likely what we are going tohave is a period of stagflation. And then you haveto understand how to build a portfolio that’sbalanced for that kind of environment.”
Ray Dalio
We are beginning a paradigm

If our assessment that we are currently experiencing the end of the 40-

shift. A paradigm shift is a shift

year disinflationary Great Moderation is correct, there are serious

from one mindset andconsequences for investors. In our view, there will probably be a longer-term

positioning of that mindset toprocess until the collective mindset of investors has completed this paradigm shift.

another mindset and anotherA fundamental repositioning of many portfolios and thus a reallocation of

positioning of that.

enormous amounts of financial capital will be the consequence of this paradigm

Ray Dalio

shift. These reallocation processes will probably last for several quarters, if not
years.

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118

US CPI, yoy%, 01/1961-04/2022
16%
14%Great Moderation
over?

12%
10%
8%
6%
4%
2%
0%
-2%
-4%
1961

Great Moderation
1966

1971

1976

1981

1986

1991

Recession

1996

2001

2006

CPI

2011

2016

2021

Decade Average

Source: Reuters Eikon, Incrementum AG

The narrative of temporary inflation was able to reassure most market
participants for a surprisingly long time. This is in large part because thebulk of Western investors have never been confronted with a significant increase ininflation during their active careers as investors, let alone with a prolonged
inflationary or even stagflationary period.

Consecutive Months Above 3% CPI Inflation, 01/1860-04/2022
140

129

120
100
80
58

60
40

54

55

40

20

13

0
1860 1870 1880 1890 1990 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020

Consecutive Months Above 3% CPI Inflation
Source: Crescat Capital LLC, Reuters Eikon, goldchartsrus.com, Incrementum AG

Many investors are still significantly influenced by the disinflationary
past of the last decades. A look at 5y5y inflation expectations shows asignificant probability that elevated inflation figures could be a multi-year
condition, and it is one that is still not nearly priced into the market.

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119

5-Year, 5-Year Forward Inflation Expectation Rate, 01/2003-05/2022
3.5%
3.0%

2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
01/2003

01/2006

01/2009

Recession

01/201201/2015

01/2018

01/2021

5-Year, 5-Year Forward Inflation Expectation Rate

Source: Federal Reserve St. Louis, Incrementum AG

From an investor’s point of view, however, this is precisely where a promising
opportunity lies, as enormous amounts of capital will be reallocated in the courseof this inflation paradigm shift.

Stagflation: Poison for the Balanced Portfolio?
The rules of the game for

Stagflation is possibly the most challenging environment for investors.

investors are changing and

At this point, we would like to take a rough overview of the different asset classes

portfolios anchored to a belief inin times of stagflation. As mentioned, there are not too many recent precedents fortransitory inflation are

pronounced stagflation in Western countries. We will therefore focus on the 1970s.

dangerously exposed.
Jamie DannhauserWith high inflation and rising yields, fixed-income securities are theobvious losers. Constant interest payments in the face of ongoing monetary
depreciation reduce the value of a security. The longer the maturity, the higher thepurchasing power-adjusted risk of loss. Values are also nominally at risk, namely
when returns on the capital markets rise and the market value of the security falls.
Investors suffered significant losses on bonds in the 1970s. In 2022, too,bondholders have recorded painful losses so far.

Real Annual Returns of US 10-Year Treasury Bonds, 1970-1980
20%
15%
10.6%

10.6%
10%

6.3%

5%
0%

-0.6%
-5%

-3.1%

-4.6%
-10%

-5.1%
-9.0%

-9.2%

-11.1%-15%-13.8%

-20%
1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

US 10-Year Treasury Bonds
Source: Stern School of Business, Incrementum AG

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120

As the following chart shows, for the second of the two 100-year Austrian
government bonds issued to date, with a coupon of a measly 0.850% and an issue
yield of 0.880%, the investment has been anything but a good one so far. As areminder, this bond, with a volume of EUR 2bn, was oversubscribed 12 times (!!!)
when it was issued in 2020, not so long ago.

Austrian 100-Year Bond (0.85%, 06/30/2120), in %, 07/2020-05/2022
150%
140%
130%
120%
110%

100%
90%
80%
70%
60%
50%
07/2020

10/2020

01/202104/2021

07/2021

10/2021

01/2022

04/2022

Austrian 100-Year Bond
Source: Deutsche Börse, Incrementum AG

But stocks as an asset class are not inflation-proof per se, either. During
the stagflationary decade of the 1970s, US equities also performed weakly in realterms.

Wilshire 5000 Full Cap Index (lhs, log), and CPI (rhs), yoy%,
01/1971-04/2022

50,000

16.0%
14.0%
12.0%
10.0%
8.0%

5,000

6.0%
4.0%
2.0%
0.0%
-2.0%

500
1971

-4.0%
1976

1981

1986

1991

1996

2001

Wilshire 5000 Full Cap Index

2006

2011

2016

2021

CPI

Source: Reuters Eikon, Incrementum AG

Only selected sectors, such as mining stocks and commodity shares, were able toescape the negative overall trend.

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121

Inflation Adjusted Performance of BGMI, GSCI TR, and S&P 500
TR, 100 = 12/31/1969, 01/1970-12/1980

700
600
500
400
300
200
100

0
1970

1971

1972

1973

1974

BGMI

1975

1976

1977

1978

1979

S&P 500 TR

1980

GSCI TR

Source: Reuters Eikon, goldchartsrus.com, Incrementum AG

And therein lies the crux for investors: Both asset classes, equities andbonds, are clobbered at the same time during stagflation. This is clearlyreflected in the correlation between the two asset classes and is precisely whatmakes construction of a diversified portfolio so challenging. Conventional mixed
portfolios face unusually high losses when the correlation between these two asset
classes increases.

1-Year Correlation of UST10Y and S&P 500, 01/1970-01/1980
1.0
0.8
0.6

0.4
0.2
0.0
-0.2
-0.4
-0.6
-0.8
-1.0
1970

1971

1972

1973

Recession

1974

1975

1976

1977

1978

1979

1980

1-Year Correlation of UST10Y and S&P 500

Source: Reuters Eikon, Incrementum AG

Another problem is that holding cash reserves at negative real interest
rates obviously leads to capital destruction. Therefore, cash should at best
be held only in the short term as part of tactical asset allocation.

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122Real Annual Returns of US 3-Month Treasury Bills, 1970-1980
2%
1%

0.8%

1.0%
0.6%
0.1%

0%
-1%
-1.0%

-1.1%

-1.3%

-1.5%

-2%

-1.7%

-3%

-2.9%

-4%
-4.0%
-5%
1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

US 3-Month Treasury Bills
Source: Stern School of Business, Incrementum AG

In an environment of rising inflation, inflation-sensitive investments
are indeed in demand. These typically include commodities or commodityrelated investments such as commodity equities or commodity currencies.
Furthermore, bonds of commodity-exporting countries such as Brazil or Australia,
inflation-indexed bonds, and real estate can be considered as inflation-sensitive
investments. However, none of these asset classes is flawless. We havecompared the most important inflation-sensitive asset classes below,
including their advantages and disadvantages.

Inflation-Sensitive
AssetsAdvantages

Disadvantages

Precious metals

Liquid, nocounterparty risk

Inflation protection only over long periods

Mining shares

Productive assets,
dividends

Equity market risk

Raw materials

High correlation with
inflation trend

High storage costs or negative return
due to rolling losses

Commodity stocks

Productive assets,
dividends

Equity market risk

Commodity currencies

Correlation to raw materials withoutstorage costs

No productive capital

Bonds:
emerging markets & commodity exporters

Yield

Interest rate risk, issuer risk

Inflation-indexed bonds

Direct hedge against theofficial inflation rate

Counterparty risk, inflation rate underreported, hedges only over term

Real Estate

Yield

Credit cycle, vulnerable to regulation
with inflation

Source: Incrementum AG

It seems intuitive that an investment in commodities is profitable intimes of high inflation. However, implementation in the portfolio involves
some pitfalls. Direct, physical investment in commodities is often difficult. The
main problems with direct investments are that they involve high storage costs orthat it is impractical to invest in the commodities themselves due to theirperishable nature (agricultural commodities, for example). This is one of theadvantages of investing in physical precious metals, as they can be stored
for a long time at a reasonable cost without any loss of quality.

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123Annual Returns of Gold, Silver and CRB Index, 1970-1980
300%
250%
200%
150%
100%
50%
0%
-50%
1970

1971

1972

1973

1974

Gold

1975

1976

1977

Silver

1978

1979

1980

CRB Index

Source: goldchartsrus.com, Incrementum AG

An investment in gold is therefore the simplest and most favorable way
to invest in a physical commodity over the longer term. However, it
should be noted that gold has a significantly lower correlation to the inflation rate
than broad commodity indices.

Rolling 5-Year Correlation of CPI Inflation Rate, yoy, Gold, and
GSCI TR, yoy%, 01/1976-04/2022

1.0

0.6

0.2

-0.2

-0.6

-1.0
1976

1981

1986

1991

CPI vs. Gold

1996

2001

2006

2011

2016

2021

CPI vs. GSCI TR

Source: Reuters Eikon, Incrementum AG

The best measure of inflation is

If investors want to hedge more directly against rising inflation, awhat is happening withbroader commodity exposure is appropriate. Futures contracts ofcommodity prices.

exchange-traded commodities are a possible alternative to physical direct

Stephen Moore

investments. The disadvantage of using these instruments is that a buy-and-holdinvestment in commodity derivatives is typically accompanied by rolling losses.
Ultimately, these losses reflect storage and financing costs.

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124

BCOM Spot, and BCOM Total Return, 01/1991-05/2022
800
700
600
500
400
300
200
100
0
1991

1996

2001

2006

Spot

2011

2016

2021

Total ReturnSource: Reuters Eikon, Incrementum AG

The situation is different for shares in companies that participate in
the value chain of commodity production. An investment in such stocks
means co-ownership of productive capital which – disregarding the potentiallysignificant company-specific risks – basically generates positive returns.
Nevertheless, as a shareholder you are typically at the mercy of general stock
market sensitivity, i.e. beta, which can be a consistent headwind in a stagflationary
environment – especially when a recession is looming.
Of course, there are also companies in other equity sectors that can, for example,
pass on increased costs due to their pricing power or benefit from the substitutionof expensive goods. In any case, the correlation with the inflation rate islower with equity investments, and company-specific risk iscorrespondingly present.

US Equity Sector Performance in High (+3% on average) and
Rising Inflation Environments, 1973-2020
Average 12-Month Inflation-Adjsuted Return

10%

EnergyPrecious Metals& Mining
Utilities
High level of outperformanceCons. Staples
vs. inflation
Health Care

5%0%

Equity REITs

Telecoms

Industrials
Financials
US Equity Market
Materials-5%

ITCons. Disc.

-10%

Mortgage REITs

-15%
25.0%

30.0%

High probability of beating inflation

35.0%

40.0%

45.0%

50.0%

55.0%

60.0%

65.0%

70.0%

75.0%

% of Time with Positive Real Returns Over Rolling 12-Month Period
Source: Schroders, Incrementum AG

While commodity stocks are typically among the winners in a
stagflationary phase, technology stocks are particularly negatively
affected. This is because growth stocks typically discount profits that lie far in the
future in order to price them in today. Therefore, there is also an especially highsensitivity to long-term yields – i.e. a duration risk – which typically provide the

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125basis for a discount rate. But any profit margins are also at risk if costs rise.
Provided investors have the appropriate risk tolerance and financial market
knowledge, tactical short positions within this sector can be promising trades. The
same applies to government bonds, which experienced investors can short via
futures, for example, in order to profit from rising yields.
Bitcoin is not a synonym for

How the young asset class of cryptocurrencies will fare within acriminality and darknet money

stagflation remains to be seen. In particular, store-of-value tokens such as

anymore. Today, it is more andBitcoin could increasingly be seen as an alternative store of value due to theirmore becoming a synonym fornoninflationary nature. Most recently, Bitcoin has tended to show a highsound money, a hedge against

correlation with technology stocks, which, as mentioned above, tend to suffer fromthe current system, a vote forrising inflation.

freedom, a different paradigm.
Gigi

3-Month Rolling Correlation of Nasdaq and Bitcoin, 11/201405/2022
1.0
0.8
0.6
0.4
0.2
0.0
-0.2
-0.4
-0.6
-0.8
-1.0
11/2014

11/2015

11/2016

11/2017

11/2018

11/2019

11/2020

11/2021

Nasdaq vs. Bitcoin
Source: Reuters Eikon, Incrementum AG

Nevertheless, one should not only look at the correlations in thisrespect but also keep an eye on the relative performance of the assets.
The Bitcoin/Nasdaq ratio shows that Bitcoin has significantly outperformed
Nasdaq over time. Against this backdrop, a certain admixture of Bitcoin with otherinflation-sensitive assets seems consistently advisable in a balanced portfolio.

Bitcoin/Nasdaq Ratio, 08/2014-05/2022
5.0
4.5
4.0
3.5
3.0
2.5
2.0

1.5
1.0
0.5
0.0
08/201408/2015

08/2016

08/201708/2018

08/2019

08/2020

08/2021

Bitcoin/Nasdaq Ratio
Source: Reuters Eikon, Incrementum AG

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126

Stagflation-proof fund strategies
Diversification is the only free

As we have seen, conventional portfolios are particularly vulnerable tolunch in finance.

rapidly rising inflation or stagflation. To diversify a broad portfolio, weHarry M. Markowitz

designed an investment strategy more than eight years ago that focuses on
inflation-sensitive asset classes. Our Incrementum Inflation Strategy is managed
using an absolute return approach. The investment process focuses on
flexible positioning for inflationary or disinflationary phases. The
positioning is largely determined by our Incrementum Inflation Signal43. In thisfund, we invest in a broad range of inflation-sensitive assets such as precious
metals accounts, commodity stocks, derivatives on commodity indices, or
inflation-indexed bonds. In addition, within this strategy we can tactically shorttechnology stocks and bonds, for example. The strategy serves as a portfolio
building block that can be added to a broad portfolio for diversification
purposes.

Incrementum Inflation Strategy, and GSCI TR EUR*, 100 =21.02.2014, 02/2014-04/2022

130
120
110

100
90
80
70
60
50
40
30
02/201402/2015

02/2016

02/2017

02/2018

02/2019

Incrementum Inflation Strategy

02/2020

02/2021

02/2022GSCI TR EUR*

Source: Reuters Eikon, Incrementum AG*Calculation incl. 1% p.a. TER

For crypto-savvy investors, we provide additional stagflation portfolio
building blocks with our two crypto/gold strategies. We featured thestrategy in the In Gold We Trust report 201944 and provided an interim report of
excellent results in the In Gold We Trust report 202145. We have taken the liberty
to extend the price time series of the investment strategy by a back-calculated
performance of the strategy’s strategic allocation of 75% gold and 25% Bitcoin by a
few years to convey a better sense of the results.

—

43 See chapter “Status Quo of the Inflation Trend” in this In Gold We Trust report
44 See “Gold and Bitcoin: Stronger Together?,” In Gold We Trust report 201945 See “Bitcoin & Gold – Our Multi-Asset Investment Strategy in Practice,” In Gold We Trust report 2021

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127

Static Allocation (75% Gold/25% Bitcoin), Incrementum
Gold/Bitcoin Strategy, and Gold, in USD, 1.000 = 02/2014, 02/201404/2022
7,000
6,000
5,000
4,000
3,000
2,000
1,000
0
02/201402/2015

02/2016

02/2017

02/2018

02/2019

02/2020

02/2021

02/2022

Static Allocation (75% Gold/25% Bitcoin)*
Incrementum Gold/Bitcoin Strategy
Gold
Source: Reuters Eikon, Incrementum AG*Calculation incl. 3% p.a. TER

People will always try to stop

The strategy has a low correlation to most other asset classes, which isyou from doing the right thing if

why it can be considered as a diversification building block for

it is unconventional.

balanced portfolios. We looked at some different combinations of these two

Warren Buffett

portfolio building blocks. Again, to be able to look at a longer time horizon, we
have extended the time series for the younger of the two funds, the gold/Bitcoin
fund, by adding the strategic asset allocation of 75% gold, 25% Bitcoin.

Static Portfolio of Incrementum Inflation Strategy, andIncrementum Gold/Bitcoin Strategy*, 02/2014-04/2022
280
260
240
220
200
180
160
140
120
100
80
02/201402/2015

02/2016

60% Inflation Strategy

02/2017

02/2018

02/2019

02/2020

70% Inflation Strategy

02/2021

02/202280% Inflation Strategy

Source: Reuters Eikon, Incrementum AG*until 02/26/2020 static allocation (75% Gold/25% Bitcoin), in USD

Conclusion
Value investing is at its core theStagflation means an extraordinarily challenging environment for

marriage of a contrarian streak

investors. Conventional investment concepts, shaped by the disinflation of theand a calculator.

past decades, are already starting to cost their investors dearly. An admixture ofSeth Klarman

inflation-sensitive asset classes is recommended for anyone who wants to diversify
their portfolio and hedge against increasingly likely stagflation. In addition to gold,these are primarily commodity-heavy investments such as commodity index
derivatives, commodity equities or, with some exceptions, inflation-indexed bonds.

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128

US Dollar Index (x-axis), yoy%, US Real 10Y Bond Yield (y-axis),yoy, and Gold Performance (Bubble Size), yoy%, 01/1972-04/2022

10%
8%
6%
4%

2%
0%
-2%
-4%
-6% 70s Stagflation
-20%

-10%

Gold Price Up

0%

10%

20%

30%

Gold Price Down

Source: Reuters Eikon, Incrementum AG

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130

Stagflation and a New Gold
Standard – Exclusive
Interview with Alasdair
Macleod“When fiat currency really does begin to fail,there will come a point where central
bankers’ own pay will need to be secured. The
last resort will be to come up with some sortof gold standard. The real question is,
how long will it take until we get to thatpoint?”
Alasdair Macleod

Key Takeaways• We are now in a situation where we have a lack of

economic growth and rising prices. This is temporary.
The collapse of the purchasing power of paper
currencies and what is actually driving that is what weshould be thinking of.
• During the stagflationary period of the 1970s, central

banks had to raise interest rates to as high as 20% in
order to fend off inflation. This is impossible in today’s
economy because of high levels of debt and deficits.
This is made even worse by globalization.
• Central banks could be forced to recapitalize by

increasing the value of their gold holdings significantly.
This could usher in a new world monetary system basedon gold.
• Central bankers seem to believe that small rate hikes

could solve the problem, but the real problem is theamount of currency in circulation.

Stagflation and a New Gold Standard – Exclusive Interview with Alasdair Macleod

131

Alasdair Macleod is the Head of Research for Goldmoney. For most of his
40 years in the finance industry, he has been demystifying macroeconomic events
for his investing clients. The accumulation of this experience has convinced himthat unsound monetary policies are the most destructive weapon governments use
against the common man. Accordingly, his mission is to educate and inform thepublic in layman’s terms about what governments do with money and how toprotect themselves from the consequences.
Find him on Twitter at @MacleodFinance.
Ronnie Stöferle and Mark Valek conducted this interview with Alasdair Macleod byZoom on April 2, 2022. We publish the highlights of the interview below. The fullversion is available for download here.
The video of the entire conversation, “Stagflation and a New Gold Standard”, canbe viewed on YouTube here.

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132

Ronnie Stöferle:
It’s my great pleasure to have my dear old friend Alasdair Macleod here as a guest
for a special interview on the topic of stagflation. Alasdair, thanks for taking thetime.
Let’s start with the official definition of stagflation. I don’t know if there’s a right orwrong definition, but I had a look at the definition by Investopedia, and it says:“Stagflation is characterized by slow economic growth and relatively highunemployment or economic stagnation. Which is at the same time
accompanied by rising prices. Stagflation can be alternatively defined
as a period of inflation combined with a decline in the grossdomestic product.”
History is too serious to be left toNow, I know that your uncle, Ian Macleod, was the shadow chancellor in 1965, andhistorians.

he basically coined the term stagflation, but he had a slightly different

Iain Macleodinterpretation, or I think the context was different. In what context did your uncle
first use this term stagflation, and how did he define it?
Alasdair Macleod:

I cannot help it if every time the

He invented the term basically to describe the economic situation at that time. And

Opposition are asked to nameit was a mixture of falling productivity on the one side and rising wage inflation on

their weapons they pickthe other side. So that was the original context in which stagflation was defined;

boomerangs.

but since then, people have taken it into the broader sense of describing a

Iain Macleod

situation, as you rightly sort of indicated from the Investopedia definition. If you
have an economy which is not doing terribly well and you have rising prices at thesame time, it’s a combination of stagnation and inflation, so it’s “stagflation”.

If you have an economy which isI think that the modern interpretation shows an ignorance of economics, because

not doing terribly well and you

it’s the Keynesians, in effect, saying that the only driver of prices is demand,

have rising prices at the same

consumer demand. Therefore, you now have a situation where you have atime, it’s a combination oflack of economic growth or a recession and rising prices, which isstagnation and inflation, so it’scompletely impossible. But they have come to call this stagflation.

“stagflation”.
In other words, they see it as something which is essentially temporary. I don’tknow whether you ever discussed what happened in Austria in 1921/22 with yourgrandparents. When we had a collapse of the Austrian crown?
In Keynesian analysis, you

The idea that the Austrian economy somehow was booming while thiscannot have a situation where

was going on is complete nonsense; but in Keynesian analysis, you cannot

you’ve got inflation, in otherhave a situation where you’ve got inflation, in other words rising prices, and awords rising prices, and acollapsing economy. So how do they explain that? I mean, it seems to me that one

collapsing economy.

way or another, we are in the sort of crisis which is probably not best described as
stagflation, except in the temporary sense. At the moment what we see is thedilemma of a global economy which is slowing in its growth; or at least
the big locomotive, China, is certainly slowing big-time, and all the othereconomies are slowing as well. Yet, at the same time, we have rising prices.

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133

Stagflation, actually does

Thus, stagflation, in the modern sense, actually does describe the current situation,

describe the current (world

but I think that’s temporary; and I’m sure that as this interview moves along, we

economic) situation, but I think

will address the issue of why stagflation is temporary and that what we should

that’s temporary.

actually be thinking in terms of is the collapse of the purchasing power of
paper currencies and what is really driving that.
Mark Valek:

We had an example ofI think that’s a great introduction, so when it comes to the term stagflation, as you

stagflation in the 1970s in the US.

already described in the modern interpretation, we had this great example in

How did they manage to get out

the 1970s in the US, and it’s often referred to as the only example of stagflation.

of that environment?

At the start of the 1980s, the US was able to get out of this kind of environment.
How would you describe this? How was this able to happen, and do you think this
could be happening again this time around?
Alasdair Macleod:

In the 1970s, Paul Volcker jacked

I think it actually gets to the center of the issue. At the end of the 1970s, Paul

up interest rates toVolcker jacked up interest rates to unprecedented levels. The Fed Funds Rate went

unprecedented levels. The Fed

to close to 20%. This meant that the prime rate, which is a margin over that, wasFunds Rate went to close to 20%.

something like 20.5%. That had one specific purpose, which was to stop theincipient inflation from turning into hyperinflation. If they had notdone that, we would have seen the destruction of the dollar, because,
remember, we went off the gold standard or what was left of the gold standard at
the beginning of the decade. That was a necessary action.

Imagine if they raise interest

Now imagine the situation today. If they raise interest rates even to fiverates even to 5% today, let alone

percent, let alone 20 percent, the industries that are stuffed full of

20%. The industries that aremalinvestments are going to come unstuck. Which means that the banks

stuffed full of malinvestments arewill have to be rescued. Not only will financial collateral values be collapsing, but

going to come unstuck. Think ofloans to industry and all the rest of it will start to become unstuck. The central

what 5% interest rates would dobank will have to rescue the banks to rescue the economy. We’reto government finances.

talking about 5%, not 20%; and think of what a 5% interest rate does togovernment finances.

In the ‘ 70s and ‘ 80s we didn’t

When you go back into the 1970s and 1980s, we didn’t have these huge

have huge budget deficits tobudget deficits to finance. We had budget deficits, but they tended to be morefinance.

cyclical than permanent. Now, not only are they permanent but they are
unimaginably large; and you have governments, not just in America but all over
the world, who seem to think that the money tree is there just to be plucked, andthat they can borrow. They think they’re borrowing with impunity, to deal
with their existing problems; but the problem is that the other side ofinflation is debt, so just to look at debt is actually looking at the wrong thing.

No one today has the mandate or

You should be looking at the amount of currency and credit in circulation, because

the will to introduce an interest

real money, which is gold, doesn’t circulate at all in this current

rate policy which is designed toenvironment. You’ve got to be looking at that and thinking: “What happens

kill inflation.

when the situation destabilizes?” Coming back to your question, I just cannot
see how today anyone either has the mandate or the will to introduce
an interest rate policy which is designed to kill inflation, in the way
Volcker did.

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134

Ronnie Stöferle:
We both agree that’s pretty much

I just got this book that I’m currently reading, Keeping

impossible raise interest rates

at It, by Paul Volcker. It’s a good read, and hesufficiently within this monetaryemphasizes the topic of trust and trust in the US

system, even if Jerome Powelldollar, why people trust gold. I found it pretty

wanted to.

fascinating that Jerome Powell, in a recent hearing,referred to Paul Volcker as one of the greatest servantsin the history of the United States. I think he wastrying to sound like a “mini-Paul Volcker”, obviously,
but I think we all know that, as you rightly said, it’s
impossible to go back to those interest ratelevels. However, for some reason, most market
participants really think that now we’re seeing a big
turnaround in interest rates. Seven to nine hikes in thenext couple of months. I think we both agree that’s
pretty much impossible within this monetary system and at this stageof the financialization of our economies.

What are the major similarities

But let’s briefly go back to the 1970s. From your point of view, what are theand differences between now andmajor similarities and also the major differences between the economy today andwhat happened in the ‘ 70s?

the economy of the 1970s, and do you think the situation at the moment is more
serious or less serious than back then?
Alasdair Macleod:
Well, there are obviously huge differences between the economy now and in the
1970s, and I think one thing I would point out is the fact that today we are in a
globalized economy. We are all tied into exactly the same policies. It was less soin the 1970s. You could have a situation where one economy was having trouble
but there were other economies that were all right and some or other arbitrage
came to the rescue of some of the economies that weren’t performing too well.

The globalization of finance has

Now we are all going in exactly the same direction, and there’s

caused everyone to be all tied

globalization. People talk about globalization in terms of supply chains and theinto the same financial policies.

disruption that it causes, but the one thing they don’t look at is the globalization ofThis time, everyone is in themoney and currencies, and that is actually the problem. Everyone is tied intosame boat.

exactly the same interest rate policies and ways of managing theireconomy in terms of trying to suppress interest rates as much as possible. Keepthe cost of government borrowing down and aim for a 2% inflation target, while atthe same time fostering maximum employment. We are all on the same crazyspreadsheet, and that I think is the big fundamental difference between then andnow.
Mark Valek:
In my view a very obvious part of the problem is that the whole system isplagued with debt, and I think this is basically a function of our debtbased currency system. We have to go deeper and deeper into debt because thiswhole system is built on debt, and this results in these exponential curves ofcurrency supply and also of debt mounting higher and higher.

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135

At the end of the 1970s, what happened was due to the fact that the gold
price actually increased that much. This was kind of a recapitalizationof the system. My question to you would be, do you think that a significant
revaluation of the gold price could recapitalize the system, starting from central
bank balance sheets? Because at the end of the day, in my view at least, the real
equity of a central bank balance sheet is gold, right? Since the gold position in
relative terms to the debt positions has shrunk significantly, it would bepossible to basically recapitalize the central bank and, at the end of theday, the whole economy, if the central banks’ gold position were toincrease significantly. What are your views on this thought?
Alasdair Macleod:
The last resort will be to come up

Undoubtedly, that is correct. I think that’s the end solution, because whatwith some sort of gold standard.

we’re likely to see is a speeding up of the falling purchasing power of currencies. At

This could happen quite rapidly.

the moment they’re sitting on the price of gold; they sit on it because it’s a rival in

Major central banks are running

this fiat paradigm. But when fiat currency really does begin to fail, there

into enormous difficulties in theirwill come a point where central bankers’ own pay will need to be

own books because they havesecured, and so will the politicians’ pay. At that stage, the last resort will be totaken on so much government

come up with some sort of gold standard. I think the real question is, how

debt.

long will it take until we get to that point? My view is that it will actually happen
quite rapidly from here, and the reason is that major central banks are
already running into enormous financial difficulties on their own
books, because they have taken on board massive amounts ofgovernment debt.
If you look at Japan, it’s not just government debt, it’s also corporate
bonds and it’s also equity ETFs. They have done what a central bank shouldn’t
do; their balance sheet is like 80/90 percent bonds now, rather than being thecounterparty to currency. Which is really what a central bank should do. What
happens as we see those rising yields? Obviously, all these central
banks go into negative equity. They are already there, and what’sinteresting is that as we speak, we see the yen appears to be in the earlystages of a collapse.

USD/JPY, 01/2020-05/2022
135
130
125
120
115
110
105
100
01/2020

04/2020

07/2020

10/2020

01/202104/2021

07/2021

10/2021

01/2022

04/2022

USD/JPY
Source: Reuters Eikon, Incrementum AG

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The yen appears to be in the

In the last four or five weeks it’s gone from JPY 115 to the dollar, to this morning

early stages of a collapse. The

we’re looking at JPY 121–122. It really is a very serious fall in the purchasing power

euro also displays greatof that currency, and this reflects the overall financial situation and the fact that

weakness.

the Japanese central bank is in negative equity. Now, these things can be resolved,
but the worst time to resolve a central bank in negative equity is when
there is a financial crisis developing, and that’s roughly the combination that
I see. The other real weakness is the euro system.

The ECB is in massive negative

The euro system is potentially worse because there you’ve got the ECB. It’sequity itself, and so are all its

now hugely in negative equity itself, and all its shareholders, who are theshareholders. This will havenational central banks, are in negative equity as well, with a few very, very minor

massive implications should

exceptions. Their banking system, if you look at the euro area G-SIBs, there againinterest rates rise.

you have leverage – assets to equity – of well over 20 times. How areyou going to resolve this situation when we see rising interest rates,when we see the ECB being forced to raise its deposit rate above zero? There arepotential collapses looming.

When the fiat system fails, we

To get back to your point about the role of gold, at some stage, unfortunately,

will find out who actually has the

you’ve got the French central bank, you’ve got the Italian central bank, the German

gold. It will all revolve aroundcentral bank, and so on. They’ve actually got significant holdings of physicaltrust. Gold will come back togold, or at least we are told they have. But quite a lot of their gold might be leased

underwrite the whole of theout; and this is a very serious issue, because when the fiat system fails, wemonetary system by being

will find out who actually has the gold. They are going to have to backexchangeable for paper.

their currencies with gold, and in the case of the euro I think we are probably
going back to the Deutsche Mark and maybe one or two other currencies. The
second-tier currencies will fail. I can tell you that because this revolves
around trust. The Italian central bank has got a lot of gold. But can you imagine
going back to the Italian lira? How much respect would the lira have? I mean, they
can deal with it, but they would have to have a proper “gold coin standard” in orderto make it stick. I think what we’re likely to see is, yes, gold will come back tounderwrite the whole of the monetary system by being exchangeablefor paper.

This time it will have to be a real

It will have to be, and it’s not just a question of doing what Germany did in 1923

gold standard. Government willwith Hjalmar Schacht, where they said, “We are going to introduce a new standard

have to stop spending all thisbut not actually make it convertible into anything”. This has got to be real thismoney. The transition back to atime in order for it to stick; and of course, the other side of it is thatgold-backed currency will begovernment is going to have to stop spending all this money on welfare

hard.

and fancy projects and all the rest of it. They’re going to have to cut rightback. It’s not going to be an easy transition from this Keynesian worldback into the real world, where it’s the productive side of the economy thatmatters and government should be as small as possible. A lot is going to have tohappen to get back to a situation where gold is backing a currency, turning acurrency into a gold substitute. A lot has to happen before that is going to work.

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Ronnie Stöferle:
Central bankers seem to believe

I have so many thoughts to pick up on from your answer. What’s really fascinatingthat by making small rate hikes

is the fact that central bankers seem to believe that by making small ratethey will get the inflation

hikes they will get the inflation problem under control again. If we lookproblem under control. They stillback to the hiking cycle from 2004-2006, the Federal Reserve did 17 rate

blame inflation on the energy

hikes. But inflation only peaked one year after that. I think it’s interesting

shock.

that it seems central bankers still believe that they have got everything undercontrol, while the market is already telling us that things aren’t going so well.
Basically, everybody is still blaming the energy shock and saying that it is mainly
responsible for rising inflation. However, if you look at headline inflation and core
inflation, the differential is quite low. It’s not only energy and food that is
rising, it’s much broader.

Central bankers now seem to

In last year’s In Gold We Trust report, wehave new mandates, such as

wrote at length that we are seeingsaving the planet, climate

amonetary climate change and that thischange, and dealing withpendulum is now really swinging

inequality. We also see rising

into the direction of rising inflation,

wages. Do you potentially see aand there’s actually quite a number ofwage-price spiral as a driver offactors, for example this move frominflation?

monetary to fiscal dominance. We’reseeing that central bankers now seemto have new mandates, for example,
saving our planet, climate change
and dealing with inequality. Wwhat
other inflationary drivers do you see thatthe mainstream is missing at the
moment?
Alasdair Macleod:

Businesses paying wages will

The thing that the mainstream is missing, more than anything else, is thehave to decide if they can afford

increase in the amount of currency and credit in the economy. That ishigher wages or not.

the root cause of it all.

Inflation isn’t rising prices;
inflation is the expansion of theInflation isn’t rising prices, inflation is actually the expansion of thequantity of money. The people

quantity of money. The thing that I think is amazing is that the FOMC (Federal

licensed by the establishment

Open Markets Committee) never mentions the quantity of money in its

don’t seem to know that.

deliberations. They are always talking about prices rising here or
temporary rises there or supply chain problems or all the rest of it.
Those are the only things that get picked up by the people who are licensed by theestablishment to manage money and to run banking licenses. They just literally
follow this meme the whole way through, and the result is that the underlying
cause is completely neglected. IIt is always the increase in the quantity ofmoney and credit. Now, I don’t subscribe to the monetarist theory, on the basisthat it is not the only thing that drives the purchasing power of a currency.

It is very important how theThe other thing, which is actually desperately important, is how the public rate

public rate a currency. Publica currency. Now, I’ll give you an extreme example. If the public decide thatperception about the currency isirrespective of any change in the quantity of currency, that they don’t want to use it

what monetarists miss.

for transactions, then, rather like the Russians now finding out that the dollars andLinkedIn | twitter | #IGWTreportStagflation and a New Gold Standard – Exclusive Interview with Alasdair Macleod

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euros in their reserves are completely worthless, the public perception of thepurchasing power of a currency, or its use value as a medium of
exchange, is the factor that monetarists miss.
The increase in money supply is

The thing is, fluctuations in the quantity of money and credit created thethe real factor that creates anAustrian business cycle, in other words the periodic boom and bust that

artificial economic boom. It is

we see; and this periodic boom and bust is a very human thing, it’s bankers

likely that people such as Jerome

getting more encouraged by the initial stimulation of an economy,

Powell know this, but they are

which comes from the central bank reducing interest rates, encouraging

unable to admit it because it

people to borrow, and eventually it builds up. Then you get to a situation

would cause havoc in thewhere perhaps a bank has a leverage of, say, 10x or 12x assets to equity. Remember

economy.

what I was saying about over 20 times in Japan and the euro area, so you can see
how this is a cycle of events, and that’s the next one they’re going to have to try andsave us from. The whole situation is completely misread. I look at it from anotherangle: What if Jerome Powell was actually to stand up and say, “The real
problem we have is not supply chains, it’s not energy prices, it’s theexcessive production of currency and credit, and that is the situation
we’ve got to deal with.” I mean, that would be shock, horror – can you justimagine what would happen if he spoke the truth? Now, I don’t know how much hebelieves in money being the “driver” of the price of currency. I’m sure he believes a
lot more than he’s letting on, but the one thing he cannot say is the truth,
because it would destabilize the whole economic system.
Mark Valek:
Fascinating. Perhaps going back to the comparison between the stagflation of the
1970s and the current situation, one of the similarities, I would argue is - and wewrote this in last year’s report - the new ice age between East and West. In the
1970s we were in the midst of the Cold War, obviously, and unfortunately it seems
we are back there. We even have hot war now, so I think this comparison is also
very interesting from a geopolitical standpoint and very relevant also to the global
architecture of the currency system and the financial system. What are yourthoughts in that regard? I mean, I’m obviously alluding to de-dollarization andespecially to what I think was really a key event, the freezing of Russian assets.
What do you think will be the effects of these developments?
Alasdair Macleod:

The War in Ukraine is really aIt’s a very dynamic situation. I mean, between my commenting here

proxy war between Russia andand this interview actually coming out, you never know, it might all

NATO, which is dominated bychange. But I think the underlying problem is that Ukraine is a proxy war. That’s

the US. Sanctions against Russia

the first thing. The real enemies in this are, on the one side Russia, on the otherwill inflict great economic painside NATO, and particularly the domination of NATO by America. This ison the West. China has backed

essentially the continuation of a financial war by other means – I think that’s theoff in its relations with Russia,

way to look at it. The sanctions that have been imposed on Russia are undoubtedly

perhaps fearing similar

going to cause great pain for the West, and we’re seeing this with oil prices. As wesanctions.

speak, US oil is $109.50 per barrel, and that’s up recently from sort of $60-$70,
something like that. This is a very serious impact. There are other things
happening, as well. Interestingly, China seems to be backing off a little bit from its
partnership with Russia, and that’s being put about by the people who interpret
this as China’s being worried that there may be sanctions extended to Chinesecompanies.

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China, is worried that capital

Sinopec, for example, has stopped or put a temporary hold on a joint project, aflows may be going out of China

refinery project, with Russia, but I think this is another aspect of a huge global

rather than worried about

financial war. If you look at it in that context, the Chinese economy itself is now

sanctions, in the direct sense.

beginning to struggle. It’s a different sort of struggle from what we’re seeing in theWest. I think what we’re seeing in China is actually similar to thesituation at the end of the 1920s and into the early ‘ 30s. You have got aproperty bust which is slowly coming through, and the result of that isthat international money is tending to leave China rather than continue
to go into China. So China, is more worried that capital flows going out of China
than about sanctions in the direct sense.
You can see that this is a very complex situation, and there are a number of ways inwhich it can evolve. My view at the moment is that the way it is evolving is that it
will make Putin more desperate. I don’t think you’re going to see a regime change
tomorrow, as Biden might hope. You’ll have a leader who’s going to get more andmore desperate. The one thing he cannot do is back down, because to back down isto admit defeat, and I think this is the point about his change of policy overUkraine. Apparently, he’s now no longer focused on taking over the whole country
but rather on taking over the borderline of the Sea of Azov and joining Crimea with
Donetsk and so on. So, he has a lot less ambition and he can then call an end to the“special operation”. That, I think, is the way he’s playing it, but we’re not going tostop putting pressure on him by saying, “Well done, we’ve achieved our objective,
we’re going to back off and remove the sanctions on central bank reserves andpeople who are not directly related with president Putin but might be”, and so on.

Putin is likely to get desperate as

I just don’t see how at the moment that we’re going to back off quickly, even if

the conflict goes on. Perhaps

Putin achieves his new objective, so I’m afraid the situation is just going to getleading to Russia demanding theworse and worse, and I can see that a more desperate Putin will not only insist that

West pay for its oil in rubles or

the protagonists in the West pay for their oil with rubles, which echoes theeven gold. The Russian economy

Kissinger-Nixon agreement with the Saudis which created the petrodollar in 1973.

is under pressure, but not

But also, the question now is gold, because it’s been rumored – or at least I thinkenough pressure to be

there was a statement from the chairman of one of the subcommittees in thedestabilized.

Russian parliament – that they would accept gold as payment.
I’m sure they would accept gold, but this is something which can beintensified; and at current prices, Russia can discount its oil to India,
China, whoever else wants to take it, even down to below $60 a barrel,
and still profit. The idea that the Russian economy is under pressure is actuallywrong – yes, obviously it is under pressure, but the sort of pressure to destabilize
it, I don’t think so. It’s actually a lot stronger than the West generally thinks; andremember, the West got the Soviet economy completely wrong before the Berlin
Wall fell.
All the intelligence was that the Soviet economy was strong, so the economic advice
behind their intelligence was rubbish. So now we’ve got a situation that I’m afraid
is going to get worse before there’s any chance of it getting better, in terms of the
supply of commodities and the financial situation. And this to me has always beena financial war.

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We are engaged in a financial

It has now turned into a financial and commodity war, and we’re not going to walkand commodities war. The only

away from winning. It’s going to be a Pyrrhic victory. If we’re lucky, we will win in

way to when this war is to be thethe sense that we’re the last one standing, but that’s about it; and this is not goodlast one standing, but this is notwhen you’ve got back channels between America and Russia, America anda good outcome.

Germany and the UK, not working. In other words, the chance of this escalating
into something completely out of control in the military sense should not bedismissed.
Ronnie Stöferle:
I agree, Alasdair, and it’s a frightening situation when your kids ask you if there’s athird world war going to start soon. I think you recently tweeted out that Russia’s
debt to GDP is just under 25%, which is the lowest for the OECD countries. I think
the average there is above 110% debt to GDP.

With Russia having its reserves

But what I would like to ask you is, we saw that basically with a stroke of a pen, theseized at the stroke of a pen, will

West took Russia’s FX reserves and made them completely worthless – $630bn.

more central banks choose gold

Isn’t that basically the strongest case for gold for every central bank on

to protect themselves against

the globe that has ever been made? I mean, if you’re somewhat critical of thesuch counterparty risk?

United States and if you, as a central banker, want to avoid counterparty risk, thenobviously there are only very few choices left; and I think the primary choice is
probably gold.
Alasdair Macleod:

Gold sits at the top of the money

I would agree with that entirely, and the situation is even more alarming than you

hierarchy and avoids thehave just stated, because the point about gold is that it’s nobody’s liability. You cancriminal recovery process inalways use it as money. The fact that we don’t use it as money is because we value

ways that CBDCs andmoney more than we value currency, and we probably value currency more thancryptocurrencies cannot.

we value a bank deposit account.
In terms of the hierarchy, gold is right up there, and make no mistake
about it. Not only that, but legally that is the situation as well, and this is a point
people miss. You know the thing about gold is that you can exchange it, you canuse it as money, and money escapes the criminal recovery process that you havewith any other asset. I mean, if I steal a painting from you, then I have committed acrime. If I pass the painting on to someone else and that person doesn’t know it’sstolen, you can recover it off that someone else, no compensation required. That iswhat the law says, and it’s common more or less throughout the world. But when it
comes to money or currency, if I steal a gold coin off you and I then go andspend it somewhere, and the person who takes that money takes it ingood faith, not realizing that it was stolen, he can pass it on and you
can’t recover it.
Gold still has that fundamental difference, which nothing else has, noteven CBDCs, not even cryptocurrencies. So, we’re talking about the top, thereal top, top asset; and this has been brought out very, very clearly by the West’s
actions against Russia.

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Central banks will be motivated

I would go further than you suggested. Imagine that you’re a central bank, you

to get their gold under their own

might even be the Austrian National Bank, and you sort of think, “Hold on, I havecontrol to avoid the same fate as

got x tonnes stored with the Federal Reserve; I have got x tonnes stored with theRussia.

Bank of England; I think I’d better get that back under my control, because lookwhat they’ve done.” I don’t know whether Russia’s got any gold in terms of market
liquidity in the Bank of England vaults. We’re not given that information; but ifthey have, that’s basically been frozen; so every central banker will be saying, youknow, we really need to get our gold back under our control; and even if they
haven’t got storage facilities, they’re going to start building them damn quickly. So
this, was a major move, and I think it will turn out to be a major mistake by theWest. I mean, going back to the Second World War, the Bank of International
Settlements still operated as a bank, as far as the Nazis were concerned. It took aneutral position, as indeed Switzerland did. But now, none of the central banks
that store earmarked gold on behalf of other central banks are taking that position,and it started with the Bank of England, with Venezuela’s gold.

Large amounts of gold have

We were told by the Americans, don’t give Venezuela back its gold; so what did the

been leased out by central banks

Bank of England do? It rolled over and said, right, we’re not giving Venezuela its

and are not expected to begold. This is not the role of a custodian, and we’re seeing these fundamental

released back into the market,changes, which I think have got unintended consequences way down the line. And

causing a tightness in the gold

there is another thing, Ronnie, and that is, there was an analyst called Frankmarket that will damage fiat

Veneroso who gave a speech in Lima, back in 2002, concerning gold leases fromcurrencies.

the central banks. He concluded in that speech that central banks had probably
leased out between ten thousand and fifteen thousand tonnes of gold – fourteen
thousand, I think, was the exact figure. Which had become the ornamentation ofIndian ladies, you know, and the central banks weren’t going to get it back. Now, atthat time 15,000 tonnes was roughly half the total world central bank gold
reserves. I don’t know what’s happened today; I would hope the situation hasn’t
deteriorated; but you can be sure there is a lot of gold out there on lease. Now, noteven assuming that that gold is gone forever, if it does come back, I don’t thinkcentral banks are going to be releasing it. So there’s going to be tightness inthe market, which is going to do a lot of damage to fiat currencies.
There’s an old saying, “The market always wins”, and I think that’s what we’regoing to see.
Mark Valek:That’s so fascinating, and I think there’s a lot of agreement from Ronnie andmyself with you. When we think about this kind of revaluation, which probably will
have to happen to some extent, we see it being forced upon by the market, as you
just said, perhaps even kind of in a legislated way. But what do you thinkwould be a price level that would have to be achieved, so that thesystem could keep on working?
Alasdair Macleod:

What we are witnessing is not

I never give a price target, and for a start, experience has told me that I never get it

the gold price rising, but theright. The second thing is that I think looking at it that way is actually looking at itpurchasing power of currencies

from the wrong end of the telescope. Really, what we’re talking about is not thefalling.

gold price rising but the purchasing power of currencies falling, so really, yourquestion should be, if I may venture to suggest, how far down do you see
currencies’ purchasing power collapsing? And I can see that, without action, they

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will become completely valueless. Coming back to the way you phrased thequestion, that means an infinite price of gold, which could be the reciprocal ofvaluelessness in a paper currency. But I don’t think it’s going to quite get there
because, as I said earlier, I think that nations will be forced to back theircurrencies with gold.
It’ll have to be done credibly, and the only way to do it credibly is to reintroduce, ifthey haven’t got it at the moment, gold coin, and make that exchangeable forcurrency notes at the central bank. If you have a stash of Austrian shillings, say,under a new currency arrangement, rather than euros, you can take it to thecentral bank, and you can say, “I have got a hundred thousand shillings”, or
whatever the figure is, and “I want coins” in return for it; and the central bank will
be obliged to supply those coins to you.
The only way to stabilize theThat I think is the endpoint, and when that happens, I don’t know. It’s asituation is to return to a gold

pain threshold problem; I think it comes to the point where thestandard.

Keynesians throw in the towel, let’s put it that way. On the one hand you’ve
got the Keynesians who are saying, “Oh, this is impossible to understand. We don’t
understand it, this is completely wrong, stimulate more”, or whatever they comeup with. And you’ll have the politicians and the central bankers who are in thepractical situation of finding that their currency is disappearing down the plughole,becoming worthless. How do we stabilize it? I know that we’ve turned our backs ongold since 1971, or at least the Americans have forced us to do so. But the only way
we can stabilize this is to return to gold; and whether that’s with gold, say, at ahundred thousand dollars an ounce, a quarter-million dollars an ounce, or ten
thousand dollars, I honestly don’t know. But I think it’s going to be further down
the rabbit hole than we would think possible at this moment.
Mark Valek:
I could imagine. I mean, I actually stated that on Twitter a few weeks ago. That,
getting back to Russia, that would be a kind of solution for their problem. They
have the gold, and they are in the desperate situation of already having very highinflation. If they really would consider such a thing, they would have to go to somekind of real circulation of gold; and as I said, they could do it, and they could also
probably do it politically. I’m not an expert on that, but they would have tosomehow opt out of the IMF, right? Because the IMF currently is forbidding you to
do such a thing; but at this stage, why shouldn’t they do that? Also, they’ve been
pushed out of every international organization I can think of. Why shouldn’t theyleave the IMF? I don’t know if that’s a realistic option; any thoughts on that?
Alasdair Macleod:

Russia likely has more gold in its

Yeah, I agree with you entirely, and I would go slightly further and say that myreserves than we know. This

information – I can’t verify this – is that actually Russia has got a lot more gold

coupled with relatively low debt

than it declares in its reserves. As one of the major producers in the world, I mean,

and a flat income tax makes athat statement shouldn’t be too surprising. Also, we have seen that President Putin

return to the gold standard

is a “gold bug”, if I can put in those terms, or appears to be. So yeah, that’s

possible.

certainly possible; but the problem is you have to get over the overwhelming global
establishment consensus, and that is that the way to manage an economy is to havethe flexibility to be able to increase the amount of currency and credit in theeconomy as the primary means of managing the economy.

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Now, if you’re going to go the gold standard route, then effectively,
you’re turning your back on that. You’re saying the economy is not the
government’s affair; it’s the private sector’s affair and we should, as much as
possible, ensure that we don’t intervene. So we’re talking about a change in the way
in which government views its own economy, but let us posit that if the change is
accepted in Russia, then they’ve got the economy which makes this eminently
possible. I mean, as Ronnie said earlier, their level of government debt is closer to
20% than 25%, so you’ve got a government which has got very little debt, as well as
an income tax that is a flat tax at 13%. They don’t have the respect for property
rights that I would like to see, but that could be dealt with.
Russia might drop a bombshellThis is an environment, actually, where they can quite easily introduce a working

on us and say: “Do you know

gold coin standard, not just on the back of the existing reserves, but on the back ofwhat? It’s not 2,000 tonnes,

more reserves which they could declare and that actually could be the next stage.

we’ve got 5,000 tonnes”.

At some stage, I think Russia might drop a bombshell on us and say: “Do
you know what? It’s not 2,000 tonnes, we’ve got 5,000 tonnes”, or
whatever the figure is. I mean it would work, because we’re not die-hardKeynesians, but the die-hard Keynesians who run the world have a problem andso, incidentally, do the monetarists, because the monetarists are inflationists, asvon Mises realized when he spoke to Milton Friedman at the Mont Pelerin Society
way back whenever it was, I think it was in the late 1960s, early 1970s.
Ronnie Stöferle:
I just found a great quote by Mises regarding the wishful thinking aroundunlimited government, and he called it the “Santa Claus principle”. I don’t know if
you’re aware of that, but he said:“An essential point in the social philosophy of interventionism is the existenceof the inexhaustible fund, which can be squeezed forever. The whole system ofinterventionism collapses when this fountain is drained off, the Santa Claus
principle liquidates itself.”
I think that’s a very good summary, basically, of the discussion that we just had.
Mark, is there anything else you want to ask Alasdair?
Mark Valek:
Alasdair, I want to say thank you very much for joining us. It was a great pleasure
and looking forward to keeping in touch and following your great research on goldmoney.

These were the highlights of our interview with Alasdair Macleod. The
full version is available for download here.
The video of the entire interview, “Stagflation and a New Gold
Standard”, can be viewed on YouTube here.

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145

A New International Order
Emerges“The world is breaking into two distinct
economic zones: the “empire of
the sea”, or the “Western block” ofnations; and the “empire of the land”,
or “Eastern block”. The former’scurrency is based on fiat money, andthe latter’s on the emerging tandem ofcommodities, gold and oil.“Charles Gave

Key Takeaways• 2022 marks a turning point for the internationalmonetary system as we turn away from the US dollar
toward a multi-currency world.
• The freezing of Russia’s currency reserves iscomparable to Richard Nixon’s closing of the gold
window in 1971.
• While the war distracts the West, Moscow and Beijing

are intensifying their cooperation.
• The Petrodollar is reeling: The relationship between

Saudi Arabia and the U.S. has rarely been worse, andChina is making tremendous progress in the Middle
East.
• What the world’s monetary architecture will look likewhen the dust settles is unclear. What seems certain isthat gold and commodities will rise in importancesignificantly.

A New International Order Emerges

146

Central banks are starting to

The year 2022 will go down as a turning point in the history ofquestion whether reliance on theinternational monetary policy. Russia’s attack on Ukraine and the

U.S. dollar is a good idea, sincesubsequent sanctions have changed everything. The battlefields are not

the United States has been

only to be found on the ground in Ukraine; another war is being waged in theextremely trigger-happy when it

financial markets. We could witness the emergence of a new global monetary ordercomes to the use of sanctions andin real time. We have been covering many of these issues in the pages of this reportother economic punishments.

since 2017, and now they have entered the mainstream. The idea of a multi-

Institute for the Analysis ofreserve-currency world, no longer dominated solely by the US dollar is gaining a

Global Security

strong foothold. China and Russia are moving closer together, and the oil-rich stateof Saudi Arabia, a pillar of US hegemony, is turning its back on Washington – andflirting intensely with Beijing. The West’s sanctions against Russia are stoking theflames. In the words of the Wall Street Journal, “If Russian Currency Reserves
Aren’t Really Money, the World Is in for a Shock”.
Europe is once again caught between a rock and a hard place. The roleof the euro is more in question than ever. Is it an “instrument of the newEuropean sovereignty”, as former EU Commission chief Jean-Claude Juncker put
it? Or is it worthless to the rest of the world because the EU has (so far) gone alongwith sanctions against Russia? Much in this story is in flux as we write these lines,
and many questions remain unanswered. We will therefore take a look at
fundamental developments.

We are witnessing the birth of

At any rate, thanks to its large gold reserves, Europe should at least be

Bretton Woods III – a new world

well prepared for what is to come. Because what we are seeing here can also(monetary) order centered

be described as the “return of real stuff”, a new monetary world that revolves

around commodity-basedlargely around gold and commodities. It’s something that the Europeans, Russians

currencies in the East that will

and Chinese have wanted for many decades, as our timeline will show. Analyst

likely weaken the Eurodollar

Zoltan Pozsar of Credit Suisse calls this “Bretton Woods III”, but this new systemsystem and also contribute torather deserves a name of its own. Out of the ashes of the gold-backed US dollar

inflationary forces in the West.

and the petrodollar will emerge something completely new, something that no

Zoltan Pozsar

longer has anything to do with Bretton Woods.
The new monetary world order is multipolar – something Jerome Powell
confirmed on March 2, 2022, when he said, “It’s possible to have more than one
major reserve currency”. Powell also emphasized the advantages of the US dollar
in the free struggle of monetary forces: legal certainty and an open, deep capital
market. No one, not Europe, not Russia, not China, can match that. At least not fornow.
But before we can perceive what a new monetary world would look
like, we need to understand the past. We need to go back to 1944, to thefounding of the Bretton Woods system, and look at how this system, which is now
breaking down, developed. We need to delve into what has been happening since
Russia invaded Ukraine; because while the Ukraine war is dominating theheadlines, there’s a fight going on in the financial system, and what is happening
there points the way to the future.
We will therefore focus on the history of the monetary system as we know it, on therole of gold and the emergence of the euro; the growing friendship between

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147

Moscow, Beijing and Riyadh; and Russia’s adventurous plans to create a new,digital world currency.

What Has Happened So Far: The Long History
of US Dollar Dominance…there are now real concerns

To understand how we got into this situation, we need to revisit pastaround the longevity of the US

decades. It’s not easy to keep track of everything happening, but if there is one

dollar as a reserve currency.

theme that keeps coming up, it is this: The use of the US dollar as a reserve

Goldman Sachs

currency is a long-term political problem because it gives the US too much power(“exorbitant privilege”), and it’s an economic problem because a national currency
is ill-suited as a world currency (the Triffin dilemma).
The solution to both these problems is to use a neutral reserve asset. This can be ofnatural origin, such as gold or other commodities, or artificially created, such as
the IMF’s Special Drawing Rights ts (SDR). Both variants have been consideredtime and again and attempts have even been made to implement them inrudimentary form – but so far without success.
The following timeline gives a brief overview.
1940s

Keynes fails at Bretton Woods and the problem takes its
courseThe U.S. dollar system was

July 1944: More than 700 delegates from 44 nations meet at the Mount Washington

founded at Bretton Woods on

Hotel in Bretton Woods, New Hampshire. Among them: the US, Canada, Australia,

three pillars: American militaryJapan, and some European powers. One year before the end of the war, theysupremacy, American financial

decide on the world’s new monetary order: the first and, so far, only monetaryhegemony, and Americansystem based on international treaties.

economic prowess.
Dan Oliver• The US dollar will be pegged to gold, all other currencies will be pegged to the
US dollar. This is a variant of a proposal by the British economist John Maynard
Keynes – with one small but important difference: Instead of a new, neutral world
reserve currency, yet to be created – called “the bancor” by Keynes – the US
dollar will play this crucial role.
o

The Bretton Woods Agreement (BW) cements the role of the US dollar as
reserve currency and that of US government bonds (Treasuries) as reserve
assets. The US dollar is “as good as gold" and will henceforth play the role ofgold in the world monetary system.

o

The International Monetary Fund (IMF) and today’s World Bank are created as
new, international bureaucracies to prop up the BW system.

1945–1959
After the Second World War, Europe’s economy is at rock bottom. National
currency reserves have been depleted. At the same time, there is a high demand
for goods from the US, where the industrial base is intact. The result is a large US
trade surplus and an acute shortage of US dollars in Europe.

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148• On paper the IMF and the World Bank are responsible for balancing temporary
imbalances by way of loans. But the imbalances are structural, and too large. The
US therefore initiates the Marshall Plan to rebuild Western Europe and restore it
to solvency.
• The reconstruction of Europe is so successful that the US has its first negativetrade balance as early as 1950, a trend that will continue and intensify until today.
• The BW system is now running as planned – but this does not eliminate thesystemic problems. In fact, they are just getting started.
• Washington starts to export paper money and import real goods. But the printed
paper money is backed by US gold reserves, and those begin to shrink rapidly inthe 1950s as other countries exchange their US dollars for gold.

1960s

Triffin discovers his dilemma
In the 1960s, economist Robert Triffin warns of the contradictions in the Bretton
Woods system. According to Triffin, the use of a national currency as the maininternational reserve currency will eventually lead to conflict between said country’s
national needs and those of the world economy. Triffin predicts that the gold pegof the US dollar will fail.
• This contradiction was one of the reasons why Keynes had advocated theintroduction of a neutral reserve asset at Bretton Woods.
• In response to Triffin, the IMF introduces Special Drawing Rights (SDRs) in 1969.
SDRs are a synthetic reserve currency, representing a basket of othercurrencies.
• Following their introduction, there are many attempts to introduce SDRs as the
major international reserve asset and thus replace the US dollar. All attempts faildue to US resistance.

As early as the 1960s, several measures are taken to stabilize the BW system. The
main concern is to maintain the fixed gold price ratio of USD 35 per ounce. Anythingelse would amount to a devaluation of the US dollar.
• To this end, the London Gold Pool is created in November 1961 and charged
with manipulating the free gold market in order to depress the price.
• Under the BW system, it is not possible for individuals to exchange US dollars forgold. Private ownership of gold has even been forbidden to US citizens, since1933.46 Only foreign governments and central banks have the possibility to
exchange their US dollars for gold.

In Europe, resentment against the Bretton Woods system grows from the 1960s
onward. People feel trapped in an unfair system in which Europe’s citizens have to
subsidize the high standard of living in the United States.
• The French, under former General Charles De Gaulle, are particularly critical of
the BW system. France is the nation that most actively exchanges US dollars for
gold.

—

46 See “A Brief History of Gold Confiscations,” In Gold We Trust report 2021

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149• French Finance Minister Valéry Giscard d’Estaing coins the term exorbitantprivilege to describe the ability of the US to print money almost at will and receive
real goods in return.
• In 1965, De Gaulle warns of a US dollar crisis in a televised speech and makes
the case for a return to the gold standard. His words are strongly reminiscent of
the criticisms of Keynes and Triffin. De Gaulle maintains that the US dollar cannot
be a “neutral and international medium of trade” and is in fact “a credit instrument
reserved for only one state”.
In March 1967, the then president of the Deutsche Bundesbank, Karl Blessing,sends a letter to the board of the Federal Reserve. Blessing promises that Germany
will not imitate the French and that Bonn will refrain from exchanging its US dollar
reserves for gold in the interest of international cooperation. The so-called “Blessing
letter” of March 30, 1967, goes down in history.
• A few years later, in May 1971, Karl Blessing describes the concession as a
mistake: “I declare to you today that I myself feel personally guilty in this area. I
should have been more rigorous with America at the time. The dollars that
accrued to us should simply have been rigorously exchanged for gold.”• In this interview, Blessing also outlines what the euro should eventually be: aEuropean central bank, independent of the nation states, with clear rules and ahard currency: “There is no doubt that, if we really had the political will in the
EEC, we could form a hard currency bloc whose rates could then fluctuateagainst the dollar. That would have taken us away from the US dollar standard,
which we have today. After all, we practically have the dollar standard.”• At the end of 1970, the “Werner Report”, named after Pierre Werner, Prime
Minister of Luxembourg, is published. It is the first real plan on the part of Europe
to create an economic union within a decade and is regarded as the starting
signal for efforts to create a common currency.

1970s
In early August 1971, France under De Gaulle sends a warship to New York to pickup physical gold that France was to receive in return for its US dollars.

The Nixon shock and the birth of the petrodollar
It wasn’t the gold standard that

On August 15, 1971, US President Richard Nixon ends the Bretton Woods

failed; it was politics.

monetary system after a quarter-century. He cancels the gold peg of the US dollar.

Alan GreenspanAt first, this is merely “temporary” and is intended to “strengthen” the US economy.
At this point, the US has “only” about 8,000 tonnes of gold in its reserves.
• Europeans are shocked at the unilateral decision. Instead of giving up the“exorbitant privilege” and moving the world to a neutral reserve asset, the UScontinues to expand its privilege. Starting in 1971, Washington no longer has tofear losing gold when printing money.
• The 1970s see high inflation rates and two oil shocks. The production of US oilreaches its temporary peak at the end of the 1960s, and the Arab oil countries
see Nixon’s move as a devaluation of the US dollar. Prices rise and crises breakout in the Arab region. For the first time, Western industrialized countries have todeal with oil shortages.

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150• In 1972, US President Richard Nixon visits communist China, marking a turning
point in relations between the two countries. Nixon spends seven days in China.
This signals the start of a new form of cooperation that will jumpstart China’s
economic development.

We are the Saudi Arabia of

In July 1974, newly appointed US Treasury Secretary William Simon flies to Saudi

dollars.

Arabia. The first oil crisis has hit the United States. Simon has previously served as

Luke Gromen

Nixon’s energy expert and before that headed Treasury trading at Salomon
Brothers. He is a proven expert on the oil and bond markets.
• At these meetings, a deal is negotiated that is to have a massive impact for
decades to come. In return for military and political support, Saudi Arabia agrees
to recycle its petrodollars into US Treasuries.
• The petrodollar is born. From this point on, the world’s reserve currency, the US
dollar, is no longer backed by gold but by “black gold”. From then on, all countries
must hold large reserves of the US currency to pay their energy bills.

The end of the 1970s and the Volcker shock
In effect, there is nothing

In 1976, the Bretton Woods system is formally buried by the Jamaica Accords. In

inherently wrong with fiat

the early 1980s, all developed countries allow their currencies to fluctuate. For themoney, provided we get perfectfirst time in history, the whole world is on a pure paper money standard, with one

authority and godlike

exception: Switzerland formally keeps the franc pegged to gold until 1999.

intelligence for kings.
• In 1979, the US dollar is under tremendous pressure due to the persistently highAristotle

inflation of recent years. In August of that year, Paul Volcker takes over as headof the Federal Reserve.
• In March 1979, the European Monetary System is created. For the first time, allexchange rates of the participating countries are linked to each other by means of
the European currency unit (ECU). This later becomes the euro.
• That summer, core inflation in the US reaches 12%. The gold, silver andcommodity markets react sensitively and prices shoot up, which makes theFederal Reserve under Volcker nervous.
• In October 1979, politicians and central bankers of the West meet at an IMF
gathering in Belgrade. In the United States, the White House has long sincedeclared the fight against inflation a “national priority”. In Belgrade, Paul Volcker
seeks the advice of the Europeans, consulting with German Chancellor Helmut
Schmidt and Bundesbank Chairman Otmar Emminger, among others.

“In Belgrade ... it became obvious to Volcker that a collapse of the US dollar was avery real possibility, perhaps leading to a financial crisis and pressure to remonetize
gold, which the United States had fought doggedly for over a decade. To forestallthis, there was only one possible course of action: do whatever was necessary tostrengthen the dollar.”47

Volcker cuts his trip abroad short and returns to Washington prematurely on
October 2: “With his ears still resonating with strongly stated European
recommendations for stern action to stem severe dollar weakness on exchange
markets.”—

47 Moffitt, Michael: World’s Money, 1983, p. 196

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151• He organizes a secret Federal Reserve meeting on Saturday, October 6, 1979.
• Volcker prevails, setting the stage for a general change of course within theFederal Reserve. Controlling money supply growth should be the most important
tool in the fight against inflation in the future. The reserve requirements for banks
are tightened.
• In 1979, annual inflation in the US rises to 14%. In the following year, the gold
price was to peak at around USD 850. At the beginning of 1981, short-term
interest rates would peak at around 20%. Volcker would succeed in stopping
inflation - at the expense of the US economy, which slides into recession.

1980s

The stability of the 1980s
In the 1980s, the system stabilized. The Europeans, however, have by now long
been working on their own currency, which should make them independent of the
US dollar system. The advocates of the SDRs and the IMF were not idle either. In
1984, economist Richard Cooper proposes a global single currency - with acommon monetary policy and a common central bank. The US, Europe and Japanare to be the first nations to join.

“Get ready for a world currency” – This was the headline of “The Economist" on
January 9, 1988. In the article, the creation of a global monetary union issuggested. In this vision the IMF is to assume the role of the world central bank andits SDRs the role of the world currency. In the description, it is striking that theenvisaged construction strongly resembles that of the later Euro area: A system
whose rules must be followed by all participating states. The Economist calls the
new currency phoenix and predicts its introduction by 2018.

Photo credit: www.coverbrowser.com“Each country could use taxes and public spending to offset temporary falls indemand, but it would have to borrow rather than print money to finance its budget
deficit. With no recourse to the inflation tax, governments and their creditors would
be forced to judge their borrowing and lending plans more carefully than they dotoday.”

1990s

The introduction of the euro
In December 1995, the EU states agree on a name for the common currency: theeuro. On January 1, 1999, the euro is introduced. Gold plays an important role forthe new currency from the very beginning. But under the first ECB president, Wim
Duisenberg, the euro is not pegged to gold as the US dollar was under the Bretton
Woods system.

Instead, gold is treated anew on the Eurosystem’s balance sheet as an independent
asset, separate from the currency. Gold is listed on the first line on the ECB’sbalance sheet. Four times a year, the value of the reserves is adjusted to themarket value. This turns the monetary world upside down.
• A rising gold price is good for the euro because it strengthens the balance sheet.
At the same time, it is a signal to EU citizens, who have free access to physicalgold, that if the central bank’s management doesn’t suit them, they can save in
hard, neutral “money”: gold.

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152• This system of market valuation of gold has now also been adopted by thecentral banks of Russia and China, but not by the US.
• To safeguard this system, the purchase and sale of “investment gold" isexempted from VAT throughout the EU in October 1998.
• On September 26, 1999, a group of European central banks sign the first Central
Bank Gold Agreement (CBGA). The aim: to reassure the market that they will
curb their gold sales in the future. The gold price finds its bottom in the coming
years and eventually starts to rise.
• Because the UK is still selling about 400 tonnes of gold at rock-bottom prices
after the CBGA is signed under then-Chancellor of the Exchequer Gordon Brown,
the period between 1999 and 2002 is today nicknamed the “Brown Bottom”.

2000s

It is no coincidence that the

The fact that the euro is also intended as an energy and reserve currency from thecentury of total war coincided

very beginning is never concealed by EU politicians. Even before the introduction ofwith the century of central

euro cash on January 1, 2002, the new currency is causing a stir. In Novemberbanking.

2000, Iraq’s President Saddam Hussein decides to switch from using US dollars to

Ron Pauleuros in the oil trade. The US protests loudly and warns Hussein against this step.
• In February 2003, it is clear: Iraq has made an economically good decision byswitching to the euro; the warnings from the US were all wrong. The euro
exchange rate has risen significantly over the past three years, and interest rates
are also higher than on US dollar accounts.
• In March 2003, the US attacks Iraq. Saddam Hussein is overthrown, and the oil
trade is switched back to US dollars. Germany and France are among the biggest
opponents of the invasion and refuse to support the US.

The financial crisis and its consequences
In the wake of the great financial crisis and the Lehman bankruptcy, concerns growagain that the US dollar system may have reached its end.

The focus of policy in China is no

In March 2009, the head of the People’s Bank of China (PBoC), Zhou Xiaochuan,

longer creating jobs at any

speaks out for the first time. In a remarkable speech at the Bank for International

cost…The new focus in China is

Settlements (BIS), he calls for a move away from the US dollar and thede-dollarizing at any cost.

establishment of a new monetary system. China’s central bank chief makes direct

Louis Gavereference to the entire monetary history since 1944 and quotes Keynes and his
bancor idea.

In November 2009, legendary journalist Robert Fisk reports on an agreement
among China, Russia, Japan, the Arab world, and France (i.e., the euro area) tomove away from the US dollar-based system.

“In the most profound financial change in recent Middle East history, Gulf Arabs areplanning – along with China, Russia, Japan and France – to end dollar dealings foroil, moving instead to a basket of currencies including the Japanese yen andChinese yuan, the euro, gold and a new, unified currency planned for nations in the
Gulf Cooperation Council, including Saudi Arabia, Abu Dhabi, Kuwait and Qatar.
‘These plans will change the face of international financial transactions,’ one
Chinese banker said. America and Britain must be very worried. You will know how
worried by the thunder of denials this news will generate.”

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2010s
In November 2010, Vladimir Putin says that Russia will one day join the euro orform a monetary union with Europe.

Also in November 2010, World Bank President Robert Zoellick advocates gold as
the “reference point" for a new monetary order.

In February 2011, then IMF chief Dominique Strauss Kahn proposes replacing the
US dollar as the world reserve currency with SDRs. He is arrested in New York in
May 2011 and resigns as IMF head. The charges against him are dropped by the
public prosecutor’s office after several months.

The PBoC announces in November 2013 that it is no longer in China’s interest to
expand its reserves of US government bonds.

On July 5, 2014, the then-CEO of the European oil company Total, Christophe deMargerie, speaks out in favor of using the euro in oil trading. On October 21, 2014,de Margerie dies in an accident at Moscow airport. The Total CEO was on his way
back from a meeting with Russian Prime Minister Dmitry Medvedev. De Margerie
was considered a friend of Russia and a critic of the sanctions imposed on Russia
by the West at the time, because of the annexation of Crimea. His private jet hadcollided with a snowplow. An investigation concludes that the driver of thesnowplow was drunk.

Russia is just a gas station

Russia and China sign a gas deal in May 2014 that is described as the “holy grail”.

masquerading as a country.

It is negotiated for 10 years and is to extend over 30 years.

John McCain
September 2014: China launches an international gold board in Shanghai,denominating the price of gold in yuan to increase international participation in the
Chinese gold market.

Luxembourg central banker and ECB director Yves Mersch says in November 2014
that the ECB “could buy gold to stimulate the economy”. It is the clearest signal yetthat euro area central banks are no longer on the sell side of gold.

As American power continues to

In his last major speech as EU Commission chief at the end of 2018, Jean-Claude

ebb, the dollar will become

Juncker directly addresses the international role of the euro, saying it needs to be

increasingly unable to rely on

strengthened and calling EU energy trading in US dollars “absurd”. His speech is

geopolitical support.

entitled “The Hour of European Sovereignty”.

Dan Oliver
2020s
From 2018 to 2022, many bilateral steps will occur between countries such as
China, Russia, Iran, Saudi Arabia, and the Europeans. Trade is often switched tonational currencies. But one thing never happens: another global currency
conference.

Instead, the monetary system is redone by political action – such as thefreezing of Russian US dollar and euro currency reserves following Russia’s attack
on Ukraine in spring 2022.

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154

When money is weaponized
The West’s freezing of Russian gold and foreign exchange reserves marks thebiggest upheaval in the international monetary system since the Nixon shock of1971 and the subsequent shift from a US dollar-based gold-forex standard to asystem of flexible exchange rates with the unfunded fiat US dollar as the anchor.
“This is a major break in the international monetary order created by Bretton
Woods II. The sanctions create de facto a new order in which central bankreserves are now worth only as much as the dominant reserve currencies
issuing them want them to be.”Can it be supposed that one day

A country’s currency reserves serve as its piggy bank for difficult times.

Russia will be in some joint

Russia has played a special role in the process of de-dollarization long before thecurrency zone with Europe? Yes,

war in Ukraine. Among the world’s powerful, Vladimir Putin has always been thequite possible… We should move

one who has most clearly opposed the supremacy of the US dollar. In particular,away from the excessive

the fact that the US uses the world currency as a tool for sanctions has always beenmonopoly of the dollar as thea thorn in his side. Thus, Putin said in 2019: “The United States started using

only global reserve currency.

dollar settlements as a tool in the political struggle for some purpose, imposing

Vladimir Putin

restrictions on dollar use and cutting the branch they are sitting on, but they will
fall with a crash soon”.
In the summer of 2021, Putin had another warning ready for Washington, awarning based on his own experience with the fall of the Soviet Union: “Theproblem with empires is that they think they can afford small errors andmistakes.... There comes a time when they can no longer be dealt with. And the
US ... is walking straight along the path of the Soviet Union”.
Clear words, which, however, did not land on open ears. Following
Putin’s attack on Ukraine, the monetary system has become a theaterof war. The Financial Times also writes about the West’s sanctions against
Moscow:“The plan agreed by Yellen and Draghi to freeze a large part of Moscow’s$643bn of foreign currency reserves was something very different: they wereeffectively declaring financial war on Russia.... This is a very new kind of war– the weaponization of the US dollar and other Western currencies to punish
their adversaries.”

I took a course in speed reading,

In recent years, Russia has massively shifted its reserves from US dollars to euros.

learning to read straight down

The Russian Central Bank now holds only about 7% of its reserves in US dollars.

the middle of the page, and I was

The fact that Moscow concluded a major gas deal with Beijing in euros, just a few

able to go through War andweeks before the invasion, is also an indication that Putin did not expect his euro

Peace in 20 minutes. It’s about

reserves to be sanctioned. After all, it has long been a goal of the EU to use the euro

Russia.

to make itself independent of the dominance of the US dollar.

Woody Allen
That is a goal that now seems far away, as Europe has clearly sided with
Washington on the Russia issue – at least so far.

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155

The Western sanctions affect around two-thirds of Russia’s currency
reserves. The reserves have not disappeared, but Moscow currently has noaccess. Importantly, the sanctions do not affect the flow of US dollars and euros to
Russia at this time. The EU has also not yet imposed an energy embargo. Instead, acomplicated construct has been agreed upon in which EU states deposit euros into
an account at Gazprombank, euros that Russia then converts to rubles.
Still, the sanctioning of reserves is a huge step with huge consequences. The Westhas “closed the FX window”, in the words of our friend Luke Gromen – who isreferring directly to the closing of the gold window by US President Richard Nixon
in 1971. Well-known economist Kenneth Rogoff takes a similar view:“It’s an absolutely radical measure to try to freeze assets at a major central
bank. It’s a break-the-glass moment.... If you want to look at the long-run
picture of dollar dominance in the global economy, believe me, China’s
looking at this. They have, I don’t know, $3 trillion in dollar reserves.”
And China is not the only country where a rethink is now taking place. LouisVincent Gave puts himself in the head of rich Saudis:“Is it too much of a stretch to imagine Western governments in a few years’time deciding that fossil fuel producers must pay for climate-change-induced
damage, leading to Saudi royals facing asset confiscation? To be clear, I am
not saying this will happen. Yet if I was a Saudi prince, a few weeks ago I
would not have worried about having my Swiss bank account closed; today I
would be hedging myself. Previously, such wealthy investors could own assets
in the US or Western Europe in the knowledge that while returns on capital
may be lousy, at least the return of that capital was assured. If such certitude
no longer exists, what is the point of earning US dollars or euros?”Like Russia, Saudi Arabia is an oil state with an authoritarian ruling structure. As
we will show later, their relations with the US are in tatters. It can therefore be
assumed that the royal family in Riyadh is following all sanction steps very closely.
Here are Russian President Vladimir Putin’s clear words on sanctions:“The illegitimate freezing of some of the currency reserves of the Bank of
Russia marks the end of the reliability of so-called first-class assets. In fact,
the US and the EU have defaulted on their obligations to Russia.... Now
everybody knows that financial reserves can simply be stolen. And many
countries in the immediate future may begin – I am sure this is what will
happen – to convert their paper and digital assets into real reserves of raw
materials, land, food, gold.”This is a strategy that China, for example, has been implementing for along time. The Middle Kingdom is sitting on large quantities of industrial andagricultural raw materials. For many years, they have been buying up land, assets
and raw material deposits all over the world. The Greek port of Piraeus is only themost famous example. Putin may talk about the future, but he knows full well thatthe development described has long since begun.

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156

Now, we have certainly pointed out more than once in the past that gold has nocounterparty risk as long as you keep it yourself – and in physical form. Our friend
Douglas Pollitt comments on this as follows:“Who knew credit-based money was so easy to take? But of course it is – by
its very nature credit requires a counterparty and if that counterparty
chooses not to honor your credit, well, that’s about that. By contrast gold is a‘credit’ with no one on the other side to rug-pull you.”Gas is just the beginning…If they

The repatriation of gold reserves of the Germans, Austrians and Dutch

want to buy, let them pay either

in 2015 to 2018 suddenly appear in a completely different light. Russia

in hard currency…gold, or inholds around 20% of its reserves in gold and that gold is located exclusively incurrencies that are convenient

Russia. Moscow has also made no moves to sell this gold so far. Nevertheless, thefor us…the national currency.

West is trying to block this part of the reserves as well and is banning trade in

The set of currencies may vary…

Russian gold everywhere possible: in the countries of the G7 and the EU.

Pavel Zalvany, Head of theAdmittedly, no one can really prevent Russia from using gold as currency in trade

Russian Energy Committee

with, say, China, India, or other countries that do not want to comply with Westernsanctions.
At the beginning of the crisis it was speculated that Russia might be forced to sell
their gold. They decided to take a different path.

Putin’s golden move
We’re witnessing a shift towards

Much has been written about Vladimir Putin’s gold plans. Russia hascommodity money among abeen increasing its gold reserves for years – not without reason. But nomore fragmented system of

one really expected Putin’s next move. Instead of selling gold, the Kremlin set acurrencies moving acrossfixed buying rate for gold at the end of March: 5,000 rubles for a gram of gold. At

disintermediated payment

the same time, they announced that they would only accept rubles for gas

infrastructure. Emerging

deliveries (and later for other commodities).

economies, particularly thoseremoved from global politics, areThe combination of these two steps led to a de facto link between gas and gold,

postured as the first movers

which was intended to stabilize and appreciate the ruble. It worked. And it worked

towards this shift.

so well that the Russian Central Bank lifted the fixed price on April 8. It did not,

Eric Yakes

however, stop buying gold per se, but said it would “negotiate” prices in the future.
Three days after the central bank announced it would buy gold from local banks
and producers for rubles, Putin’s gas-for-rubles policy came into play. Here, theimpact of Western sanctions is directly observable. Russia has no interest inreceiving US dollars or euros when they can be frozen immediately. Russiancompanies are now also required by law to exchange at least 80 percent of theforeign currency they receive into rubles. Putin’s announcement reads as follows:“I would like to stress once again that in a situation where the financial
system of Western countries is used as a weapon, when companies from thesestates refuse to fulfill contracts with Russian banks, enterprises, individuals,
when assets in dollars and euros are frozen, it makes no sense to use thecurrencies of these countries.

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157

In fact, what’s going on, what’s already happened? We supplied European
consumers with our resources, in this case gas, and they received it, paid us ineuros, which they then froze themselves. In this regard, there is every reason
to believe that we have supplied part of the gas supplied to Europe virtually
free of charge.”
At the beginning of April, Kremlin spokesman Dmitry Peskov spoke out. He said
that the gas-ruble deal was only the “prototype" and that the model would soon be
extended to other export goods. He called the blocking of Russian currency
reserves by the West a “robbery”.
The US are living like parasites

What are the long-term goals of this policy? Peskov leaves no doubt about it: The

off the global economy and their

Kremlin wants a new world monetary system to finally replace the lastmonopoly of the dollar…if overremnants of Bretton Woods: “It is obvious – even if this is currently a distant

there (in America) there is a

prospect – that we will come to some new system, different from the Bretton

systemic malfunction, this will

Woods system”.

affect everyone.
Vladimir Putin

What followed Putin’s announcement was European political theater. The EU
countries understandably could not accept suddenly switching to rubles. And whilemuch of the debate in the media revolved around an oil and gas embargo against
Russia, German Chancellor Olaf Scholz had to ask Putin to at least continue toaccept euros. Putin relented, but not completely.
Europe may continue to pay in euros, Putin said, but the money must flow into a
specific account at Gazprombank. This is conveniently exempt from the sanctions,a circumstance that the new deal cements. Since the beginning of April, the gas
trade between Europe and Russia has looked like this: Russia allows the gas tocontinue flowing in exchange for euros or US dollars paid to Gazprombank. The
bank then exchanges the money for rubles – the euros concerned are exempt fromthe sanctions. However, the debt is not discharged until the ruble amount iscredited to the seller’s account.
That way, both sides can save face. German Chancellor Olaf Scholz and theother EU heads of government can claim that they will continue to insist on
payment in euros. Putin can say that he will exchange the money for rubles
immediately. And despite the official hostility, both sides are de facto working tochange the currency system and end US dollar dominance – a goal Europe andRussia have shared for many decades.
Today, Russia basically does not care in which currency payment is made – as longas this currency is convertible into gold and/or rubles. After the deal with Scholz,
this is only not the case for the US dollar: Russia has now opened up the energy
market for all other currencies. This is a big step.

Fear provides the catalyst for

No one has explained it better than Pavel Zavalny, a Russian politician andcommon sense.

chairman of the Duma’s energy committee. “Hard money,” he said recently, “isVladimir Putin

only gold for Russia. Friendly nations (and Europe) may also pay in national
currencies”. Only one currency is not accepted, Zavalny said: “The dollar ceases tobe a means of payment for us, it has lost all interest for us.” And Zavalny added

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158that from the Russians’ point of view, the US dollar is worth no more than “candy
wrappers.”
In this interview, Zavalny even showed a willingness to accept Bitcoin for gas, adetail that was heavily emphasized in global coverage of the story. One gets theimpression, however, that the Russians were primarily concerned with one central
point. Something along the lines of: If that’s what our friends want, they can pay
however they want, even in Bitcoin. However, states classified as hostile, such as
the EU states and the US, will only be able to pay in rubles or gold.

Zoltan Pozsar’s vision: Bretton Woods 3.0
A crisis is unfolding. A crisis of

No one in the financial and mainstream media has taken a closer lookcommodities. Commodities areat these developments than Zoltan Pozsar, an analyst at Credit Suisse.

collateral, and collateral is

Similar to our friend Luke Gromen, who speaks of the “closing of the FX window,”

money, and this crisis is about

Pozsar also sees the freezing of Russian currency reserves as a rupture in thethe rising allure of outside

international currency system. After Bretton Woods, i.e., the US dollar-gold peg

money over inside money.

from 1944, and Bretton Woods 2, i.e., the petrodollar/eurodollar standard from

Bretton Woods II was built on

1971, he sees Bretton-Woods III dawning with the war of 2022. Bretton Woods III,

inside money, and its

Pozsar says, will be dominated by more nationalism and protectionism, by higher

foundations crumbled a week

military budgets and a much greater focus on real assets like gold or commodities,

ago when the G7 seized Russia’sand by inflation – at least in the West: “This crisis is not like anything we have

FX reserves.

seen since President Nixon took the US dollar off gold in 1971 – the end of the era

Zoltan Pozsar

of commodity-based money.” And Pozsar continues: “When this crisis (and war)is over, the US dollar should be much weaker and, on the flipside, the renminbi
much stronger, backed by a basket of commodities.” Finally, he sums up, “After
this war is over, ‘money’ will never be the same again.”
What is striking in view of the sanctions and this new phase of realpolitik is that
Western Europe seems to be in a good position – especially when it comes to gold.
With more than 12,000 tonnes, the euro area holds the largest gold reserves in theworld. The US still has around 8,000 tonnes. And if you look at the importance ofgold reserves relative to other currency reserves, the picture is also clear.
Countries such as Germany (66%), Italy (63%) and France (58%) are well prepared
for a world in which commodities act as currency anchors, even if they can hardly
boast any domestic commodity production themselves. Portugal, the Netherlands
and Austria are also betting on gold, along with the “Stan" states: Kazakhstan,
Uzbekistan and Tajikistan.

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159Gold Reserves, in % of Total Reserves, Q1/2022
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%

Gold Reserves
Source: World Gold Council, Incrementum AG

Russia and China are building an alliance –and a new world currency
No matter how the international

The fact that the Eurasian Economic Union (EAEU) is working together

landscape may change, China

with China on a “new global monetary system” would have been awill continue to strengthen

sensation a year ago. Even more so, since none other than the influential

strategic coordination witheconomist and politician Sergey Glazyev is pushing this plan. Today, after theRussia.

collapse of cooperation between the West and the East, news of a new monetary

Le Yucheng,system is hardly surprising. But it is relevant nonetheless, as these plans also

Chinese Vice Foreign

reveal much about the growing cooperation between Moscow and Beijing. They

Ministeralso fit Zoltan Pozsar’s vision of the monetary future.
On March 11, a videoconference of representatives of China and the Eurasian
Economic Union (read: Russia) agreed to plan an “independent internationalmonetary and financial system”.
“As a result of the discussion, it was decided to develop a project for an
independent international monetary and financial system. It is assumed that
it will be based on a new international currency, which will be calculated as
an index of the national currencies of the participating countries andcommodity prices.”
In an interview with the Russia-friendly journalist Pepe Escobar, Sergey Glazyev
elaborates on how he envisions this financial and monetary system of the future.
He outlines the formation of an Eastern IMF that would operate completely
independently of the current system. At its core is to be a new, synthetic currency
backed by both national currencies and commodities. This resembles a practicalimplementation of the system outlined by Zoltan Pozsar on the basis ofpurely economic considerations.

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With food you control people,

Glazyev expects the “imminent disintegration” of the US dollar-based global

with oil you control nations, andfinancial system, which will rob the US of its power base. This would be the final

with money you control thestep in a development that has been underway for 30 years. In Glazyev’s timeline,

world.

this transition to a new global economic order already began with the end of theHenry Kissinger

Soviet Union. The US hegemony in the monetary system will be replaced by a
combination of the systems that have been established in China and India in recent
decades. Glazyev speaks of a “combination of the advantages of centralizedplanning and a market economy.”
Glazyev describes three phases of the transition. In phase one, many nations would
revert to their own currencies in international trade. This is a trend that we have
not only seen since the war in Ukraine.
“This phase is almost over: after Russia’s reserves in dollars, euro, pound,and yen were ‘frozen’, it is unlikely that any sovereign country will continue
accumulating reserves in these currencies. Their immediate replacement isnational currencies and gold.”
The second step is to create pricing mechanisms that do not require theuse of the US dollar. This is also a development we have been seeing for someyears, for example in China, where gold and oil are now priced in yuan. But theyuan will not become the direct successor to the US dollar, says Glazyev, because it
is not convertible and Chinese capital markets are partly closed to outsiders.
Gold could not take on this role, either, as it is too impractical as a means of
payment. Therefore, something new is needed: a “new digital payment currency”.
This is the third step:“The third and the final stage on the new economic order transition will
involve the creation of a new digital payment currency founded through aninternational agreement based on principles of transparency, fairness,
goodwill, and efficiency. I expect that the model of such a monetary unit that
we developed will play its role at this stage. A currency like this can be issued
by a pool of currency reserves of BRICS countries, which all interested
countries will be able to join.”

Given gold's historic store of

At first glance, the plan resembles that of the West, based on thevalue as a currency, it's easy toSpecial Drawing Rights that were created in the 1960s as a neutral

see how this could be a sought-

reserve asset, based on a currency basket. With one difference: The

after asset in the years ahead. In

currency basket of the East will also include a “price index" of importanta modern twist, the appeal ofcommodities, according to the Russian economist and politician: gold, industrial

alternative digital currencies

metals, oil & gas, grain, sugar – and even water.

may also build.
Deutsche Bank

Every country in the world should be able to participate in the new system. At thesame time, debts accrued in the old system could be declared null and void if one
wanted to – a process that Glazyev already observes and that poses a further threat
to the US dollar system.
It is important to note, however, that this plan is probably not currently being
implemented in the way Glazyev envisions. He sees the Russian Central Bank as

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161still being under the influence of the West. It will take time for Russia’s blocking of
US dollar reserves to convince other countries that a new system is needed,
Glazyev says.
But he is not fighting alone. In an interview at the end of April, for example, thepowerful former intelligence chief, Nikolai Patrushev, reported that a group of
experts was already working on covering the ruble with gold and raw materials. In
doing so, Patrushev, a close ally of Vladimir Putin, provides insight into Russia’s
specific plans. To create an independent monetary system, there must be a way toanchor the value of the currency – without “tying” it to the US dollar, Patrushev
says.
The castle gates will always open

This point is important, because it is not just about power games and the conflictfor gold-laden donkeys.

between West and East, but about basic economics. To truly break away from theRussian Proverb

US dollar, a new reference point is needed, i.e. gold and commodities, because
Russia’s true wealth is stored in oil and gas. Patrushev comments on this asfollows:“The West has unilaterally appropriated an intellectual monopoly on the
optimal structure of society and has been using it for decades.... We are notopposed to a market economy and participation in global production chains,
but we are clearly aware that the West allows other countries to be its
partner only when it is profitable for itself. Therefore, the most importantcondition for ensuring Russia’s economic security is to rely on the country’s
internal potential, a structural adjustment of the national economy on amodern technological basis.”
China is not seen to play an active role in Patrushev’s remarks, but the geopoliticalroute is clear: “Russia is moving from the European market to theAfrican, Asian and Latin American markets.” Russia would strengthen its
cooperation with the other BRICS countries, i.e., Brazil, India, China and South
Africa, and the Shanghai Cooperation Organization (SCO), where India andPakistan as well as four other countries are involved in addition to China andRussia. The Eurasian Economic Union would receive the most attention, Patrushev
says. This is also the vehicle that Sergey Glazyev sees at the heart of the new
system.

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Source: Russiabriefing.com

A pact against the WestTo go fast, go alone, to go far, go

Alongside Russia, China is always looking for ways to circumvent the US dollar. In

together.

doing so, the two countries have been making common cause for years. This trend

Chinese proverb

has intensified tremendously in 2022. The relationship between Moscow and
Beijing seems to have never been better. The common enemy: the Western
monetary system. As early as February, Russia announced that it would no longer
use the US currency for exports to China at all.
In the run-up to the Beijing Olympics, Russia and China also concluded a new,huge gas deal. The euro was chosen as the settlement currency. A clear signal to
the EU: Russia and China want to drop the US dollar, but would have no problem
with the euro. However, this deal came about before the war and the sanctions
against the Russians’ euro reserves.
And that’s not all. In early February, shortly before Putin’s invasion of
Ukraine, Russia and China concluded their largest friendship treaty
ever. It is not a formal alliance – for such are fundamentally rejected by China –but it is a pact against America and the West. It is a document that historians
might regard as the beginning of a new Cold War, a view also held in the West.
Thus writes the New Yorker:“Agreements between Moscow and Beijing, including the Treaty of Friendshipof 2001, have traditionally been laden with lofty, if vague, rhetoric that faded
into forgotten history. But the new and detailed five-thousand-wordagreement is more than a collection of the usual tropes, Robert Daly, thedirector of the Kissinger Institute on China and the United States, at the
Wilson Center, in Washington, told me. Although it falls short of a formal
alliance, like NATO, the agreement reflects a more elaborate show ofLinkedIn | twitter | #IGWTreportA New International Order Emerges

163

solidarity than any time in the past. ‘This is a pledge to stand shoulder toshoulder against America and the West, ideologically as well as militarily,’
Daly said. ‘This statement might be looked back on as the beginning of Cold
War Two.’”
It has been 14 years since the financial crisis triggered by the US real estate market.
Even then, in 2008, when Beijing hosted the Summer Olympic Games, Putin
arrived as a guest with a hefty proposal, as then-US Treasury Secretary Hank
Paulson describes in his book:“Putin’s proposal was that Russia and China attack the US economically by
selling massive amounts of US bonds issued by mortgage lenders Fannie Maeand Freddie Mac, to trigger a huge financial crisis and bring the common
enemy to its knees.”
China refused at the time, but the Ukraine war and the new pact between Russia
and China have changed everything. The friendship between the Russians andChinese has certainly never been as solid as it is today. Putin and Xi refer to therelationship as a “partnership without limits.” In other words, no area of foreign
security or economic policy is left out. The Europeans had to experience what thismeans at a virtual summit with China in early April. Again, Xi backed his ally Putinby deciding to do nothing. Officially, this was a big disappointment for theEuropeans, who had hoped that Beijing would put pressure on Moscow.
EU representatives under Josep Borrell had hoped that Xi would takeadvantage of his good relationship with Putin to get him to negotiate
peace with Ukraine. Nothing of the sort happened. China did nothing at all,signaling support for Russia in the Ukraine crisis. Borrell later called the EU-China
parley a “dialogue of the deaf.” A month later, Beijing is clearly showing where its
loyalties lie, even calling the friendship pact with Russia a “new model ofinternational relations.”
Because, like Russia, China has much to gain in a world that is no longer
dominated by the dollar. That’s why Beijing is also lobbying heavily in Saudi
Arabia, the US’s most important ally in the Middle East; and China’s chances havenever been better.

Xi and MBS – Pretty Much Best Friends
Nations have no permanent

Only a few weeks after the Russian invasion of Ukraine, an invitation

friends or allies, they only have

was sent from Riyadh to Beijing: President Xi Jinping should pay a visit topermanent interests.

the kingdom. It was the clearest signal yet from Saudi Arabia that the oil state is

Lord Palmerston

turning eastward. The relationship with their traditional ally, the United States,
has been in tatters for some time. This is most evident at the personal level. Crown
Prince Mohammed bin Salman (MBS) had gotten along well with former President
Donald Trump. Trump flew to Riyadh on his very first trip abroad and wasreceived with much fanfare. It’s an honor the Saudis now want to bestow on the
Chinese president.

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164

The Wall Street Journal quotes a Saudi official: “The crown prince and Xi are closefriends and both understand that there is huge potential for stronger ties. It is notjust ‘They buy oil from us and we buy weapons from them.’”
People are saying, "Oh my God,The young crown prince is not on friendly terms with US President Joe

Saudi Arabia has changed." It's a

Biden. Virtually every article about the rapprochement between the Saudis andcontradiction. Do you want us to

the Chinese mentions how difficult the relationship between Riyadh andlead, or do you want us to play a

Washington is. Biden was vice president under Barack Obama, who actively turned

supporting role?

his back on Saudi Arabia and struck the Iran nuclear deal. That deal was important

Adel al-Jubeir

to China, Russia and Europe – and was later rescinded by Trump.
Biden holds MBS responsible for the murder of journalist Jamal Khashoggi. He
also refuses to treat MBS as a political equal to the US president. The official headof state remains King Faisal, MBS’s father. In a long interview with US magazine
The Atlantic, MBS makes it clear where this American strategy is driving him:
eastward, toward the Chinese: “Where is the potential in the world today? It’s in
Saudi Arabia. And if you want to miss it, I believe other people in the East aregoing to be super happy.”
After the start of the war in Ukraine, the White House may have suddenly changed
its position. Thus, the Wall Street Journal reported an attempt to contact MBS. But
the crown prince refused to take a call from Joe Biden. And Sheikh Mohammed bin
Zayed, the ruler of the United Arab Emirates, also declined to talk to Biden.

All concepts of politics, of

The Gulf states are indignant about the lack of support for Saudi

whatever kind, are about

Arabia’s war in Yemen and the resumption of negotiations with Iranconflict──how to contain it, or

under Biden. The rulers of the oil states, however, had no qualms about holding

abolish it.

telephone conversations with Russian President Vladimir Putin. The tensions

Ralph Miliband

between Washington and the Arab world cannot be illustrated much more clearly.
There are no such tensions with China. MBS and Xi are “good friends”. Saudi
Arabia is also a central pillar of China’s Belt and Road Initiative and in the top
three when it comes to Chinese construction projects abroad. Here, the Chinese
renminbi is also already involved as a currency.
All of this is important. After all, Saudi Arabia has always been the US’s central
ally in the Middle East and was the decisive factor in establishing the petrodollar
system. However, China has long been the oil state’s largest customer. To date,
about 80 percent of the global oil market has been transacted in US dollars, andSaudi Arabia has probably been the decisive factor – for decades. But Beijing wants
to finally switch the oil trade to the renminbi.
Some 25 percent of Saudi oil exports already go to China, and never
have we been closer to a switch to renminbi than in 2022. Russia’s attack,sanctions, and Moscow’s response have shaken up international trade in energy
and currencies. Ahead of Xi’s possible visit in May, Saudi Arabia again signaled awillingness to accept yuan (renminbi) soon.
Negotiations in this regard have been ongoing since 2016. In 2019, Saudi Aramco,
the state oil company, presented plans for bonds in renminbi. China is also actively

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165

pursuing better relations with Saudi Arabia. It supports Riyadh in a nuclear
program and has invested in the crown prince’s favorite project, the futuristic cityof Neom.
In February 2022, plans were revived to jointly build an oil refinery in China. This
project has been in planning since 2019, but it was put on hold during the
pandemic because of low oil prices. Now it is topical again:“The fact that this landmark refinery joint venture is back under serious
consideration underlines the extremely significant shift in Saudi Arabia’s
geopolitical alliances in the past few years – principally away from the US
and its allies and toward China and its allies.”
The fact that Norinco, one of the two Chinese companies in this joint venture, isalso one of China’s largest arms manufacturers should not go unmentioned; norshould Saudi Arabia’s plans to buy Russian missile systems.
The deal between Riyadh and Washington always had a militarycomponent. Protection and material were to be supplied by the US in exchange
for oil – and the pricing of oil – in US dollars. But Saudi Arabia is not only
diversifying in the oil trade. Since late 2021, it has also been working with China on
a missile program. It seems that the exclusive relations between Saudi Arabia andthe US are finally history.
China’s renminbi is widely

It is only a matter of time before an extremely important oil nation, like Russia,

regarded as a potential

accepts currencies other than the US dollar: renminbi, rupees, or maybe evencandidate to supplement theeuros. Russia, along with Saudi Arabia, Angola and Iraq, is one of China’s mostdollar in the international

important oil suppliers and will be ready at any time to sell even more oil in

sphere.

exchange for renminbi. According to our friends at Gavekal, this increases theBarry Eichengreenpressure on Riyadh, because Beijing can use the oil trade with Russia as a goodargument:“China is the world’s largest oil importer, so what happens if Beijing tells
Saudi and other Middle Eastern producers ‘I would love to do more businesswith you. But when I trade with Russia, that business is denominated inrenminbi. Which works so much better for me. So unless you can takerenminbi as well, I will likely import more energy from Russia.”
The consequences of these developments for the US dollar and thus for theinternational monetary and financial system are serious.
Gal Luft, co-director of the Institute for the Analysis of Global Security inWashington, says: “The oil market, and by extension the entire global
commodities market, is the insurance policy of the status of the dollar as reserve
currency. If that block is taken out of the wall, the wall will begin to collapse”.
Now, of course, there is more to consider in the question of whether the oil trade
could be conducted in renminbi (yuan). China’s currency and economy are still
hampered by strong capital controls. However, with many Chinese companies now
operating in Saudi Arabia, the kingdom needs liquidity in Chinese currency. China

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166

is also very likely to promise further billions in investment in return for a currency
conversion in the oil trade, which would further strengthen the link between thetwo states.

Conclusion: A New International Order Is
Emerging
In due time, the dollar, currently

The sanctions against Russia, the response from Moscow, the Russians

the anchor currency for roughly

and Chinese moving closer together, the indecision of the Europeans,

two-thirds of world GDP, could

the new love between Saudi Arabia and China – that the world is inlose nearly half its weight.

upheaval is obvious. Even the IMF, guardian of the US dollar order, isKenneth Rogoff

becoming active again. Kristalina Georgieva, managing director of the IMF, caused
a stir with a statement in April:“I think we are not paying sufficient attention to the law of unintended
consequences. We take decisions with an objective in mind and rarely think
through what may happen that is not our objective. And then we wrestle with
the impact of it. Take any decision that is a massive decision, like the decisionthat we need to spend to support the economy. At that time, we did recognizethat maybe too much money in circulation and too few goods, but didn’t
really quite think through the consequence in a way that upfront would haveinformed better what we do.”Then there was this big report that the IMF published shortly after the start of the
Ukraine war. It bears the significant title “The Stealth Erosion of Dollar
Dominance”. The report has a lot going for it, not least because the well-known
economist Barry Eichengreen is a co-author.

Allocated Foreign Exchange Reserves not Held in USD, EUR, JPY
and GBP, in % of World Total, Q1/1999-Q4/2021

12%
10%
8%
6%
4%
2%

0%
1999

2001

2003

2005

2007

2009

2011

2013

2015

2017

2019

2021

Non USD, EUR, JPY and GBP Reserves
Source: IMF, Incrementum AG

We find the choice of time period in the above chart particularly relevant. Aroundthe turn of the millennium, the euro was established, the price of gold began torise, and the dot-com bubble burst. Historically, this was arguably the turning
point for the US dollar-dominated system. In our timeline, we show that things
moved very quickly from that point on – and that the financial crisis, the pandemic
and, most recently, the war in Ukraine accelerated the process further.

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167

Hardly anything illustrates this development more impressively than this news
item from the end of April 2022: Israel is cutting back on its US dollar and euro
reserves and is investing reserves in yuan for the first time.
The freezing of Russia’s foreign exchange reserves was another nail inthe coffin of the US dollar system. We do not know what exactly will take its
place, but the trends we have documented in this chapter point in two directions:
The world will become multipolar or bipolar, depending on Europe’s choices. And
metals and commodities will become more important and either directly or
indirectly involved in the monetary system.
The sinews of war are infinite

We are at the end of a development that began in 1944. If Keynes had

money.

been listened to back then, perhaps the world would look different today. But the

Marcus Tullius Cicero

attempts to create a rules-based monetary system have all failed. Politicians like totout Special Drawing Rights as an option, but that could just be a distraction, a way
to point out dissatisfaction with the US dollar system without immediately
bringing their own solution into play. The euro is perhaps the best example of what
occurs with a rules-based international monetary system: The rules wereimmediately broken. But the euro’s strong gold component should also equip it forthe other path, the one that China and Russia are already signaling very clearly: aworld in which currencies find their anchor in reality – through reference tocommodities, without a direct peg, but designed as a flexible system that is tested
daily by the market.

Learn from yesterday, live for

It is not easy to put this new monetary order into words, as it is extremely

today, hope for tomorrow. The

dynamic. But the statements and actions of state leaders, as well as analyses suchimportant thing is not to stopas those by Zoltan Pozsar and Luke Gromen, all point in this direction. Let’s notquestioning.

forget that the US has large reserves of raw materials – and 8,000

Albert Einsteintonnes of gold. These have been lying around unused since Richard
Nixon declared the gold window closed.
Now, it opens again.

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168

Energy, War & Inflation –Exclusive Interview with
Luke Gromen“We all know what to do, we just don’tknow how to get re-elected after we’ve
done it.”
Jean-Claude Juncker, former president of the European Commission

Key Takeaways•

Contrary to what we saw in previous crises, we now
have a debt crisis at the sovereign level. This isexacerbated by rising energy prices anddeglobalization.

•

The Federal Reserve needs to hike rates in order tocurb inflation on the one hand, but needs higher asset
prices in order to obtain higher tax receipts for theTreasury to pay off their deficit on the other.

•

Since the fall of the USSR in 1990 there has been aslow and steady acceleration back to a more
decentralized global system, primarily around energy.

•

China, Russia and others are moving away frompricing oil and other commodities in US dollars. Thisis causing a backlash from the US, who are trying toprotect the petrodollar system.

•

This will drive a steady gold bid from foreign central
banks over time. Holding physical gold will become
more important to central banks.

•

The Federal Reserve wants to avoid yield curve
control and certainly explicit yield curve control at all
costs. It is likely that we will see the US government
purchasing Japanese bonds within the next few years.

Energy, War & Inflation – Exclusive Interview with Luke Gromen

169

Luke Gromen is the founder of FFTT, LLC (“Forest for the Trees”), a
macro/thematic research firm catering to institutions andsophisticated individual investors.
Luke’s vision for FFTT was to create a firm that would address the opportunity hesaw created by applying what customers and former colleagues consistently
described as his “unique ability to put the big picture pieces together” during atime when they saw an increasing “silo-ing” of perspectives occurring on WallStreet and in corporate America.
Ronnie Stöferle and Nikolaus Jilch conducted the interview with Luke Gromen on
April 20, 2022 via Zoom.
We are publishing the highlights of the interview below. The full version of theinterview is available for download here.
The video of the entire interview, “Energy, War & Inflation”, can beviewed on YouTube here.

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Ronnie Stöferle:
Luke! Thank you very much for taking the time! We featured you for the first timein our . Then we had an interview with you for the In Gold We Trust report 2018
which we called “The Dollar Appears to be in Zugzwang”. Then, in the In Gold We
Trust report 2020 we did another interview, titled “A Deep Dive into the
Geopolitics of Oil, Gold, and Money”. This is our fourth interview, we are truly
looking forward to it, there are so many topics to talk about. I would like to startwith a Tweet, it is something that you wrote recently in your FFTT Tree Rings. You
wrote:“We want to be very clear; the current setup may be the scariest setup we
have seen in our 27-year career. For traders that mange a book on amonthly basis, we would recommend to be in maximum defensive position. Cash,
short term US treasuries and maybe gold, until the Federal Reserve is forced tocome to the rescue.”
Could you give us your view about all these topics that are currently unfolding andthe “everything bubble” that might be crashing at the moment. What do you see
happening over the next couple of weeks?
Luke Gromen:
The marginal costs of producing

We have an extremely difficult setup in terms of the macro view, where over theenergy are moving secularly

last 20 years we had started with an equity bubble, then kicked that up to thehigher due to geology, we alsobanking system via the housing bubble, then kicked that up to the sovereign level,

have geopolitical tensions and on

where we now have the biggest sovereign debt bubble, the first global

top of that, deglobalization andsovereign debt bubble, in 100 years, since the immediate aftermath ofcommodity interruptions from

WW1. This is also the first Western sovereign debt bubble since the end of WW2.

Russia and from Ukraine.

This leads to a number of different things. Within this bubble you have an overlayof a commodities crisis of sorts, that we had already in terms of “peak cheap
energy”. The marginal costs of producing energy are moving secularly
higher due to geology. Now we also have geopolitical tensions on top of
that, deglobalization, commodity interruptions from Russia, and from
Ukraine.

The credit risk is at the sovereign

We have this setup where the credit risk is at the sovereign level, andlevel, and sovereigns cannot

sovereigns cannot default. This is not really credit risk, it is duration

default. This is not really credit

risk. What duration risk is, is just inflation. The sovereigns, and particularly

risk, it is duration risk. What

the Western sovereigns,are in a position where they need to try and manage

duration risk is, is just inflation.

themselves between inflating enough to inflate away the debt on a debt to GDP
basis, in order to make the debt sustainable, while also not inflating so much thatthey spook the bond market. They are trying to fine-tune where that is. They were
probably running at bout the correct rate, when we were at 8% CPI in the US,
11.5% nominal GDP growth, it probably needs to be 12%-15% nominal GDP growthin the US to get the debt/GDP to levels that are sustainable, from which theFederal Reserve can raise rates without blowing things up. We have been saying all
along that they have not been doing enough, here they are, they are raisingrates but they have not done enough in terms of deleveraging thebalance sheet on a debt/GDP basis and now things are starting to blow
up. It’s not surprising to me that things are starting to come unhinged.

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Inflation is now so high that it is

We have been increasingly warning people in our reports over the last three to six

now a political problem, they aremonths, that when the Federal Reserve first came out last June and started talking

triggering a crisis.

about being more hawkish, I initially thought it was just jawboning because I did
not think that they could be that stupid. But they have positively surprised me as tohow stupid they could be. I’m saying that tongue in cheek because it is political,
inflation is now so high that it is now a political problem, now they aregoing to do the wrong thing to address the needs of domestic politics,
and domestic politicians in the USA – and lots of other places – are wrong all thetime, and that is where we are. They are triggering a crisis.

The “Putin price hike” is a

The “Putin price hike” is a perfect example of what I was talking about.

convenient scapegoat for

I don’t know what is more disappointing, the fact that they try to pass that off orAmerican politicians.

the fact that more than half of Americans actually believe it. It is what it is, I don’teven think it is good propaganda because it is so easily disprovable, but here weare. This thing was going on well before that and it is a convenient scapegoat for
American politicians.
Niko Jilch:
The conventional wisdom would be that if inflation is going up, whatever thereason is, we need to tighten and we need to raise rates. Do I understand you
correctly that you think that is stupid and that the Federal Reserve should not beraising rates right now?
Luke Gromen:

If they want to crash the system,

Well, that depends on what they want to do. If they want to crash the system,

raising rates is the smart thing tothen it’s the smart thing to do. If they don’t want to crash the system

do. If they don’t want to crashthen they need to let inflation run. Last year about this time we published athe system then they need to letreport that estimated that if they wanted to normalize policy without crashing the

inflation run. Having made thesystem they needed to let inflation in the US run somewhere between 12% and 18%

decisions they made; you justfor 5 years. That is the level of negative real rates they would have to get to in order

have to inflate it away, otherwise

to get debt/GDP down from 130% to about 80% which is what we estimated where

you are going to cause a bigger

they could normalize policy without blowing up the system. They managed to get it

calamity than what is alreadydown from 129% down to 122% with 12% nominal GDP growth and 8% CPI whichtranspiring.

tells up that our numbers probably were not that far off. But at 122% debt/GDP
and 8% CPI they began panicking and now they are tightening and we are alreadystarting to see debt/GDP go back up.
American politicians are worried about inflation, but they are always worried
about the wrong thing. They are going to have an asset price problem and an
economic problem right around election time if they don’t turn course soon.
Niko Jilch:

This is a US-centric politicalThat is an extremely important point because this is very much political and it isproblem, and the politicians will

US-centric politically. There are mid-term elections and the administration isrealize at some point that people

trying to fight inflation, that is what it looks like. This seems to be a plan that came

don’t like it when their stocks gofrom before the war, now they are doing it. Are you saying that they will realize at

down.

some point that people don’t like it when their stocks go down?
Luke Gromen:
That is exactly what they are going to realize. Stocks and their houses etc.

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Ronnie Stöferle:
Central bankers all over the

But Luke, didn’t Bill Dudley write about this “reverse wealth effect” on Bloomberg?

world now seem to have new

Dudley is not a nobody, he is very influential and he probably talked to his former

mandates when it comes toFederal Reserve friends before publishing that piece. Do you think that is ahead

climate change, inequality andfake or is it a strategy that the Federal Reserve might be persuing now whenother social issues. Do you thinkrealizing that they will have to do something about this inequality? We know thatthey have been pivoting into thiscentral bankers all over the world now seem to have new mandates“reverse wealth effect”?

when it comes to climate change, which seems to be the most important thing
for Ms. Lagarde these days. But also fighting inequality, which is something that
Lael Brainard and also Jerome Powell refer to quite often. Do you think they havebeen pivoting into this “reverse wealth effect” and demand destruction, leading toa cooling effect on inflation without causing a recession? The hubris that they haveto think that they are trying to fine-tune this thing like it’s a thermostat, it’s
astounding. Do you believe that or is it just a story that they are making up?
Luke Gromen:

The so-called “boomer”

I think it is factoring into their thinking. That asset price inflation is driving CPI

generation owns a large

inflation and my view of this has been that there is USD 35trn in assets that

proportion of the money

the baby boomer generation owns and the US policymakers and the US

available in the economy andmedia have spent the last two years scaring the US baby boomers tothey are now spending it. This

death: “You are going to die sooner than expected because of Covid”. Now they

contributes to the current highare spending their money sooner.

inflation numbers we are seeing.
It’s a tricky thing and I think the Federal Reserve is seeing that when you reallylook at the problem, the reason that the boomers have USD 35trn in
wealth is because of policy to sterilize inflation in the first place. When
you look at how these boomers got all this money, in no small part it is deferred
accounts. 401k plans, IRA plans, things where there was inflation happening andthe US government gave tax breaks to take that inflation out of the real
economy and put it into asset inflation instead and thereby defer it.
Central bankers are basing

We have two things happening at once in terms of asset inflation. First, asset pricemonetary policy decisions based

inflation that was sterilizing CPI for 40 years is coming back into the economy.

on non-monetary criteria,

Secondly, this is driving velocity – and I don’t really care what the velocity

especially on political andnumbers say, I think they are BS – but velocity is coming back, because

environmental issues. This isboomers are long money and short time. The question then is: Ok, I do

extremely dangerous andthink this is happening and I do think the Federal Reserve is thinking about it thisirresponsible because it will haveway. Is crashing the markets a way to deal with it? William Dudley is the same guy

adverse economic effects.

who, in August 2019 wrote an op-ed similar to the one he just wrote about crashingstocks to reduce inflation. He wrote in August of 2019 that the Federal Reserve
should tighten rates to put pressure on Trump, to basically ensure that he lostthe election in 2020. This was 3 weeks before the repo rate spiked, because
liquidity was already that tight. The Federal Reserve was already loosening at thatpoint, we were about to have a blowup, the Federal Reserve’s balance sheet wasliterally 3 weeks from beginning to grow again and it hasn’t stopped since, and thisguy was talking about tightening rates to fight a politician.
This is just to illustrate how political and how mainstream groupthink inWashington is. I think this is part of their thought process and he is talking to all

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the same people, and they are thinking of it and it is going to be a disaster because
they are not running a dial, it’s a switch.
The Federal reserve can get

I understand what they are doing and I understand why they are doing it, but it isstocks to go down any time they

not going to work. They can get stocks down any time they want, but the flip

want, but the US governmentside is – and this is the side nobody is talking about – the problem is at theneeds asset prices to rise in ordersovereign level and the US government needs asset prices to rise toto drive tax receipts.

drive tax receipts. When asset prices fall, tax receipts fall and 120% of all-time
record tax receipts, at this moment are entitlements, defense, and treasury
spending. They are not even covering the basic spending with all-time
record-high high tax receipts and with asset prices in an “everything bubble”.
If they want to take asset prices down to try and tame inflation, great, but withinmonths, if not weeks, the Federal Reserve will be in a precarious
position because there are no buyers for these treasuries. You can shiftsome money out of stocks and into treasuries, but as you do that you are also going
to be increasing treasury issuance, because your receipts will be falling along withasset prices. There is this dynamic that nobody is talking about, the importance ofasset price inflation driving treasury receipts, primarily through the consumption
link which is 2/3 of GDP.
Niko Jilch:
Luke, we talked about “Putin’s price hike” and the funny thing is that here inEurope, where we are closely connected to what is happening, nobody is trying tosell the “inflation is Putin’s price hike” narrative. This tells me something positive
about the Europeans, but my question is this: Under the new circumstances,because the war is driving inflation, it’s just that not all of the inflation is
because of the war. Will it even be possible to get inflation down with thewage hikes like there are in play now?
Luke Gromen:

If you take unemployment toI think yes, but I question what the collateral damage will be. If you want

10% to fight inflation, Le Pens

to send unemployment in Europe high enough, we can get inflation down. If you

are going to pop up all oversend unemployment to 10% or even 20%, you can get inflation down. But if there isEurope.

a shortage of food, those types of inflation levels will have political side
effects. We saw Macron winning in France, that might put the side effects on theback burner for now. But if you take unemployment to 10% to fight inflation, Le
Pens are going to pop up all over Europe. There is this very established historicalpresident for that. This again gets back to the fiscal situation, Europe’s fiscal
situation is not good either, what does that imply for budget cuts, or a deflationary
spiral?
Taming inflation will have dire costs for Europe. Political populism
and high unemployment, and the central bank will have to fund thegovernment because they made all these entitlement promises and now
we don’t have any tax receipts at all to fund them. Then they will haveto re-do QE.

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I question what the collateralI think they can probably do it, but if you think how draconian the economic

damage will be. High

downturn needs to be, it needs to be much greater in order to tame

unemployment, political unrest,

inflation this time because of these structural factors. This will mean thatand possibly the rise of political

you used to need to take GDP down 3% to get inflation down and now maybe it

populism could be some of theneeds to be down 5% or 8% or maybe 10%, and those numbers are bigger thanconsequenses.

what we saw in the Covid-19 crisis, and that was enough to crash everything.
Can they do it? Sure. Can they do it without blowing their head off andblowing the economy’s head off? Probably not.
Ronnie Stöferle:
I agree, I am not aware of too many soft landings where things worked out well inpractice. Luke, there are a great many topics to talk about. I would love to talkabout Japan later on, but let’s talk about your main area of expertise,
which is de-dollarization. You are the superstar when it comes to this topic
and a few years ago it was a topic only for macro nerds in the gold community, but
now it is becoming mainstream.

Let’s talk about de-dollarization,Lets’s talk about the Russia/Ukraine war and how it will impact our

the war in Russia/Ukraine, andmonetary system. Zoltan Pozsar wrote about the possibility of Bretton Woods

the happening impacts of this on

III, we know that over the last couple of weeks there was so much going on that it

the world monetary system.

is exciting but also exhausting to follow everything that is going on. From yourpoint of view, what have been the most interesting and most under-researched
topics that you have seen over the last couple of weeks?
Luke Gromen:
It has been interesting to see some of the evolution of this de-dollarization theme
that you talked about. For me, there has always been a yin and a yang to it, where
people want to say that it is an attack by the Chinese and the Russians and thesepeople who are fighting the rules-based global order, and that is part of it. But it isalso partly a defense by those same people against the dollar being weaponizedagainst them.

It is a matter of urgent national

It is literally a matter of acute and urgent national security for China

security for China, Russia, andand for Russia and for others to move away from pricing energy, inothers to move away fromparticular, and also commodities more broadly into dollars alone.

pricing energy and commodities

There has been this movement, driven by both geopolitical aggression andin US dollars alone. We are seing

geopolitical national defense for these countries to move away from pricing oil, in

more and more countries

particular, in US dollars. When we first started talking about this in 2014 – 2017,actively persuing this and the US

people thought we were nuts, earlier this year you have on the front page of themoving to try and slow or halt

Wall Street Journal: “Saudi Arabia Considers Accepting Yuan Instead of Dollars

this process.

for Chinese Oil Sales”. When you see things like that and you see India in the midstof this crisis with Russia and Ukraine, telling the US: “We will do what makes themost sense for us and that is to buy Russian oil in Rupees”. It is almost formulaic, aweek later all of a sudden the US is concerned about human rights violations inIndia. It’s very, very cynical and I am to old to be naïve when I watch these things,
you could have predicted it.

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Luke Gromen:
Every country has both pro-

Ultimately this all feeds back into the de-dollarization theme, which is: The

dollar and pro-de-dollarization

whole world is realizing that they are going to have their turn in the spanking

factions who have different

machine, no matter what, and the spanking machine is the dollar system and thedomestic views, but the de-

US politicians running it. So they might as well do what is best for their interests.

dollarization factions are rapidly

Within every country, there are both pro-dollar and pro-de-

growing and the Russian

dollarization factions for different domestic self enlightened views But

situation has accelerated it.

you can see it moving quite steadily and ultimately this Russian situation has
accelerated it, because now it is crystal clear that if you do something the US does
not like, they are going to confiscate your reserves. The US has been threatening it,
they did it to Afghanistan, they did it to the Iranians, but all of those were smaller
nations, they were not the world’s biggest commodity and energy exporter, they
were not the world’s biggest country by landmass, they were not a nuclear-armed
nation, they were not a G7 nation.
It’s an entirely different situation and like I have said before, everybody has
been a bad actor in the eyes of the US over the years. That’s not because
America is bad or good, it’s just how international geopolitics go.
I don’t think people ever really loved this dollar system, I think they accepted it
because it was less worse than getting invaded by the USSR, and as soon as the
USSR broke up, since 1990 there has been this slow and steadyacceleration back to a more decentralized system, primarily aroundenergy.

Since the fall of the USSR in 1990

I don’t think this de-dollarization is something that can be stopped. It’s going tothere has been this slow andkeep moving in bits and starts and I think what Russia did accelerated things quite

steady accelleration back to ameaningfully. There is this quote from Frank Zappa:

more decentralized system,
primarily around energy.

"The illusion of freedom will continue as long as it’s profitable to continue theillusion. At the point where the illusion becomes too expensive to maintain, they
will just take down the scenery, they will pull back the curtains, they will movethe tables and chairs out of the way and you will see the brick wall at the back of
the theater."I think that by implementing the Russian sanctions, the US was saying:“Ok, the curtains are gone, the set is gone, all of the props are gone, here is thehard brick wall”. If you do something we don’t like, we are going to grab
your money.
Niko Jilch:

There are indicators pointing

One of the main things in monetary politics for decades has been that the US

toward the IMF possibly trying

dollar is a national currency and also an international currency, andto set up something like a Brettonthat is a problem. We have known this since the introduction of the Bretton

Woods III system. Do you see a

Woods system, then in the 1960s, Robert Triffin layed out the Triffin dilemma andpossibility for a new monetary

one of the so-called “solutions” was the “special drawing rights” at thesystem built around the IMF, orInternational Monetary Fund. A basket of currencies used as an international

is the IMF just trying to stayreserve asset. There have been numerous attempts over the years to reintroduce

relevant in changing times?

this. My question is this: When we are moving into a new monetarysystem, how high do you think the chances are that the IMF will try to

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set up something like a real Bretton Woods III? Could we see themarranging a conference where they establish new rules and potentiallydiscuss something similar to Special Drawing Rights, because I see the
IMF moving on this. If you look at the interview with IMF director Kristalina
Georgieva, where she said:“I think we are not paying sufficient attention to the law of unintended
consequences. We make decisions with an objective in mind and rarely think
through what may happen that is not our objective. And then we wrestle with
the impact of it.”
“We act sometimes like eight years old playing soccer. Here is the ball, we are
all at the ball. And we don’t cover the rest of the field.”
Her admitting thise things seem crazy. Then there was a report called: The Stealth
Erosion of Dollar Dominance, written by Barry Eichengreen, who has been very
vocal about the exorbitant privilege, etc. Do you see a possibility for a newmonetary system built around the IMF, or is this just the IMF trying to stay
relevant in changing times?
Luke Gromen:
I think it is one of those situations where they are just trying to stay relevant. I
think they know what the problem is, it is as Jean-Claude Juncker famously said:“We all know what to do; we just don’t know how to get re-elected after we’ve
done it.”
The IMF seems to be having a

I think it is the same issue for the IMF where they know what they needdifficult time deciding between

to do, Eichengreen’s paper (as mentioned above) highlights some of the issues.

their own members what is the

The challenges are that you have to get a whole lot of nations together

correct way to move forward.

and maybe that was possible 10 years ago, but that does not seem

This infighting will likely hinder

possible now.

them greatly from making any
real progress.

At the IMF you will get a bunch of people together who don’t want to
get together. The US is controlling a big part of the IMF and they have to agree,
and they don’t want to agree, then there are the different factions in each of theminority voting members of the IMF to agree. I just don’t think they will ever makeany progress.
Niko Jilch:

Is it possible that we could see

When you look at what China and Russia are doing behind the scenes, they are

two de-facto IMF’s, an easternbasically trying to build something like the Special Drawing Rights, something likeIMF and a western IMF? Witha “common currency” that is denominated in their local currencies and also

China-Russia leading one factioncommodities. This would tie in with what you are saying and also with what Zoltan

and the USA leading the other?

Pozsar is saying, then you have Janet Yellen talking about a bifurcated financial
system. My question is: Is it possible that we will see two IMFs, an eastern
IMF and a western IMF?
Luke Gromen:
Yeah, it is. The challenge would be to get all the right people in your club, because
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manufacturing in your club and the other club has more manufacturing andenergy, or is more efficient than you are, then your club is going to die over time.
You’re going to lose.
The key question is what type of

If the factory of the world, which is China, is married with Russia, who

resources and manufacturing

has all these metals and energy, etc., and a quorum of the Middle East

your side will end up with.

participates in that, then the US is left with shale gas, which isn’t ramping up. The

China/Russia seem to have a lot

oil price has been up for 8 weeks and there has been no increase in US shale

more resources andproduction and no increase in US oil production, and then you have European

manufacturing output at thismanufacturing.

stage than the west. This will be
problematic for the west andIt would be workable, but you will have two competing systems and thesecause problems for the westerncompeting systems will force the system to be kept more honest. What that looks

led side over the long term.

like is: The US is going to have to either see much higher inflation or reallydraconian measures to fight inflation and takedown asset prices, which is going tofeed itself in the wrong direction on the fiscal side. So, it’s possible, but I don’t
think it’s a happy path from here to there.
Ronnie Stöferle:

Emerging countries’ gold

If we come back to the topic of gold, this decision by the western world to say that:holdings relative to the western“Your FX reserves are worthless”. Isn’t that the best case there could be forworld as a percentage of total

owning physical gold over the long term for central banks?

reserves are minuscule, do you
see this as a driver of the gold

My question now leads to a topic that has been going on for a while already. Whatprice? How would this impact

Kenneth Rogoff said in a piece published by Project Syndicate, where he

the paper market for gold vsrecommended emerging market countries buy physical gold to hedge

holding physical gold?

their US dollar exposure. Do you see this as a big driver going forward
on the demand side for gold and, if yes, wouldn’t that also be some sortof threat to the paper market for gold?
Luke Gromen:

Yes, this will drive a steady goldYes, absolutely. I think it’s going to continue to drive a steady gold bid

bid from foreign central banksfrom foreign central banks over time. Importantly, the manner in which weover time.

are going after Russia’s gold, anything that is held offshore is subject to sanction or
seizure. That speaks to the market being physically driven.

Holding physical gold will

We will look back in 5 years and say: “Wow, that was really positive forbecome more important tophysical gold”. Now, does that blow up the paper market? I think at some point

central banks. The paper market

it does, but that is an entirely political construct. It’s not going to matter andfor gold will not necessarily

then suddenly we wake up a week later and suddenly it matters, and“blow up”, but we could see athere are any number of geopolitical or market-driven reasons that you could see

steady move toward physicalthat happen. A certain set of political circumstances has to be in place gold to haverather than paper gold.

significant price movements. We are moving in the right direction in termsof the gold market being more physically driven. What has happened inregards to these sanctions are likely to be a positive catalyst for that, but when will
it really matter? It’s hard to know.

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Ronnie Stöferle:
Regarding stagflation, what are

Luke, a topic that I wanted to talk about, because it’s the leitmotif ofthe main differences between

this year’s In Gold We Trust report, is the topic of stagflation. What arewhat we saw in the 1970s andthe main differences between the stagflation we saw in the 1970s and the current

our current setup?

setup?
Luke Gromen:

The most important difference is

I think the main difference is by far the most important difference, which is

the global sovereign debt bubble.

the global sovereign debt bubble, and in particular the western sovereign debt
bubble. USD as the global reserve currency, they are currently the center of thesystem. In the 1970s, US debt/GDP was 30%, now it’s 125% and moving higher.
The point is that in the 1970s there was a lot of leeway for the US to allow theinterest rate to rise and fight the inflation/stagflation. When we eventually
managed to crack down on it, yes it caused a severe economic contraction and arecession, yes it caused a lot of private-sector bankruptcies, however, there were no
risks to the sovereign solvency of the US, the European Union, or Japan. Right
now, fractions of the type of rate hikes that we saw in the 1970s will
mathematically cause threats to the solvency of the US, European Union, andJapan.

In the 1970s there was a lot ofLet’s look back in history and see how many times nations with aleeway for the US to allow thepurely fiat currency has gone bankrupt instead of printing money, it’s ainterest rate to rise and fightreally, really short list. They always print money; they don’t go bankrupt.

inflation/stagflation. This is

That’s where we are right now, where there is this collective delusion that we areimpossible now.

watching central bankers and governments engage in, and markets are believing
them. Like the “Putin price hike”, markets actually believe that governments will
let themselves go bankrupt. It’s crazy, there is no chance. We have to becognizant to play that game and understand that in our position, shortrun, that markets actually believe that central banks will let theirsovereigns go bankrupt, there is no chance that’s going to happen. It’s
really just a question of when circumstances get dire enough to force the central
banks to finance these deficits and prevent that insolvency. That’s the big
difference.

History shows that not many fait

The sovereign balance sheets are just night and day different (from the 1970s);

currency governments gothey are reminiscent of post-WW1 Europe. In post WW1 you have the six big

bankrupt instead of printing

industrial powers. The Austro-Hungarian empire, the UK, Germany, France,money.

Russia, Japan, and the USA. Austro-Hungary hyperinflated, Russia hyperinflated,Japan depreciated, I think 80% vs gold, the French devalued at least twice, the UK
was amongst the last to go, in 1931 they devalued massively vs gold and the USA
went last in 1933 when we devalued 75% against gold. Sovereign debt amongst allthese participants in real terms just collapsed. I think that is much more apropos.

After WW1, all large industrial

I think we are seeing a blend of the 1970s, the immediate aftermath of WW2 andnations in the west devalued

the immediate aftermath of WW1. This is some sort of toxic mix of all thosetheir currencies vs gold.

situations. The most important thing is the sovereign balance sheets
globally and in the west in particular. There is just no ability to fightinflation the way that they did in the 1970’s.

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Niko Jilch:
Current governments don’t want

And we don’t want to. Nobody actually wants to fight inflation. The Bank forto fight inflation, but they needInternational Settlements said that we are going to see a new age of inflation.

some kind of new narrative toEven if you hike rates and cause the stock market to go down, that isallow them to print more money.

what you need to do before you can print even more money. You need a
new narrative; you need a new crash in order to print more money to “save theworld”.
Luke Gromen:

Central banks are currently

I think that is probably what they are working on right now. This newcrafting this new narrative, somenarrative, the full macroeconomic narrative of “Putin’s price hike”. The

sort of existential crisis that will

narrative will be “Oh, the system crashed, we need to print more money, we needallow them to come in and “save”

to save you all again, so we central bankers can be heroes again”. That is what we

the word.

are watching in real time.
Ronnie Stöferle:

The BOJ tried to implement YCC

One example that I think is worth following is what is going on inand the release valve seems to be

Japan. The Japanese did many many rounds of quantitative easing, but so far it

the yen crashing vs the dollar

has not been extremely successful. Now they are also doing “QQE”, that’sand vs gold.

quantitative and qualitative easing, so they are also buying REITs and ETFs andother things.

What other, possibly similar

I have to admit that I thought that when the 10-year bond yield reaches 2%, that

actions can we expect from thewould be the level where the Federal Reserve would get very nervous and start

Federal Reserve?

talking about yield curve control. Going forward, do you think this would be ameasure taken by the Federal Reserve? Will they at some point start buying
equities or other assets? Probably not Bitcoin, yet. What is the next tool that
the Federal Reserve has in its toolbox?
Luke Gromen:
One thing that they can do is that the Federal Reserve can, by their mandate, buy
the sovereign debt of other nations. A very likely step if we continue to see adisorderly decline in the yen, for the reasons you just discussed, is that we could
see either the Federal Reserve or the United States Exchange Stabilization Fund,the ESF, which is under Treasury, and can do whatever it wants to maintainorderly markets. I think we could see them buy Japanese Government
Bonds, for the Bank of Japan.

It is likely that we will see the US

You would see the USA selling dollars and buying yen effectively, to try

government purchasing

to stabilize the yen and weaken the dollar, which would help Japan, but also

Japanese bonds within the next

the US because as the dollar weakens against the yen it improves Japanese

few years.

purchasing power to buy treasuries. The US has a demand problem fortreasuries which will get a lot worse if the yen keeps weakening. I thinkthat would be the first step, the Federal Reserve wants to avoid yield curve
control at all costs and certainly explicit yield curve control.

The Federal Reserve wants to

If they can get Japan’s current account deficit back into a current account surplus

avoid yield curve control andby getting energy prices down, then they can stabilize the yen and the JGB market,

certainly explicit yield curve

if you can do that then you will get a weaker dollar and a stronger yen and more

control at all costs.

treasury purchases from Japan again. I think you will see, within the next 18 to 24

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180

months, either the Federal Reserve or the US Exchange Stabilization Fundintervening in the yen, by buying JGBs.
Niko Jilch:
Where do you see the global

Can we try to get some long-term positive outlook on this whole global

monetary system going over thesituation that we are in right now? Let me give you a few examples: On 22

next 10 years?

April we saw Israel adding the renminbi to their currency reserves. Somebody
there decided that it is time to buy some yuan. In the middle of April, we saw
Kuwait and Saudi Arabia indict Iran to talk about a gas field that all three of themclaim and exploit together. Can you talk about what is going on from the long-term
perspective globally? Especially, where will Europe be standing?
Luke Gromen:

Middle East, and in particular

I think the Middle East desperately wants stability, in particular Saudi

Saudi Arabia, wants stability,

Arabia. They want USD 90 oil and stability, that is what they are after. But they

the Chinese also need stability inhave seen nothing but instability for the last 25 years in the Middle East. The

the Middle East, but there are

Chinese also desperately need stability in the Middle East.

interests in the US that thinkalong the lines of fostering

If it comes down to what is a happy version of the outcome, you get some sort of

instability in that region.

détente between Eurasia and non-Eurasia has no choice but to go
along, out of commercial interests, and the world prospers, all together. There
would have to be some relative wealth influence shift that would take place.
I think ultimately that is what will happen. Basically, you will have Russia as aconnector between China and Europe. In Europe right now, the Federal
Reserve is trying to ride two horses with one ass in regards to inflation.
They need to convince the bond market that they are not going to
inflate away their debt while doing that.

Europe’s economic future is likely

Europe, on the other hand, is trying to ride two horses with one ass with regards toto its east and not its west.

geopolitics, which is: We are going to keep the Americans happy and thinking we

Russia and China have big plans

are with them, when our economic future is really to our east and not our

economically, including the Belt

west. So, the happy version is Eurasia connects and there is this huge boom of

and Road Initiative.

economic growth as you bring together the east of Europe and the west of China,
the Belt and Road fills out, out get economic trade, you get a virtuous cycle, US
companies also benefit from this as well, etc., and everyone gets along. That iswhat I think when I think about those three headlines in sort of a happy scenario.
Niko Jilch:

It seems like the Russians are

And the Russian foreign minister, Sergey Lavrov, even during the war

also interested in connecting theis still talking about having a Eurasian union from Lisbon to

entire Eurasian area and

Vladivostok, when that landed in the European press, everybody thought it was

forming some sort of a pan-crazy. The Russians wanted to go the euro route, they even used the euro in theircontinental alliance.

dealings with China and India. But then Europe says that they can’t access theirreserves. If we wanted to, how could we get out of this situation of conflict?

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Luke Gromen:
Americans are prepared to fightMy friend Louis Gave, said a couple of weeks ago that the Americans

the Russians down to the lastare prepared to fight the Russians down to the last European. As tongue-

European. The US threw the ballin-cheek and brutal as it is, is that what we are watching in real-time? The

back into the court of Europe andEuropeans didn’t freeze US reserves when they invaded Iraq. The Europeans

Russia and China. If they keep

protested but no one did a thing. That is not to say that I am approving orfighting the Europeans could

necessarily even trying to equivocate what is happening in Russia and Ukrainecommit economic suicide. It willwith that, but I guess I am. I’m not sure if it is that different.

be interesting to see how this all
plays out.

I don’t know where this goes from here, it’s almost like the US threw the ball backinto the court of Europe and Russia, and China. China isn’t doing themselves any
favors with their lockdowns. To the extent that that reverberates into US
stagflation, maybe that is where we see this show up next, which is: US supply
chains keep breaking down, US inflation keeps rising. But it’s getting tricky. We
are quickly getting to a point where there is not going to be a way to get back.
Niko Jilch:

Was the freezing of the currency

I have to ask this right now, the freezing of the currency reserves by Europe andreserves by Europe and the US

especially the US, Kenneth Rogoff, whom Ronnie already quoted earlier, he called

such a big moment as some makeit a “break the glass” moment. You only do that once, and the Saudis are looking

it out to be?

and the Chinese are looking at this, so from a structural system point of view, thatwas the west shutting the system down, basically?
Luke Gromen:

We were at the end of a period ofYes. Someone said to me, “that round is downrange”, you can’t go back and get it.

great globalization. The question

The question is: What does that mean and what is the next move? That ties back to

now is what will happen frommy prior point, the ball is now back in Eurasia’s court, so are we going to see

here?

Putin de-escalate, or are we going to see Eurasia brokering peace, or are we going
to see China broker peace, or will we see some sort of big sign where the three ofthem get together and say: This isn’t in any of our interests, let’s stop this. All we(Russia) want to do is sell energy to both of you, all you want to do is grow youreconomies. But we are now all focusing on one thing in this part of the world.
Niko Jilch:
I do have one more question on the topic of gold and what I call “the return ofreal stuff”. The report is called In Gold We Trust and we are not going to change
the name, but is this a time to really trust in gold, something that is
important not only for individuals and investors but also on thesovereign level?
Luke Gromen:

With globalization breaking

Yes, I think it is. It seems like globalization is breaking down, which has been very

down and the rise in energy

disinflationary, which would seem to be inflationary. You have peak cheap energy;

prices, gold will become

you need a reserve asset that has the ability to rise in price with the riseincreasingly important on thein the prices of energy and commodities and other inputs. We were justsovereign level and on thetalking about how the sovereign debt positions of the west, and particularly, theindividual level in order toglobe more broadly, are such that interest rates cannot be allowed to rise that far topreserve purchasing power.

compensate and offset that inflation. That is why you need a reserve asset
like gold and at least hold some of it on the sovereign level and on theindividual level to preserve your purchasing power. Because

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182

circumstances from geopolitical and commercial globalization and commodity
standpoint all point to structural inflation and away from short-term economic
hiccups that may be as a result of Federal Reserve policy error, that I think they are
now well underway of making.
I think gold is one of the few reserve assets. But then you see things like the
Swiss National Bank buying US equities etc. Things that are more finite that havethe ability to better hedge structural inflation over time, those are the things you
want to own.
Ronnie Stöferle:
Luke, I think we should come to an end, I want to thank you very much for taking
the time so early and for being a friend and supporter of us. You can follow Lukeon Twitter; he is very active and it’s always new information. Also have a look at
his website, Forest for the Trees, or his book, The Mr. X Interviews, on Amazon.

These were the highlights of our interview with Luke Gromen. The fullversion is available for download here.
The video of the entire interview, “Energy, War & Inflation”, can beviewed on YouTube here.

LinkedIn | twitter | #IGWTreport

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China – At the Crossroads“The Chinese mentality was not understoodthen either in Europe or America: Europe
was at the pinnacle of world power, full ofconfidence in the present and future, andEuropeans found the Chinese amusing fortheir rejection of paper money and theirpractice of weighing metallic currency onscales. People presumed that the Chinese
were five generations behind us – in reality
they were a generation ahead of Europe.”
Felix Somary, The Raven of Zurich, 1913

Key Takeaways• Xi Jinping seems less and less willing to continue thereform course of his successful predecessors Hu andZheng. In the medium to long term, this poses thegreatest threat to Chinese prosperity.
• The real estate market is in critical condition. New

regulations could make investors increasingly looktoward gold.
• China is now also rhetorically abandoning interest rate

restraint.
• The Chinese zero-Covid strategy is causing severe

dislocation, while for most other countries the pandemic
seems to be over.
• Chinese gold demand over the next 2–3 years is

probably less relevant to price developments thanglobal monetary policy and inflation expectations.

China – At the Crossroads

185…the real economic struggle

As recently as last fall, Yi Gang, the governor of China’s central bank, the People’s

between the US and China may

Bank of China (PBoC), warned against excessively low interest rates and the moral

not be fought out over trade or

hazard associated with quantitative easing (QE) policies. Yi thus continued thetechnology but end up as apolicy of his legendary predecessor Zhou Xiaochuan, who controlled monetary

monetary war.

policy in the Middle Kingdom for almost two decades and always proved to be aCharles Gavemonetary policy hawk – at least rhetorically. Accordingly, unlike the West, China
does not have zero or negative interest rates: Policy rates are 3.70% – dramaticallyhigher than in the Eurozone (0%) and the US (0.75–1%). China’s central bankacted with a great deal of judgment in the crises that preceded Covid-19 – not least
because China has rarely been directly affected – and has many more arrows in its
monetary, fiscal, and economic policy quiver than its Western counterparts.

Central Bank Policy Rate (Federal Reserve, ECB, PBoC), in %,01/2006-05/2022
9%
8%
7%
6%
5%
4%
3%
2%

1%
0%
2006

2008

2010

2012

Federal Reserve

2014

2016

ECB

2018

2020

2022

PBoC

Source: PBoC, Reuters Eikon, Incrementum AG

Less than half a year later, China’s position has apparently changed
fundamentally. No less a figure than Xi Jinping himself warned against aninterest rate turnaround in his opening speech at the World Economic Forum2022. Although he initially addressed inflation concerns, he then warned against amonetary policy U-turn:“The global low inflation environment has notably changed, and the risks ofinflation driven by multiple factors are surfacing. If major economies slam on
the brakes or take a U-turn in their monetary policies, there would be serious
negative spillovers. They would present challenges to global economic andfinancial stability, and developing countries would bear the brunt of it.”
Relations between the US &In parallel, the PBoC cut key interest rates, although by only 0.1%. In March 2022,

China are destined to get worse

the China Securities Journal, the PboC’s mouthpiece, announced further interest

before they get worse.

rate cuts to “stabilize growth”. Xi’s concerns are understandable. If the US does

Graham Allison

indeed tighten the monetary reins, the Chinese economy would also suffer. All
measures to boost consumption in the West also indirectly benefit the Chinese –after all, a large proportion of everyday necessities are manufactured in the Middle
Kingdom.

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186

In the face of complex economic

A return of the West to economic prudence, to moderate economic

and financial situations at bothactivity, and to consumption that is not financed on credit, would

home and abroad, it is necessary

immediately have a direct impact on China’s economy. If the Federal

to proactively set up an

Reserve were to get serious, this would undoubtedly have an impact on the capitalauthoritative and efficient

flows of foreign investors, and the Middle Kingdom would lose its attractiveness.

system to prevent, resolve

This at a time when it is clear that China needs foreign capital for continued strong

financial risks and prepare for

growth, as well as to promote more personal freedoms and a more reliable rule ofrainy days.

law. Moreover, the current economic situation in China is anything but rosy. The

PBOC Statement,

5.5% economic growth targeted for 2022 is quite ambitious given the current

April 6, 2022

situation, but on the other hand, it is the absolute lower limit of what is still
acceptable from Beijing’s point of view: (even) lower growth would result in rising
unemployment, since productivity gains would destroy more jobs than are createdby economic growth.

Neither a man, nor a crowd, nor

The reasons for this are homemade crises and government programsa nation can be trusted to act

and concepts that have not been as successful as Beijing had hoped.

humanely or to think sanely

The Covid-19 pandemic hovers over everything. Although China wasunder the influence of a great

officially the first country to emerge from the pandemic, its zero-Covid strategy is

fear.

becoming more and more expensive for China’s economy, the longer the policy has

Bertrand Russell

to be maintained, as the virus becomes endemic in the rest of the world. For the
past two years, Chinese trade shows and conventions have been canceled or
postponed nonstop. Travel within the country has also become much more difficult
and riskier. In 2020, at least 4.5mn small and medium-sized enterprises wentbankrupt, and the numbers are likely to be even higher for 2021. In addition,mortality rose to a 20-year high last year – not because of the virus itself but
because of the follow-up costs of lockdown policies. The Diplomat magazine
estimates that about 160,000 people did not receive timely treatment as a result of
the extremely strict lockdown regime and died as a result.

Mortality in China (Deaths per 1,000 Inhabitants), 2000-2021
7.4
7.2
7.0
6.8
6.6
6.4
6.2
6.0
2000

2002

2004

2006

2008

2010

2012

2014

2016

2018

2020

Deaths per 1,000 Inhabitants
Source: Statista, OECD, Worldbank, Incrementum AG

Ruptured supply chains are now also affecting China, and when the
country’s largest ports are regularly closed for a few days due to a
Covid-19 outbreak, or when even entire cities are quarantined,
uncertainty and costs to the economy grow. Since the outbreak of the

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187

pandemic, it has become virtually impossible for foreign specialists to enter thecountry: A not inconsiderable number of expats in China have left the country or
can no longer return to it. Now Omicron, a fairly harmless but highly contagious
variant of the coronavirus, has entered China. Shenzhen went into lockdown inearly March, 2022, as did many other cities. These lockdowns naturally haveserious consequences, not only for China’s economy but also for all international
partners, suppliers, and supply chains.
Power does not corrupt. Fear

A way out of the lockdown policy is difficult to discern. In the past two

corrupts... perhaps the fear of ayears, China’s zero-Covid policy has been sold as extremely successful, especially in

loss of power.

the face of the relative failure of Western countries to mitigate Covid. A suddenJohn Steinbeck

180º turn is hard to sell, even in a society like China, and would therefore
represent an almost unacceptable loss of face, especially for Xi Jinping. In thecurrent phase – Xi wants to be confirmed for a third term in November – this ishardly conceivable.
Contrary to what is perceived in the West, Xi’s rule is not without
controversy. Within the Chinese Communist Party (CCP), there are more than a
few who would be anything but happy with a third term. Premier Li Kequiang, who
unlike Xi is considered a profound economist and outspoken reformer, is taking
his leave from politics due to his age. At the last press conference on the occasionof the People’s Congress in mid-March, Li Kequiang stated that the further
opening of China was, like the Yangtze, irreversible – which could be understoodas a finger pointing at the president. Accordingly, Xi cannot afford to show any
weakness at the moment – but revising the zero-Covid strategy would be one. A
real end to the zero-Covid policy can therefore be expected in Februaryof next year at the earliest, with the concluding of the Chinese Spring
Festival, and with corresponding consequences for the Chinese
economy.
Moreover, the structure of the fight against the coronavirus provides a massive
incentive for all levels of government to take the strongest measures possible.
Indeed, if other economic targets cannot be met, failure can be excused by the fightagainst the pandemic. The failure to meet targets is, however, happening at anumber of levels.

Power Crisis
Trust, like the soul, never returns

The severe electric power crisis that occurred in 2021 for various

once it goes.

reasons, especially in southern China, is having greater consequences

Publilius Syrus

than generally communicated. Numerous companies have doubts as towhether China can and, above all, will really provide a reliably functioning energy
supply in the future. The problem was not only the lack of electricity but the lack ofcommunication. A power cut is (relatively) unproblematic if the affectedcompanies can adjust and prepare for it. But if there is only a terse message thatthe power will be cut off in an hour, then it is almost impossible for companies tomake appropriate preparations. Japanese companies in particular have therefore
begun to move production sites out of China, or at least to use this circumstance as

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188

an excuse. With the ending of the pandemic (in the West), this trend will be
exacerbated.
The pandemic has made Western companies suddenly aware of how
vulnerable their supply chains have become due to their focus on
China. The war in Ukraine further reinforces this perception. It is foreseeable thatin the coming years producers will focus on diversifying production locations to
cushion future supply chain disruptions – resilience and economic sovereignty are
the buzzwords. Even in the short term, the consequences have been painful,particularly at the municipal and provincial levels, where authorities have sufferedpainful losses in tax revenue: In November 2021, the decline was more than 11%
compared to the same month last year.

Real Estate Crisis Continues to Smolder
For now, it’s clear that the future

Even more serious is the danger posed by the ever-smoldering real estate crisis.

will not look like the past andSince Guangzhou Evergrande, China’s No. 2 real estate developer, was unable totoday’s conventional investment

service its debts for the first time in September last year, dozens of companies havewisdom will be tomorrow’s folly:

suffered a similar fate. In addition, Evergrande and nine other companies listed on

liquid will be the new illiquid;

the Hong Kong Stock Exchange were unable to submit financial statements as of

rapid turnover the new patience;

the reporting date, March 31. While in developed economies such as the US or

niche strategies the new index

Germany (well) below 20% of the gross domestic product depends on the real

trackers. What rose furthest in

estate market, in China it is 25–30%. For the Chinese, buying their own home isduration’s golden age –essential – whether they find a suitable spouse or whether their offspring cangovernment and corporate

attend a good school depends to a large extent on owning the right home. Realbonds, public equities, private

estate is by far the most important investment in the Middle Kingdom. What’s

equity, venture, real estate – will

more, the Chinese know only rising prices. The possibility of the market going infall furthest with its passing.

the other direction is virtually inconceivable to them. Accordingly, everyone who

Dylan Gricecan do so invests in real estate. Now, however, this 40-year trend seems to bereversing or at least slowing down considerably. Sales by real estate developers
collapsed in January compared with the same month last year.

Sales of Chinese Real Estate Developers, yoy%, 01/2022
Evergrande
ShimaoR&F
Vanke
JinmaoCIFISeazenLongfor
COLI
Agile
KWG
YuexiuCR Land
Greenland
Sunac
Sino-Ocean
Country Garden
-100%

-90%

-80%

-70%

-60%

-50%

-40%

-30%

-20%

-10%

0%

Sales of Chinese Real Estate Developers
Source: CRIC, Incrementum AG

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189

This, of course, feeds back into the ability of real estate developers to service thedebt and interest that is coming due – this year it will be around USD 120 bn, of
which USD 36bn in US dollars. Looking at real estate loans extended in February2022, this worrying trend will continue on a massive scale.

New Yuan Loans, and New Mid and Long-Term Loans toHouseholds, in CNY trn, 01/2007-03/2022
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5

0.0
-0.5
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

New Yuan Loans

New Mid and Long-Term Loans to Households

Source: Bloomberg, Incrementum AG

The collapse is fundamentally

Beijing is now faced with a dilemma that has long been known in thedue to the unstable position; theWest: If the failing companies are rescued, they will fuel moral hazard

instantaneous cause of the crashand the real estate merry-go-round will continue to spin. If you let themis secondary.

go bankrupt, you risk an uncontrollable crash of the economy. It should also be

Didier Sornette

remembered that, especially for Chinese municipalities, leasing land for real estate
projects is an important source of income. A major real estate crisis would cause
fiscal revenues to collapse.
In this respect, it is hardly surprising that China is trying a mixture ofboth paths. Investors will probably have to write off part of their capital,
especially if they are based abroad, while attempts are being made to make the
dream of homeownership come true for (Chinese) homebuyers. At the same time,efforts are being made to curb the real estate mania, which is why regulations arebeing tightened. Loans are now (almost) only available for new buildings, andanyone who wants to buy a second or third home is confronted with significantly
higher equity requirements. This, however, destroys the market for usedapartments. As a result, prices for new buildings continue to soar, especially if they
are located in areas that are particularly desirable – for example, because they
provide access to a good school. At the same time, it is becoming much moredifficult for owners of old apartments to resell or borrow against them. This has adirect impact on the prosperity of citizens.

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190

Little Success with Government Programs
The greatest danger in times ofAt the same time, various government programs have either not taken

turbulence is not the turbulence.

off as hoped or are causing a lot of unrest. First and foremost is the latest

It is to act with yesterday’s logic.

Double Reduction program. Officially, this program aims to ease the load onPeter Drucker

overburdened students and parents, both in terms of time and, above all, money,
because enormous sums are spent on the further education of children in China.
For example, the amount of homework was reduced; learning clubs and apps, mostof which have to be paid for, were banned; (international) private schools were puton the spot; and English lessons were drastically reduced. The ban on learningapps, in particular, was (also) a completely unexpected attack against the country’s
tech corporations like Alibaba and Tencent.

Alibaba Group, in USD, 01/2015-05/2022
350
300
250
200
150
100
50
0
01/2015

01/2016

01/2017

01/2018

01/2019

01/2020

01/2021

01/2022

Alibaba Group
Source: Reuters Eikon, Incrementum AG

Experience shows that the mostThis program has raised doubts about China’s continuing on the pathdangerous moment for a badof reform. For investors, the decision means sensitive losses on the stock

government is usually just as it’smarkets; and for tens of thousands of people employed in the eLearning sector, it

starting on reform.

means the loss of their livelihoods virtually overnight, with their activities thus

Alexis de Toquevilledisplaced onto the black market. If the Double Reduction program continues inthis manner, in a generation only the upper class will be able to speak, read andwrite English, because only they can afford unofficial private tutors. The middle
class will no longer have access to Western sources. It is much less relevant thatthey will no longer have access to alternative political news – most Chinese are notvery interested in that – but that they will lose the ability to exchange economic,
technical, and scientific information with the West. For Western investors, thisshould be a clear warning sign. The start of the war in Ukraine was, then, thetrigger for an unprecedented outflow of capital. It remains to be seen whether thisprogram is actually part of a new trend or is just based on short-term motives. But
the fact that this development is being received with nervousness even in China
reflects Li’s analogy regarding the waters of the Yangtze and China’s will to reform.
The Double Reduction program is not the only policy program causing trouble. The
Belt and Road Initiative (BRI) is coming under increasing criticism, and many
widely announced projects have fallen asleep. This is not only because developing
countries are now much more critical of the debt problem, but often because of

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191

fundamental misunderstandings between Chinese investors and the target
countries. The high hopes placed on the program have not been fulfilled so far, andaccordingly, domestic coverage of the BRI has also faded significantly into thebackground. With the Russian invasion of Ukraine, the project also faces the
problem that the central overland route connecting China with European markets
and passing through Russia and Belarus is no longer usable – and probably
permanently so. Alternatives such as through Iran and Turkey must first be further
developed and are by no means free of risks.
I worry the Chinese didn’t readMade in China 2025, another central program, which aims to achieve market

enough Hemingway about

leadership and a 70% share of domestic production in 10 defined sectors, such as

bankruptcy.

semiconductors, robotics, and artificial intelligence by 2025, is threatening to fail –Kevin Muir

at least in part. In the extremely important area of the semiconductor industry, forexample, China is clearly lagging behind. While one of the focal points of global
chip production is in the Greater Bay Area around Shenzhen in southern China,
innovation is driven by non-(mainland) Chinese companies. While TSMC, IBM,Intel, and Samsung are working on 3nm and 2nm chip technology and theseproducts will reach commercial maturity next year at the latest, the leading
Chinese company, Semiconductor Manufacturing International Corporation(SMIC), is struggling to stabilize production in the area of 7nm or 8nm technology
to the point where mass production can be started. One company is at least
two chip generations behind. In the semiconductor sector, thatamounts to a small eternity.

We should favor innovation andIn the AI sector, where China is well positioned, the government put on the brakes

freedom over regulation.

massively. The last presidential election in the USA clearly demonstrated to Beijing

George Allen

the power that tech companies can develop in the 21 st century. Therefore, theytightened the reins and introduced far-reaching regulations that came into force on
March 1, 2022. This is a heavy blow for the AI industry: Many of the regulations
are difficult to implement, because the threat of fines and other penalties is
extremely high; and in addition, Chinese laws are often not clearly formulated, sothat one quite often has to operate in a gray area.

Understanding that China plays

Uncertainty also pertains with regard to the concept of the two cycles

the long game is one of the mostthat was officially presented only last year.48 Through this, China wants toimportant insights you can haveplace itself at the top of the value chain (at least in Asia) and generate future

about what lies ahead. China’s

economic growth primarily through its own consumption. The rest of Asia,

leaders know where they want toespecially Southeast Asia, is primarily intended to play the role of a supplier of raw

be five and ten years out.

materials and intermediate products. However, Indonesia’s President Joko

Stephen Leeb

Widodo, for example, made it clear at the beginning of the year that the emerging
countries of Southeast Asia will by no means be satisfied with this when, in
addition to Indonesia’s long-standing export ban on nickel, he announced aprogressive penalty tax on the export of nickel alloys. Widodo wants to turnIndonesia into a central supplier hub for the EV industry, as nickel is a key
building block for high-performance batteries. The move hits China and its steel
industry particularly hard, as nickel is elemental to the production of stainlesssteels. China’s steel giants have invested billions of US dollars in Indonesia andbuilt smelters there for the production of nickel-iron alloys in order to circumvent—

48 See “Gold Mining in China,” In Gold We Trust report 2021

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192

the nickel export ban. If the tariffs are maintained, it will be very expensive for
China’s steel industry, and the attempt to focus more on the production of highquality steels is likely to be doomed to failure.

Nickel Sponge Iron Production, China and Indonesia (lhs), in
Kilotonnes, and % of Total Nickel Production (rhs), in %, 2006-2020

700

50%
45%

600

40%

500

35%
30%

400

25%
300

20%
15%

200

10%
100

5%

0

0%
2006

2008

2010

China

2012

Indonesia

2014

2016

2018

2020

% of Total Nickel Production

Source: Eramet, Incrementum AG

Common Prosperity
A society that puts equality

In 2021, thanks to a strong yuan and economic recovery, China reached a per

before freedom will get neither. A

capita income of USD 12,468. This would make China a high-income country. The

society that puts freedom before

threshold for this is USD 12,675. The middle-income trap would finally beequality will get a high degree ofovercome. But this is only a half-truth; in fact, wealth in China is still very

both.

unevenly distributed, which is seen as a problem in many places. While Deng

Milton Friedman

Xiaoping made the statement, surprising for a communist, that as a result of hisreforms it was to be accepted that “some people will get rich first,” Xi takes adifferent position. He wants to strengthen the general level of prosperity: The
Chinese should strive for common prosperity (共同富裕 gòngtóng fùyù). This
would shift the focus of economic development to rural areas and Tier-3 and Tier-4
cities as a way to address the imbalance in the country.

Socialism is like Neil DiamondConsequently, rural China is precisely where Xi enjoys the greatest

music. It’s not good and belongs

support – he sees himself as belonging to the peasantry, due to hisin the past, yet there’s a group of

biography. Xi’s father was Xi Zhongxun, who was China’s deputy premierpeople who think that it will

between 1959 and 1962. He fell out of favor because of suspected disloyalty to Mao

eventually catch on if only they

Zedong. During the Cultural Revolution, Xi Jinping was therefore forced to flee tokeep playing it.

the countryside. He spent most of his adolescence there, a total of 7 years. Without

Jeffrey Evan Brooks

any formal education, he took up studies as a chemical engineer at Tsinghua
University thanks to the Worker-Farmer-Soldier Program (工农兵学员 Gōngnóngbīng xuéyuán). This program placed a special focus on the study of Marxism andthe achievements of the People’s Liberation Army; chemistry and engineering wereactually secondary.
This “common prosperity” is also an important component of the twocycles concept. After all, the willingness to consume and the strengthening ofdomestic demand are the mainstays of this program, for which a broader social

LinkedIn | twitter | #IGWTreportChina – At the Crossroads

193

prosperity is needed. The problem is that if this is to be brought about throughredistribution and regulation, then these measures very quickly have the opposite
effect. Especially since the goal of the campaign is also a populist ideological one
and, beyond that – at least for individual freedom and any rule of law – a highly
dangerous one: “The common prosperity campaign is most significantly apolitical – in fact, a populist – strategy to revitalize the roots of communist
ideology in China.”49
Globalization has created thisA further thought: The Chinese economic miracle was one factor,

interlocking fragility. At no timeperhaps even the most important factor, in containing the inflationary

in the history of the universe has

tendencies inherent in the enormous global expansion of the money

the cancellation of a Christmas

supply since the turn of the millennium. China’s determination to be theorder in New York meant layoffs

world’s workbench kept the prices of the vast majority of everyday and consumer

in China.

goods (relatively) low. Monetary inflation was primarily reflected in asset price

Nassim Taleb

inflation. The two-cycle concept in conjunction with the goal of common prosperity
could significantly exacerbate inflation, especially in the Western world: China nolonger wants to be a workbench, but to position itself at the top end of the value
chain. But setting up a new workbench somewhere costs more than just time andmoney. The unique Chinese conditions, a population that is as large as it is poor
and at the same time capable and willing to perform, with a high average IQ,
coupled with a stable political order and a (relatively) efficient administration, do
not necessarily exist a second time on our planet – certainly not on the scale of
China.

Demography – A Ticking Time Bomb
Time erodes everything.

Moreover, a demographic catastrophe awaits on the horizon.50 ChineseCountries included.

society is aging rapidly. China’s birth rate continues to fall. With not even 1.3

Peter Zeihan

children per woman, it now lags behind most Western industrialized countries.
This effect is slightly intensified by emigration, as around 500,000 Chinese leave
the country every year. Last year, the population grew by a negligible 0.034%.
Around the year 2030, the population will start to shrink, with the corresponding
consequences for industry but also for the social systems.

—

49 Wu, Guoguang: “China’s Common Prosperity Program – Causes, Challenges and Implications,” Asia Society

Policy Institute, New York, 2022, p. 5
50 See “Global Demographics Turn Inflationary,” In Gold We Trust report 2021

LinkedIn | twitter | #IGWTreportChina – At the Crossroads

194

Population China, in mn, 1950-2090
1,500
1,400
1,300
1,200
1,100
1,000
900
800
700
600

500
1950

1960

1970

1980

1990

2000

Forecast

2010

2020

2030

2040

2050

2060

2070

2080

2090

Population China

Source: UN, National Bureau of Statistics of China, Incrementum AG

Beginning in 1978… China has

China is already struggling with the consequences of demographic

been moving in a steady threechange, and the unusually low retirement age of around 55 is being

steps forward/one step back kind

successively raised, as are social security contributions, while benefitsof trend—away from the statist

are being reduced. But China’s social systems are primarily nongovernmental inteachings of Marx and towards anature. It is primarily the responsibility of children who have grown up to take caremore market-oriented society…

of their parents who have grown old, for which the parents in turn contribute muchthe “Communist Party” still rules,

more than in the West to the upbringing of their children. This concept of the

but the degree of coercive statesocial division of labor functions remarkably in a traditional agrarian society.

intrusion into individual andThanks to China’s previous one-child policy, however, this division of labor is now

corporate lives and decisions has

suddenly reaching its limits. The only child of most Chinese families is now

been in clear retreat.

expected not only to take care of the parents but also to start a family at the same

Michael Oliver

time. Many Chinese capitulate in the face of this double burden and refuse to starta family. This background also plays an important role in the Double Reduction
program mentioned above.

Source: UN, National Bureau of Statistics of China

Above all, however, hovers a dilemma that is presumably insoluble for
the CCP. Chinese society needs more individual freedoms and a morereliable rule of law if the prosperity of the population is to continue toincrease across the entire social spectrum. This is precisely Xi’s declaredgoal, which he describes as common prosperity. But this would mean that the CCP
would withdraw and intervene less and less in the lives of individual Chinese, as

LinkedIn | twitter | #IGWTreportChina – At the Crossroads

195

well as subjecting itself to the law. In fact, this path was followed – at least in part– by Xi’s predecessor, Hu Jintao. At the latest with the outbreak of the Covid-19
pandemic, but in fact probably already from about the middle of Xi’s first term in
office, China departed from this path again. Massive recentralization is taking
place. Competition among the levels of government, i.e. municipalities, provinces,
central government, is being reduced. Private entrepreneurs are again increasingly
seen as enemies who deny society its fair share of prosperity. Xi is reaching deep
into the toolbox of Maoism, which was thought to have been exhausted long ago.
Austrianchina, a blog worth reading, which looks at China from the perspective of
the Austrian School of Economics, puts it as follows:“Bit by bit China is being transformed from a country with a decentralized
minimalist government nurturing a culture of entrepreneurship, competitionand private sector-driven innovation into a country with an increasingly
centralized big government propagating the idea that better governance isthe cure to all ills.”

End of China’s Gold Hunger?
Whether it’s QE in the West or

But what does all this mean for gold and Chinese gold consumption,

China’s recent regulatory

which has been a major price driver of the precious metal in recent

intervention in theyears? China has not faced a severe economic crisis directly since 1989. At most,aftermath of the bursting of its

the Asian Financial Crisis of 1997–98 hit China’s outposts of Hong Kong andequity bubble, market

Macau hard, but also allowed then-president Jiang Zemin to implement his reform

manipulation has becomeplans faster and stronger in the face of conservative critics.

global in scope.
Stephen RoachGold, in CNY (lhs) and INR (rhs), 01/1990-05/2022
16,000160,000

14,000140,000

12,000120,000

10,000100,000

8,000

80,0006,000

60,0004,000

40,0002,000

20,000

0
1990

0
1995

2000

CNY

2005

2010

2015

2020

INR

Source: Reuters Eikon, Incrementum AG

The bursting of the new economy in 2000 also had rather positive effects in themedium to long term, because even more companies began to look for cheaper
production locations. The real estate crisis that struck the US in 2006 barely
touched China, while the European debt crisis that hit in 2009 allowed the CCP to
get a foot in the logistics doors of Europe. But even in this case, the impact on
China’s economy was short-lived. China, in particular, also benefited from therescue measures of the West, especially in the form of an expansive monetary

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196

policy. Initially, China came out of the Covid-19 pandemic very well because,
unlike the West, it did not have to completely cripple its own economy. Because of
the annual Spring Festival, business was at a relative standstill already; it was justthat the restart had to be postponed by almost three weeks. The significant
economic slump in the first half of 2020 was again almost completely
made up for in the following months – also on the gold market.

Asian Gold Consumer Demand, in Tonnes, Q1/2018-Q4/2021
800
700
600
500
400

300
200
100
0
-100

Q1/2018

Q3/2018

China

India

Q1/2019

Q3/2019

ThailandQ1/2020

TurkeyQ3/2020

Q1/2021

Iran

Vietnam

Q3/2021

Other

Source: World Gold Council, Incrementum AG

Nevertheless, 2020 naturally remained a weak year for gold, not onlyin China but throughout Asia. In 2021, however, overall demand picked up
significantly. The anticyclical attitude of the Asians was evident once again.
Demand only picked up significantly after the gold price marked an all-time highin Q3 2020. Late in Q4, it was precisely the major consumers China and India that
returned to the market, naturally justified by the start of the wedding and festival
season in India and by the Chinese New Year. This pattern was repeated last year.

Indian Gold Demand for Jewelry and Investment, in Tonnes (lhs),
and yoy% (rhs), 2021

700

94%

611

100%
90%

600

80%

500

70%
60%

400
316

43% 286

300

50%
40%

199

30%

200

20%
100

10%

0

0%
Jewelry

2020

Investment

2021

yoy%

Source: World Gold Council, Incrementum AG

China and India in particular saw a significant increase in consumption of jewelry,bullion, and ETFs.

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197

Chinese Gold Demand for Jewelry and Investment (lhs), in
Tonnes, and Gold (rhs), in USD, Q1/2019-Q4/2021
250

2,500

200

2,000

150

1,500

100

1,000

50

500

0

0
Q1/2019

Q3/2019

Q1/2020

Jewelry

Q3/2020

Q1/2021

Q3/2021

Investment

Gold

Source: World Gold Council, Incrementum AG

Year-on-year, Indian jewelry purchases increased by 93%, Chinese by 63%.
Indians in particular confirmed their reputation as anticyclical – around 265t werepurchased in Q4/2021. This extremely strong quarter ensured that Indian gold
consumption climbed to a six-year high.
Disaster is a strong but

Gold investment by the world’s two largest consumers also rose significantly lastappropriate word that applies

year. 285t was purchased in China, 186t in India. Demand also developed

perfectly to the state of U.S.

positively in the other Asian countries. In Thailand, Indonesia, Singapore,monetary policy.

Malaysia, and South Korea, investors bought a total of around 90t of gold; only in

Dr. Lacy Hunt

Japan were there de facto no inflows. In Q4/2021, around 4t of gold was soldthere, leveling out the weak inflows of the previous three quarters.
In contrast to the global trend, Chinese and Indian gold ETF
investments also increased. At year-end 2021, Chinese gold funds held arecord 75.3t, up 14.4t or nearly 25% year-on-year. Around 9t of gold was bought by
Indian EFTs. The total investment amount of the funds on the subcontinent thusrose by more than 25% to 37.6t. Thus, these two countries also accounted for thelion’s share of ETF inflows in Asia, a total of 25t. Nevertheless, these financial
products play only a subordinate role in China, and even more so in India. This will
not change much in the foreseeable future due to investor mentality. Jewelry andphysical gold remain the preferred forms of precious metal investment in Asia.

I’m known as a gold bug andCentral banks abandoned the restraint they had shown in 2020 andeveryone laughs at me. But whybought significantly more gold. The buyers list was dominated by Asiando central banks own gold now?

central banks last year. 7 of the top 10 buyers were from Asia, with the Bank of

Alan GreenspanThailand leading the field with about 90t and the Reserve Bank of India with 77t.
The largest seller was the Philippine central bank, Bangko Sentral ng Pilipinas(BSP), which offloaded about 30t of gold. The decision to manage its reserves more
actively was made shortly after the (then) all-time high in August 2020, when gold
accounted for about 13% of the island nation’s foreign exchange reserves.
Benjamin Diokno, governor of the BSP, defended the decision against sometimes
sharp criticism by saying that gold should account for a maximum of 10% of the
BSP’s total reserves.

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198

Asian Central Bank Gold Purchases, in Tonnes, 2021
100

90
77

80
60
40

30

26
15

20

6

5

2

0
-2

-20

-4

-7

-40

-31

Tonnes of Gold
Source: World Gold Council, IMF, Incrementum AG

Demand from central banks should remain high in the coming years.
As the expansion of the money supply, which has been pursued for decades, is now
likely to reach the full breadth of society, central banks worldwide should tend to
expand precious metal reserves.
If you want peace prepare forThis expansionist tendency was to be exacerbated by the West’s

war.

response to Russia’s attack on Ukraine. With the blockade of Russia’s

Flavius Vegetius Renatus

foreign exchange reserves, the Western world has certainly drawn the sharpest
sword in terms of sanctions. China’s PBoC holds the largest foreign exchange
reserves in the world and is undoubtedly watching the West’s actions with a waryeye. It is safe to assume that Beijing will reconsider, or perhaps has alreadyreconsidered, its strategy that gold should account for no more than about 2% of
the PBoC’s portfolio. After all, the West has made it clear with the sanctions
against Russia that both the US dollar and the euro are not safe havens in the eventof a conflict. Thus, the real, perceived, and potential rogue states, of which there
are plenty in Asia, will look for alternatives and certainly not disregard physicalgold. In this context, it is worth noting an interesting divergence. There iscurrently a gap of more than USD 200bn between the PBoC’s onbalance-sheet foreign assets and foreign exchange settlements.

China Balance of Foreign Exchange Settled & Sold (lhs), in CNY
bn, and Net Monthly Chnage in PBoC's Funds Outstanding for
Foreign Exchange (rhs), in USD bn, 01/2014-03/2022
60

600

40

400

20

200

0

0

-20

-200

-40

-400

-60

-600

-80

-800

-100

-1,000-120
2014-1,200
2015

2016

2017

2018

2019

2020

2021

2022

China Balance of Foreign Exchange Settled & Sold
Net Monthly Change in PBoC's Funds Outstanding for Foreign Exchange
Source: Bloomberg, Incrementum AG

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199

Those entrapped by the herd

Some analysts speculate that China has been quietly buying gold on a

instinct are drowned in thelarge scale. This is certainly conceivable, because in the past China has alsodeluges of history. But there arehandled its gold purchases quite discreetly and usually only communicated thealways the few who observe,purchases much later, if at all. Often, the gold position on the balance sheet was

reason, and take precautions,simply increased without any comment. How much gold the PBoC actually holds

and thus escape the flood. For

can therefore not be discerned with absolute certainty. Other reasons can bethose few, gold has been the asset

assumed for the gap as well. It is also conceivable that the PBoC has quietly takenof last resort.

parts of the debts of Chinese real estate developers, especially those denominatedAntony Sutton

in US dollars, onto its books in order to take pressure off them. That China willcontinue to accumulate gold in view of global developments, and possibly do soeven more aggressively, seems only logical.

Official Reserve Assets and Other Foreign Currency Assets (Approximate Market Value), in USD bn, 02/2022
A. Official reserve assets

3,397.39（1）Foreign currency reserves (in convertible foreign currencies)

3,213.83（a）Securities

3,211.21（b）Total currency and deposits with:

2.62（i）other national central banks, BIS and IMF

1.07（ii）Banks headquartered in the reporting country

0.89（iii) Banks headquartered outside the reporting country

0.66（2） IMF reserve position

10.65（3） SDRs

53.63（4） Gold (including gold deposits and, if appropriate, gold swapped)

119.64

Volume in millions of fine troy ounces

62.64（5）Other reserve assets-0.35

B. Other foreign currency assets

179.24

Securities not included in official reserve assets

177.89Loans not included in official reserve assets

1.35

Source: PBoC, Incrementum AG

Any thoughts that China andRussian countermoves against the sanctions imposed by the West in the financial

Russia’s strategic relationshipsector could set in motion a highly exciting development. By linking the ruble,

will be impaired by Russia’sgold, and natural gas, the Russian central bank has opened a (small) door for theinvasion of Ukraine should be

precious metal back into the financial system. Our advisory board member Jim

dismissed as wishful thinking.

Rickards, in his book Currency Wars, traced a similar scenario during a US

Simon Huntgovernment simulation. How China and the PBoC will react to this is currently
unclear, especially since the Middle Kingdom is at best indirectly affected for thetime being. After all, China is not among the countries that Russia considers
unfriendly. However, the latest gas contracts are denominated in euros.

LinkedIn | twitter | #IGWTreportChina – At the Crossroads

200

Conclusion
Under capitalism, people have

A severe economic slump in the Middle Kingdom will undoubtedly also leave clear

more cars.

traces in the Chinese demand for gold, as suggested by the development of demand

Under communism, they havein the first half of 2020, for example. China’s impending departure from themore parking spaces.

reform path will also ensure weaker economic development and thus weaker gold

Winston Churchill

demand. At the same time, however, the continued focus and strengthening ofrural, more gold-loving areas and the idea of common prosperity are ostensibly
positive factors for gold demand. Further regulation of the real estate sector could
also shift investor capital toward the gold market because other investment
alternatives are both scarce and not in line with the Chinese mentality. Gold isand will remain deeply rooted in China as well as other Asian societies.

We’ve had a couple hundred bad

Moreover, the Chinese central bank’s support measures definitely have anyears, but now we’re back.

inflationary effect and thus tend to be positive for precious metals. However, thisShanghai resident

also indicates that in the coming years private demand will probably play a lesssignificant role in the pricing of precious metals. The decisive factors are likely tomonetary policy and, above all, geopolitical and financial strategy issues. Should
the US actually initiate a sustained turnaround in interest rates, China would haveto increasingly lower interest rates to support the market.

The man who removes a

It remains to be seen what consequences the latest measures of themountain begins by carrying

Russian central bank will have. However, it is highly unlikely that a gold

away small stones.

standard supported by China will ultimately emerge, no matter how it is designed.

Chinese Proverb

No government in the world will voluntarily (!) put fetters on its fiscal policymaking power – not even with regard to gold. The demographic turnaround thatwill occur at the end of the decade could then in turn be accompanied by the end of
China’s hunger for gold. An aging Chinese society might even tend to reduce its
gold holdings. Until then, however, there will still be a lot of waterflowing down the Yangtze.

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202

When Rome Lost Its
Reserve Currency“If you must break the law, do it to seize power:
In all other cases observe it.”Julius Caesar

Key Takeaways• The Roman world collapsed in a hyperinflationary, eco-nomically destructive spiral.
• The process behind Ancient Rome’s rise and fall are dis-turbingly similar to the situation we face today.
• A comparative economic study of Rome suggests theworld is on the precipice of a turbulent transition froman old world order to a new one.
• Rome and countless other empires, both before and af-

ter, went through similar stages; and history teaches usthat the years and decades ahead will be extremely turbulent.
• In this chapter we look at Rome’s experience in detailand compare it to the United States of today.

About the author: This chapter was contributed by our dear friend
Hans Fredrik Hansen, who worked as a senior economist for several
large multinational oil companies, in the US, Europe and the Middle East.

When Rome Lost Its Reserve Currency

203

No one tells the tale of Diocletian’s destructive economic policies better than his
contemporary, Lactantius51, in chapter 7 of his De Mortibus Persecutorum:“There began to be fewer men who paid taxes than there were who received
wages; so that the means of the husbandmen being exhausted by enormous
impositions, the farms were abandoned, cultivated grounds became
woodland, and universal dismay prevailed. …
He also, when by various extortions he had made all things exceedingly dear,
attempted by an ordinance to limit their prices. Then much blood was shed
for the veriest trifles; men were afraid to expose aught to sale, and thescarcity became more excessive and grievous than ever, until, in the end, theordinance, after having proved destructive to multitudes, was from merenecessity abrogated.”
Whilst Gaius Aurelius Valerius Diocletianus meant good, his years as a military
man gave him a strong predisposition for centralized solutions. Ills plaguingsociety, more often than not from prior decisions made by the same central
authority, found in Diocletian solutions that condemned Europe to a millenniumof economic stagnation.

The Free-Market Economy Is Established in
RomeStop quoting laws; we carry

Before we start, it is important to note that the Roman Empire was an

weapons!

outlier in ancient times. Rome’s many farmers were not serfs, but freemen

Gnaeus Pompeius Magnus

protected by Roman civil law to the same degree as wealthy Roman aristocrats. In
the time of the Republic, before Octavian became the first Roman Augustus, a large
land-owning oligarchy had risen on back of a constant influx of slaves from newly
conquered lands. Real wages came under pressure, and land increasingly became
concentrated among the rich and powerful, who bought land from distressedsmall-scale farmers, who were unable to compete with cheap labour provided byslaves.

Every socialist is a disguised

Civil wars were fought over the land issue, this led Octavian to understand the

dictator.

importance of creating a successful ‘middle-class’ from land-owning peasants.

Ludwig von Mises

When Octavian came out on top in the civil wars of 27BC, he set the Roman
Empire on course to freedom. This led Rome on a path toward a proto laissez-faireeconomy.
Romans were free to seek opportunities across the empire. They were safe,
whether they were in one of the many cities, on their farms or whilst travelling
along the extensive network of excellent roads and wide-spanning sea routes.
Pirates and brigands were a thing of the past. Property rights were secure.

—

51 Lucius Caecilius Firmianus signo Lactantius (c. 250 – c. 325) was an advisor to Constantine the Great andpublished several works which have become important primary sources from the time period.

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204

While most of the Empire was agrarian, historians suggest that the
Italian peninsula, and certain parts of the provinces, were 30%
urbanized,52 and GDP per capita was on par with that of England andHolland before the industrial revolution.53 Well off citizens lived
comfortably in houses with central heating, whether their estates were in Rome orclose to Hadrian’s wall at the outermost part of the Empire. This standard of living
was unobtainable to even the most wealthy lords and kings of the Middle Ages.
Let’s compete freely. Goddam

Complex trade routes spanned across the Mediterranean Sea – and Europe’s manytariffs! Free trade and free seas—

rivers – which connected every corner of the Empire. A private merchant fleet

that’s what’s right!

ensured grains and other foods, clothes, travelers, and even soldiers were

James Clavell

transported across Mare Nostrum. The grain trade from Egypt to the city of Romewas by far the most important of these routes. Traders assured that a single market
for commodities across the empire developed.54 Willing investors could buy sharesin ships and diversify risk to their own liking, similar to modern stock companies.
The Roman economy was, in other words, a free market economy.
Complete with fluctuating market prices to ensure efficient capital allocation. They
even had rudimentary markets for loanable funds aided by variable interest rates
which, as always, were affected by the fluctuations in money supply.55
During Augusts’ reign, new precious metals mines were discovered in Spain and
Gaul (modern France), this led to increased activity at the Imperial Mint. The risein spending brought about an economic boom, driven ever higher by lower interest
rates, and increasing land values. A boom which eventually, or should we sayinevitably, ended with a financial panic, a bust and economic depression that was
triggered by rising interest rates and falling land valuations in 33AD56 when the
inflation in the money supply dried up.
But generally, Romans lived in an environment where peace andfreedom flourished, bringing forth prosperity to all within its borders.
By the time of Hadrian, new conquests were a thing of the past. This ended thelarge influx of slaves, which turned out to be a boon to Roman workers andfarmers alike. Over time, even the rich benefitted from this development as
freemen had incentives to innovate and improve, something lacking in a dull
workforce of slaves. Higher productivity more than made up for higher wages paid
to a freeman.

'Capitalism' is a dirty word for

It is no wonder Romans were wealthier and more prosperous thanmany intellectuals, but there are

their many neighbors who all coveted Roman wealth. It was because of

a number of studies showing that

this wealth that invaders of Rome did not want to conquer Rome, but rather toopen economies and free trade

become part of the empire and enjoy the freedom and fortune that came withare negatively correlated with

Roman citizenship. In lieu of becoming a Roman, outsiders at the very least sought

genocide and war.

trading rights with and within the Empire.

Steven Pinker—

52 Rathbone, Dominic: “Grain Prices and Grain Markets in the Roman World,” presented at the conference on the

Efficiency of Markets in Preindustrial Societies, Amsterdam, May 19-21, 2011
53 Haskell, Henry J.: The New Deal in Old Rome, 1947
54 Kessler, David and Temin, Peter: “Money and Prices in the Early Roman Empire,” Working Paper 05-11, April 14,
2005
55 Temin, Peter: “A Market Economy in the Early Roman Empire,” February 2001
56 Haskell, Henry J.: The New Deal in Old Rome, 1947, p. 184

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The Free-Market Economy Disappears from
Rome
This was the situation up to the first half of the third century. If we add another 50
years to that though, to the time of Imperator Diocletian and Constantine, we findthat peasants are no longer free, nor are soldiers, carpenters, masons, goldsmiths,
or other skilled laborers. They have become bound to their posts. A Roman’s new
bondage had even become hereditary with sons and grandsons expected to assume
the same occupation as their forefathers. This new form of slavery57 had evenbecome entrenched in, and protected by, the same Roman civil law which proudly
served freemen just a generation prior.
The world is not a wish granting

What can explain such a radical transformation? The people of Rome

factory.

certainly did not choose the new dismal state of affairs out of their own volition. It

Augustus (Gaius Octavius)

had to be forced upon them.
The reasons for this are manifold, complex, and often mutually
reinforcing. Most have heard of invading Barbarians and unruly armies led byusurping generals, but few know about the havoc created by exponential inflationin the relatively sophisticated market economy of Rome.

I was reading in the paper today

Inflation took the form of diluting silver content in coins. Every newthat Congress wants to replaceruler minted new coins to proclaim to the civilized world and beyond

the dollar bill with a coin.

that he was now in charge. The process of reducing silver content of new coins

They’ve already done it. It’s

as they retired older ones became modus operandi. New mints retained their facecalled a nickel.

value, but lost intrinsic value. Gold coins were often exempt from debasement

Jay Leno

because the standard gold coin, the aureus, was used as a store wealth for the richand politically connected. The exchange rate between the silver denarius and gold
aureus diverged ever more, which concentrated wealth among the already rich in ahidden regressive tax on the poor.

Inflation is as violent as a

Such trickery worked like magic at first, but gradually problems ofmugger, as frightening as an

escalating prices led to a vicious cycle where Gresham’s Law ensured

armed robber, and as deadly as

taxes were paid in diluted money, while good money was hoarded.

a hitman.

Successive emperors therefore had to dilute coins ever more just to keep up. By the

Ronald Reagan

crisis of the third century, Roman coins had a silver content of less than half apercent. Some coins found from the reign of Claudius II Gothicus (268-270AD)
had a silver content of 0.02 percent. Needless to say, prices skyrocketed.
For example, one measure of Egyptian wheat, which sold for seven to eightdrachmaes in the second century, cost 120,000 drachmaes in the third century.
This equals an annual average price inflation of 10-15%, but there was little
structural price inflation present in 250AD, and even by 260AD it did not pay tomelt old silver coins into new ones. Thus, it is safe to say that most of that priceinflation occurred in a very short time span, from around 260 to 270AD. In many
places the monetary economy ceased to exist, and traders had to resort
to barter.
—

57 Rostvtzeff, Michael: “The Problem of the Origin of Serfdom in the Roman Empire,” The Journal of Land & Public

Utility Economics, Vol. 2, No. 2, April 1926, pp. 198–207

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Silver Content in Roman Denarius, in %, 30 BC-300 AD
100
Monetary Reform
Antoninianus replaces Denarius
at value of 2 Denarius

90
80
70

Elagabalus

60
Augustus

50

Dicoletian
Aurelian

Tiberius
Nero
TrajanAntonius Commodus
Caligula VespasianHadrianMarcusAurelius

40
30
20
10
0

-30 BC

0

30 AD

60

90

120

150

180

Range

210

240

270

300

MedianSource: Langmuir, Robin (2018), Author's Calculations, Incrementum AG

The first panacea for a

When Diocletian finally managed to end the cycle of military coups andmismanaged nation is inflation

countercoups, he was faced with an enormous problem. How to pay for hisof the currency; the second is

expanded army? Diocletian increased the number of soldiers from ~350 thousand

war. Both bring a temporary

men to between 500 and 600 thousand, but he could not pay for his army withprosperity; both bring aworthless cash.

permanent ruin.
Ernest Hemingway

The new Augustus therefore also decided to use barter, or tax payment
in-kind. Diocletian’s enlarged bureaucracy calculated backwards; starting by how
much grain, weapons, transportation, tents, leather etc. five hundred thousandsoldiers needed, and from that they determined in-kind taxation. This system had
slowly evolved before Diocletian, but it was he who formalized and entrenched it inlaw.

The curious task of economics is

Imperial bureaucrats quickly realized that they could not ask every

to demonstrate to men how little

town or farming community to provide an equal share of all the various

they really know about what

products needed. This was unreasonable and to inefficient to ever work, so they

they imagine they can design.

came up with relative prices. Curiously, Diocletian’s bureaucrats found a practicalFriedrich August von Hayek

application in Ricardo’s postulate of comparative advantage around 1,500 years
before Ricardo’s famous “On the Principles of Political Economy and Taxation”.
A farming community with productive barley fields would supply a certain numberof bushels, which had to be priced relative to everything else. A merchant shipper
on the other hand would supply X-amount of nautical miles worth of transport
corresponding to the value of bushels supplied from the farming community.
Weapon manufacturers, leather tanners, wine producers, shoemakers and a fullrange of other suppliers all went into Diocletian’s fiendishly complicated ledgers.
It is easy to see how this repressed innovation in the Roman economy as pricesignals disappeared. By keeping relative prices fixed, tax rates would also varyconsiderably from one harvest to the next. A year of bumper crops meant low tax
rates relative to others, just as a poor harvest had the opposite effect. The state had
no incentive to substitute expensive items for cheaper since they operated with
fixed amounts of, say, bushels of barley, and did not consider the market price ofgoods.

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Cleopatra’s nose, had it been

The economic system therefore stopped responding to price signals.

shorter, the whole face of theMaking matters worse, the newly established and, highly complex, tax

world would have changed.

system, could not allow people to freely move around the empire orBlaise Pascal

find alternative employment. Any incentives to optimize were therefore
further eroded. From a bureaucratic point of view, workers changing theiroccupation or moving to a new city, would see the government’s tedious andexpensive census network derailed. To get around this problem, Diocletian, an oldarmy general, simply ordered men to stay put. A tanner on the day of Diocletian’s
directive thus became a tanner till death. Not only was the poor tanner bound to
his position, his son and grandson were also obligated by law to become tanners.
It did not take long before the Roman economy was run by people stuckin occupations they were ill fit to perform; mindlessly producing what they
had always produced, unmoved by any notion of relative scarcity, unable andunwilling to innovate and improve. A dearth of, say, farmers, did nothing toincentive new farmers, or for existing farmers to rotate crops according to changes
in relative prices. With innovation stifled, Roman society cemented itself into a
structure completely powerless to change with changing circumstances.
The reforms Diocletian stubbornly introduced did not only leave his Empire
doomed, but also set the European economy back a millennium. His economic
policies are the reason we to this day have occupational surnames.
Zimmermann, Ziegler, Schumacher, Spengler, Wagner, Bauer, Fischer, Gerber,
Jäger, Müller are all well known to Germans and a product of an old feudal society
where each man was born into his post. Just as Diocletian ordered.

The Destructive Effect of the Roman Welfare
State
Either I find a way or I makeDiocletian’s illogical reforms are the logical endpoint of policy choicesone.

taken centuries before him. Republican leaders and Emperors determined

Hannibal

Diocletian’s policy choices for him by myopically, but expediently, implementing
reforms which incrementally led to monetary – and by extension – imperial
collapse.
Take for example the old grain dole, a remnant from the Republican days when thetwo populistic Gracchus brothers sought public office by handing out subsidized
grain to the have-nots of the Eternal City. In 124BC, Gaius Gracchus finally got his
populistic grain dole legislation enacted despite stiff opposition from Senators
draped in the Roman ideal of self-reliance and low taxes. Expedient for Gracchus
but devastating for Rome; with enough time his policy will be among those that
greatly exacerbated the inflationary cycle.
The story of Gracchus the populist and Piso, a strict conservative, satisfyingly
demonstrates how the new-fangled ideas clashed with old. Piso, consul at the time,
was a particularly adamant opponent of Gracchian populism, so it came as a big

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surprise to Gracchus when he spotted Piso in the throng, waiting patiently in line
for his state subsidized handout.
Puzzled, Gracchus enquired Piso about his apparent hypocrisy: “I shouldn’t like it,
Gracchus,” Piso replied, brilliantly if I may say so, “if the bright idea should comeinto your head to divide up my property among all the citizens. But if you should
do it, I would be on hand to get my share.”
As expected, subsidized grain soon became free, and by the time of Augustus
320,000 Romans were provided food on the dole daily. Augustus and others tried
to reign in the spendthrift policy, but it proved impossible. Rome was never ademocracy, but its leaders still feared the people and often had to placate them.
Polices that aim to thwart

Rome’s welfare state was not only a heavy burden on the state’s coffers,

market forces rarely work, andit also led to perverse incentives for productive members of Roman

usually fall victim to the law ofsociety. Subsistence farming meant back-breaking work for the scant privilege ofunintended consequences.

paying taxes and barley filling up your family’s belly. As time went by and inflation

Lawrence Summers

eroded away any extra purchasing power a farmer may have accumulated, hewould eventually prefer free grain – which was later expanded to bread, oil andwine – over his tough life on the farm. Skilled and unskilled workers alikeundoubtedly were driven by the same incentive.
Unintended consequences from government policies, no matter how well meaning,always catch up in the end. Fewer farmers and workers to pay taxes, andconsequently, more people on the dole meant a need for more inflation to plug the
gap between increased government spending and lower tax revenue. This inflation
brought about a further reduction in productive members and the cycle repeats
itself ad infinitum.

I shall be a good politician. Even

It is not only in lower farm yields that we see the adverse effects of

if it kills me. Or if it kills anyone

inflationary policies. By studying lead emissions we can get an idea of how badelse, for that matter.

inflation was for the productive manufacturing capacity of Rome. Lead was the

Marcus Antonius

primary source of metallurgical output throughout the Empire. Any changes in
production of the metal is a good proxy for the state of the overall economy.

Lead emissions found in ice cores show how industrial production collapsed, froma peak around 100AD, to a trough in the third century from which it neverrecovered.

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209

Lead Emission Derived from Ice Cores as Proxy for Industrial
Production, in kt/a, 500 BC-500 AD
Sulla's
Civil War Caesar

1.4

assasinatedPrincipate

1.2

Peak
1.0
Accelerating
inflation

0.8
0.6

Diocletianstabilizes

0.4
0.2
0.0
500 BC

400 BC

300 BC

200 BC

100 BC

Lead Emission

0

100 AD

200 AD

300 AD

400 AD

500 AD

11-Year Median Filtered Estimated Lead Emissions

Source: McConnell, J.R. et al. (2018), Author's Calculations, Incrementum AG

While acknowledging the many limitations of using lead emissions as a proxy forindustrial production, we can cautiously say that Roman manufacturing output
declined by about 80% from peak to trough and was still about 75% below its peak
200 years after its nadir around 260AD.58
To be ignorant of what occurred

Much has been said about the utter destruction of city life in Rome, but little isbefore you were born is tounderstood of why Romans gave up on the city. Historians are not economists, andremain always a child.

more often than not that is a good thing, but to explain the de-urbanization, orMarcus Tullius Cicero

ruralization, of Rome, knowledge of monetary systems can be quite helpful. The
eternal city turned out to be transient. Although there are large differences in
estimates of Rome’s population, several scholars claim it was as high as 1.5 million
at its zenith, while some claim it was as high as two million.

Population Estimates: City of Rome, in mn, 700 BC-700 AD
1.6
1.4
1.2
1.0

0.8
0.6
0.4
0.2
0.0

700
BC

600
BC

500
BC

400
BC

300
BC

200
BC

100
BC

0

100
AD

200
AD

300
AD

400
AD

500
AD

600
AD

700
AD

Population Estimates
Source: Twine, Kevin (1992), Author's Claculations, Incrementum AG

Not long after Romulus founded the city named after him in 753BC, it is estimatedto have had a population of about eighty thousand. In 700AD its population was
reduced to a mere seventy thousand, and in 1100AD less than forty thousand.

—

58 The author used a statistical filter to smooth out volatility in the dataset to better show trends in lead emissions.

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How Inflation Threw Rome Back into the Barter
EconomyAs shown, inflation caused a breakdown of the monetary system and are-introduction of barter. Barter is incompatible with specialization andeconomies of scale.
Inflation is like a country where

Producing at scale necessitates, among other things, large purchases of raw

nobody speaks the truth. Itmaterials which cannot be paid for without money. Specializing in, say, masonry,

introduces an element of deceit

makes direct transactions very difficult. How should the baker pay the mason for

into all our economic dealings.

the newly erected wall? It is worth several thousand loafs of bread, but the

Henry C. Wallichstonemason cannot possibly eat those before they turn stale. Money is theinstitution that enables indirect transfer between parties and even more
importanty, allows for temporal transactions.
City life means a high degree of specialization and large-scale
manufacturing. Without the institution of money, large cities become
unsustainable and must shrink down in scale in order to function – exactly what
happened to Roman cities. Societal effects, exponentially positive with theintroduction of money, division of labor, specialization and increased productivity,
turn negative, falling at an ever-faster rate when the institution of money andindirect exchange disappears.
The story of Constantinople’s Theodosian walls will help you
understand what I mean. Theodosius II ordered the famous defensive walls
built in 404AD and his walls stood solid against attempted sieges for centuries.
Even the mighty Umayyad Caliphate had to abandon their siege of 717AD in theface of Constantinople’s impregnable walls, and never managed to conquer
Byzantium. However, additions and repairs done 400 years later are shown to beof inferior quality to the original walls. Knowledge, expertise, and the technology
needed to construct sturdy walls simply disappeared. This regression mostcertainly occurred across all sectors of the economy, and probably also in the army.

Every expansion of the personalWith cities come specialization, leading to invention, and later, innovations to bedivision of labor brings

commercialized. Productive societies are always spawned from cities. Knowledge isadvantages to all who take partsomehow stored in the DNA of its people through the city. New generations are

in it.

brought up with centuries of accumulated wisdom at their disposal. Wisdom they

Ludwig von Mises

themselves can improve upon and pass on to the next generation. When cities
disappear, knowledge slowly fades away with them and subsequent
generations intellectually regress.
Literacy rates substantiates my hypothesis. Ten percent of the population isestimated to have been able to read at Rome’s height, compared to only one
percent during the European Middle Ages. When the tide eventually turns for the
better, old understandings, skills and knowledge must be re-learnt.
Europe lost a millennium of wisdom when Rome succumbed to the inflationary
spell, and we can only marvel in our imagination at the potential technologicaladvancement we could have had today, if Europe did not spend centuries stuck in

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post-Romanian dark ages. It is true that the Church did make significant
contributions to science, but the economic structure that followed Diocletian was
unable to commercialize new discoveries.
Superficial goals lead to

The story of the Theodosian walls proves beyond doubt that inflation, if

superficial results.

taken to the extreme, is catastrophic for society. Even as Aurelian and later

Atilla the Hun

Diocletian managed to stabilize the precious metal content in Roman coins, priceinflation continued unabated through the process of the rising velocity of money,
which is perfectly described by the actions of a Roman official upon hearing that
another debasement of coinage was coming. The official wrote to his servant,instructing him to “Hurry, spend all my money you have; buy me any kinds ofgoods at whatever prices they are available.”59
When trust in Roman coins fell, it could not easily be regained. Prices thus
continued to soar even when the silver content was stable. In Bruce Bartlett’s
words, “the fall of Rome was fundamentally due to economic deterioration
resulting from excessive taxation, inflation and overregulation.”60

The US Walks in Rome’s Footsteps to Ruin
Sooner or later, everything old is

The Roman experience looks eerily similar to the present US economic situation.

new again.

Just like ancient Rome, the USA enjoys the privilege and shoulders the burden of

Stephen King

enforcing its “Washington Consensus” on the world, but like late-stage Rome, theUS cannot fund its army and welfare state through taxation alone.

Share of US Federal Spending Covered by Tax Revenue, 19002022
Depression

140%

WWI

WWII

COVID-19120%
GFC100% Covered by Tax

100%
80%
60%

50% Covered by Tax Revenue

40%
20%
0%
1900

1910

1920

1930

1940

1950

1960

1970

1980

1990

2000

2010

2020

Share of US Federal Spending Covered by Tax Revenue
Source: OMB, Author's Calculations, Incrementum AG

As Rome had to resort to currency debasement to pay for its welfare/warfare state,
the US finds itself increasingly unable to fund current expenditures throughtaxation. For each downcycle the US relies ever more on a complex process of bondissuance, covert, and more recently, overt inflationary policies to ensure the oncemighty Empire can pay its bills.

—

59 Martin, Thomas R.: Ancient Rome: From Romulus to Justinian, Yale University Press, 2012, p. 174
60 Bartlett, Bruce: “How Excessive Government Killed Ancient Rome,” Cato Journal, Vol. 14, 1994, p. 301

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A gold standard is to moochers

Although the US saw expenditures soar during the world wars, large

and looters in the government

subsequent surpluses allowed the Federal fiscal house to remain inwhat sunshine and garlic are toorder. When the last vestiges of the old Gold Standard were abandoned in thevampires.

1970s, the spending dynamic changed as the Empire no longer needed to adhere toHerman Caina sound fiscal policy. Funding was secured via the central bank. The modern-day
Empire felt entitled to take full advantage of its ‘exorbitant privilege’ to keep its
soldiers and plebs content, docile and obedient.
During the Global Financial Crisis (GFC), taxes covered less than 60%
of outlays, down from an average of ~90% in preceding decades. In thecourse of the Covid-19 shutdowns the US government funded less than 50% of its
outlays from taxation.
Rome found itself equally tied down by a Gordian knot. The ancient Empire had tofund its army above all else. Imperator Severus famously advised his sonsCaracalla and Geta to “Be harmonious, enrich the soldiers, scorn all others”61 toremain in power.
Similarly, the US has to placate its industrial military complex, but even more
important to modern day ‘Imperators’ is to mollify the ~60% of its population whoare either on state welfare or directly employed by the government.

US Military and Social Spending as Share of Tax Receipts, 19002025e
400%
WWI

350%

WWII

GFC

COVID19

2010

2020

300%
250%
200%
150%
100%
50%
0%
1900

1910

1920

1930

1940

Military Spending

1950

1960

1970

1980

1990

2000

Social Spending

Source: OMB, usgovernmentspending.com, Author's Calculations, Incrementum AG

Welfare and warfare spending equates to more than 100% of all tax receipts, and it
has proven just as hard to cut back on ‘bread and circus’ spending today as it wasfor Augustus 2000 years ago.
The productivity of the people

Needless to say, the increasing share of resources allocated to current

backs the currency.

consumption, as opposed to productive investments, has zapped all energy from

William E. Simon

the system, and growth is stagnant. The only way to record ‘growth’ in the annalsof the Empire is to count debt-fueled consumption as a measure of an expanding
economy. And the only way to fund that ‘growth’ is to fully exploit the US dollar’sreserve currency status. To maintain that status though, Washington must keep—

61 Dio, Cassius: Roman History, published in Vol. IX of the Loeb Classical Library edition, 1927, p. 273

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funding the vast military-industrial complex, which acts as the all-important stickused to threaten anyone brave enough to deviate from Imperial policy.
In this not-so-merry-go-round, unfunded spending on the Imperial army isnecessitated to maintain its stick’s threat level. This only serves to ensure spending
can continue, but at the same time, this spending circle cannot be sustained
forever.
History, with all her volumes

Also like Rome, the US Empire has resorted to ‘coin clipping andvast, hath but one page.

debasement’ to keep the wheels turning. Tax revenues aren’t even close to

Lord Byron

keeping up with spending requirements, and bond issuance covers the difference.
However, from 2009 the colossal amount of bonds needed could no longer be
issued in honest markets, prompting the Imperial Bank at the Eccles building tostep in. In 2020 the Federal government covered less than 50% of its spending via
taxes, and more than two-thirds of the ~50% bond issuance needed to cover the
shortfall was monetized by the Federal Reserve.

Federal Reserve Ownership of US Treasury Securities, as % ofGDP, 01/1900-12/2021

30%

WWI

Depression WWIIGFC COVID-19

25%

20%

15%

10%

5%

0%
1900

1910

1920

1930

1940

1950

1960

1970

1980

1990

2000

2010

2020

Federal Reserve Ownership of Treasury Securities
Source: Reinhart, Carmen & Kenneth Rogoff (2010), Author's Calculations, Incrementum AG

US Federal Debt, YoY%, 1900-2021
30%
25%
20%
15%
10%
5%
0%
-5%

COVID-19

-10%
1900

WWI
1910

1920

GFC

Depression WWII
1930

1940

US Federal Debt

1950

1960

1970

1980

1990

2000

2010

2020

of which Monetized by the Fed

Source: Reinhart, Carmen & Kenneth Rogoff (2010), Author's Calculations, Incrementum AG

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Monetary inflation caused wealth inequities in ancient times just as it
does today. That in turn creates political polarization. Rome in times past,and the US today both became incapable of implementing the needed reforms.

The Descent of the US Has Already Begun
The end game has begun. When a weakened Roman army lost the Battle of
Adrianople against the Goth’s in 378 it became clear to foes and friends alike that
Rome was no longer indestructible. Foes took the momentum while friends sought
new alliances to secure their fiefdoms in the coming post-Roman world.
Furthermore, I think [the central

Rome’s defeat at Adrianople acted as a catalyst, just like the sinking by thebank] must be destroyed.

Japanese of Britain’s most advanced battleship in the South China Sea on

Cato the Elder

December 10th, 1941, prompting Pacific allies to turn toward Washington rather
than London for protection. This date marked the end of Britain’s Empire.
The humiliating US defeat in Afghanistan has had the same psychosocial impact on
the world. Few allies believe the US have the political will or the resources toprotect them if needed. If one ally decides to leave the Imperial order, others will
follow suit. America’s adversaries are increasingly emboldened. They see this as anopportunity to carve out larger spheres of influence for themselves.

Great empires are not

Russia’s move in Ukraine is directly related to its perception that the Western

maintained by timidity.

world is splintered and too exhausted to act. Worryingly, the only way for the US to

Tacitusmaintain imperial discipline will be to prove everyone else wrong. A large, but nonexistential conflict is the only way to sway opinions in capitals around the world.
Defending Ukraine at all costs could have been a way to show the world that the
US army should not yet be discarded, but with Russia’s invasion that option is nolonger available to the US.
It is the ultimate Catch-22. By doing nothing, the Empire will crumble.
Alternatively, they can surprise adversaries by acting, but that would
risk conflagration of hostilities with potential bankruptcy and militarydefeat. Such is the predicament facing Imperial strategists. What they ultimately
conclude is their best course of action, will profoundly affect us all.
Inflation of the money supply will undoubtedly continue unabated;spending cannot be reined in without an internally unifying, but
externally derived existential crisis. Adversaries know this and willcontinuously prod Washington for weaknesses.
A surprisingly draconian sanction regime imposed on Russia made others, mostnotably China, fully understand what awaits them if Beijing forces Taiwan backinto the fold. The majority of Russia’s USD 500-600bn worth of FX reserves weremade worthless overnight.
China is even more exposed. The whole point of keeping reserves is to have a
war chest in times of crisis. If those reserves can be frozen overnight, they no

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215

longer serve their main purpose. We will see regional payment systems and foreignexchange reserves moving away from fiat currency and into unencumbered assets,
those that are not simultaneously someone else’s liability, such as precious metals.

Fighting the Symptoms Accelerates theDescent
We appeal to the devotion of all,Frustrated with persistently rising prices, even after stabilizing the silver content inthat the decision made [for a

the Denarius, Diocletian issued his infamous price edict on maximum prices

price edict on maximum prices…]

Edictum de Pretiis Rerum Venalium in 301AD, covering basically all goods and…be observed with generous

services. Punishable by death, no seller could sell at prices exceeding Diocletian’s

obedience.

view of what constituted a fair sum.

Diocletian
The edict was issued at a very late stage. This suggests that some remnantsof the old laissez-faire attitude was still embedded in Roman ways, but Diocletian
eventually became vexed enough to implement it, despite his adviser’s better
judgment.
As expected, the amount of goods and services available on the market declined
even more, and the number of plebians seeking ‘refuge’ on the dole grew evenlarger. It was a disaster. Thankfully, as soon as Diocletian abdicated in 305AD, theedict was promptly rescinded.
History repeats itself, but in such

The United States, also a nation of rugged individualism and free markets,

cunning disguise that we never

imposed a price edict on crude oil in the 1970s, under a Republican President nodetect the resemblance until theless, with the exact same result. In the most bureaucratic fashion possible, thedamage is done.

Nixonian law on maximum price applied only to ‘old oil’, that is oil already in

Sydney J. Harris

production.
As Nixon and his bureaucrats soon discovered, Gresham’s law doesn’t
only apply to money. Oil companies soon started to hoard ‘old oil’ and sold asmuch ‘new oil’ at higher price they could. In the end, the edict led to shortages,
economic dislocations, and a severe recession.

The object of life is not to be on

Stupid economic ideas are hard to eradicate, and so Diocletian’s edict

the side of the majority, but tohas been revived recently. With re-election in mind, Victor Orban looked at aescape finding oneself in theprice inflation rate of over 7% while he fretted over how angry Hungarians will castranks of the insane.

their vote. Orban has therefore imposed price caps on fuel and some basic

Marcus Aurelius

foodstuffs such as flour, sugar, milk, pork legs and chicken breasts. In addition,
mortgage interest rates were frozen for the first half of 2022, as since May 2021
Hungary’s central bank, the MNB, has raised interest rates 11 times so far, from
0.60% to 5.40%.
The Polish government’s decisions were economically wiser. They have
implemented temporary tax cuts to supplement household income, as the populace
has to spend more, due to price increases.

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With a new geopolitical order comes a new financial order. The
transition to a new equilibrium will be volatile and highly inflationary as the oldreserve currency gives way to a new. During this transition, the political center –already stretched thin – will fail. We see this more clearly in Europe’s
parliamentary structure than in the US two-party system, but we know thedifferences between Republicans and Democrats are the widest in over a century.
History is seasonal, and winter is

In today’s Europe, ‘mainstream’ parties together hold 40-60% of thecoming.

vote. Four decades ago, they held 80-95%. One more crisis and the center

Neil Howefalls far below 50%. This means politics becomes even more radicalized. Even if theso-called ‘mainstream’ parties cling on to power, they will only be able to do so by
moving the center to avoid being flanked by populist’s ‘fringe’ parties.

Share of Total Votes for Political Center vs. Fringe Parties, in %,1900-2020

100
90

Political 'Center'

80
70
60
50
40
30
20

Political 'Fringe' Parties

10
0
1900

1910

1920

1930

1940

Fringe Range

1950

1960

1970

Center Range

1980

1990

2000

Center2010

2020

FringeSource: National Sources, Author's Calculations, Incrementum AG

It is easy to see how populists will take advantage of the situation, blaming
runaway inflation on past governments, greedy businessmen or foreign elements.
Luring a desperate electorate with quick fixes such as price controls or other stateimposed measures. No matter who comes out on top, the result is a dramaticchange in political direction.62
War, pandemic, lockdowns and failing supply chains spreading across the globe –intertwined between friends and foes alike – have revealed weaknesses inherent in
the current system.
Our system works on trust…

Politically expedient solutions will be aimed at autarky and away from globalism.

Remove trust and it affects theRussia will never trust the Western world again and China is taking notes. The

creditworthiness of an individualWest understands that they cannot be reliant on Russian energy, grain and metals.

or company. Remove trust from

Neither can they put their trust in steady supplies from Asian manufacturing hubs.

a system and the entire system

Onshoring will be the new mantra, but that also implies sub-optimal capitalcan unravel very quickly.

allocation when viewed through a simple motive to maximize profits.

Jeff Booth
Political control over the ‘commanding heights,’ defined ever broader, will takeprecedent. To achieve this, politicians will start by handing out tax-sponsoredfinancial incentives. This could include paying for utilities in order to keep larger—

62 See “From Decades Where Nothing Happens to Weeks Where Decades Happen,” In Gold We Trust report 2021

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strategic reserves of fuel and increase their carrying capacity. The same goes for
vaccines and production of medication, personal protective equipment, and above
all else energy and food. Europe has pursued a ‘green transition’ with zeal, less dueto their concern of global warming, but rather driven by their reliance on imported
fuels. Now they will double down on green energy, which is tantamountto self-sufficiency.
Monetary decline tends toWhile these are still to be considered minor steps, politicians know incentives andcoincide with the decline ofsuasion will only take things so far, while the plebiscites will demand stronger

governments and dynasties.

political action as soaring price inflation keep reducing their real wages. Price

Those who claim “this time iscontrols may help placate a myopic electorate, but the next step will be to impose

different” simply have no idea

capital controls to force savings into national champions and lock capital inside thehow much it is the same.

realm. ‘Independent’ central banks will guarantee real yields stay negative. WithNathan Lewis

nowhere to hide, debt will be inflated away at the expense of creditors and savers.
Economic growth will suffer as a consequence.

Conclusion
Civilization is an interlude

Crisis always precedes grand projects of state intervention.

between ice ages.

Unfortunately, the process is more often than not demanded by a desperate

Will Durant

people, who gladly trade their freedoms for action. Covid-19 taught us how easily afree society can fall prey to fear, the greatest ally to self-aggrandizing populists.
Diocletian was the answer to Rome’s crisis. A ruthless ruler who ended the idea of
the Emperor being the Principate – merely the first citizen among many – andtransformed the office to the Dominate, where his word was law. In Diocletian, theempire was ruled by a man that could change the course of a whole continent on awhim. The result was complete collapse.
At our stage in history the path forward is set in stone. A Dominate will be
put in charge to fix the myriad of problems that have accumulated over decades ofmismanagement.

There is no security in life, only

The history of Rome is not unique. Several Empires throughout history have gone

opportunity.

through the same rise and eventual fall. The transition from the old to a new world

Mark Twainorder cannot happen without causing a lot of friction. We will go through anothertransition over the next decades. It will be turbulent, but where there is volatility
there is also opportunity.

•

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Why Does Fiat Money
Seemingly Work?
“The most important thing toremember is that inflation is not an act
of God. … Inflation is a policy.”
Ludwig von Mises

Key Takeaways• History is rife with examples of governments inflating

their money supply. This has always ended with
monetary collapse. A primary example is the fall of the
Roman Empire.
• This can also be observed in England’s medieval tally

stick system that allowed the king to use goldsmiths as
fractional reserve bankers, and in John Law’s disastrous
experiments with paper money in France in the 18th
century.
• Legal-tender legislation is required in order for the

public to accept and use fiat currency. This innovation
has allowed paper money to push gold out of circulationeven as the purchasing power of fiat currencies has
dropped considerably.
• In a free market, fiat money would never come into

existence. While a true free market may not always
choose gold, a free market in money would never lead tofiat.
• Governments use fiat currency to siphon wealth awayfrom productive citizens into the coffers of
nonproductive bureaucrats and financiers. This is a defacto hidden tax on citizens.
• Government-mandated fiat currency simply does notwork in the long run. This is evident through empiricalevidence and basic reason. Every fiat currency system
in history has failed, except the current one, which has
not failed… yet.

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In memory of Heinz Blasnik
A couple of months ago, Heinz Blasnik, a brilliant mind, long-time collaborator
and good friend, passed away. With this article, which first appeared on June 27,
2007 on "Mish’s Global Economic Trend Analysis" (now “Mish Talk”), we want tocommemorate him. At that time Heinz was using his first alias, Trotsky. The
reprinted text is a slightly revised version published on February 21, 2015 on
www.acting-man.com, Heinz’s blog, under his latter pseudonym Pater
Tenebrarum. This article demonstrates Heinz’s deep and broad knowledge, his
witty intellect, and his excellent writing skills. RIP, dear friend!

Introducing Money
Imagine three men living on a small island. Tony operates the local salt mine, andthen there is Pete, the fisherman and Tom, the apple grower. They have a bartertrading system set up: Tony exchanges his salt for Pete’s fish and Tom’s apples,
and they in turn trade fish and apples between each other.
One day Pete says, “I have an idea. Instead of fish, I will from now on give you
pieces of papyrus with numbers marked on them”. (Papyrus grows in great
quantities nearby, but has so far not been of practical use to any of the islanders.)
Pete continues: “One papyrus mark will represent 1 fish or 5 apples or 2 bags ofsalt, according to our current barter exchange rates. This will make it easier for us
to trade with each other. We won’t have to lug fishes, apples and salt around all thetime. Instead, we can simply present the pieces of papyrus to each other, and they
can later be exchanged for our products on demand.”John Law at a young age – the world’s first Keynesian economist“Portrait of John Law”, by Casimir Balthazar
Photo credit: wikimedia.org

Paper money eventually returns

In short, Pete wants to modernize their little island economy by introducing money

to its intrinsic value – zero.

– and he already has one of those new papyrus notes with him, which he is eager toVoltairetrade for salt. However, the others would immediately realize that there is aproblem: The papyrus per se is not of any value, since none of them have found a
use for it as yet. If they were all to agree on using the papyrus as a medium of
exchange, its value would rest on a promise alone – Pete’s promise that any
papyrus he issues will actually be “backed” by fish, which would make Tony and
Tom willing to accept it in exchange for salt and apples.

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Since papyrus grows in great abundance on the island, Pete could easily issuemoney by the bucket load. Both Tony and Tom like Pete, but they can see that theidea of installing him as the island’s papyrus banker would likely tempt him into
taking advantage of them. In fact, it is unlikely that any of the other islanders
would ever using papyrus as money.
There is no honest man — not

It is far more likely that they would use another good as a medium for indirect

one — that can resist theexchange, one for which there is an actual demand (for instance, a rare type of sea-

attraction of gold!

shell that is prized as an ornament and only seldom found on the island). In

Aristophanes

short, in a free market, only something that enjoys an alreadyestablished demand due to its use value would emerge as a medium of
exchange. An object widely considered as worthless would never
become money in a free market.
However, today we all use irredeemable paper money. How did essentiallyworthless objects come to be widely accepted as money? Let us take a brief detourand look at a few slices of monetary history.

Flashback: Rome 27 BC – AD 301
Rome’s long history of inflation and monetary debasement actually started with
Caesar’s successor, Augustus, whose inflationary method was at least not a prima
facie fraud. He simply ordered the mines to overproduce silver so as to finance theempire that had grown greatly in size under Caesar and himself. When thisoverproduction began to have inflationary effects, Augustus wisely decided to
cut back on the issuance of coins. This was the last time that a Romanemperor attempted to correct a monetary policy blunder by honestmeans, aside from a brief flash of monetary rectitude under Emperor Aurelius
some 280 years later.
The natural tendency of the state

Under Augustus’ successors, the situation deteriorated at a rapid clip. Claudius,

is inflation.

Caligula and Nero all embarked on enormous spending sprees that depleted

Murray Rothbard

Rome’s treasury. It was Nero who first came up with the idea to actually debase
coins by reducing their silver content, in AD 64 , and things quickly went downhillfrom there.
It should be mentioned that Mark Anthony financed the army he used in his fightagainst Augustus with debased coinage as well. These coins remained incirculation for a long time, in line with Gresham’s Law – “bad money drives goodmoney from circulation”.
In AD 274 the soldier-emperor Aurelius (who ruled from AD 270–AD 275) entered
the scene with a well-intentioned monetary reform, by fixing the silver-copper
content of the then most widely used coin, the Antoninianus, at a 1:20 ratio.
However, shortly after this reform was instituted, the coin’s silver content resumed
its inexorable decline.

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Emperor Diocletian, the price fixer
Photo credit: hellenicaworld.com

The only lesson you can learn

In AD 301 Emperor Diocletian tried his hand at reform, this time by instituting

from history is that it repeats

price controls to mask the effects of his inflationary policies, a policy repeated byitself.

numerous politicians many times thereafter, in spite of the fact that it can be

Bangambiki Habyarimana

shown both theoretically and empirically that it never works (Richard
Nixon’s ill-fated experiment with price controls serves as a fairly recent example,
as does a similar policy currently enacted in Venezuela).
Diocletian’s price control edict, De Pretiis Rerum Venalium (which he soon
repealed , as it proved unenforceable in spite of harsh punishments meted out topeople trying to circumvent it), accelerated Rome’s downfall, as goods simply
began to disappear from the marketplace. Merchants would rather hide their goods
than abide by an edict forcing them to sell them at a loss. Shortages of goods
are an inevitable effect of price controls.
It is no exaggeration to state that monetary inflation combined with subsidies andattempts to centrally control important aspects of the economy eventually caused
Rome’s downfall. The ancient Romans at least had the excuse that they
were not familiar with economic and monetary theory. As this brief lookat Rome’s monetary history shows, governments have engaged in theft fromthe citizenry via monetary debasement from the very dawn of Western
civilization.

Money Substitutes Enter the Scene
How was the leap from debasing coinage to outright fiat money accomplished?
There are two distinct intertwined historical developments that ultimately led tothe present system. Fractional reserve banking was first practiced by theforerunners of modern day commercial banks, namely goldsmiths.

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A goldsmith deposit receipt from 1729
Photo credit: britishmuseum.org

If you owe your bank a hundred

Goldsmiths were used as depositories for gold and silver, and the receipts theypounds, you have a problem. But

issued for such deposits soon began to circulate as the first bank notes

if you owe a million, it has.

– especially once they hit upon the idea of issuing “bearer” receipts instead of tying

John Maynard Keynes

receipts to specific deposits. This has obvious advantages. Since one gold coin is as
good as any other of the same weight and fineness, there is obviously no need forthe strict allocation of deposits.
The convenience of carrying and using these banknotes instead of
lugging around bags of gold and silver soon made them popular, and it
didn’t take long for the goldsmiths to realize that the actual coin deposits wererarely withdrawn in great quantities. Instead, the receipts would remain in
circulation, being regarded as perfect money substitutes. It followed from this that
one could temporarily lend deposits out and collect interest on such loans. Thiswas problematic from a legal perspective, as demand deposits should be available
at all times.

New Golden Rule of Fractional

Moreover, since the originally issued receipts remained in circulation, the total

Reserve Banking: He whomoney supply actually increased once these deposits were lent out. In fact, many

creates the "fool’s gold" controls

goldsmiths simply issued additional receipts for gold, even if they were

the fools.

not actually backed by deposits (with a similar effect on the broadly defined

Orrin Woodward

money supply). This was an early form of fractional reserve banking, namely
lending out far more receipts for money than one actually holds in one’s vaults.
Obviously, this activity was fraudulent (though some people claim it was merely
ingenious). Nevertheless, it is perfectly legal today, although it remains in

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essence the same fraud it has always been. The main difference is that today
it is a far more sophisticated, as well as officially sanctioned, fraud.
When banknotes were still backed (at least partially) by specie on deposit, theexpansion of money substitutes was frequently held in check by bank runs (or,from a banker’s perspective, the fear of bank runs). Nowadays, no such fear exists.
The lender of last resort – the central bank – can (up to a point) prevent bank runs
by conjuring new money out of thin air and making it available to banks in
distress.

Tally Sticks and Charles II
The other historical development that can be seen as an important ancestor of themodern day fiat money system is England’s application of the medieval tally sticksystem of recording payments. Taxes in the largely agricultural economy of the
Middle Ages were usually paid in the form of goods, and these payments wererecorded with notches on wooden sticks that were then split in half length-wise(one half remained with the tax-paying serf, as proof of payment). This was aningenious method of preventing counterfeiting of receipts, as the two halves of atally stick perfectly match and every tally stick is unique.
You don’t pay taxes, they take

In AD 1100, King Henry the First ascended the English throne and adopted thetaxes.

tally stick method for the purpose of recording tax payments. By the time of Henry

Chris RockII’s reign, taxes were paid twice a year, and a secondary market for tally sticks
recording the partial tax payment made at Easter developed. Tally sticks were
circulating in the secondary market at a discount to their face value and were
accepted as payment for goods and services, since they could be later presented tothe exchequer as proof of taxes paid.
It didn’t take long for the king and his treasurer to realize that they
could actually issue tally sticks in advance, in order to finance“emergency spending” (such emergencies often involved war). The sale of theseclaims to future tax revenue created the market for government debt – which is an
essential part of today’s fiat money system as well.

“A wooden stick for recording transactions. Made in England in the third quarter of the thirteenth century, the firststick reads ‘£9.4s.4d. from Fulk Basset for the farm of Wycombe’; probably Fulco Basset, bishop of London, who diedof the plague in 1259. The second one reads: ‘£4. 8p. from Robert of Curclington for an injustice.’”
Photo credit: oldcurrencyexchange.com

The power to tax is the power toAfter a brief hiatus of experimentation with a pseudo-republican government

destroy.

under Oliver Cromwell, the English monarchy was reinstated in 1660 and Charles

John Marshall

II began his reign, albeit with vastly reduced powers, especially in the realm of
taxation. Since Charles had to beg the parliament for money, he struggled mightily
with paying his vast pile of bills. Whenever Charles wrangled permission to raise

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taxes from parliament, he immediately went to cash in these future tax receipts byselling tally sticks to London’s goldsmiths at a discount. Such debt was payable tothe bearer, which allowed the goldsmiths to sell it in the secondary market to raise
yet more funds that could be lent to the king.
Running on, running on empty

They also began to pay interest to depositors, in order to attract still more funds. At

Running on, running blindthat stage of the game, the goldsmiths figured they had a good thing going for

Running on, running into the sunthem, since the king was widely regarded as the equivalent of a modern-

But I'm running behind

day triple A-rated sovereign borrower, who could always be relied

Jackson Browne

upon to cover his debts with future tax receipts. No one thought itproblematic that the vaults soon contained far more wooden sticks
than gold. An active market in this government debt developed, and thegoldsmiths profited handsomely.
The king meanwhile hatched a cunning plan: He decided to circumvent Parliamentand began to issue tally sticks as he pleased (as an aside, one half of such a stick,which was given to the party advancing funds, had a handle and was called thestock, while the other half was called the foil. The term stock has evolved todescribe shares in publicly listed corporations). Not surprisingly, Charles was morethan happy to exchange sticks of wood for gold and soon kicked off a sizablecredit boom by vastly increasing his production of wooden sticks.

To carry on war, three things are

So what did the king do with all the gold he received for his tally sticks? During his

necessary: money, money, and25-year reign he waged three wars, all of which he lost (two against the Dutch, one

yet more money.

against the French); he survived 4 different Parliaments (only the first of which

Gian Giacomo Trivulzio

wasn’t hostile to him); he helped to establish the East India Company, madenumerous shady deals with Louis XIV of France (his cousin), sired a horde ofillegitimate children of which he acknowledged 14, and was renowned across thelands for his hedonistic court. That, along with the king’s ability to talk London’s
goldsmiths into handing over their gold for wooden sticks, may explain why
Charles was nicknamed the Merry Monarch.

Contents of a typical London goldsmith’s safe at the height of the king’s borrowing spree.
Photo credit: The National Archives

There was of course a natural limit to this debt expansion. Once all the money
attracted from depositors had been transferred to the king, additional
deposits could only be acquired by means of offering higher interest
rates than previously. By 1671 the annual discount on the King’s debt hadreached 10%. As redemption demands nearly overwhelmed the funds raised by

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new debt issues, the king’s cunning plan had clearly ceased to work. However,Charles suddenly and quite conveniently remembered that there was a law againstusury on the statute books, and lo and behold, interest rates in excess of 6% wereactually not permissible.
Since all his recently issued debt carried a far bigger discount, he simply declared
the debt illegal, and stopped making payments on it (with a few judiciously
selected exceptions, i.e., it was a selective default). Overnight, the king’s tally
sticks reverted back to what they had really always been – worthless
sticks of wood. The king’s creditors, chiefly the goldsmiths and their customers,
had quite literally “drawn the short end of the stick” (if you have ever wondered
where this expression comes from, now you know).
Although tally sticks were still used until the early 19th century, and even formed
part of the capital of the Bank of England when it was founded in 1694, thesecondary market never really recovered from this blow. With the stroke of a pen,Charles had killed off the better part of London’s budding banking system andtransformed countless of his creditors into destitute and quite involuntary donors
to the crown.
To add insult to injury, Charles even gained a propaganda victory, as the public
blamed the goldsmiths for the ensuing mess. They were of course not entirely
innocent, since they had proved quite gullible (a bit like the people buying
government bonds with negative yields today…). Eventually, in 1834, all the still
extant tally sticks were burned in the coal furnaces under the House of Lords – andby mistake, the entire Palace of Westminster burned down with them.

J.M.W. Turner’s painting “The Burning of the Houses of Lords and Commons” in 1834.
Turner had witnessed the event firsthand.
Photo credit: wikimedia.org

The ideas which now pass for

What the tally stick system did however achieve was to plant the idea ofbrilliant innovations andhow a fiat money system might actually be made to work. The tally stickadvances are in fact mere

system and the transformation of goldsmiths from deposit-taking institutions into

revivals of ancient errors.

bankers practicing fractional reserve banking delivered the basics of the structure

Henry Hazlittof the modern monetary system.

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John Law’s Fiat Money Experiment in France
It was a Scotsman, John Law – ironically born in the very year (1671) when Charles
II defaulted on his debt – who attempted the first great fiat money experimentinspired by these ideas. Living in exile in France, he found a willing partner in
Philippe II, the Duc d’Orléans, who was the regent of a near-bankrupt state andproved eager to put Law’s ideas into practice.

Philippe duc d’Orléans régent de France. When Louis XIV of France died in 1715, Philippe d’Orléans became regent
to the then five-year-old king. Together with John Law, he proceeded to completely wreck France’s economy.
Copper engraving, 1750
Photo credit: britishmuseum.org

More paper money cannot makeJohn Law’s basic idea was that the more money there is in circulation, the greatera society richer, of course – it is

the prosperity of a country would be. He discussed his ideas in a treatise publishedjust more printed paper.

in 1705, entitled Money and Trade Considered. In Law’s own words: “Domestic

Otherwise, why is it that there

trade depends upon money. A greater quantity [of money] employs more people

are still poor countries and poor

than a lesser quantity. An addition, the money adds to the value of the country”.

people around?

Considering the above quote, John Law was arguably the world’s first KeynesianHans-Hermann Hoppe

economist. He evidently thought that economic growth was the result of“spending”. John Law became France’s comptroller general of finances and set up
the Banque Générale Privée (later renamed the Banque Royale), which used
French government debt as the bulk of its reserves and began to emit
paper money ostensibly “backed” by this debt – however, with apromise attached that the notes could be converted to gold coin on
demand. There was actually neither an ability nor a willingness to keep
this promise.
In an effort to make the new paper money more palatable to a distrustful public, it
was decided to make it acceptable for payment of taxes (this idea is key andas noted above was the reason why English tally sticks were able to function as asecondary medium of exchange). A credit and asset boom of vast proportions
ensued, and became especially pronounced after Law decided to float shares of theCompagnie des Indes, a.k.a. the Mississippi Company, which enjoyed a trademonopoly with the New World and the West Indies.
Between 1719 and 1720 shares in the company rose from 500 to 10,000 livres.
Predictably, the bubble eventually burst, and the stock lost 97% of its peak value inthe subsequent bust. Enraged and nervous financiers tried to convert their Banque

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Royale banknotes into specie in the ensuing economic crisis, but naturally, thecentral bank’s promise of convertibility could not be fulfilled – it had inflated the
supply of bank notes way too much (in the end, its notes traded at discounts of up
to 99% of their face value).
The government at first tried to stem the tide with edicts forbidding the private
ownership of gold, but the enraged population eventually drove Law into exile, andthe fiat money experiment ended with the Banque Royale closing its
doors forever, leaving France in a far worse economic position than
before the experiment. Countless “paper millionaires” had become destitutepaupers.

1720: Investors in John Law’s Mississippi Company scam are desperate to get their money back.
Copper engraving by Antoine Humblot; Photo credit: pinterest.fr

Never underestimate the power

The economic crisis following the collapse of Law’s Mississippi enterprise and fiatof bad ideas. They must be

money scheme gripped all of Europe – the eloquent master of fiat disaster had

refuted again and again.

seduced investors from all over the continent, many of whom suddenly found

Lew Rockwell

themselves penniless. Confidence in other European banks and companies eroded
as well, and a great many bankruptcies ensued. Still, Law’s idea, evidently copiedfrom the tally stick system, that fiat money could be supported by making it themedium in which tax obligations could be discharged, was not forgotten.

Share price of John Law’s “Compagnie des Indes” – eventually the stock made a complete round trip.
Source: Dave Smant: Mississippi Bubble 1720

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There are several historical examples similar to the above, for instance the fiatmoney inflation in France under the revolutionary assembly, which took place ascant 70 years after John Law had ruined the country and which ruined it all overagain. Numerous hyperinflation episodes occurred in the course of the20th century as well, always in connection with attempts to fundgovernment spending with the printing press.

From Coin Clipping to Fiat Money
There is only one institution that

For a long time, states were forced to accept gold’s role as money. The introduction

can arrogate to itself the powerof irredeemable paper money wasn’t considered viable, and failed experiments

legally to trade by means ofsuch as John Law’s served to dissuade governments from pursuing the idea

rubber checks: the government.

further. Rather, heads of state resorted to coin clipping or otherwise

And it is the only institution that

diluting the precious metals content of coins if they wished to rob the

can mortgage your future

citizenry via inflation. These early instances of inflation by means of

without your knowledge or

reducing the precious metals content of coins led to the downfall ofconsent: government

entire empires, with the Roman empire the most prominent. However, the tally

securities…are promissory

stick system and John Law demonstrated how public demand for fiat currency

notes…on your future

could be generated, namely by means of the government’s accepting it for

production.

payment of taxes.

Ayn RandThis is why pieces of paper with some ink slapped on them are not laughed out of
the room straight away. The two major pillars of this system are based on coercion:
directly via the legal tender laws, which decree that fiat currency must be used inand accepted for all payments of debt, public or private, and indirectly via thedemand for fiat money as a means to discharge tax obligations. It is safe to say thatwithout this second criterion, it would have been impossible for governments to“monetize” irredeemable paper.
The mere legal proclamation that something shall be money does not suffice tomake it money in the economic sense, just as the “official demonetization” of amarket-chosen money commodity cannot rob it entirely of its monetarycharacteristics. It is necessary that market participants use whatever
object has been declared to be legal money in commercial transactions.
Only if they are doing so, then it is money.
Paper money is liable to be

As noted above, banknotes were originally merely money substitutes – claims toabused, has been, is, and foreverdefinite weights of metallic money held in bank vaults. People were getting used towill be abused, in every country

these money substitutes representing money, and governments instituted thein which it is permitted.

changeover to fiat money by robbing these money substitutes of theirThomas Jefferson

convertibility, gambling that people would continue to use them in commercial
transaction anyway, out of habit. Nowadays banknotes are no longer money
substitutes, but have effectively become standard money. Money
substitutes consist of two kinds of deposit money: uncovered (fiduciary media forwhich no counterpart in the form of standard money exists) and covered money
substitutes (deposit money for which bank reserves exist, either in the form ofvault cash or as reserves held at the central bank).

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What is also extremely important for the system to function is faith in the valueof government debt, which rests on the conviction that governments will be able
to extract enough wealth from their citizens in the future to repay that debt.
Government bonds serve, so to speak, as the main “backing” of bank notes andtheir digital counterparts in circulation. They tie governments and the banking
system together via the central bank. The central bank has the power to “monetize”
such debt by creating new money out of thin air and using it to buy debt securities.
This roundabout way of going about money creation is an essential part of theconfidence game.

Theft of Purchasing Power
Since the central bank’s balance sheet is largely composed of government debt, thebank has an incentive to manage the public’s “inflation expectations” and inflate
the currency as inconspicuously as possible. This does of course not mean that the
inflation racket is inhibited per se. The theft has merely been organized in such amanner that people don’t complain too much. The frog is boiled slowly, so to
speak.
Inflation is the one form of

If the government had to actually raise taxes instead of borrowing the staggering

taxation that can be imposedsums of money it uses to keep its welfare/warfare programs running and the vote-without legislation.

buying mechanism well-oiled, it would have to raise taxes by so much that it would

Milton Friedman

face a rebellion. Instead, government resorts to inflation. From thegovernment’s perspective, money supply inflation is nothing but acleverly disguised tax.

Photo credit: Gold Eagle

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The chart above depicts fiat currencies in the 20th century. Countless monetarycatastrophes have unfolded around the world at varying speeds since theestablishment of the Federal Reserve. This chart is dated and doesn’t include thelarge gain in gold’s purchasing power vs. fiat currencies since 2005.
Inflation is when you pay fifteen

In a missive published in 2007, veteran market analyst Richard Russell reminisced

dollars for the ten-dollar haircut

about the monthy salary of USD 125 his first job after college earned him and theyou used to get for five dollars

then very high USD 22.50 per month he had to pay for his USD 10,000 GI life

when you had hair.

insurance policy. A new car cost USD 450 at the time. Those were princely sums in

Sam Ewing

the 1940s but have become chump change now.
This devaluation has obviously not happened overnight, although one can happen
very quickly if the public’s confidence in the money-issuing authority crumbles.
The public has become inured to the “inflation tax”, as it is proceedingat what appears to be a snail’s pace (at least according to the government’s
official inflation measures). It is of course not possible to measure the“general level of prices”. There is an array of exchange ratios between money
and countless disparate goods, the adding up of which simply makes no sense.
Money itself is subject to the forces of supply and demand, just as the goods it isexchanged for are, leaving no fixed yardstick against which price changes can bemeasured. As a result, these inflation measures have to be taken with a big barrelof salt.

Inflation takes from the ignorantWith legal tender legislation in place, fiat money has pushed gold out ofand gives to the well informed.

circulation. No one is going to use sound money for transactions when he has the

Venita Van Caspel

choice of using an unsound money instead. Over time, gold has increasingly
moved from the world’s monetary bureaucracies into private hands,
serving as a store of value and insurance against the failure of themodern fiat money experiment. Note, though, that the opposite will happen if
an unsound money becomes entirely useless as a medium of exchange: In thatevent, people will adopt an alternative medium of exchange that they expect tohold its value better. For example, during Zimbabwe’s hyperinflation,
Zimbabweans began to use US dollars, the South African rand, and gold dust for
payments.
On a global basis, only about 2.5% of all official central bank reserves are held in
the form of gold these days. Some countries hold far larger percentages of theirreserves in gold, most notably the US and many European countries; but even so,these reserves pale in comparison to the amount of fiat money and central bankcredit they have issued.

Everybody Is Happy
It is also important to note that although they are being subjected to a hidden tax,
most citizens actually are quite happy with things as they are. As Gary North once
observed, everybody involved appears to be happy, the robbers as well as therobbed. The banks are happy to be part of a cartel led by the central bank, which
gives them immense latitude in indulging in consistent and flagrant overtrading ofLinkedIn | twitter | #IGWTreportWhy Does Fiat Money Seemingly Work?

231

their capital, spurred on by the moral hazard created by having a “lender of lastresort” backstopping them, which can conjure up money out of thin air without
limit. Politicians and bureaucrats are happy because there is very little restriction
on their spending and there is nothing stopping them from buying votes or
indulging in whatever pet projects they happen to dream up.
Today is already the tomorrow

And lastly, among the people who should actually rise up in protest, there are large

which the bad economist

subgroups that are either wards of the state and dependent on its largesse (theyesterday urged us to ignore.

shameful secret of the welfare state is that it makes irresponsible slaves out of what

Henry Hazlitt

would otherwise be free and responsible people) or have amassed so much debt in
the pursuit of instant gratification that they are quite happy to see money being
devalued at a steady pace. In a nation where the majority are debtors,
inflation is the politically most palatable form of monetary policy. Afterall, everybody is focused on the short term (politicians and bureaucrats on theirterms of office, consumers on their debt and their desire to buy more things they
don’t need with money they don’t have, and so forth).
Few people stop to consider that this policy means ruin in the long run. Over time,the middle and lower classes will see their real incomes and living standards shrink
ever more, while the true beneficiaries of inflation – those who get firstdibs on newly created fiat money – amass more and more wealth in akind of reverse redistribution from later receivers.

Wealth Producers Have No Say
Production is the only answer to

Savers and genuine wealth producers are put at a great disadvantage by inflation.

inflation.

Wealth generators have to contend with the fact that the creation of additional

Chester Bowles

money creates a demand for scarce goods without a preceding contribution to thepool of savings. Nothing can be exchanged for something, and their own savings
will no longer allow them to exercise demand for goods to the extent they expected.
Not surprisingly, the small elite that actually profits from the fiat money
system is quite content to take the long-term view. Actual producers ofwealth are a very small group, too small to have a decisive voice in how
things should be run. They would all have to go on strike if they wanted toexercise some pressure, a la John Galt. Unfortunately, big established businesses
are usually in bed with the state and are happy with the status quo as well – theirmain aim is to keep competition from upstarts at bay, so they are quite content
with the various methods by which the market economy is hampered. They give lip
service to the idea of truly free, competitive markets, but concurrently lobby for
anticompetitive regulations all the time.

Decades of Successful Propaganda
Those who are capable of

The propaganda effort in support of the fiat money system has been enormous

tyranny are capable of perjury

over the decades, and has been quite successful. Former Federal Reserve chairman

to sustain it.

Alan Greenspan once told Ron Paul on the occasion of his semiannual testimony in

Lysander Spooner

Congress that he believed “We have had extraordinary success in replicating the

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features of a gold standard”. We are quite sure he was aware that this is actually
not the case. And yet, apart from Ron Paul, no congressman would have eventhought of questioning this absurd assertion. One would think that the factthat the US dollar – one of the world’s “better” fiat currencies – haslost 97% of its purchasing power since the Federal Reserve has been inbusiness speaks for itself. Mises has already shown in 1920 that socialist
central economic planning is literally impossible. No rational economy can becentrally planned. Central banking simply represents a special case of the theoremof the impossibility of socialism, applied to the financial sphere.
There is still a market economy operating, hampered though it is, alongside thehuge swathes of economic activity that have been appropriated by parasitic entities
such as the state and its dependents. The part of the economy that can beconsidered relatively free produces all of our wealth. It unwittingly
supports the fiat money system’s continued viability by doing what it does best,
namely by enhancing productivity, thereby exerting downward pressure on theprices of goods and services – which works against the upside pressure on prices
created by monetary inflation.

Economic Interventionism vs. the Free Market
Socialism is an alternative to

Apologists for the current system laud its “flexibility”. This is nothing more than an

capitalism as potassium cyanide

argument in favor of interventionism based on the misguided belief that theis an alternative to water.

market economy is inherently prone to “failure”. Another commonly heard

Ludwig von Mises

argument is: “If the economy is to grow, the supply of money must grow as well”,
as if that were immediately obvious. In fact, many people believe this to be atruism, as it sounds superficially convincing. In reality, increasing the supplyof money confers no benefit whatsoever on society at large. It is notimportant how much money one has in terms of numbers in a bank account, it isimportant what this money can buy. In a free market, the prices of goods andservices will tend to steadily decline over time. That is the inevitable result of
increasing productivity. This is why the widely accepted tenet that “we need
constant inflation of the money supply to enable the economy to grow”
is misguided.

Morality is only moral when it is

It is not 100% certain that a truly free market economy would settle on using gold

voluntary.

as money nowadays, although the chances seem good that it would play an

Lincoln Steffens

important role. It seems highly probable that the previous historical period of trial
and error that has led to the establishment of precious metals as money would still
be widely regarded as likely to produce a satisfactory outcome. It is however not
really important whether gold or something else would emerge as money. What is
important is that the decision on what should be used as money would
be arrived at voluntarily by the actions of market participants.
In an unhampered free market with a relatively stable supply of money, the supplyof and demand for money would still be subject to fluctuations, but it is a good bet
that these would be small. A freely arrived at market interest rate would at all
times correctly signal to entrepreneurs what the state of society-wide time

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233

preferences was at any given point in time, allowing them to allocate capital in themost efficient manner.
A Law cannot give to Bills that

By contrast, in a fiat money system in which interest rates are administered by aintrinsick Value, which thebureaucratic central economic planning agency, the signals sent by interest rates touniversal Consent of Mankind

entrepreneurs about expected future consumer demand and the true cost of capital

has annexed to Silver and Gold.

are continually falsified and thereby encourage malinvestment of scarce capital.

John Locke

Phases during which the supply of credit and money expands strongly andmalinvestments proliferate are known as “economic booms”, and everybody loves
them. When a boom turns to bust and the liquidation of malinvested
capital becomes necessary, few people are aware that the preceding
boom is at fault. And so the cry for more monetary and fiscal intervention arises,
which lengthens and deepens the malaise by putting malinvested capital on
artificial life support.
Government mandated fiat currency simply does not work in the long run. We
have empirical evidence galore – every fiat currency system in history has
failed, except the current one, which has not failed yet. The modern fiatmoney system is more ingeniously designed than its historical predecessors andhas a far greater amount of accumulated real wealth to draw sustenance from, so it
seems likely that it will be relatively long-lived as far as fiat money systems go.
In a truly free market, fiat money would never come into existence, though.
Greenspan was wrong – government bureaucrats cannot create something “asgood as gold” by decree.

LinkedIn | twitter | #IGWTreportNZBD

New Zealand Bullion Depository

New Zealand Bullion Depository, providing discreet
secure storage for this generation and beyond.

www.nzbd.com

Company Descriptions

235

Gold Storage: Fact
Checking Germany,
Canada, and the UK“The most contrarian thing of all is not
to oppose the crowd but to think foryourself.”
Peter Thiel

Key Takeaways• In turbulent times investment decisions turn towards

wealth preservation rather than profit-seeking. Rather
than a focus on the price of gold, investing in physicalgold involves concepts of trust, security, risk
diversification, and hedging against the vulnerabilitiesof the current monetary system.
• The outbreak of the Covid-19 pandemic has heralded thefinal innings of the current era. With blinding speed,
liberties are taken away by emergency orders, while thecracks in the financial system threaten to break it apartunder the weight of global indebtedness – rising
inflation rates being just one symptom of many. The
question of wealth preservation is receiving renewed
attention.
• Most recently, wealth confiscation has become sociallyacceptable again. Maintaining ownership of your bullion
in a secure storage facility is just as important as theinvestment decision to diversify into gold.
• In previous years’ In Gold We Trust reports we havecovered Liechtenstein, Switzerland, Singapore, New
Zealand, Australia, and Dubai as well as the USA,
Cayman Islands, and Austria as storage locations forgold bullion.
• This year we will examine Germany, Canada and the UK

including the Channel Islands as jurisdictions for secure
gold storage.

Gold Storage: Fact Checking Germany, Canada, and the UK

236

Why the Safe Storage of Gold Is More
Important Than Ever
There’s no harm in hoping for theWith the Covid-19 crisis unfolding over the past two years, the aging

best as long as you’re prepared

process of the global financial system has only experienced further

for the worst.

acceleration. Never before has the public debt load reached such heights, in a

Stephen King

world more interconnected than ever before, making it a global issue rather than aregional one. At the same time, the political response to this global healthemergency has significantly weakened people’s trust and confidence in societal
institutions, including science, democracy, and law and order.
The outbreak of the Ukraine crisis has proven to be an additional
catalyst: In response to Russia’s actions, the West has levied hefty economic
sanctions against Russia. Amongst the first measures was the seizing of Russia’sforeign exchange reserves and the freezing of assets of over 400 individuals withallegedly close ties to Putin. However, the ultimate goal of the Western authorities
is precisely to adjust the legal framework in order to permanently confiscate theassets frozen under the sanctions-regime. This is nothing but a slippery slope.
Once the rule of law has been suspended for a so-called justified exceptional case,then the exception can be expanded arbitrarily. All this brings a new urgency toconfronting the obstacles to wealth preservation.

If you decide you want to buy

Gold has weathered many crises in the past and thus, unsurprisingly, many turngold, you have the weight of

towards the precious metal in times of uncertainty when looking for a trusted

history behind you.

investment disconnected from the financial system. The principal objective for

Herb Stein

physical gold holdings is that they serve as a strategic asset, uncorrelated tofinancial markets while at the same time providing access to liquidity.
Gold is exceptional in providing such independence from the global
financial system, eliminating all counterparty risk. Being bothindestructible and portable allows it to be stored hidden in a vault, even for
centuries, without risking a loss of purchasing power due to default. Increasingly
appreciated is gold’s cyber immunity, protecting it from nefarious hackers. In
combination these features make gold an effective risk-diversifier.
The determination of a secure storage location is a highly personal decision thatmust be tailored to the bullion owner and involves careful considerations of
security, third-party trust, and liquidity. There is no one-size-fits-all solution
for a gold investor. Different jurisdictions can be compared along measures likeeconomic freedom, rule of law and enforcement of private property rights, politicaland economic stability, and historical track record of the country.
In previous years’ In Gold We Trust reports we have covered Liechtenstein,
Switzerland, Singapore, New Zealand, Australia, and Dubai, as well as the USA,
Cayman Islands, and Austria as storage locations for gold bullion.63 This year we
will examine Germany, Canada and the UK including the Channel Islands as
jurisdictions for secure gold storage.
—

63 See “Gold Storage: Fact Checking Austria, the USA, and the Cayman Islands,” In Gold We Trust report 2021,“Gold Storage – Fact Checking New Zealand, Australia, and Dubai,” In Gold We Trust report 2020, “Gold Storage:
Fact Checking Liechtenstein, Switzerland, and Singapore,” In Gold We Trust report 2019

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Germany – the Reliable Constant in the Heartof Europe

Photo credit: wikimedia

Located in the heart of Europe, the Federal Republic of Germany has
become the world’s fourth largest economy (USD 3.8trn) and theeconomic powerhouse of Europe, garnering fame for its precision,
acumen, and efficiency.
Poor old Germany. Too big for

Bordered by nine countries – Poland, Czech Republic, Austria, Switzerland,

Europe, too small for the world.

France, Luxembourg, Belgium, the Netherlands, and Denmark – Germany isHenry Kissinger

situated on the North European Plain, with access to the North Sea and Baltic Sea
and mountainous terrain in the south stretching towards the Alps. With a surface
area of 350,000 sq. km, it is only the 7th largest country in Europe, yet with the
Danube, Rhine, Oder, and Elbe Rivers, Germany has the most concentrated
navigable river system in the world, which allowed it to become one of the leading
export nations despite having few physical resources. The lack of natural
boundaries, both towards the east and the west, in combination with Germany’s
overall flat topography make the country vulnerable to invasion. Over centuries
these topographic imperatives have shaped Germany’s greater strategy: gaining
regional dominance through internal stability and strength in order to deterneighbors from invasion.

It would be illogical to assume

This strategy has not always proven successful, locking the country inthat all conditions remain stable.

an ongoing rise-and-fall cycle. For centuries the territories of today’s Germany

Spock, commanding officer,

were a collection of kingdoms, principalities, and city-states that formed part of thestarship Enterprise

1000-year-long Holy Roman Empire. Only in 1871, after three major wars, did a
unified Germany emerge, dominated by Prussia. However, the precarious balanceof power in Europe could not be sustained for long. When tensions again escalated

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toward World War I, Germany saw itself as obliged under multilateral defense
agreements among the powers to support Austria by declaring war on Russia, thus
triggering a two-front conflict, as France was in alliance with Russia – an outcomethat Germany had historically sought to avoid.
Two thousand years ago, theAfter its defeat in World War I, Germany was allowed to remain as a republic byproudest boast was “civis

bearing war-reparation costs, but it was no longer a monarchy. Hyperinflationromanus sum”. Today, in thecaused by the war-reparation costs and increasing societal division paved the pathworld of freedom, the proudest

to Hitler’s rise, the Nazi –regime, and World War II. With the end of World War II,

boast is “Ich bin ein Berliner!”

Germany was divided. While East Germany became part of the Soviet-dominatedJohn F. Kennedy

Eastern Bloc, West Germany became a founding member of the European
Communities (ECSC, EEC, and Euratom) and NATO. This division ended onlywith reunification in 1990, almost exactly one year after the fall of the Berlin Wall.

Germans know what they do

A crucial factor in Germany’s rise to becoming one of the world’s strongest

because everywhere they go

economies was it’s the successful leveraging of its high-quality manufacturing

there’s a ‘made in Germany’ label

sector towards global exports, supported by German efficiency and a well-educatedon it, they can feel proud ofworkforce. “Made in Germany” says it all. Originally imposed by the British as a

Volkswagens, Audis, Mercedes.

label suggesting inferior quality, today it has become a unique selling point,

Evan Davis

promising excellent quality, durability, and reliability. Furthermore, Germany’s
decentralized and federated governance structure facilitated the emergence of astrong small and medium-sized business landscape with a multitude of champions
in niche sectors. The success of Germany is further based on a sound rule of law –it ranks 5th on the WJP Rule of Law Index – while corruption is very low. As aresult, Germany offers a high living standard to its population of just over 83mn.
In 2019, it ranked 6th on the Human Development Index.

If my theory of relativity is

An important role in Germany’s social stability is played by the country’s extensive

proven successful, Germany will

wealth redistribution, providing a generous system of government services fromclaim me as a German andfree education to universal healthcare to pensions to the German population.

France will declare that I am a

However, this setup is increasingly facing challenges, as the German population is

citizen of the world. Should myaging rapidly. With a fertility rate below 1.6 and a median age of 46 years,

theory prove untrue, France will

Germany is heading for a demographic demise – unless it can be

say that I am a German andcounteracted. This trend will only reinforce the country’s dependency on exports

Germany will declare that I am a

– for many years it has registered a trade surplus contributing almost 50% of

Jew.

Germany’s GDP.

Albert Einstein
Exemplary of the German mentality is fiscal prudence, reinforced
through the hyperinflation of the Weimar Republic. Unlike most other
European countries, Germany has been determined to maintain a “black zero”,
that is, a balanced federal budget. Since 2012 the debt-to-GDP ratio even reversed,
falling below the Maastricht criterion of 60% again. However, the economic
difficulties caused by the Covid-19 crisis proved too challenging, and Germany
decided to abandon its self-imposed fiscal reticence to prevent an economic
recession, resulting in a 10% jump in the debt-to-GDP ratio.
The German central bank, the Bundesbank, has the second largest physical gold
reserves after the US, currently 3,359 tonnes. In relative terms this equates to a
65% share of Germany’s total FX reserves, similar to the US’s share. The majorityof those reserves were accumulated in the 1950s and 1960s by converting US dollar

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surpluses. Significant payments in gold were made upon the foundation of theEuropean Monetary System and upon the creation of the European Central Bank.
Since 2000 the country’s gold holdings have decreased only slightly, for the
purpose of minting coins. Headlines were made by the German Bundesbank’s gold
repatriation scheme, which brought more than 600 tonnes of gold back toGermany, making Frankfurt home to one of the largest stockpiles of gold in theworld.

Cental Bank Gold Reserves per Capita, in Troy Ounces, 2020
1.4

1.30

1.2
1.0
0.8
0.6
0.4

0.15

0.2

0
0.0
2020

Germany

United Kingdom

CanadaSource: World Gold Council, OECD, Incrementum AG

The Germans, by the way, areGold enjoys great popularity amongst German retail investors.

whimsical people! - With their

According to a study conducted by the German Reisebank and the Research Center

deep thoughts and ideas, which

for Financial Services at Steinbeis University Berlin, German adults own anthey look for everywhere and put

average of 75 grams of gold. This number includes a 4-gram increase – or 5.6% –in everywhere, they make theirsince the outbreak of the Covid-19 crisis. It is estimated that more than 60% of

lives more burdensome rather

gold owners are invested in jewelry, while only every fourth German adult isthan easier.

invested in physical gold such as coins and bars. With gold holdings of about 7,500

J. W. von Goethe

tonnes, German private individuals own 2.7 times as much gold as the German
central bank. In total, approximately 12,000 tonnes of gold are being held inGermany.

You cannot find a bank safe

The German gold market operates in a decentralized network of banks,

deposit box in Germany because

refineries, wholesalers, and retailers. Due to geographical proximity, theevery single one has alreadyGerman gold market is also well integrated with those of Switzerland and Austria.

been taken and stuffed with gold

Important for gold investors is the exemption of gold from the VAT,

and silver.

while silver, platinum, and palladium do fall under this tax or are

Wilhelm Hankel

subject to differential taxation. In addition, price gains on gold are tax-freefor private investors after the speculation period of one year. In the course ofincreased efforts against money laundering, cash-loving Germany has clamped
down on cash transactions in recent years. While in 2017 the upper limit foranonymous cash payments for gold purchases stood at 14,999.99 EUR, it was
subsequently reduced to 1999.99 EUR in 2020.

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240

Number of ounces that can be purchased anonymously, 01/201005/2022
Reduction of theupper limit from EUR
14,999.99 to EUR

20Upper limit inAustria remains at
EUR 9,999.99

15

10

Reduction of theupper limit inGermany to EUR
1,999.99

5

0
2010

2011

2012

2013

2014

2015

2016

2017

2018

Germany

2019

2020

2021

2022

Austria

Source: Federal Reserve St. Louis, Incrementum AG

Learning German is what

Further challenges for the private and anonymous ownership of gold lie ahead. A

eternity was made for.

member state of the EU, Germany could become subject to a European AssetMark Twain

Registry – once it is implemented. The EU Commission has already given the order
for an initial “Feasibility Study for a European Asset Registry in the Context of theFight Against AML and Tax Evasion”. The main objective of such an EU-wide
asset registry is to build a huge central database containing all assets, including art,
real estate, cryptocurrencies – and gold.
While the advantages of Germany’s strong legal and politicalenvironment, supported by a resilient economic system are obvious, its
risk-averse but very gold-friendly culture make Germany to one of the
top bullion storage jurisdictions in the world.

Canada – the Most Unpretentious Place toStore Gold

Photo credit: Pixabay

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Canada is a broad land – broad

Canada is the world’s second largest country by land surface, coveringin mind, broad in spirit, andan area of 9,984,670 km2, yet with only 36mn inhabitants it ranks

broad in physical expanse.

amongst the least densely populated countries. As many parts of Canada

Harry S. Trumanare uninhabitable, either due to climate or terrain, the majority of its population issettled in a narrow corridor along the US-Canadian border. This border is over
7,000 km long and is the longest in the world, stretching from the Atlantic to the
Pacific. Toronto is Canada’s largest city and is well-known to gold investors as themining capital of the world. Ottawa, the capital of Canada, is a small city, while
Montreal is the cultural hub and one of the oldest cities in North America.
Vancouver is a trendy, bustling port on the Pacific Ocean.

I’ve been to Canada, and I’ve

Perhaps Canada’s most unique geographical feature is the Canadian Shield, also

always gotten the impression

known as the Laurentian Plateau, an area mostly scoured by glaciers and left withthat I could take the country overthousands of shallow lakes and thin soil. The Shield, extending over about 8mn

in about two days.

square kilometers and covering more than half of Canada, makes those regions

Jon Stewart

difficult to inhabit, thus pushing the population centers southward. Together with
the Rocky Mountains in the west and Canada’s sheer size, it presents Canada’s
main geographical challenge: maintaining unity across the various population
centers. One of the early efforts to overcome this challenge was the construction of
the Canadian Pacific Railway in the second half of the 19th century.
The first European colonists from France and Great Britain arrived in the late 15thand 16th centuries, establishing the first permanent settlements at Port Royal (in1605) and Quebec City (in 1608). In 1763, after the Seven Years War, France ceded
most of its territories on the North American continent to the UK. The legacy of
two languages remains today. About a century later, the Dominion of Canada wasestablished, uniting three British North American provinces, the Province ofCanada, Nova Scotia, and New Brunswick, into one federation. Over the next 82
years Canada continued to integrate other parts of British North America, resulting
in the current nation of ten provinces and three territories that has been in placesince 1949.

Canadians have been so busy

Politically, Canada has had a responsible government, i.e., one that has adhered to

explaining to the Americans thatthe principle of parliamentary accountability, since 1848; yet Britain ruled in

we aren’t British, and to thematters of foreign policy and defense. Under the Statute of Westminster, theBritish that we aren’t Americans

British Parliament acknowledged Canada as co-equal with the United Kingdom inthat we haven’t had time to1931, then granted Canada full sovereignty under the Canada Act in 1982. Today,

become Canadians.

Canada is a federal parliamentary constitutional monarchy. Queen Elizabeth II is

Helen G. McPherson

the reigning monarch, providing the source of authority, albeit today in rather asymbolic manner. The Canadian Parliament is dominated by the two relatively
centrist parties, the governing Liberals and the opposition Conservatives.
Given its British legacy, Canada’s legal system follows common law, with the
exception of Quebec, which follows the French tradition of civil law. In aworldwide comparison, Canada’s legal system ranks amongst the top ten
judiciaries. This picture is confirmed repeatedly by high scores regarding property
rights and by low scores regarding corruption.

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Emergencies’ have always been

Unease amongst investors mounted recently, when the Canadian

the pretext on which thefinance minister enforced the freezing of financial assets of individuals

safeguards of individual liberty

related to the trucker-convoy protests. This was possible only through thehave been eroded.

use of the Emergencies Act, which was resorted to for the first time since the law

Friedrich August von Hayek

was passed in 1988. The banks were instructed by the authorities to freeze assets
and suspend bank accounts without a court order and without facing civil liability.
Moreover, under the umbrella of the Emergencies Act, Prime Minister Justin
Trudeau expanded the country’s anti-money laundering and counterterrorist
financing legislation, making all payment services providers and crowd-funding
platforms subject to FINTRAC reporting. Canada’s state of emergency isover, but the cat is out of the bag – all digital assets are subject togovernment sanction at any time and without any due process.

If you know the lessons ofWith an economy worth USD 1,644bn, Canada rank among the G10

history, you know it’s time tocountries, just behind Italy in the 9th position and ahead of Russia in

learn analog.

the 11th spot. Because of its geographical imperatives, transporting goods proved

Simon Mikhailovich

most efficient across the southern border, leading to strong trade relations with the
US. In 2021, Canadian exports to the US amounted to USD 378bn, making the US
its main export market. Meanwhile, US exports to Canada stood at USD 306bn.
These numbers highlight how economically integrated the two countries are.
Moreover, Canada has a significant interest in maintaining peaceful relations with
its powerful neighbor.
While challenging for habitation, the Canadian Shield has provenhighly valuable from an economic perspective. With the third-largest oil
deposits after Venezuela and Saudi Arabia, as well as industrial minerals, metals,
and lumber, Canada has commodity resources estimated to be worth more than
USD 33trn. This commodity treasure is an important driver of the Canadian
economy and provides the country a high standard of living. Unsurprisingly,
Canada also ranks amongst the top stock exchange centers for mining and energy
stocks in the world with more than 550 companies in the extractive sector listed.

When you run in debt; you give

In spite of the nation’s massive commodity treasure and steady economic growth,

to another power over yourfiscal imprudence by the government has increased its vulnerability to anliberty.

economic slowdown. Due to Covid-19 fiscal spending, Canada’s public debt load

Benjamin Franklin

saw a huge increase from 87% of GDP in 2019 to 117% of GDP in 2020, reaching asimilar level to Spain’s. In 2021, the public debt load slightly decreased to 112% ofGDP. A similar extreme is seen in Canada’s private household debt level, currently
at the equivalent of 110% of GDP, largely stemming from mortgages facilitated by
low interest rates.

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243

Canadian Government Debt, as % of GDP, Q1/1990-Q3/2021
110%

100%

90%

80%

70%

60%

50%
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020

Canadian Government Debt
Source: BIS, Incrementum AG

If you postpone a reckoning, you

Canada’s gold mining industry, the fifth largest in the world, is wellalmost always have to pay backknown amongst gold investors. Home to a multitude of gold mines, Canada

with interest.

produces about 182 tonnes of gold per year. While a lot of the gold is sold

Rick Ruleinternationally via the London Gold Market, Canada is also home to one of thelargest mints, the Royal Canadian Mint, established in 1908. Besides coining thenational currency, the mint also offers its services to other central banks.
Famously, the Royal Canadian Mint’s refinery was the first to achieve .9999 purity,
the so-called “four nines”. The Canadian Maple Leaf is amongst the biggest sellinginvestment coins in the world. In 2007 the Royal Canadian Mint was included in
the Guinness World Records for producing the largest ever gold coin, weighing 100
kg and of 99.999% purity, a “five nines” coin.

Photo credit: Royal Canadian Mint/ Monnaie Royale Canadienne

Given Canada’s close connections with precious metals, it came as a surprise when
the Canadian Central Bank fully emptied its gold vaults in 2016 – it is now the onlyG7 member without any gold bullion holdings. The finance department, throughspokesperson Dave Barnabe, provided the following explanation: “The decision tosell the gold was not tied to a specific gold price, and sales are being conducted
over a long period and in a controlled manner”. He continued, “The government
has a long-standing policy of diversifying its portfolio by selling physicalcommodities (such as gold) and instead investing in financial assets that are

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easily tradable and that have deep markets of buyers and sellers”. However, in
2021 rumors emerged that Canada had added 100 tonnes of gold to their reserves.
Apparently, the sponsors of theFounded only in 1934, in the aftermath of the Great Depression, the Bank of

1923 Act did not realize that

Canada is amongst the younger central banks. However, supported by close ties towhen Canada went back on theits British counterpart, the Bank of Canada quickly gained in importance. Goldgold standard, as she did in 1926,

played a crucial role. Canada had introduced the gold standard in 1855, long before

the effects of the operations of thethe Bank of Canada was founded. The Canadian dollar was valued at par with the

Act would be vitally different

US dollar and at CAD 4.867 to the British sovereign. During World War I, Canada

from what they were during theabandoned the gold standard and returned to gold redeemability only temporarily

paper money period.

between 1926 and 1931, before banning gold exports in October 1931 andJames Creighton, 1933

suspending the redemption of Dominion notes in gold in April 1933.
Nevertheless, the government’s interest in gold remained, and in 1936 the idea
emerged of Britain acquiring Canadian gold and storing it in Canadian vaults.
Increasing the Bank of Canada’s gold trading activities was also meant tostrengthen its mandate “to regulate credit and currency in the best interests of theeconomic life of the nation, to control and protect the external value of thenational monetary unit”. When international gold demand saw a huge increase
throughout the 1930s, Canada began to tighten regulatory oversight over the gold
market. The Royal Canadian Mint became the country’s principal refiner, while the1932 Gold Export Act required licensing from the finance minister for any exportof gold. In other words, the Canadian government had the preemptive right to buy
gold, as it had discretion over the provision of export licensing. Only a few years
later, financial settlements in gold were outlawed, too. The introduction of theconfidential British earmark account – a courtesy function amongst central banks
entailing gold deliveries and safekeeping – was a step that became increasingly
significant during World War II, providing the fundament for various central
banks to store their gold in Canadian vaults.

The only difference between a tax

Canada is a popular place amongst gold investors, given its close ties to

man and a taxidermist is that thethe gold industry and the favorable tax status of precious metals

taxidermist leaves the skin.

investments. Gold, silver and platinum are exempt from taxation in Canada,

Mark Twain

provided that they meet the required purity level – 99.5% for gold and platinum,
99.9% for silver – and come in the form of a bar, ingot, coin or wafer. Palladium,on the other hand, is subject to the goods and service tax (GST) and/or the
harmonized sales tax (HST). Also, all sellers of precious metals are also liable toundertake KYC measures, while FINTRAC reporting requirements apply to cashtransactions exceeding CAD 10,000. The Royal Canadian Mint does offer vaulting
services to financial institutions – about 10% of Switzerland’s gold holdings arebeing stored in Canada – as well as to business clients. Other private vaulting
services exist, too.

I believe the world needs more

All in all, Canada is an appealing jurisdiction for gold storage, given its

Canada.

strong historical connection to the gold mining industry and its track

Bonorecord of being a stable and peaceful country.

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245

United Kingdom – the World’s Largest Gold
Vault

Photo credit: Pixabay

There’s an accent shift, on

The United Kingdom of Great Britain and Northern Ireland, oftentimes

average, every 25 miles injust referred to as the UK or Britain, is a unitary sovereign island state

England.

located on the greater part of the British Isles archipelago off theDavid Crystal

northwestern coast of the European mainland. The largest island within
the archipelago is the island of Great Britain, where the UK’s capital, London, islocated. The three islands Isle of Man, Guernsey, and Jersey are not part of the UK,
but as Crown Dependencies the UK does defend them militarily. Together with thenorthern part of the island of Ireland and many smaller surrounding islands, theUK totals an area of 242,500 km2. Surrounded by waters, it faces the Atlantic
Ocean in the West, the Irish Sea in the northwest and the North Sea in the east.
The English Channel, in parts as narrow as 35 km, separates the UK from theEuropean continent. The rugged coastline of the UK, extending over 12,500
kilometers in length, has served as a geographical barrier to a multitude ofinvasion attempts over the centuries.

We have really everything in

The UK consists of four countries: England, Wales, Scotland, andcommon with America

Northern Ireland. The rugged topography of the UK contributed to the

nowadays except, of course,

emergence of cultural differences among the four countries. A unitary

language.

parliamentary democracy and constitutional monarchy, the UK’s current head ofOscar Wildestate, since 1952, is Queen Elizabeth II. She is also head of the Commonwealth of
Nations, consisting of 54 member states and former territories of the British
Empire, amongst them Canada and Australia.

If you want to swim across theHistorically, the British Isles have always been a target of interest for

English Channel from England to

invaders. In 55 and 54 BC the Romans, led by Caesar, attempted two invasions,France - you have to leave yourand later southern Britain became part of the Roman Empire. Over the next one

doubt on the beach in England.

thousand years, there was an endless series of invasions from the Europeans: from

Lewis Gordon

the Germanic Anglo-Saxons in 400 AD, the Scandinavian Vikings in the 9th
century, the Danish crown in the 10th and 11th centuries, the Spaniards in the 16th

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246

century, and the French in the 19th century. In other words, Britain’s main
geopolitical challenge was defense against invasion, which it sought to accomplishby building a strong naval force and, beyond that, by engaging selectively on theEuropean continent to prevent the emergence of a dominant power.
The sun never sets on the British

The Kingdom of Great Britain was only established in 1707, by

Empire. But it rises every

politically uniting the two kingdoms of England and Scotland under themorning. The sky must get

Treaty of Union. A century later, the Act of Union 1800 merged Great Britain

awfully crowded.

with Ireland, establishing the United Kingdom of Great Britain and Ireland.

Stephen WrightThroughout those years, Great Britain rose to become the world’s principal naval
force and imperial power, establishing the British Empire. Forced into both world
wars, the UK emerged victorious, albeit with heavy losses. After the Second World
War, the UK became one of the five permanent members of the UN Security
Council and had a leading role, together with the US, in establishing the IMF, theWorld Bank, and NATO. While the postwar 20th century was marked by the
economic recovery from the war, most colonies of the British Empire sought
independence. Maintaining close ties with its European neighbors, the UK was afounding member of the European Free Trade Association (EFTA), as well as afounding member of the European Union after joining the European Communities
in 1972; but the UK resisted joining the monetary union and the Maastricht Treaty.
Following a national referendum in 2016, with the majority voting for leaving theEuropean Union, since January 2020 the UK is no longer a member state of theEU.

The English are not a very

The birthplace of the Industrial Revolution and once the largest empire in history,

spiritual people, so they invented

Britain today is still amongst the largest powers in the world, exercising significant

cricket to give them some idea ofinfluence on the international stage. The UK is a recognized nuclear power, has the

eternity.

fifth largest military budget, and maintains a strong presence on the world stage,

George Bernard Shaw

although not with the power it wielded during the days of the British Empire. In
2021 the British economy was estimated at USD 3.1trn, the 5th largest in the world,
while its currency, the British pound, is the fifth largest reserve currency in theworld. Often casually referred to as sterling or cable or quid, the Great British
pound is the oldest surviving national currency, dating back to the 7th century.
Just like all fiat currencies, its purchasing power has declined
significantly over the past 14 centuries, but to be fair, all of its
historical competitors are marked at zero and are no longer inexistence.

You find no man, at all

The emergence of London as one of the world’s major financial centers played an

intellectual, who is willing toimportant role in Britain’s gold history. A port city already back in the 16th and 17th

leave London. No, Sir, when acenturies, London rose to be an important trading center, home to the East India

man is tired of London, he is

Trading Company. The Napoleonic invasion of Amsterdam triggered a further

tired of life; for there is in

influx of traders who relocated to London, allowing the city to overtake Amsterdam

London all that life can afford.

as the most important trading hub. In 1565 the Royal Exchange was founded, and a

Samuel Johnson

century later Lloyd’s coffee house in Lombard Street became the birthplace ofLondon’s world-leading insurance market.

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247

Photo credit: wikimedia

The maxim of the British people

In 1694, the Bank of England opened its doors, and the first purpose-is “Business as usual“.

built vaults were set up only a couple years later upon high demand, as

Winston Churchilllots of gold was shipped from Brazil to London in the first gold rush in
1687. In 1750, the London Good Delivery List was introduced, formallyrecognizing refineries that were allowed to trade on the London gold market. As oftoday, this list is still the most recognized accreditation in the gold market,
although it is now the responsibility of the independent London Bullion Market
Association (LBMA). In the vaults of LBMA members currently a record quantityof gold is held, amounting to 9,636 tonnes, which equates to approximately
770,877 gold bars, as well as 35,191 tonnes of silver, which equates toapproximately 1,173,049 silver bars.

Men of business in England do

Reputedly, the Bank of England has the second largest vault in the world after the

not like the currency question.

Federal Reserve in New York. The Bank of England is clearly one of the globe’s

They are perplexed to definelargest custodians of gold, both for central banks and institutional customers. As ofaccurately what money is: how

the beginning of 2022, the amount of gold stored in the vaults of the Bank ofto count they know, but what toEngland stood at almost 5800 tonnes of gold. In the Bank’s 326-year history no

count they do not know.

gold has ever been stolen from its vaults.

Walter Bagehot
Each day physical gold worth some USD 60bn is being traded in
London, making London the center of global gold trade. The sheer
quantity of precious metals stored in the vaults of London underpins the enormous
size of the market and secures its liquidity. The UK’s profound and long-lived
cultural and financial history, founded on the tenet that precious metals are equal
to money, as well as its direct access to the largest gold market in the world, makethe UK an excellent location to store gold.

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248

Photo credit: pixabay

True progress lies in theHighly interesting, too, for bullion investors are the three British

direction of decentralization,crown dependencies: the Bailiwick of Guernsey, comprising the islands ofboth territorial and functional, in

Alderney, Brecqhou, Guernsey, Herm, Jethou, Lihou, and Sark; the Bailiwick of

the development of the spirit ofJersey, comprising the island of Jersey and uninhabited islets such as Écréhous

local and personal initiative, andand Minquiers; and the Isle of Man.64 They do not form part of the UK but are self-

of free federation from the simple

governing possessions of the British Crown for which the UK bears theto the compound, in lieu of the

responsibility of military defense as well as international representation. Unlike

present hierarchy from thethe UK they never were members of the European Union but only formed part ofcenter to the periphery.

the customs union. Approximately 260,000 people live on the various islands ofPeter Kropotkin

the three crown dependencies. Their legislative independence from the UK is
unique, as is the fact that both the Bailiwick of Guernsey and the Bailiwick ofJersey consist of several jurisdictions.

I hope for nothing in this world

With a history dating back more than 1000 years, these islands have aso ardently as once again to see

long track record of a stable legal and political system. Above all, theirthat paradise called England. I

local governance approach allowed for the decision making to focus on the best

long to embrace again all my oldinterests of the islands. On those grounds, the exceptional combination of legal andfriends there.

political stability plus financial innovation emerged, letting Jersey and Guernsey

Cosimo III de’ Medici

rise to being favored offshore financial jurisdictions.
An obvious example of this approach is each island’s independence to establish its
own tax scheme. On Guernsey, for example, there is a flat income tax of 20% with aliability cap, while no capital gains, inheritance, capital transfer, or value added
taxes are levied. Similarly, the jurisdiction of Jersey also applies a 0% default tax
rate for corporations, with exceptions for financial and utilities companies.
Propelling the islands’ reputation as tax havens was a now-closed European VAT
tax loophole known as low value consignment relief (LVCR), which allowed for
VAT-free importing of goods valued at less than 22 EUR. The absence of any formof value added tax or goods and sales tax has helped to create a very interestingbullion storage location, especially as some bullion investments are also exempt
from the UK capital gains tax.
Unlike many other offshore jurisdictions, Jersey, Guernsey, and the Isle of Man
have a long track record of professionalism, financial prudence, and compliancewith international standards. All three crown dependencies are committed to—
64 Many thanks to Swen Lorenz from Sarnia Asset Management for the detailed insights.

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249

improving transparency and establishing an effective exchange of information intax matters. Give their secure but innovative environment, these unique islands
have earned the appellation “British Switzerland by the Sea”.
A miniature of all the Western

Guernsey alone is home to more than 1,400 investment entities, 30 international

world. Such wildness and suchbanks, more than 850 insurance firms, and over 150 investment funds, with a total

sophistication, such oldness andof more than GBP 270bn under management. Less known is the fact that Guernsey

such newness.

has its own stock exchange, TISE, listing more than 3,500 securities with a market

Sir John Betjeman

capitalization of more than GBP 500bn. Big names listed include Netflix andRefinitiv.

Even in the rain and mist, theAll in all, the UK including the Channel Islands offers a great

arrival at Guernsey is splendid.

proposition to any gold investor looking for a safe gold storage

Victor Hugo

location.

Conclusion – Weighing Risks
The World has changed and

The single most important step in selecting a gold storage location is tochanged utterly – although wethoroughly examine and critically evaluate existing market risks. While

may not realize it yet. We are

geopolitical factors and jurisdictional peculiarities play a significant role, the final

likely on course for massive

determinant is usually the investor’s personal situation and preferences. Certainly,

disruption, inflation, rising

all three jurisdictions we have covered can make a strong case for providing ageopolitical crisis andsecure gold storage solution. Germany scores high with its stable political-

uncertainty, and a higheconomic environment; Canada can make its case with its large gold industry andprobability of stagflation. But –proximity to the US market; while the UK has by far the longest history with gold

don’t tell anyone.

and provides unique access to the most liquid and transparent precious metals

Bill Blainmarket.

LinkedIn | twitter | #IGWTreportTHE GLOBAL AUTHORITY IN WEALTHPRESERVATION THROUGH DIRECTGOLD & SILVER OWNERSHIP

Matterhorn Asset Management AG
GoldSwitzerland
Bahnhofstrasse 43
CH-8001 Zurich
Switzerland+41 44 213 62 45
contact@goldswitzerland.com
www.goldswitzerland.com

Company Descriptions

251

The Synchronous Equity
and Gold Price Model“I don’t think anybody has a very goodmodel of what makes gold prices go up
or down.”
Janet Yellen

Key Takeaways• The Synchronous Equity and Gold Price Model explains

the price movement of the S&P 500 and the USD priceof gold using only two variables: the US M2 money
supply as the base driver and investor confidence as thecontrol valve.
•

The model is based on the following two key
observations:
1. An index that adds the price of the S&P 500 to
the price of 1.5 ounces of gold reflects thedevelopment of the US M2 money supply
comparatively accurately.
2. The value split between equities and gold in thisindex can be explained by current investor
confidence.
• The Synchronous Equity and Gold Price Model delivers

convincing results – both in backtesting and in
validating future forecasts – making it interesting not
only to gold investors.

About the author: Dietmar Knoll is a banker and worked for four
decades in corporate banking at Deutsche Bank AG, most recently as a
restructuring expert in risk management advisory. In his retirement, heis researching the question of what really drives the price of gold.

The Synchronous Equity and Gold Price Model252

In this chapter, we will explore what a new validation approachsuggests to us about the importance of money supply and investor
confidence, and what future scenarios you can prepare for with it.65“For the fact that gold has served as money, asset, or store of wealth since time
immemorial, remarkably little is known about how the price of the precious
metal has come about at all” – From the investment magazine Institutional
Money in an article entitled “Die Stunde der Spekulanten” (“The Hour of theSpeculators”), published in March 2020.
Anyone who wants to grapple with the question of which factors reallyexplain the gold price must deal with many different theories.
Furthermore, gold does not generate any cash flows, and thus there are – unlike inequities and real estate – no commonly used valuation methods.
As a general rule, the mostSome observers consider the yields of US TIPS as the key determinant of the gold

successful man in life is the man

price, while others point to ETF holdings. Market sentiment is also said to play a

who has the best information.

role. Other factors alluded to are trends in the money supply, the US Dollar Index,

Benjamin Disraeli

consumer price inflation, the yield on 10-year US Treasuries, the Federal Reserve’s
total assets, the equity market, the global economy, credit spreads, theunemployment rate, budget deficits, government debt, mine production, physicalsupply and demand, as well as the wedding season in India and geopoliticaltensions and crises in general. However, this list of possible influencing factors is
by no means complete.
This situation leaves the average investor perplexed.

The Synchronous Equity and Gold Price Model(SEGPM)
The correlation between money supply and the prices of individual
assets is widely discussed in academia and in financial markets.
Professor Mathias Binswanger argues in his book Geld aus dem Nichts (“Money ex
nihilo”) that the correlation between money supply growth and equity market
prices can be observed from as early as the end of the 19th century – especially in
the US. In his opinion, inflation tends to shift from the real economy to financial
markets in times of booming equity prices.
One of the first things taught in

The relationship between equity prices and the price of gold is also much-

introductory statistics textbooks

discussed. The widespread opinion is that these markets mostly correlate

is that correlation is notnegatively with each other. However, a truly stable relationship – over longer

causation. It is also one of theperiods of time – does not exist.

first things forgotten.
Thomas Sowell

No broader study has yet been conducted on whether and, if so, how a joint
investment in equities and gold correlates with the money supply. This is
surprising, because an investment diversified as such is said to have positive—
65 You can reach the author at knoll-dietmar@gmx.de.

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The Synchronous Equity and Gold Price Model253

portfolio characteristics in terms of volatility and risk and could therefore also
have a more direct relationship with changes in the money supply.
We try to create a situation

The logic behind the Synchronous Equity and Gold Price Model

where we’re the casino. It’s like

(SEGPM) is that there has been a close and predictable relationshiphow an actuary would set

between the money supply and the prices of equities and gold for the

insurance rates. Predictability,

last 50 years. However, this close relationship is overlaid by investor confidence,

predictability, predictability.

which – as a control valve, so to speak – regulates the allocation between these two

What’s the path to least risk?

assets and – depending on the situation – prefers one or the other. Therefore,

What’s the greater chance oflooking at the relationship between equities and gold prices, together with thegetting some return on thismoney supply, using a 50/50 approach, eliminates the influence of investor

asset?

confidence and reveals the direct relationship between money supply and theBilly Beane

prices of both assets.
The SEGPM derived from these analyses is aimed at medium- and long-termoriented investors and is intended to serve as a general guide – not to be used only
in difficult investment times.
A first important impetus for the SEGPM is provided by the analysis ofProf. Stefan Mittnik, in an article titled “Gold – eine wirksame
Risikobremse?” (“Gold – an effective risk brake?”). In this article, Prof.
Mittnik examines the interaction of equities and gold over the last five decades andanalyzes how adding gold in different proportions would have affected the returnand risk profile of an equity portfolio. The 100/0, 80/20, 60/40, 40/60, 20/80
and 0/100 allocations were analyzed.
To put it succinctly: Gold curbs volatility and allows investors a goodnight’s sleep.
Another impetus came from the article “The F.E.D. Index & Price Increases”, byGary Christenson. In this article he suggests using his own F.E.D. Index (F.E.D.=
Fiat-Enduring Devaluation) instead of CPI to measure inflation, because his index
includes increased prices of financial assets. The composition of this index is:
S&P 500 + 1.5 oz. gold. This is a roughly 50/50 split on a historical average basis.
We have adopted Christenson’s composition, and so the SEGPM is defined as "theprice level of the S&P 500 + the price of 1.5 oz. gold".
Ex-post analysis yielded an interesting insight that proves central to the SEGPM.
The joint index of S&P 500 plus 1.5 oz gold follows the US M2 money supply muchcloser than either of the two individual assets on its own.

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The Synchronous Equity and Gold Price Model

254

Gold, S&P 500, and Joint Index (log, lhs), in USD, and M2 (log,rhs), in USD bn, 01/1963-03/2022
6,400

19,200

3,200

9,600

1,600

4,800

800

2,400

400

1,200

200

600

100
1963

M2

1973

1983

3 oz Gold

1993

2003

2013

Joint Index (1x S&P 500 + 1.5 oz Gold)

300
2023

2x S&P 500

Source: Author's calculations, Incrementum AG

While the joint index of S&P 500 plus 1.5 oz. gold follows the US M2 money supply
comparatively closely, the relative value of the two assets within this index has
fluctuated to a large degree. Gold had its peak at the beginning of the 1980s whenit contributed 90.5% of the value in this index, while equities peaked in August
2000 when they contributed around 78%.

Shares of Index Components: 1x S&P 500 and 1.5 oz Gold, in %,01/1963-03/2022

100

Gold Feb 80
90.5 %

90

S&P Aug 00
78.0 %

80
70
60
50

40
30
20
10
0
1963

Gold Aug 00
22.0 %

S&P Feb 80
9.5 %
1973

1983

1993

Share 1x S&P 500

2003

2013

2023

Share 1.5 oz Gold

Source: Author's calculation, Incrementum AG

In the absence of the gold

Investors buy gold when they are concerned about rising debt, inflation, a decline

standard, there is no way toin the value of the US dollar, a recession, a stock market crash, or even concerns ofprotect savings from confiscationa financial system reset. Equities, on the other hand, are bought when the economy

through inflation. There is no

is strong, growth rates are good, prospects are favorable, profits are high, thesafe store of value.

unemployment rate is low, and inflation is moderate.

Alan GreenspanHowever, since companies are fundamentally value-creating, while gold is not,equities should – in a normal environment and over time – outperform gold andthus gain a successively higher share of the joint index.
The question now is: How does all this fit together, and what causes thevalue composition between equities and gold in this joint index tofluctuate so strongly?

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The Synchronous Equity and Gold Price Model

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The In Gold We Trust report 2019 provides a crucial clue. In particular in the
introduction, the meaning of trust was examined from many different
perspectives. In the opening quote by Roland Baader, gold was characterized as
coagulated trust. That is a thought that captures the mind and does notlet go!

The Importance of Trust for our Monetary and
Financial System
He who trusts, assumes willingly and confidently that a thing willdevelop as promised or hoped for.

• Together with societal bonds and norms, trust forms the social capital of asociety. Any form of cooperation and division of labor necessarily presupposes
trust.

• Trust is the main driving force behind banks’ lending activities. The decisive
factor is the bank’s trust in the borrower’s ability and willingness to repay thefunds entrusted to him, at a future date – with interest. If new bank lending
falters, the financial system no longer receives enough new money and runs
into difficulties.

• Trust is also a decisive factor in an investors’ decisions to invest their money
more offensively (opportunity/risk on) or more defensively (safety/risk off).
This is a matter of trust in the strength of the economy and the stability of thefinancial system.
The importance of trust cannot be overestimated. The question thenarises: Can investor trust also be measured and evaluated?
Trust is a great force multiplier.

For some analysts, trust in capital markets is not just a vague concept.

Tom Ridge

For Jim Grant, gold is the inverse of trust in the banking system, theeconomy and the government. Steve Saville considers gold and the S&P 500,
as the world’s most important equity index, to be the two opposite ends of aninvestment seesaw. In addition, for many years he has described a data set he calls
the Gold True Fundamentals Model (GTFM). He considers many of the sevenfactors included to be measures of trust.
The significance of the counterpart to gold in such an investment seesaw is seen in
an examination of history. Even in times when there were no stock markets intoday’s form, gold as the natural money competed with the profit-oriented
financing of trade activities, discoveries and conquests, or the purchase of land. In
certain places and for a short time, this competition also existed with tulip bulbs,
South Sea companies, or shares in a Louisiana colony. However, the exchange ratioof gold with its respective authoritative counterpart was always determined by thecurrently prevailing investor confidence.
The modern era in gold began at least half a century ago, when US President
Richard Nixon closed the gold window in 1971, thus finally ending the era of the

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The Synchronous Equity and Gold Price Model

256

gold standard. Prior to that, the price of gold was largely fixed in the Bretton
Woods system. Since then, the equity market has been the clear competitor of gold.
Combining the ideas of Jim Grant and Steve Saville, one inevitably concludes thatin today’s world, the S&P 500-to-gold ratio should be an excellent tool formeasuring investor confidence, with investors’ risk appetite in the denominatorand their need for hedging in the numerator. Money supply growth is in both thenumerator and the denominator and is thus trimmed out. Equities benefit fromhigh levels of trust and gold from low ones.

Aug 00: 100%
5.41

4.00

extremely high

Percentile

Investors Trust, measured as S&P 500/Gold Ratio (log), 01/197303/2022

90%
80%
70%
60%
50%
40%
30%

2.00
Median: 1.20
1.00

20%

0.50

10%
0.25

extremely low

Jan 80: 0%
0.16
0.13
1973
1978

1983

1988

1993

1998

2003

2008

2013

2018

2023

Investors Trust (S&P 500/Gold Ratio)
Source: Author's calculations, Incrementum AG

The SEGPM is based on measuring trust using the S&P 500-to-gold
ratio. But now the question arises: Could investor trust also bemeasured and evaluated using alternative indicators?
Trust everybody, but always cut

A number of indicators and ratios were tested that are said to be sensitive tothe cards.

changes in the trust level observed in the financial market, such as the Buffett

Finley Peter Dunne

indicator, Tobin’s Q, the US bank-to-gold ratio, US corporate bond interest rate
spreads, the USD index, and some commodity ratios.
The CAPE ratio for the S&P 500 has proven to be by far the best single indicator in
the analyses. Although the gold price is not considered at all in this ratio, theShiller P/E ratio shows a very similar trend to the S&P 500-to-gold ratio.
Obviously, investor confidence works in a very similar way in this ratio as well.

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The Synchronous Equity and Gold Price Model

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Investors Trust, measured as S&P 500/Gold Ratio* (log, lhs), and
CAPE Ratio** (log, rhs), 01/1945-03/2022
Bretton Woods

Aug 00: 100%
5.41

Free Gold Price

64.00

Percentile

8.00

4.00

90% 32.00
80%
70%
60%
50%
40% 16.00
30%
20%

2.00

1.00

0.50

10%

0.25

8.00

Jan 80: 0%
0.16

0.13
1945

4.00
1955

1965

1975

1985

1995

S&P 500/Gold Ratio

2005

2015

2025

CAPE Ratio

Source: Author's calculations, Incrementum AG*used in the model

Testing leads to failure, andIn a backtest, the SEGPM delivers convincing results. Backtesting is about

failure leads to understanding.

testing the model and its validity using actual historical data. The theory of

Burt Rutan

backtesting is based on the assumption that correlations and models that haveworked well in the past will also deliver good forecast results in the future.
The calculus of the SEGPM is simple. The two fundamentals are:

• The US M2 (in bn USD) determines the value of the joint index (in USD).
• Based on this, investor trust – measured by the S&P 500-to-gold ratio –determines the value distribution in the index.

Synchronous Stock and Gold Price Model (1x S&P 500 + 1.5 ozGold): Actual Index Value vs. Model Index Value, 01/1973-03/2022

8,000
7,000
6,000
5,000
4,000
3,000
2,000
1,000

0
1973

1978

1983

1988

1993

Actual Index Value

1998

2003

2008

2013

2018

2023

Model Index Value

Source: Author's calculations, Incrementum AG

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The Synchronous Equity and Gold Price Model

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Synchronous Stock and Gold Price Model (1x S&P 500 + 1.5 ozGold): Actual S&P 500 vs. Model S&P 500, 01/1973-03/2022

5,000
4,500
4,000
3,500
3,000
2,500
2,000
1,500
1,000

500
0
1973

1978

1983

1988

1993

1998

2003

Actual S&P 500

2008

2013

2018

2023

Model S&P 500

Source: Author's calculations, Incrementum AG

Synchronous Stock and Gold Price Model (1x S&P 500 + 1.5 ozGold): Actual Gold Price vs. Model Gold Price, 01/1973-03/2022

2,200
2,000
1,800
1,600
1,400
1,200
1,000

800
600
400
200
0
1973

1978

1983

1988

1993

Actual Gold Price

1998

2003

2008

2013

2018

2023

Model Gold Price

Source: Author's calculations, Incrementum AG

The charts show that the price development of the S&P 500 as well as thedevelopment of the gold price can be traced well with the model. Only in the wellknown exaggeration phases – for gold: late 1970s/early 1980s and 2011/2012; for
the S&P 500: 1998–2001 – does the respective boom asset clearly overshoot.
The common weak phases of the actual values of gold and the S&P 500 in the
period from 2001 to 2006 and then again in 2008 are also striking. These periods
are probably to be interpreted as temporary miscorrections in the course of crisis
management that do not endanger the SEGPM’s robustness.
The great benefit of the SEGPM is the simple generation and validationof future forecasts. All that is required are specifications for the development of
the money supply and the trust level.

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The Synchronous Equity and Gold Price Model

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Thoughts on the Further Development of the
Money Supply
Our last monetary forecasts based on historical experience were made in the In
Gold We Trust report 202066. At that time, three different scenarios were outlined
for the newly dawned decade and weighted with probabilities. The following
overview is provided once again:

Scenario

M2 growth

Probability

Historical reference period*M2 2030 in billions

Low

3.9% p. a.

5%

1990s

USD 23,350

Base6.3% p. a.

80%

2000s

USD 30,000

Inflation

9.7% p. a.

15%

1970s

USD 42,450*The In Gold We Trust report 2020 does not explicitly mention the absolute value of M2 in 2030. It was recalculated
to USD 15,326bn with December 2019 as basis.

As of December 2021, the US M2 money supply already amounts to USD 21,553bn.
Compared with December 2019, this represents an increase of around
USD 6,215bn or 40.5%. The annualized average growth rate for these 2 years thus
equals 18.5% p.a.
The more the state "plans" theThis shows how difficult it is to make a reliable money supply forecast

more difficult planning becomeswhen the central bank switches to acute rescue mode. In normal times,

for the individual.

commercial banks are responsible for the lion’s share of the newly created money

Friedrich August von Hayek

supply with their lending. In times of crisis, however, they hold back on granting
new loans, which is why the central bank has to provide temporary emergency aid– via asset purchases.
If one measures the problem by the amount of aid provided, the US economy andfinancial system were in historically unprecedented trouble. As recently as the endof 2008, the Federal Reserve’s share of M2 stood at around 11%. After three QE
programs and the stimulus package to combat the economic consequences of theCovid-19 pandemic, the Federal Reserve’s share exploded to 40% at the beginningof 2022. It is thus already significantly higher than during World War 2, when it
peaked at around 30%.

In reality there is no such thing

In the meantime, it is argued that the Federal Reserve’s money creation must comeas an inflation of prices,to an end in order to prevent inflation from getting out of hand. For this reason,

relatively to gold. There is such a

the Federal Reserve now intends to end its stimulus measures and startthing as a depreciated paper

quantitative tightening. The question then is whether US bank lending, whichcurrency.

collapsed in the wake of the Covid-19 crisis, can again provide sufficient new

Lysander Spooner

money on its own. History shows that the financial system could otherwise quickly
become unstable (again).
In any case, in the first two months of 2022, the M2 money supply grew by another
USD 258.7bn compared with December 2021, to USD 21,812bn, corresponding toan annualized growth rate of around 7.2%. Contributing factors were bothcommercial banks, with an expansion of net new lending, and the Federal Reserve,with continued balance sheet expansion.
—

66 “Quo vadis, aurum?,” In Gold We Trust report 2020, pp. 346

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The Synchronous Equity and Gold Price Model

260

The first casualty of war is said

However, the Russian attack on Ukraine, Western sanctions, and the willingness of

to be the truth, and it probably

the US to use the US dollar as a weapon now threaten developments that could

perishes even before the first shot

force the Federal Reserve to prematurely abandon its intended monetaryis fired. The second casualty oftightening policy. One does not have to share all the fears discussed in the media,

war is sound money.

but the study of Ray Dalio’s ninth book, The Changing World Order: Why Nations

Russell Napier

Succeed and Fail, and the thinking and analysis of Zoltan Pozsar are worthwhile.
Based on Pozsar, it is understandable that many analysts consider the freezing of
Russian foreign exchange reserves as a monetary earthquake and a turning point
for the current world financial order.
With respect to the money supply component of the SEGPM, thisdevelopment raises at least two key questions:• At the short end: Will the Federal Reserve remain true to the intended
shrinking of its balance sheet even if a shock event of some kind, a recession or
stagflation, actually hits hard, or will it react – once again – in the usual way
and flood the market with newly created US dollars?

• At the long end, who – other than the Federal Reserve – would finance U.S.
twin deficits in the future if major creditor countries such as China, Brazil,
India, and Saudi Arabia turn to alternative safe-haven assets and/or organize
their foreign trade on an alternative settlement basis?
In this respect, money supply forecasts remain difficult. If you continue
to adhere to the well-founded growth rates forecast in the In Gold We Trust report,
you should bear in mind that the base effect will result in significantly higher
absolute money supply targets for 2030 in the meantime.
This is important, because the SEGPM defines the value of the joint index –S&P 500 + 1.5 oz. of gold – solely in terms of the amount of money.

Scenario

M2 growthTarget value in 2030 -old-

Target value in 2030 –new-Low

3.9% p.a.

USD 23,350bn

USD 30,400bn

Base6.3% p.a.

USD 30,000bn

USD 37,400bn

Inflation

9.7% p.a.

USD 42,450bn

USD 49,600bn

Thoughts on the Further Development of theLevel of Trust
In principle, there is much to suggest that the trust level of investors – at least in
the medium and long term – is based on hard macroeconomic facts. The questionis what criteria can actually be used to determine the strength of an economy inconcrete terms and how the criteria included can be condensed into a robust
overall assessment.
The German Stability and Growth Act (StabG) specifies four key
objectives: stable and appropriate economic growth, high employment,
price level stability, and avoiding external imbalances. At the European
level, the Convergence Criteria and the Stability and Growth Pact (SGP) adds two

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The Synchronous Equity and Gold Price Model

261

further objectives, the core of which is to limit public deficits and public debt toacceptable levels.
However, since there are conflicting goals between these six criteria, it is hardly
possible to achieve all criteria simultaneously and equally well. If this succeeds atleast in a form that comes close to the optimum, the perfect middle, the financial
markets speak of a Goldilocks scenario. For the US, for example, this was the casein the mid to late 1990s.
The following table provides a good overview of the six stability and growth
criteria. Included are both the current values and the data as of the end of 1999
and the end of 1979, as well as the value ranges, split into percentiles, ranked from
top to bottom by which criterion is most supportive of investors’ trust.
Current

Goldilocks Scenario

Trust Crisis

Percentiles

Situation

End 1999

End 1979

Values 1973 - 2021

Value

Rank

Value

Mar 22

Rank

Value

Rank

90%

70%

50%

30%

10%

0.23

2%

2.9

1.9

1.2

0.8

0.4

Dec 99Dec 79Trust (S&P 500/Gold Ratio)

2.2

77%

5.03

98%

Real GDP Growth

6.3%

97%

3.5%

70%

-2.8%

6%

4.8%

3.6%

2.6%

1.6%

-2.0%

Inflation

7.0%

13%

2.7%

70%

13.2%

1%

1.4%

2.2%

3.0%

4.3%

8.7%

Unemployment Rate

3.9%

93%

4.0%

96%

6.0%

48%

4.3%

5.2%

5.9%

7.1%

8.7%

Current Account

-3.7%

17%

-3.7%

17%

-0.4%

81%

0.2%

-1.3%

-2.1%

-2.9%

-4.5%

Budget Balance-12.1%

3%

1.5%

97%

-1.8%

79%

-0.4%

-2.4%

-3.0%

-3.9%

-7.1%

Public Debt

123%

0%

58%

44%

31%

98%

32%

48%

60%

65%

103%

Source: Author’s calculations, Incrementum AG

You take my life when you do

For the general public, unemployment and inflation are the mosttake the means whereby I live.

critical issues. This is because both a higher unemployment rate and a

William Shakespeare

worsening of inflation lead – directly and noticeably – to a deterioration in theeconomic situation of citizens. This is probably one reason why the Federal
Reserve has a dual mandate to address both issues.
The Misery Index introduced into the academic debate by theAmerican economist Arthur Okun in the 1960s adds both variables
with equal weighting. If we stick to this logic and add the government deficit to
the Misery Index or subtract the surplus and the current account balance, both asa percentage of GDP, and subtract real growth as a percentage of GDP, we obtain asimple macro score that compares well with investor confidence over the past 50
years.

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The Synchronous Equity and Gold Price Model

262

Investors Trust, measured as S&P 500/Gold Ratio (log, lhs), andMacro Score (log, inverted, rhs), 01/1970-03/2022

4.80

2.40
1.20
0.60

Percentile

9.60

Macro Score per Sep 2021:
Unemployment Rate:
4.7%+ Inflation Rate:
5.4%+ Budget Deficit:
11.6%+ Current Account Deficit: 3.7%
- Real GDP Growth:
6.4 %
Sum:
19.0 %

90%
80%
70%
60%
50%
40%
30%
20%
10%

3.00

6.00

12.00

0.30
24.00

0.15
0.08
1967

1972

1977

1982

1987

1992

1997

2002

Investors Trust (S&P 500/Gold Ratio)

2007

2012

2017

2022

Macro Score

Source: Author's calculations, Incrementum AG

Admittedly, this is a very rough and simple approach. Significant points ofcriticism are already apparent at first glance. For one thing, debt is not taken into
account. The equivalence of different criteria may also be questioned. In addition,negative inflation rates (= deflation), for example, have a positive effect on thescore.
On the other hand, even this simple addition shows a surprisingly direct
relationship with investor confidence. Adding one’s own unproven conditions,limits, or offsets would at least not improve the transparency and credibility of themacro score. Moreover, this back-of-the-envelope calculation requires neither an
economics staff nor a supercomputer.
Ultimately, however, it is not necessary to share the reasoning behind the macroscore and its derivation. It is merely intended to support one’s own assessment of
the development of the confidence level. The macro score is not included in the
SEGPM.
Attitudes are more important

Even without the two charts shown previously, it is plausible and understandable

than facts.

that investor confidence and its macroeconomic fundamentals do not always run

George MacDonald

in parallel. This is not unusual, because in the short term it is not only facts thatcount on the capital market, but also whether the data match expectations and how
they are interpreted and classified.
High inflation, for example, is less worrisome when it is seen as
temporary. An economic slump loses its horror if a V-shaped economic recovery
followed by a continuation of the real growth trend is the defining narrative.
However, if expectations are not confirmed, the hard facts always prevail in theend. However, the tipping point at which the markets and investor confidence
switch from narrative to reality is difficult to predict.
Carmen Reinhart and Kenneth Rogoff described this phenomenon very aptly in the
introduction to their book This Time Is Different: Eight Centuries of Financial
Crises: “Highly indebted governments, banks, or corporations can seem to be

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The Synchronous Equity and Gold Price Model263

merrily rolling along for an extended period, when bang! – confidence collapses,
lenders disappear, and a crisis hits.” In a figurative sense, this certainly also
applies to capital markets, valuation rules, and asset prices.
Forced to confront a reptile or an

To enable a straightforward assessment of the level of trust, historical trust values

international financial crisis, I’ll

were also divided into percentile ranges of 10% each. The extreme values of 0%

take the reptile every time.

and 100% trust are also shown. On the one hand, this may seem exaggerated, but

Alexandra Petrion the other hand, the values are real. In addition, it cannot be ruled out that in the
future these upper and lower corner values will not be shifted more deeply into theextreme range again.
The methodology and results of the model can be illustrated using thefollowing matrix:
US Monetary Aggregate M2, in USD bn.
22,00024,00026,00028,00035,00040,00045,00050,000

7,333

8,000

8,667

9,333

10,00011,667

13,33315,00016,667

5,742

6,264

6,786

1,061

1,158

1,254

7,308

7,830

9,135

10,43911,744

13,049

1,350

1,447

1,688

1,929

2,170

2,412

4,831

5,270

1,668

1,820

5,709

6,148

6,587

7,685

8,783

9,881

10,979

1,972

2,124

2,275

2,654

3,034

3,413

3,792

4,444

4,848

5,252

5,656

6,060

7,070

8,081

9,091

10,101

1,926

2,101

2,276

2,451

2,626

3,064

3,502

3,940

4,377

4,120

4,495

4,869

5,244

5,619

6,555

7,491

8,428

9,364

2,142

2,337

2,532

2,726

2,921

3,408

3,895

4,381

4,868

3,724

4,062

4,401

4,739

5,078

5,924

6,770

7,617

8,463

2,406

2,625

2,844

3,063

3,281

3,828

4,375

4,922

5,469

3,257

3,554

3,850

4,146

4,442

5,182

5,923

6,663

7,403

2,717

2,964

3,211

3,458

3,705

4,323

4,941

5,558

6,176

2,814

3,070

3,326

3,582

3,838

4,477

5,117

5,757

6,396

3,013

3,287

3,560

3,834

4,108

4,793

5,478

6,162

6,847

2,472

2,696

2,921

3,146

3,371

3,932

4,494

5,056

5,618

3,241

3,536

3,830

4,125

4,420

5,156

5,893

6,630

7,366

2,059

2,246

2,433

2,620

2,807

3,275

3,743

4,211

4,679

3,516

3,836

4,156

4,475

4,795

5,594

6,393

7,193

7,992

1,572

1,715

1,858

2,001

2,144

2,502

2,859

3,216

3,574

3,841

4,190

4,539

4,888

5,237

6,110

6,983

7,856

8,729

Trust
(S&P 500/Gold
Ratio)
Values since
1973
5.41

Index Value, in USD
S&P 500 Shareof Index, in %100%

S&P 500

78.3

Gold
2.90

90%

S&P 500

65.9

Gold
2.31

80%

S&P 500

1.92

70%

S&P 500

1.55

60%

S&P 500

60.6

Gold
56.2

Gold
50.8

Gold
1.20

50%

S&P 500

44.4

Gold
0.93

40%

S&P 500

38.4

Gold
0.76

30%

S&P 500

0.59

20%

S&P 500

0.41

10%

S&P 500

33.7

Gold
28.1

Gold
21.4

Gold
0.16

30,0000%

S&P 500
Gold

9.9

724

790

856

922

988

1,152

1,317

1,482

1,646

4,406

4,807

5,207

5,608

6,008

7,010

8,011

9,012

10,014

Source: Author’s calculations, Incrementum AG

In the table above, each USD 1,000bn increase in M2 leads to a
USD 333 increase in the value of the index. This relationship is based on
actual historical data since 1963. Perhaps more extensive research and simulations
could establish a more precise correlation. However, the chart “Shares of Index
Components: 1x S&P 500 and 1.5 oz Gold” and the backtest of the model suggestthat there is little potential for additional optimization.

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The Synchronous Equity and Gold Price Model264

If there is a concrete expectation for the development of the money supply in the
coming years or if that expectation is to be validated, the confidence-dependent
spectrum of possible price developments can also be depicted as in the following
chart.

Trust Dependent Projections of the S&P 500*, 01/1975-12/2030
Trust
10,000

100%

9,000

90%

8,000

80%
70%
60%

7,000
6,000

50%

5,000

40%
30%

4,000

20%

3,000

10%

2,000
0%

1,000
0
1975

1980

1985

1990

1995

2000

2005

2010

2015

2020

2025

2030

Actual S&P 500
Source: Author's calculations, Incrementum AG*under the assumption of M2 money supply growth of 6.3% p.a. between 12/2021 and 12/2030

Trust Dependent Gold Price Projections*, 01/1975-12/2030
Trust

8,000

0%
7,000
10%
6,000

20%
30%
40%
50%
60%
70%
80%
90%

5,000
4,000
3,000
2,000

100%

1,000
0
1975

1980

1985

1990

1995

2000

2005

2010

2015

2020

2025

2030

Actual Gold Price
Source: Author's calculations, Incrementum AG*under the assumption of M2 money supply growth of 6.3% p.a. between 12/2021 and 12/2030

However, the applications of the model are even broader. Anothermajor benefit of the SEGPM is the validation of forecasts. This is because,with the inclusion of the money supply, any forecast for the S&P 500 also
automatically becomes a forecast for the gold price.
Facts are facts and will not

This will first be illustrated by some price forecasts for the S&P 500 for the end of

disappear on account of your2022. The basis for all subsequent calculations is the additional expectation thatlikes.

the M2 money supply will increase by 6.3% to around USD 23,000bn in the course

Jawaharlal Nehru

of 2022.
Thus, in the model, the value for the joint index of the S&P 500 plus 1.5 oz. gold isfixed at USD 7,633. If now a price target for the S&P 500 is called, the gold priceresults logically from the remaining difference.

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The Synchronous Equity and Gold Price Model

265

Forecast
S&P 500*

Joint index
in USDGold content(1.5 Oz)

Oz price

S&P 500
to gold

Investor confidence

Morgan Stanley

4,400

7,666

3,266

2,177

2.02

~ 73%

Goldman Sachs

5,100

7,666

2,566

1,710

2.98

~ 90%

Bank of America

4,600

7,666

3066

2,044

2.25

~ 78%

Credit Suisse

5,200

7,666

2466

1,644

3.16

~ 91%

Institute* Forecasts according to “Factbox: Wall Street analysts’ 2022 outlook for S&P 500”

But also, with the model, any gold price forecast is implicitly a commitment to acertain level for the S&P 500, as long as the money supply is included. Some
examples:Forecast gold
price*

Joint index in
USDGold content(1.5 Oz)

S&P 500

S&P 500
to gold

Investors’ trust

ABN Amro

1,500

7,666

2,250,00

5,416

3.61

~ 92%

ANZ

1,725

7,666

2,587,50

5,079

2.94

~ 90%

Scotia Bank

1,850

7,666

2,775,00

4,891

2.64

~ 84%

1,750

7,666

2,625,00

5,041

2.88

~ 90%

InstituteWorld Bank

* Forecasts according to “Gold price forecast for 2022 and beyond: A buy, hold or sell” (as of February 2, 2022)

I had preached for forty years

A notable gold price target for the end of 2030 at USD 1,653 was published by thethat the time to prevent theWorld Bank in the fall of 2021. In order to meet the forecast of USD 1,653 with acoming of a depression is thetrust level of 83% as of October 2021, according to the model, the M2 money

boom. During the boom nobody

supply would have to go down slightly to around USD 20,000bn, which effectively

listened to me…

corresponds to zero growth for the next 8 years. Such a development would beFriedrich August von Hayek

extremely remarkable from a historical perspective. After all, only during the corephase of the Great Depression was the 8-year rate of growth of the money supply
zero or negative for several years. Since then, the growth rate for any 8-year period
has always been more than 26%, which is equivalent to about 3% p.a.
Such a growth rate of 3.0% p.a. – which would result in M2 of about
USD 28,100bn in 2030 – translates in the model to a rise in the level of trust to
about 95% if the World Bank’s gold price forecast of USD 1,653 is considered as
fixed.

I figure lots of predictions is best.

However, if money supply increases in line with the In Gold We Trust report 2020

People will forget the ones I getbase variant of 6.3% p.a. to USD 37,500 in 2030, this leads at the given gold pricewrong and marvel over the rest.

of USD 1,653 to an S&P 500 of around 10,000 points and a new high in investor

Alan Coxconfidence, with an S&P 500-to-gold ratio of 6.0. The previous high was reached at
5.41 in August 2000.67
Money-supply-based long-term forecasts of gold or equity prices have been veryrare in the past, probably because the link to the money supply, if it was seen at all,was previously considered to be very loose. One exception was the money-supplybased gold price forecast for two different M2 growth scenarios in the In Gold We
Trust report 2020.68

Scenario

M2 growthTarget value 2030 -old

Gold price forecast for 2030

Base6.3% p. a.

USD 30,000bn

USD 4,800

Inflation

9.7% p. a.

USD 42,450bn

USD 8,900—

67 See “Quo vadis, aurum?,” In Gold We Trust report 2020
68 See “Quo vadis, aurum?,” In Gold We Trust report 2020

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The Synchronous Equity and Gold Price Model

266

The validation of the forecast with the SEGPM shows that both price forecasts
would not have been achievable with the expected monetary expansion alone. For
an unchanged trust level of around 76% (as of the end of 2019), the model shows agold price for 2030 of around USD 2,740 in the base scenario and of around
USD 3,880 in the inflation scenario.
In order to meet the In Gold We Trust report 2020 forecasts for 2030, theconfidence level would also have had to fall significantly, along with the forecast
monetary expansion: in the base scenario to around 20% and in the inflation
scenario to 0%, with a new, slightly lower extreme value.
With the absolute money supply targets for 2030 increased in the meantime by thebase effect, the gold price forecast of USD 4,800 in the base scenario is now
already achievable at a level of trust of around 46%, and the forecast of USD 8,900
in the inflation scenario at a level of trust of around 8%.
In summary, the SEGPM conveys two important insights:• If the influence of investor trust is eliminated by a hedge (through the use of
the joint index) or else – properly measured – taken into account, there is astrong and calculable link between the development of the money supply andthe prices of equities and gold.

• In the short run, investor trust is decisive for the development of equity andgold prices. In a direct comparison of the two variables, the influence of money
supply growth is generally only strong in the medium and long term. In thisrespect, the historically unprecedented money supply expansion of 2020 and
2021 is an exception.

Conclusion
A model that tries to explain the development of the equity market and the gold
price over the last 50 years on the basis of only two variables can, of course, only bea highly simplified reflection of reality, quite in the sense of George Box, astatistician at the University of Wisconsin, who once provocatively formulated: “Allmodels are wrong, but some are useful.”
The Synchronous Equity and Gold Price Model can be used to calculate future
effects that are significant for investment decisions on the basis of robust
correlations. In particular, it gives investors a better sense of how future monetary
expansions and changes in investor confidence may specifically affect equity andgold prices.
Please avoid surprise by including the uncertainty and fickleness ofconfidence in your strategic investment decisions. The model will
provide you with valuable services in this regard.

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268

How to Understand Gold’s
Supply and Demand
Fundamentals“Lasting backwardation in gold istantamount to the realization that gold
is no longer for sale at any price.”
Antal Fekete

Key Takeaways• Copper and oil are produced to be consumed. If

production gets ahead, there is a glut. If production falls
behind, there is a shortage. One can analyze
commodities markets by looking at production andconsumption data.
• Gold is different, because it is not consumed. Gold has

been accumulated for millennia.
• The price of a commodity in the futures market isnormally higher than the price in the spot market. Whenit flips the other way, this is proof of a growing scarcity.
This is true for ordinary commodities and for gold,
though for gold the mechanism is a bit different.
• Gold’s availability to the market has held steady over thelast year. Silver has become scarcer, but that’s in part
because the price has dropped.
• Governments have gone mad. There’s no other word fortheir fiscal and monetary policies. This is why people
have been turning to gold, though it remains quite
unloved. And they are likely to continue turning to gold
at an increasing rate.

About the author: Keith Weiner is the founder and CEO of Monetary Metals,

an investment firm that is unlocking the productivity of gold. Keith is an
economist who is a leading authority in the areas of gold, money, and credit andhas made important contributions to monetary theory. He is also a serial
entrepreneur.

How to Understand Gold’s Supply and Demand Fundamentals

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For ordinary commodities,

With an ordinary commodity, such as copper, you add up the supply

marginal utility is falling.

and you add up the demand. Supply is the output of the mines, plus recyclers.

Gold is different. Gold’s marginal

Demand is the manufacturers of wire, pipe, etc. If a large new mine is coming

utility does not decline.

online next quarter, then all else being equal, we should expect the price of copper
to fall. If there is a strike in a major copper-producing district, or a socialist
takeover, then we should expect the price to rise.
This extends to import numbers, especially for countries known to be doing a lot of
construction of buildings and infrastructure. For example, if China’s copper
imports number is rising, that represents is an increase in demand.
But gold is different.
Gold has been mined for thousands of years. And virtually all of that gold is still
held in human hands. Gold is not consumed, merely held. And we keep mining
more! Think about the implications of this.
One, there is no such thing as a glut of gold. The concept of glut isinapplicable. If the market absorbed all the gold that came from the mines overmillennia, then it will absorb whatever comes out of the mines next year.
Two, total annual mining is a small percentage of total existing gold. If
we invert it, we have the stock-to-flow ratio, which for gold is measured in decades(compared to months for ordinary commodities).
Three, all of that gold out there is potential supply. At the right price, andunder the right conditions. And all people on the planet are potential demand, atthe right price and under the right conditions. This confounds the conventional
approach to supply and demand, as one would use for copper.

The massive amount of gold

Four, changes to the quantity of mine output or jewelry manufacturing

already above ground makes an

are insignificant, relative to all that gold out there. To put this inincrease in mining output

perspective, annual global gold mining output is around 3,000 tonnes. Total gold

relatively insignificant.

stocks out there are estimated to be around 200,000 tonnes. However, there aregood reasons to believe that the official estimate understates the realty, as people
have been hiding gold from their governments and nosy neighbors for thousandsof years, and there is no way to inventory it. So the total stock is increasing around
1.5% a year. Now, how about a change in gold mining? Suppose gold miners have aslow year and produce only 2,400 tonnes. 20% may seem like a big change. But
relative to 200,000 tonnes, 600 tonnes amounts to a mere 0.3%. The effects of thischange will be de minimis.
Five, jewelry and objets d’art are just different forms of gold, whether
people hold the metal in the form of coins and bullion bars, or hold itin the form of rings and necklaces. And changes to the form of gold held do
not predict price moves.
Economics has a term called marginal utility. This is the value of the next unit of agood. For ordinary commodities, the nth + 1 unit is worth less than the nth. Suppose
you are walking in the desert around Phoenix in the summer. It is 46°C in theshade (if you can find any). You’re getting very thirsty. You stumble acrossLinkedIn | twitter | #IGWTreport

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someone selling bottles of water. How much is the first liter worth to you? You’dempty your wallet. It’s your life. What about the second? It will get you back tocivilization. The third? A spare. A fourth? You would have to carry the dead weight,
so it’s not worth much. By the 5th liter, water has no value to you.
For ordinary commodities, marginal utility is falling. When it falls below
the cost of production, that is a severe glut and the price crashes. The low priceattracts buyers who use the cheap commodity for purposes that normally are notjustified. Then the inventory is worked down, and eventually, the glut subsides.
Gold’s marginal utility does not

So, six, gold is different than ordinary commodities. Gold’s marginal utility

decline, at least not at adoes not decline – or if it does, the decline is so slow that, after thousands of years

meaningful rate.

of chronic accumulation, the price of gold is still above the cost of production.
Seven, if a commodity has constant marginal utility, then you cannot
analyze it by looking at the quantity produced, the quantity held ininventory, or the quantity purchased (which is not for consumption
anyway).
Eight, you also cannot measure its value in terms of commodities withdeclining marginal utility! Indeed, gold’s non-declining marginal utility meansthat the next unit has the same value as the last one. Gold is the best unit ofmeasure of economic value, the way a steel meter stick is the best unit of measureof length. The steel meter stick does not shrink as you bring it to higher altitudes.
The gold meter stick does not shrink as gold miners bring it to higher stocks.
Incidentally, Bitcoin’s designer and most Bitcoin proponents fear that this is nottrue for Bitcoin. Thus Bitcoin has a cap on its ultimate quantity, of 21mn.
Nine, gold is not valuable due to scarcity. Indeed, measured
appropriately, it is quite abundant. Gold has a greater stock to flow thanalmost any other commodity – perhaps with the exception of water.

If gold moves from one place toTen, the high stock-to-flow ratio and great abundance of gold mean

another, or from anonymousthat there is a massive amount of it relative to any one market

sellers to a famous buyer, thatparticipant. Even the biggest central bank in the world has only 8,000 out ofdoes not help predict the price.

200,000 tonnes, or 4%. Here are the things that are not predictive of the price ofgold, other than, perhaps, for a quick trade:•

Gold moves from one country to another, or one owner to another.

•

Gold moves from one vault to another, or one vault category to another.

•

Gold is moved from one kind of entity to another.

•

Gold is transformed from one form to another.

•

Mine output increases or decreases.

•

Jewelry input increases or decreases.

•

New stocks of gold are discovered, or a claimed stock proves to be
fraudulent.

•

A famous buyer or famous seller•

The price of consumer goods rises, especially if the increase is due tononmonetary drivers, like green energy restrictions.

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The above discussion is important to put gold in context as money. If
you think about it, money ought to have certain properties, such as non-declining
marginal utility and high stock to flow.
This context is also important as background to the next section, which is about
how to analyze the supply and demand fundamentals of gold.
Suppose you could sell wheat in

Suppose the market offers a profit for the following trade. You can sell

the spot market for USD 8.00

your gold bar for US dollars, and simultaneously buy a futures contract that will

and buy the next month’sdeliver an equivalent bar next month. You end up with the same gold that you had,contract for USD 7.00. This

plus some free US dollars. And suppose that every day, the profit offered for thisindicates scarcity.

trade is increasing. What would that tell you?
Before we answer this for gold, suppose this happened with an ordinary
agricultural commodity. Suppose you could sell wheat in the spot market for
USD 8.00 and buy the next month’s contract for USD 7.00. And every day, theprice of wheat in the spot market moved up, while the futures contract price did
not change.
In order to play, you must have wheat. If you do not, then you cannot sell wheat in
the spot market, which requires immediate delivery.
Therefore, if the bid in the spot wheat market is higher than the offer in the futures
market, that indicates scarcity. By the way, the technical term for this condition isbackwardation. Normally, the price in the futures market is higher than the pricein the spot market, to cover the cost of storage and credit for the warehouseman –the market maker who trades the spread between spot and futures – to finance theposition. This condition is called contango.
In backwardation, everyone’s screen is offering them a profit. And the
profit persists; it is not just some nanosecond flash, for big firms with fiber-optic
connections and fast computers. It’s there, and it lingers. But no one is taking it.
Because to take the free money off the table, the requirement is, you must have
wheat.
This applies to gold, though there is no such thing as a shortage of gold. As we justsaw, virtually all the gold mined in human history is in human hands. However,even with gold, there can be a shortage of the commodity in the market.
Gold is money, so a shortage in the market is more serious than ashortage of wheat before the harvest. Gold is money, so a shortage inthe market is more serious than a shortage of wheat before the harvest.
To understand what makes gold so economically important, let’s look at theconcept of bid and offer in a new way. It is commonly known that the bid is theprice you are paid, if you need to sell immediately. And the offer is the price you
pay, if you need to buy immediately. You can bargain with the market by making
your own bid or offer, but you risk not having a trade at the end of the day.
It’s also well understood, at least among the gold community, that the
fiat currency regime is headed towards a crisis. Many gold thinkers say

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that the offer to sell gold will be withdrawn off the board. In other words, you will
see offers to sell wheat, oil, shares of Apple, etc. But the gold offer will be blank.
Many gold thinkers say that, in a

Some would go farther and say that gold is unique. In a crisis, other things go “no-fiat currency crisis, the offer tobid”. Suppose the US Geological Survey says there will be an earthquake in LA – 15sell gold will be withdrawn off

on the Richter scale, nothing taller than a dollhouse will be left standing. All bids

the board. This is a mirror image

on real estate – probably from Santiago de Chile to British Columbia, Canada, andof the reality, that gold will

as far east as the Mississippi River would be pulled. There would be no lack ofwithdraw its bid on the US

offers from owners eager to sell! But not a bid to be found.

dollar.
But here we are discussing a currency crisis in which it is not the bid on
gold that is pulled but the offer! How do we explain this apparent anomaly?
How did the Medievals explain the apparent retrograde motion of the planets?
They could not, from within their geocentric paradigm. The explanation came from
Copernicus, who said, there is no retrograde motion. In his heliocentric model,
apparent retrograde is just an artifact of observing other planets from Earth.
The explanation of the apparent anomaly of the withdrawal of the gold
offer does not come from the present, paper-centric paradigm. It mustcome from a proper, gold-centric paradigm. In this paradigm, it is not the US
dollar that is money. It’s gold. Gold bids on all things, including the Federal
Reserve’s – and European Central Bank’s – irredeemable paper.
And, one day, gold will withdraw its bid on the US dollar. This is not a mererhetorical trick. This is not deducing the desired conclusion from a definition. I am
not just saying “gold is money” and “hey, look at this”. There is a reason why goldowners will withdraw their bid on the US dollar.
There is a reason why gold

It’s because the quality of the US dollar is declining. The US dollar isowners will withdraw their bid

credit, but increasingly unsound. The US government – and trillions of US dollars

on the US dollar. It’s because theof other major borrowers – cannot pay the principal and interest when due. They

quality of the US dollar isrely on selling new bonds to pay maturing bonds. This game has a finite terminus,

declining.

even when, as Adam Smith said, “there’s a great deal of ruin in a nation” and it
takes a long time. But when it finally does, the distinction between goldand paper currency becomes clear. And the following is also very
important.
Gold is not the liability of any counterparty.
In the endgame, people will not want to be lenders to bankrupt debtors. Thus they
will try desperately to get their hands on gold. The desire to trade US dollars
for gold will not be in question.
However, those who hold gold will not have a reciprocal feeling. They will not want
to trade gold for US dollars. Thus the withdrawal of the gold bid on the US dollar.
The first sign of this is gold backwardation. Let’s look at the mechanics ofthis. Suppose the following prices appear on your screen (Future meaning acontract maturing in three months):

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How to Understand Gold’s Supply and Demand Fundamentals

•
•
•
•

Spot (bid):
Spot (offer):
Future (bid):
Future (offer):

273

USD 1800
USD 1801
USD 1781
USD 1782

You could simultaneously sell your gold for USD 1800 and buy a contract for thesame amount of gold for USD 1782. That is a USD 18 profit, or 1%. This is 1% forthree months, or 4% per annum. So the market is offering you 4% on a short-term
trade. At the end, you have the same gold as before. Plus 18 free US dollars. And
there is no risk. You can’t have a margin call, because you sold the gold for cash.
With the full cash to take delivery on the contract, there is no margin.
But you hesitate. If this is truly risk-free, why has no one else taken it?
It’s not like there’s a shortage of gold! Then the reason becomes clear.
The risk is that you have exchanged your gold for a contract. What if the contract
does not deliver in the end?
Gold backwardation is an indication of the erosion of trust. It is theharbinger of monetary collapse.
Gold backwardation is an

It should never happen. There is no shortage of gold. But it has happened

indication of the erosion of trust.

intermittently since Dec 2008. Recall that in late 2008 there was widespread fear

It is the harbinger of monetaryof a banking system collapse. That fear was visible as gold backwardation. It did

collapse.

not last long, as the monetary authorities pumped out so much credit that thedanger of collapse was no longer imminent.
Gold backwardation has occurred many times since then.
The normal condition of the gold market is contango. Normally, you can buy a gold
bar at, say, USD 1791 and sell a future for USD 1800. That is, you can make a profit
to carry gold. Someone buys a gold future, and you are providing the service of
warehousing the gold for him until the contract matures. And you earn a small fee
to do so – 0.5% in this case, which is 2% per annum.

Hyperinflation has nothing to do

If there is contango and the contango is growing, then we can infer something:with quantity, it has everything

There are more participants carrying gold today than yesterday. We can be sure of

to do with quality of money.

that because the profit – i.e. the incentive – is greater. If someone is motivated to

Antal Fekete

carry gold for nine bucks an ounce, then two someone may be motivated to do it
for ten bucks. And so on.
This means that in rising contango the marginal buyer of gold is putting it into thewarehouse. Not sustainable. If the price is rising, a rising contango meansthat speculators are driving the price.
In backwardation, it is profitable to de-carry. That is, to unwind the carry trade
put on earlier. So the warehouseman got paid to carry, and backwardation pays
him again to de-carry. That is, to sell the bar and buy back the contract. In rising
backwardation, the incentive to de-carry increases. The warehouse is now themarginal supply of gold. Also not sustainable. And bullish.

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The cure for the temporary backwardations, so far, has been rising prices. At
higher prices, some people are motivated to sell. So more gold is offered on themarket, and the backwardation subsides until the next episode.
To understand the fundamentals of the gold (and silver) market, one must study
the gold basis.
• Basis = future (bid) – spot (offer)• Cobasis = spot (bid) – future (offer)
When the basis is positive, then the market is in contango. A high andrising contango means abundance. To trade on a positive basis, the warehousemanputs on an arbitrage trade. He borrows US dollars, buys gold metal in the spot
market, and simultaneously sells a gold futures contract. The (annualized) profit
on this trade is the basis. This trade will scale up, the greater the spread between
basis and LIBOR.
The gold basis is fairly stable. In

When the cobasis is positive, then the market is in backwardation. A

a period where the gold pricehigh and rising backwardation means scarcity. To trade a positive cobasis, themoved around between

warehouseman sells a gold bar and buys a futures contract. Note that this trade

USD 1,686 and USD 1,905, thedoes not rely on credit; there is no borrowing. And no margin calls. In this sense, itgold basis moved only between

is deemed risk-free. Also, a positive cobasis gives the warehouseman an additional

0.2% and 0.75%.

profit to close a gold carry trade that he previously put on, when the basis was
positive.
NB: It is not mathematically or physically possible for both basis and cobasis to bepositive.
There are a few other interesting things worth mentioning. One, the gold need not
be held in a futures market warehouse. It could be in a bank basement. It could
also be coming from a refiner, or even a gold mine. The warehouseman may havean arrangement for the miner’s output.
A rising basis provides an incentive to create new futures contracts. That is, thewarehousemen buys more gold bars from the market, and sells futures contracts
against them. And conversely, a rising cobasis provides an incentive to buy backand close futures contracts.
Armed with this understanding, you can interpret a chart of the gold basis. Here isthe chart as of May 2, 2022. It shows one year of data.

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The green line is the price of the US dollar, measured in gold, currently 16.7 mg ofgold. This is basically the inverse of the price of gold, as measured in the elastic
and volatile US dollar, currently USD 1,862.
The first thing you may notice is that the basis is fairly stable. In a period where the
US dollar price banged around between 15.2 mg and 18.0 mg gold, i.e. the gold
price was between USD 1,727 and USD 2,047, the gold basis was pretty steadyaround 0.5%, before moving up to around 1.5%
This shows that the price rise was driven by speculators in the futures market,
whose demand is pulled into the spot market by the arbitrage of carrying gold.
Next, notice the correlation between the green and red lines, that is, between theprice of the US dollar and the gold cobasis. This correlation holds at the generallevel, the overall shape of the chart. And it is especially revealing in the second
week of February through the second week of March. This is when the price of thedollar falls from 17.15mg to 15.19mg, i.e. the price of gold rose from USD 1,813 to
USD 2,047. During this price move, the cobasis fell from -0.6% to -1.1%.
The more the buyers in the

In other words, someone bids up the price of gold futures. This widens the basis,

futures market push up the pricethus attracting a warehouseman to buy gold metal and sell a future. But theof gold contracts, the more thewarehouseman is attracted not by the idea of making the price of gold in bothwarehousemen pull up the pricemarkets identical but by an uptick in the profit of arbitraging. So he pulls the priceof gold metal – and the more thisof spot gold up, but not as much as the futures buyers pushed up the price of

spread widens.

futures. The more the buyers in the futures market push up the price of gold
contracts, the more the warehousemen pull up the price of gold metal – and themore this spread widens.
In other words, gold tends to be scarcer at lower prices and moreabundant at higher prices.
Finally, one notices that even as the price of the US dollar has increased since then,i.e. the price of gold has moved down, the cobasis has kept on falling. Gold would
seem to be getting more abundant in the market, even as its price is falling.
In other words, this was the selling of physical metal and futures are following.

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However, during this time the Federal Reserve hiked the interest rate. Libor went
up from around 0.3% to around 1.3%! This is a big move, and it directly impacts
the cost of carrying gold, which involves borrowing at Libor to buy gold metal andsimultaneously selling futures contracts. The basis moved up about half as much as
the interest rate. We will look at the impact on the price projection, below.
Here is the chart for silver.

The green line is the price of the US dollar, in silver, currently 1.4 grams of silver.
The silver basis is less stable than the gold basis, which reflects that silver is lessmarketable and the silver market is less liquid.
For the last year, the ratio of theAlong with the price moves, there is a more pronounced move of the silver basis.

gold cobasis…to silver cobasis

It’s the same basic pattern, that is falling price of silver is accompanied by fallinghas been above the ratio of thecobasis, i.e. scarcity. With one difference. Since mid-April, the basis has beengold basis to silver basis.

falling. This is despite rising interest rates. Silver’s scarcity – relative to gold – isincreasing. Here is a graph of the gold basis to silver basis, and gold cobasis tosilver cobasis.

For the last year, the ratio of the gold cobasis to silver cobasis (i.e. the red line) has
been above the ratio of the gold basis to silver basis. This means gold has been
the scarcer metal, to the market.

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As of April 28, this reversed. The ratios are farther in silver’s favor than they’vebeen in a year, actually for several years.
The buyer (or seller) of futures is not a long-term holder. He is trading withleverage, and that means he will seek to take profits or cut losses. He is a
speculator. By contrast, the buyer of physical metal is usually doing so without
leverage, and likely with longer-term time horizons.
Price is set at the margin, andWhat if one could use the basis to build a model to look at what thethe traders at the margin haveprice of the metal would be, absent the speculators? Sometimes theaccess to a great deal of credit

speculators are pushing up the market price. Sometimes they are pushing it down.
Price is set at the margin, and the traders at the margin have access to a great dealof credit. Monetary Metals has built this model. Here is a chart of the gold pricefundamentals.

Remember from above, the gold basis is rising – but not as fast as Libor. The
Monetary Metals gold fundamental has come just a bit off its high a month ago,but not much. It is currently USD 1,961.
And here is the chart for silver.

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How to Understand Gold’s Supply and Demand Fundamentals

The fundamental price of silver

Here, we see a different picture from gold! The fundamental price of silver had

had been declining since last

been declining since last year, but it has recovered most of that loss in the lastyear, but it has recovered most ofmonth. We calculate a fundamental price – if silver metal were clearing withoutthat loss in the last month.

speculators influencing the price one way or the other – of USD 25.22. This is278

almost three US dollars above the market.
So where does this take us?
The following is based not only on the basis and analysis of the current
fundamentals of the gold and silver prices. It is based on a broader
macroeconomic view.
Clearly, something changed when the world plunged into Covid-19
lockdown. We had USD 1,600 gold and USD 18 silver, at that point. Then, withina few months, we had USD 2,050 gold and USD 29 silver. The prices havesubsequently subsided, but not to their pre-Covid levels.
You know what else changed after Covid, and then mostly recovered? The yield on
the 10-year Treasury bond. It plunged to 0.54% on March 9, 2020. By the end of2021, it had not recovered its pre-Covid level of 1.8%. That did not happen until
the Federal Reserve seemingly got serious about tightening – we shall see about
that. The yield temporarily peaked in February at 2.05% then subsided by early
March to below its pre-Covid level. Since then, it has been on a tear, even reaching
the 3% mark – we shall see how long this can hold.
There is not a direct correlation between the interest rate and the gold price. We
had rising rates in the 1970s, and rising gold prices. And we had falling rates post2001, and rising gold prices.
However, in the wake of Covid-19, we have had a major increase in the risk ofbeing a creditor to governments. Their debt levels have skyrocketed, but not theircapacity to pay those debts. At the same time, we have had a drop in rates –granted, this is now correcting, and we shall see how far it goes from here. There isa lesser reward for taking on greater risk.
No wonder people turn to gold and silver!
The economic and interest rate

The economic and interest rate situation is not likely to improve.

situation is not likely to improve.

Therefore, people will keep turning to gold. And this highlights two key

Therefore, people will keep

differences between gold and silver. One is that silver demand comes partiallyturning to gold.

from industrial and consumer product demand. This is not necessarily rising as wego forward.

…gold is priced out of the reachTwo, gold is priced out of the reach of many wage earners, especially in emerging

of many wage earners, especiallymarkets. So there is a disparity between the demand by wealthy vs. poor people.

in emerging markets. So there is

For the former, it is about a safe haven to store wealth. This can be the inflation-a disparity between the demand

protection trade, but increasingly it will be the default-avoidance trade. Whenby wealthy vs. poor people.

you own gold, there is no counterparty and you have no worries about
credit default.

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When the wealthy buy gold, they are putting the proceeds of the sale of other assets
into it. Contrast with the poor, who are putting part of their wages into silver. The
wealthy have lots of US dollars to buy gold, so long as their assets are worth lots of
US dollars. It is not necessary that their assets are rising in price, merely that they
have saleable assets and a concern about the solvency of the counterparties.
But the poor have only US dollars to put into silver, if they have wages. And notjust wages but US dollars remaining after paying their living expenses.
A falling interest rate tends to put downward pressure on wages, and right now
there are several large forces pushing up the cost of living: increasing regulations
generally, increasing green energy restrictions specifically, trade wars and tariffs,
and finally what could be called lockdown whiplash. Shipping and logistics havebeen distorted and stressed, first by the collapse of trade and then by the surge indemand as fiscal stimulus pulled demand forward.

Conclusion
As of this writing, the fundamentals of gold seem to be appealing, andwhen you don’t want to invest even in the allegedly safe assets such as
government bonds.
Silver certainly has the potential to rise in gold terms, especially with a gold-silver
ratio over 80 as it is now. The logistics industry will get their issues sorted, yet one
should be less optimistic about energy restrictions and economic nationalism, bothof which seem to be global megatrends. There have been better setups forsilver in the past than we see today. And the balance of risks suggests a
better setup for silver is likely in the future.

•

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The Largest Silver
Producer in the U.S.

Safety, Health, and Environmental Stewardship • Honesty and Integrity • Respect and Responsibility • Teamwork and Innovation

NYSE: HL | hecla-mining.com | 800.432.5291
Coeur d’Alene, Idaho | Winnemucca, Nevada | Vancouver, British Columbia | Val d’Or, Québec

Company Descriptions

281

Silver’s Inflation
Conundrum“You think you know that monetary
policy is controlled by a central bankadjusting interest rates and/or the sizeof its bank balance sheets. You arewrong. The consequences of being
wrong on this will be the greatest causeof wealth erosion in the modern age.”
Russell Napier

Key Takeaways• Silver prices disappointed investors, who observed

consumer price indices exploding higher. Is silver nolonger a monetary metal that hedges against inflation?
Rest assured, fellow investor, it is. But there were two
impediments to price appreciation.
• Real rates stopped falling in August 2020. Silver’s

inverse correlation to real rates first halted priceappreciation, and then stagnation set in, as with real
rates. Secondly, consumer price increases are notnecessarily inflation.
• The problem was not the monetary metal but the lack ofmonetary inflation. The consumer price increases wereprimarily caused by supply shocks, i.e. shuttering andrestricting business and making it uncertain, anddemand surges, i.e. the ordering of goods in place ofservices that were less available due to Covid-induced
government restrictions.
• The good news (for silver investors, at least) is that thebalance of probabilities strongly favors an inflationary
decade ahead.

Silver’s Inflation Conundrum

282

Stagnant Real Rates Put a Lid on Silver’s
Nominal Price
Silver prices are strongly correlated to real rates. When real rates stopped
falling in early August 2020, silver prices peaked shortly thereafter. The tablebelow shows, across different frequencies and time periods, that the monetary
metal is strongly repelled by the real, inflation-adjusted price of money.

Silver (USD) is Negatively Correlated to Real Rates (US 10-year Treasury)
Time Period

Daily

WeeklyMonthly

QuarterlyAug. ‘07 – Mar. ‘22 (15 yrs.)

-0.53

-0.53

-0.54

-0.55

Feb. ‘18 – Mar. ‘22 (5 yrs.)

-0.87

-0.87

-0.88

-0.89

Mar. ‘20 – Mar. ‘22 (2 yrs.)

-0.70

-0.70

-0.73

-0.79

Source: Bloomberg, Incrementum AG

The August 2007 starting point was chosen because that is when the Global
Financial Crisis began and changed the monetary system irrevocably – so far –from exponential growth to stagnation.69 February 2018 was when the fourth bout(since 2007) of monetary deflation began. March 2020 was when the acutereaction to the pandemic and government actions set in.
Gold is the money of capital,

Peaking in early November 2018, real rates stepped away from Globally

silver the money of commerce.

Synchronized Growth70 and began a steady 21-month downtrend. Real rates fell

Dan Oliver

2.25 percentage points, from 1.17% to -1.08%. That’s when silver prices rose. But
from August 2020 to March 2022 they stagnated (min: -1.19%, avg: -0.89%, max: 0.42%). That’s when silver prices basically went nowhere.
During the first phase, silver’s inverse correlation raised the metal from a monthly
average of USD 14.36 in November 2018 to an average of USD 27 by August 2020.
And during the second phase, the phase when the CPI was registering multidecadehigh rates of acceleration? Silver stagnated (min: USD 21.54, avg: USD 24.99, max:
USD 29.13). Silver ignored the CPI inferno because it is not a CPI metal,
it is a monetary metal and we were not witnessing monetary inflation.

—

69 See “How Bankers Turned Money into ‘Σ 0 ∞ € ¥’,” In Gold We Trust report 2021
70 The mainstream financial community’s name for the third attempted recovery from the Global Financial Crisis. The

first two were called Green Shoots (2009-11) and Global Growth (2013-14). Each was brought to an ‘unexpected’end by another “unexpected” bout of money/credit/collateral scarcity or shortage.

LinkedIn | twitter | #IGWTreportSilver’s Inflation Conundrum

50

283

Silver (lhs), in USD, and Inflation-Indexed US 10-Year Treasury
Bonds (rhs, inverted), in %, 01/2003-05/2022

-2

45
-1
40
35

0

30
1
25
20

2

15
3
10
5
2008

4
2010

Recession

2012

2014

Silver

2016

2018

2020

2022

Inflation-Indexed US 10-Year Treasury Bonds

Source: Federal Reserve St. Louis, Reuters Eikon, Incrementum AG

Silver Outperforms Gold, at First
Both gold and silver stopped appreciating in US dollars when real rates stagnatedin August 2020,71 but the two metals have had very different experiences since thatsummer. From August 2020 through February 2021 silver outperformed gold.
Why? Because markets expected monetary reflation and then economic recovery to
be floated to victory on a wave of continuous wartime-like fiscal stimulus andpolitician-led control of the private banking system.

Silver and Gold, in USD, 100 = 31.07.2020, 08/2020-02/2021
125
120
115
110
105
100
95
90
85
80
08/2020

09/2020

10/2020

11/2020

Gold

12/2020

01/2021

02/2021

Silver

Source: Reuters Eikon, Incrementum AG

Politicians are like bad horsemen

Stimulus checks! Furlough programs! Government-guaranteed bank loans! To

who are so preoccupied withname just a few of the programs: the UK’s Bounce Back Loan Schemes, the US’staying in the saddle that theyMain Street Lending Programs, the French Prêt Garanti par L’état, the Canadian

can’t bother about where they’reHighly Affected Sectors Credit Availability Program. All of this was to be done bygoing.

politicians demonstrating that they could preserve the socioeconomic status ofJoseph A. Schumpeter

millions – of registered voters! No wonder silver’s higher beta to (monetary)—

71 Gold, denominated in US dollars, is typically even more strongly correlated (inversely) to real rates (US 10-year

Treasury) than silver.

LinkedIn | twitter | #IGWTreportSilver’s Inflation Conundrum284

inflation purred with satisfaction. There was a real chance that the feckless,hapless central banking policies of the past decade and a half would be abandoned.
… politicians are not trying to

But as more time passed it became clearer to markets that thesolve our problems. They arepoliticians were not ready to take the world into a new socioeconomic

trying to solve their own

order. Instead, elected representatives treated the economic circumstances ofproblems…getting elected and2020 as a one-off, an exogenous factor to be overcome. That worldview allowed there-elected are No. 1 and No.

politicos to go back to things the way they were, which they considered perfectly

2. Whatever is No. 3 is far

fine. Or, at least, more electorally safe than leading society into a new andbehind.

uncertain future.

Thomas Sowell
Universal Basic Income was not introduced. Modern Monetary Theory
was not tried. The sovereign-bank-corporate nexus, as ECB executive board
member Isabel Schnabel has called it, was not pursued. Instead, just morequantitative easing, which has failed to revive moribund economies or stoke
monetary creation everywhere it has been tried for the past 20 years. There
would be no monetary reflation floated to victory on a wave of
provocative money expansion after all. Silver’s days of outperforming
gold were numbered.

When Fedwire Snapped, Silver’s Run Ended
Prepare for the unknown by

In late February 2021 the private banking system – the one that creates

studying how others in the pastmoney/credit/collateral that the global economy and financial system run on –have coped with thewas given a terrible fright that it would not recover from: Fedwire went offline

unforeseeable and thefor several hours.72

unpredictable.
George S. Patton

What is Fedwire? It is a real-time gross settlement system used by banks,businesses and government for – as the Federal Reserve itself puts it – “missioncritical same-day transactions”. Mission critical. As per the Federal Reserve’s
Treasury Market Practices Group:“On Wednesday, February 24, 2021, the Federal Reserve experienced adisruption across financial services – including Fedwire® Funds, Fedwire®
Securities, NSS, ACH, and Credit Risk – that lasted for approximately threehours, with service resuming at approximately 2:30 pm EST.”
What happened? We really don’t know! Or at least we haven’t been told; theauthorities won’t divulge. What do the authorities know and/or want us to know?
That it was not a cyberattack, as the TPMG Meeting Minutes of March 23, 2021 state:“Staff noted that the root cause behind the disruption was identified quickly by staff
and was not linked to a cybersecurity incident.”
Even the IMF noted there was remarkably little information available (emphasis
added):—

72 See “How Bankers Turned Money into ‘Σ 0 ∞ € ¥’,” In Gold We Trust report 2021

LinkedIn | twitter | #IGWTreportSilver’s Inflation Conundrum

285“According to a statement from the Federal Reserve, it took steps to help
ensure the resilience of the Fedwire and NSS applications, including recovery
to the point of failure. No further details were provided. Fedwire
resumed normal operations after the 3 to 4 hours outage.”73
No custodian of the truth should

The lack of forthrightness by the authorities and/or investigation by the financial

have to fear their deliverance ofpress is a real shame, because a significant number of markets began to turnthe facts.

against successful reflation from that point forward. Below is a partial list of

Jacob Riggs

capital markets, currencies, commodities and balance sheet items thatwere affected:• Treasury yield curve: Steepening since the pandemic, the curve began ayearlong (so far) retreat on February 25. The spreads started to flatten : 5yr
vs. 30yr, 10yr vs. 30yr, 20yr vs. 30yr. The 2-yr vs. 10-yr spread began toflatten a few weeks later, in mid-March.
• Japanese government bonds: The 10-year yield peaked, then fell throughthe end of 2021.
• British gilts: The 10-year yield peaked, traded sideways, then fell throughAugust 2021.
• Swap spreads: Both the 5- and 10-year maturity spreads stopped
expanding (i.e. reflation, recovery) and began a multi-month contraction intoa negative spread by June 2021. (Fixed to floating interest rate swap, spreadto US Treasury rates of similar maturities.)• Indian rupee: Strengthened against the US dollar from the depths of theCovid-19 crisis until February 24; weakened ever since.
• Australian dollar: Strengthened against the US dollar from the depths of
the Covid-19 crisis until February 25; weakened ever since.
• New Zealand dollar: Strengthened against the US dollar from the depthsof the Covid-19 crisis until February 24; weakened ever since.
• British pound: Strengthened against the US dollar from the depths of theCovid-19 crisis until February 24; then traded sideways, then weakened eversince.
• Reverse repurchase agreements: The Federal Reserve’s overnight
Treasury security lending program experienced a sudden surge from nothing
to USD 11bn, presaging a supernova explosion to USD 1.9trn by the end of2021.
• Repo fails: Primary dealers reported a significant increase in failures todeliver and to receive US Treasury securities lasting several weeks.
• Securities lending: The Federal Reserve reported a marked increase in
Treasury and federal agency debt securities lent overnight from February 24
to mid-April; securities lending would not come off a boil until July 2021.
• Copper: On an escape-velocity trajectory to outer space since the depths of
the Covid-19 crisis, the metal’s flight path took a sudden hard right on
February 24 and remained effectively unchanged through December 2021.

—

73 Khiaonarong, Tanai, Leinonen, Harry and Rizaldy, Ryan: “Operational Resilience in Digital Payments:

Experiences and Issues,” IMF Working Paper, No. 2021/288, December 10, 2021, p. 34

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286

Always the bridesmaid never the

The skittish banking system reacted naturally: It flinched. Remember, it

bride but silver in the last year

has been in a 15-year abusive relationship with a malfunctioning monetary order.

has been more like the poor

It began to back away from monetary reflation and began to doubt economic

stooge sweeping up the confetti

recovery. So the system defaulted back to the status quo – anticipating theand rice.

escalating probability of periods of monetary deflation. That environment is an

Christopher Ecclestone

unwelcome one for silver. Indeed, just two days after the Fedwire
blackout, on February 26, the gold-silver ratio bottomed out.

Gold/Silver Ratio, 01/1970-05/2022
120
110
100
90
80
70
60
Median: 60.6

50
40
30
20
10
0
1970

1975

1980

1985

1990

1995

2000

Recession

2005

2010

2015

2020

Gold/Silver Ratio

Source: Reuters Eikon, Incrementum AG

As has been explained in previous editions of the In Gold We Trust report,74 arising ratio signals deflationary monetary circumstances – the kind one observes
during global depressions and great monetary scarcity. A falling ratio, i.e. silver
gaining in relative value, signals the opposite, an expansion in monetary supply.
A rising ratio and the underperformance of silver makes complete
sense from that perspective. The monetary conditions had flipped fromreflation to retrenchment. The economy continued its recovery – such as it was –but monetary matters had now turned against silver. The monetary warnings have
only escalated since then: The US dollar began its tightening appreciation in June
2021, the eurodollar futures curve inverted on December 1, 2021, and the US
Treasury yield curve inverted, (2-year versus 10-year yield) on April 1, 2022.

Monetary Metal in a Monetary Deflationary
Context
You will not find it difficult to

But how can we explain the rise in consumer price indices and not lay

prove that battles, campaigns,

it at the feet of an expanding monetary base? Why didn’t silver rally, withand even wars have been won or

all this inflation? Because it wasn’t monetary inflation, it was an increase inlost primarily because of

consumer prices. That increase was brought about by supply/demand imbalances

logistics.

and shocks, not by an expansion in money supply. How can we be sure?

Dwight D. Eisenhower—

74 All previous In Gold We Trust reports can be found in our archive.

LinkedIn | twitter | #IGWTreportSilver’s Inflation Conundrum287• Because we have observed for two decades the Bank of Japan and Ministry of
Finance pursuing an awe-inspiring expansion of base money and Godzillalike deficit spending.
• Because we have observed for 15 years the Federal Reserve and Treasury
Department super-sizing policies of quantitative easing and stimulus.
• Because we have observed seven years of the ECB and capitals of Europe
raining bank reserves and raising public debt-to-GDP ratios to
Brobdingnagian proportions.
In each and every case, consumer prices effectively did the opposite of what
authorities wanted: They remained muted and/or fell. Not until supply chainswere repeatedly electroshocked and economies randomly turned on
and off like light switches did we witness consumer price rallies.
Was the increase in consumer prices due to the ‘money printer go brr’thing that has not worked for a generation? Or is it more likely that it was
the sledgehammer taken to a logistics plan designed for expanding globalization? A
plan turned all the way up to 11 for maximum efficiency and minimum resiliency.

Optimism for the Future
Asset inflation for investors is

Silver prices will rise in concert with persistent, pervasive monetaryfun, consumer inflation – not so

inflation. That is not what we have been witnessing, but surely it is not far away.

much.

Silver’s future is bright because the future is inflationary, as this is the mostFred Hickey

humane and politically feasible option for dealing with inequality andprivate/public debt burdens.

The crisis consists precisely in

The next crisis is already upon us – Russia/Ukraine/NATO – and surely the far-the fact that the old is dying andreaching consequences will convince leaders that the old order – quantitative

the new cannot be born; in thiseasing, globalization, WW2-era institutions – is to be abandoned and a new one –interregnum a great variety of

government-guaranteed bank loans, local supply, Universal Basic Income – to bemorbid symptoms appear.

fashioned. And even if it is not the present crisis in Eastern Europe, there are any

Antonio Gramsci

number of other candidates queueing up in this our Fourth Turning75 that will
force politicians’ hands to fully embrace inflation.
To know when we’ve tacked the good ship towards a new inflationary
horizon, keep an eye on politicians’ announcements in favor of:• picking winners, e.g. on March 15, 2022 Australia’s Energy and Industry
Minister announced a AUD 240mn investment in the rare earths metals
industry,• and losers, e.g. on March 19, 2022 Italy’s Mario Draghi announced windfall
taxes on Italian energy companies;• disabling markets, e.g. on March 17, 2022 Italy’s Ignazio Visco stated“Administered prices for a small period of time would not be a bad idea”;• localizing industry, e.g. on March 16, 2022 the EU’s Valdis Dombrovskis
announced tariffs against Indonesian and Indian steel;—

75 See “From Decades Where Nothing Happens to Weeks Where Decades Happen,” In Gold We Trust report 2021

LinkedIn | twitter | #IGWTreportSilver’s Inflation Conundrum

288• guaranteeing bank loans, e.g. on March 16, 2022 France’s Jean Castex
expanded and prolonged the state guarantees of bank loans originally created
to deal with the Covid-19 crisis.

Silver Supply Buoyed by Mexico and Peru
Let us now give you a brief overview of the most recent developments
in supply and demand of silver. Overall supply, including both fundamental
and speculative, grew 5.6% in 2021 to 1,025 million ounces (Moz). Analysts
anticipate that tally will rise 4.3% in 2022 to 1,069 Moz. But the big picture
takeaway is that total silver supply has remained effectively unchanged since 2010,averaging 1,037 Moz per year from 2010 through 2021. This stagnation extends out
through to 2025, which the industry consensus has penciled in for 1,100 Moz – notmaterially different than 2010’s 1,079 Moz.

Total Silver Supply, in Moz, 2010-2025e
1,150

1,100

1,050

Mean: 1,039 Moz

1,000

950

900
2010

2012

2014

2016

2018

2020

2022e

2024e

Total Silver Supply
Source: Silver Institute, Incrementum AG

Mine supply clawed most of its 2020 losses back last year, rising to 827 Moz from
780; the 2019 total was 836 Moz. The consensus analysis forecast is that mine
production will rise to a six-year high in 2022 of 879 Moz and then breach the 900
Moz barrier for the first time in recorded history the following year.

LinkedIn | twitter | #IGWTreportSilver’s Inflation Conundrum

289

Mine Supply, in Moz, 2010-2025e
950

900

850

800

750

700
2010

2012

2014

2016

2018

2020

2022e

2024e

Mine Supply
Source: Silver Institute, Incrementum AG

Analysts expect Mexico and Peru, the world’s top two producers, to account for justunder one-third of global supply and increase production during 2021 by 10.6%
and 7.5%, respectively. China is the only other country with a double-digit market
share in global production; it is estimated to produce 2.2% more in 2022 than lastyear.

Mine Supply by Country, in Moz, 2010-2025e
1,000
900
800
700
600
500
400
300
200
100
0
2010

MexicoPoland
USA

2012

2014

Peru
Australia
India

2016

2018

2020

China
RussiaCanada

2022e

2024e

Chile
Bolivia
Rest of World

Source: Silver Institute, Incrementum AG

Secondary supply consists of industrial and photographic scrap along with therecycling of jewelry, coins and silverware; it accounts for just under one-fifth of
total supply. Analysts forecast this category of supply to shrink year-over-year by
4.9% in 2022.
Speculative silver supply consists of exchange-traded products, commodity
exchange inventories, precious metal dealer inventories, and/or mining company
hedging and is forecast to be an immaterial 2 Moz in 2022. This is clearlyencouraging because it tells us these financial market participants do
not expect to be selling silver.

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290

Silver Demand Forecasts Are Way Off
An expert is one who knows

It seems more likely that industrial and ornamental demand will be

more and more about less andsomewhere between weak and meek in 2022 rather than match theless until he knows absolutely

zoom-to-boom consensus outlook. Despite peculiarly optimistic estimates

everything about nothing.

about the global economy and consumer finances, analysts expect demand to

Nicholas Butler

outstrip supply in 2022 (and for every year thereafter, through to 2025). The
coming year is set to use 1,204 Moz of silver, resulting in a 135 Moz annual deficit
in supply relative to demand. Those ounces will have to come from above-groundstock, which is estimated to be around 3,200 Moz.

Above-Ground Stock (lhs), in Moz, and Market Balance (rhs), in
Moz, 2010-2025e

5,000

0

4,500

-50

4,000

-100

3,500

-150

3,000

-200

2,500
-250

2,000

-300

1,500
1,000

-350

500

-400

0

-450
2010

2012

2014

2016

Above-Ground Stock

2018

2020

2022e

2024e

Market Supply Balance

Source: Silver Institute, Incrementum AG

The largest opportunities are

Approximately 55% of demand is for industrial purposes in categories such as

found in ideas that go against the“electrical, electronics, batteries”; “Brazing and Soldering Alloys”; and “Catalyst for

grain.

Ethylene Oxide”. Industrial users include solar panel and vehicle manufacturers.

Omar Hamoui

Industrial demand grew 5.9% in 2021, and analysts expect another truly
impressive year, estimating 5.0% growth for 2022. The automotive and 5G
segments will accelerate growth rates in 2022 to 17.3% and 21.3%, respectively,
according to the consensus outlook. For us, it is hard to understand why
analysts are so optimistic when Europe is rationing energy, China ispursuing zero-Covid policies, emerging markets are confronting a foodshortage, and the United States is predicted to fall into a recession.
Photographic demand is in a secular downtrend and will shrink by just under 7%.
The analyst outlook is for ornamental demand to increase strongly in 2022.
Silverware and jewelry are expected to increase 7.3% after already rising 12.0% in
2021. Ornamental demand is 24% of overall demand. These estimates areastonishing, because this category grows when consumers are experiencing risinglevels of income and are optimistic about their economic future. It is not clear to us
how analysts have come to the conclusion that such a cheery future lies directly
ahead.

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291

Consensus is what many people

Financial demand consists of government and private purchases of

say in chorus but do not believe

silver coins, medals and bars; it takes 18% of the overall demand pie.

as individuals.

The consensus forecast is that this category will only rise 3.0% in 2022. With

Abba Eban

consumer prices at such high levels, war in Europe, the global order in retreat, andmarkets like US Treasuries and eurodollar futures predicting more economic
trouble directly ahead, it is – again – hard to understand why mainstream
economists are so negative on financial demand. At least they are consistent: A
booming economy leads to rising industrial and ornamental demand and falling
financial demand. The only booms on the horizon your authors see aredestructive explosions.
Speculative demand is the last category of silver demand and includes
exchange-traded products, commodity exchange and precious metal
dealer inventories, as well as mining company hedging. It is 9% of the
global silver demand total. Here again rosy predictions for socioeconomic orderand geopolitical fraternity have encouraged the consensus to predict a 21.5%
decrease in demand.

Demand by Category, in Moz, 2010-2025e
1,600
1,400
1,200
1,000
800
600
400
200
0
2010

2012

Industrial

2014

Photographic

2016

2018

Decorative

2020

2022e

Investment

2024e

Speculative

Source: Silver Institute, Incrementum AG

Conclusion
The Future's So Bright, I Gotta

If past cycles are anything to go by, silver will be pulled along by gold

Wear Shades.

throughout the 2020s as we experience geopolitical and socioeconomic

Timbuk 3

upheaval. That means consumption by individuals (e.g. coins, bars), institutions(e.g. financial market inventories), and governments (reserves). Then silver willtake over and be pushed forward by the hot winds of inflation for a decade or two
as governments burn off private and public debt levels via financial repression. We
are bullish on silver through to the 2040s, but after that you’re on yourown.

LinkedIn | twitter | #IGWTreportSilver’s Inflation Conundrum

292

Silver (Nominal), and Silver (Inflation Adjusted - April 2022), in
USD 01/1971-04/2022
160
140
135.4 USD
120
100
80
60
40
20
0
1971

1981

Recession

1991

Silver (Nominal)

2001

2011

2021

Silver (Inflation Adjusted - April 2022)

Source: Nick Laird, Reuters Eikon, Incrementum AG

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significant leverage to the silver price with approximately 60% of its revenue anticipated to
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294

Bitcoin: Bull Market in
Adoption, Bear Market inPrice“If you just did an overlay of the
Nasdaq and the cryptocurrency
markets, they are unbelievably
correlated for right now, so I thinkthat’s creating a lot of churn and painin the markets. While that’s happening,billions of dollars are going into
Web3.”
Anthony Scaramucci

Key Takeaways• Although Bitcoin is in a veritable bear market again rightnow, there are remarkable happenings and progress interms of adoption.
• Several nation states have declared Bitcoin as theirofficial currency within the past 12 months.
• The stock-to-flow model (S2F model) can explain theprice development of Bitcoin remarkably well
historically. In the current cycle, the price of Bitcoin is
below the range assumed by the model.
• Due to the wide range of the S2F model, it can serve as a

guide regarding the halving cycle, but not as the basisof an automated trading strategy.
• A U-turn back to a loose monetary policy could make fora delayed high in the price of Bitcoin within the next 24
months.

Bitcoin: Bull Market in Adoption, Bear Market in Price

295

Since 2016 – when the price of BTC was trading at around USD 500 we have been writing an annual chapter on the topic of Bitcoin andcryptocurrencies in the In Gold We Trust report. This year, too, we want tostick to this tradition. Not least because the topic has gained in importance for us,
as we now manage two funds that combine precious metals and cryptocurrencies.

Bitcoin vs. GoldI would take the gold andIn past years we have dealt with this much-discussed topic in detailsprinkle a little bitcoin on top.

several times. We would like to refer interested readers to the chapters “GoldRay Dalio

and Bitcoin: Stronger Together?”76 and “In Bitcoin We Trust?”.77
On a philosophical and to some extent on a practical level, gold andBitcoin are similar because they

• cannot be inflated by central banks,• do not represent the debt of another party (no counterparty risk),• are easily transferable and• represent values outside the fiat money system.
In our view, both asset classes have advantages and disadvantages. Dueto their different characteristics, they are not in direct competition with each otherbut rather complement each other. Gold and Bitcoin are friends, not foes.78 In thefollowing table we summarize the most important differences between gold, fiat
currencies and Bitcoin, knowing full well that one or another nuance can be
discussed extensively and passionately here.

PropertyGold

Fiat currencies

BitcoinFungibility

moderate/high

high

high

moderate

high

high

high

moderate?

highhigh (cash)
low (fiduciary money)

moderate

Transferability
Longevity
Anonymity
Non-monetary benefit

high

–

–

moderate/high

low

high

Decentralization

moderate

low

high

Volatility

Scarcitymoderate

low

high

Energy intensity – Creation

high

low

high

Energy intensity – Usage

low

high

high

Source: Incrementum AG

Probably the most important argument for Bitcoin as a long-term storeof value is the non-inflatability of its supply. In this fundamental
characteristic, Bitcoin and gold are particularly similar. In both cases, the future
development of the money supply is highly predictable. In contrast, fiat currencies—

76 “Gold and Bitcoin: Stronger Together?,” In Gold We Trust report 2019
77 “In Bitcoin We Trust?,” In Gold We Trust report 2017
78 “Crypto: Friend or Foe?,” In Gold We Trust report 2018

LinkedIn | twitter | #IGWTreportBitcoin: Bull Market in Adoption, Bear Market in Price296

are constantly inflated under normal circumstances; in times of crisis, inflation
often increases by leaps and bounds.

Bitcoin Stock (lhs), in Coins, and Gold Stock (rhs), in Tonnes,
01/2010-01/2030

25,000,000

250,000

20,000,000

200,000

15,000,000

150,000

10,000,000

100,000

5,000,000

50,000

0
2010

2012

2014

2016

2018

2020

2022

Bitcoin

2024

2026

2028

0
2030

Gold

Source: blockchain.com, World Gold Council, Incrementum AG

I think the internet is going to be

Especially in terms of volatility, gold and Bitcoin have fundamentally

one of the major forces fordifferent characteristics. Gold is known to have significantly lower volatility

reducing the role of government.

than Bitcoin. Measured in annual standard deviation, gold’s volatility is around 15-

The one thing that’s missing but

20% p.a., while Bitcoin’s is between 60 and 100%. Bitcoin holders are currently

that will soon be developed, is afeeling the high volatility of Bitcoin again on the markets. Historically, thereliable e-cash.

drawdowns from the all-time highs have been over 80% several times.

Milton Friedman

Bitcoin and Gold Drawdowns from ATH, 07/2010-05/2022
0%
-10%
-20%

Gold Median:
-28%

-30%
-40%
-50%

BitcoinMedian:
-50%

-60%
-70%
-80%
-90%
-100%
07/201007/201207/201407/2016

Bitcoin Drawdowns

07/2018

07/2020

Gold Drawdowns

Source: Glassnode, Reuters Eikon, Incrementum AG

Price versus Adoption
Bitcoin is like investing with

After hitting a new all-time high in November 2021, Bitcoin is now

Steve Jobs and Apple... I think

clearly back in a bear market. On the logarithmic scale below, you can see thewe are in the first inning ofphenomenal long-term rise. Nevertheless, one should not be fooled by the optics

bitcoin and it’s got a long way tointo taking the short-term setbacks seriously.

go.
Paul Tudor Jones

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297

Bitcoin (log), in USD, 01/2015-05/2022
100,000

10,000

1,000

100
2015

2016

2017

2018

2019

2020

2021

2022

Source: Reuters Eikon, Incrementum AG

Although Bitcoin is currently in a veritable bear market again, there
are remarkable events and progress to report in terms of adoption.
Below is a small selection of significant events:• China introduces a mining ban; the lost hash rate is made up in a few months
by miners in other countries.

• Lightning Network will be integrated into Bitcoin’s blockchain.
• Bitcoin hits a new all-time high of USD 69,000 in November 2021, but halvesin the following 6 months.
The resilience of the network was once again impressively
demonstrated last year. Following the Chinese government’s legal ban on
Bitcoin mining, Chinese miners went offline within a few weeks, and some moved
to new jurisdictions.

35

Bitcoin Mining Difficulty (lhs), in trn, and Bitcoin (log, rhs), in USD,
01/2016-05/2022

100,000

30
25

10,000

20
15
1,000

10
5
0
2016

100
2017

2018

2019

Bitcoin Mining Difficulty

2020

2021

2022

BitcoinSource: blockchain.com, Reuters Eikon, Incrementum AG

In the meantime, Bitcoin adoption continues to advance. Around theglobe, numerous notable government initiatives have been implemented that aregradually further integrating Bitcoin into highly diverse economies. To name just a
few:

LinkedIn | twitter | #IGWTreportBitcoin: Bull Market in Adoption, Bear Market in Price

298• El Salvador declares Bitcoin as official currency in September 2021.
• The Central African Republic introduces Bitcoin as official currency in May
2022.

• Madeira, an autonomous region of Portugal, announced that no taxes will belevied on profits from the purchase and sale of Bitcoin, and that Bitcoin can be
freely used as a means of payment.
Bitcoin is a technological tour de

Although these countries are comparatively small, it is worth noting that just 18

force.

months ago it was inconceivable to anyone that a nation state would adopt Bitcoin

Bill Gates

as legal tender. Given the current developments on a global level, we would not be
surprised if more states follow suit and use Bitcoin as a reserve currency in the
future.
But there has also been notable progress at the institutional level.
Fidelity Investments, the largest provider of retirement plans (401(k)) in the US,announced in April 2022 that they will allow investors to invest up to 20% of their
401(k) portfolios in Bitcoin. This is the latest in a string of news reports about
institutional investor adoption of cryptocurrencies.
Bitcoin-owning companies include Microstrategy, Tesla, Square, Block, and anumber of publicly traded crypto and bitcoin-specific companies. A recent report
by VanEck mentions that so far this year, nearly 160 separate 13F filings fromvarious hedge funds have referenced their Bitcoin holdings.

S-Curve Adoption
Economics is driven by scarcity

Breakthrough technologies almost always follow an S-curve adoption

and technology creates

pattern. This pattern reflects the cumulative rate at which a population adopts aabundance.

new technology. This pattern has been observed with the introduction of railroads,

Jeff Boothelectricity, radio, telephones, television, fax machines, microwaves, computers, theInternet, cell phones, and so on. The S-curve demonstrates that the time it takes
for a new breakthrough technology to achieve 10% penetration is broadly
equivalent to that required to increase penetration from 10% to 90%.

Bitcoin will do to banks what

Bitcoin was invented in 2009. In 2019, 10% of US households owned Bitcoin.

email did to the postal industry.

Today, according to the US government, the figure is already 25%. If we look at

Rick Falkvinge

these numbers using the S-curve model, Bitcoin distribution would reach 90%
around 2029. So far, this matches well with the expected numbers in the S-curvemodel. This means that we are currently in year 3 of 10, where Bitcoin should risefrom 10% to 90% adoption according to this model.
Taking a longer-term view of Bitcoin, it appears that we are still in the early stagesof the adoption curve and that there is much more potential. It is worth noting thatthese numbers are for the US, and the US is way ahead of the rest of the world in
Bitcoin adoption. Global adoption numbers are extremely difficult tomeasure, but are estimated to be between 1% and 2% in 2022.

LinkedIn | twitter | #IGWTreportBitcoin: Bull Market in Adoption, Bear Market in Price299

Source: Off the Chain CapitalIf adoption continues to follow the S-curve model and takes into account thelimited supply of Bitcoin, price is the only other variable that could move to meetincreasing demand.

Bitcoin, the Interest Rate Turnaround, and the
S2F Model
Adoption and resilience are advancing, but prices are not. As we havealready discussed in detail in this report, we have had to record continuously rising
inflation rates worldwide over the past 12-18 months. The turnaround in US
monetary policy that has been heralded is now having far-reaching implications forfinancial markets. We therefore want to look at the extent to which this turnaround
may also affect Bitcoin.

Bitcoin’s integration into the financial markets
The market currently views both

Until now, Bitcoin has led “a life of its own” to a certain extent and has

bitcoin and the Nasdaq as "long-

been only peripherally affected by general macro events. As it adapts andduration, interest-rate-sensitive

begins to be integrated into institutional portfolios, Bitcoin will be increasingly

risky assets.

exposed to the vagaries of the financial markets. At its peak, Bitcoin’s market

Brent Donnelly

capitalization significantly exceeded USD 1tr by a wide margin; currently it isaround USD 600bn. The debate on whether Bitcoin should be valued as an
inflation-hedging asset has now fully flared up. We have already expressed somethoughts on this in the chapter “Stagflation 2.0” in this In Gold We Trust report.
Recently, there has been increasing talk of Bitcoin behaving like a risk
asset. This thesis is supported by its increased correlation to stocks, especially to
the US technology stock index, Nasdaq. According to Kaiko Research, the 30-day
rolling correlation between Bitcoin and the Nasdaq rose to 0.8 on May 9, an alltime high.

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300

Rolling 180d Correlation of Bitcoin and Nasdaq, 01/2012-05/2022
1.0
0.8
0.6
0.4
0.2
0.0
-0.2
-0.4
-0.6
-0.8
-1.0
2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

Correlation of Bitcoin and Nasdaq
Source: blockchain.com, Reuters Eikon, Incrementum AG

Even though the correlation to technology stocks is currently quite
high, it should be noted that correlations tend not to be stable. In thepast, Plan B’s stock-to-flow model (S2F model) has been able to explain the price76F

trend over longer periods much better than individual stock indices do. We
previously presented this model in the In Gold We Trust report 202079 anddiscussed it in detail in a In Gold We Trust classic80, among others. We would liketo take another close look at the S2F model at this point.
Essentially, all models are

The key premise of the S2F model is that the halving of mining rewards

wrong, but some are useful.

every four years (halving) provided for in the Bitcoin protocol has a

George Box

significant impact on price development. Technically, halving increases
Bitcoin’s stock-to-flow ratio, because fewer new bitcoins enter circulation after
each halving due to lower mining returns. The SF model leverages the uniquefeature of the Bitcoin protocol, which transparently and traceably reveals the pastand future supply curve, to forecast Bitcoin’s price evolution based on its historicaland future stock-to-flow values. The model regresses the log price development of
Bitcoin with the prevailing stock-to-flow ratio.

S2F Model Price, and Bitcoin Price, in USD, 01/2010-12/2026

1,000,000.00
100,000.00
10,000.00
1,000.00
100.00
10.00
1.00
0.10
0.01
2010

2012

2014

2016

S2F Model Price

2018

2020

2022

2024

2026

Bitcoin Price

Source: Plan B @100trillionUSD, Glassnode, Reuters Eikon, Incrementum AG—

79 “The Plan B Model: The Holy Grail of Bitcoin Valuation?,” In Gold We Trust report 2020
80 “The stock-to-flow ratio as the most significant reason for gold’s monetary importance,” In Gold We Trust classic

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301

Remarkably, the Bitcoin price has followed the path of the predicted
S2F model quite precisely since its first release in March 2019. It must
be noted, however, that in relative terms the model forgives a rather highfluctuation range of the price of Bitcoin due to the regression with logarithmic
prices. Therefore, its use is probably only suitable to a limited extent, but not, forexample, to build an automated trading strategy on it.

I’m a bit of a dinosaur, but I havewarmed up to the fact that
Bitcoin could be an asset classthat has a lot of attraction as astore of value.
Stanley Druckenmiller

In the current cycle, there was a significant price increase last fall,
which was also predicted by the SF model, but it remained below
expectations. For completeness, it should be noted that there are now several
variants of the model. According to the original variant, the price of Bitcoin should
average USD 55,000 during this halving cycle (May 2020–May 2024). A later
variant, which was frequently cited last year, calculated a significantly higher
average price of USD 100,000.
The following questions now arise:• Will the average price of Bitcoin in this cycle be lower than predicted by thetwo model variants?

• Will there be a delayed increase in the price of Bitcoin during this cycle, or will
the average price of one of the model variants still be reached or evensurpassed?

• Has the forecasting quality of the S2F model decreased or has it even become
obsolete?
Due in part to too-bullish expectations, many analysts, investors and market
observers have asked themselves in recent months whether the current Bitcoin
halving cycle is already over. We have also thought about this and published our
first Bitcoin chartbook at the end of 2021. In the following, we would like totake a closer look at some key elements in connection with this topic.
The next chart suggests that the price of Bitcoin formed peaks 12 and 17
months after halving in the last two cycles. The last halving was now 24
months ago, and we wonder whether the cycle already peaked in
November 2021 or whether another all-time high could still be in store
in this cycle.

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302

Bitcoin (log), in USD, 07/2010-05/2022

Halving cycle high:Halving +? Months

1,000,000.00

Halving cycle high:Halving +17 months

100,000.00

Halving
July 9, 2016

1,000.00
100.00Halving
May 11, 2020

Halving cycle high:Halving +12 months

10,000.00

HalvingNovember 28,
2012

10.00
1.00
0.10
0.01
07/201007/201207/201407/2016

07/2018

07/2020

BitcoinSource: blockchain.com, Reuters Eikon, Incrementum AG

In December, we formulated three scenarios for the current halving
cycle in our Bitcoin chartbook. In our opinion, the most likely scenario (60%)
was a delayed peak in this bisection cycle. However, we assigned a probability of
40% to the possibility that this bisection cycle is over, or that the model is obsolete.

Bitcoin Performance by Halving (Halving Month = 100, log)
9,000

900

Price ranges with estimated probabilities in parentheses:
Bullish (Halving cycle delayed): 75k - 200k USD (60%)
Neutral (Halving cycle over): 35k - 75k USD (25%)
Bearish (Halving cycle broken): 20k - 35k USD (15%)

90
0

5

10

15

Halving 2012

20

25

30

Halving 2016

35

40

45

Halving 2020

Source: Reuters Eikon, coinmarketcap.com, Incrementum AG

Given Bitcoin’s increasing adoption, higher market capitalization, andthe entry of institutional investors into the crypto market, it seems
plausible that Bitcoin is becoming increasingly sensitive tomacroeconomic trends. For example, it can be noted that the current rise inbond yields is having a strong negative impact on the entire risk asset sector –including cryptocurrencies. Therefore, it cannot be ruled out that these will face
further headwinds in the coming months should bond yields continue to rise andthe risk-off movement persist.
In our view, current developments on the bond markets could cause afurther delay in this bisection cycle. Nevertheless, we want to take account of
the advanced stage of the cycle and adjust our December 2021 forecast. From
today’s perspective, it has probably become somewhat less likely that we will stillsee a new all-time high in this halving cycle. Nevertheless, based on

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303

macroeconomic conditions, we do consider it possible that there will be a delayedhigh in this cycle. We put the probability of Bitcoin reaching a new alltime high in the remaining 24 months of this cycle at around 40%. This
scenario could manifest itself if the currently priced-in monetary tightening does
not materialize.

Conclusion
Bitcoin is also a monetary asset

It seems plausible that due to the increasing adoption of Bitcoin by institutional

outside anyone’s control. This

investors, its sensitivity to macroeconomic events has increased. Due to this, acontests the state’s monopoly ondelay of the high point in the current halving cycle seems possible. Because ofmoney and banking. Less state

the high bandwidth of the S2F model, it can be used as a guidecontrol empowers individuals toregarding the halving cycle, but not as a basis for an automated trading

unleash latent creativity thatstrategy.

would otherwise be stifled bygovernment or cultural

US monetary policy is currently in a phase of transition from loose tocensorship. In other words,

tighter. In view of high inflation and recent hawkish communications, markets

Bitcoin increases marginal

are expecting a significant change in interest rate policy. In our view, it is quite

productivity in society.

likely that rising volatilities in the markets will force central banks to revert to a

Bitcoin is the life raft during theloose monetary policy again.

great fiat flood.
Brandon Quittem

Therefore, we think that interesting entry opportunities in Bitcoin andother cryptocurrencies could arise in the wake of the current monetary
policy-induced turmoil.

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305

Mining Shares –Fundamental andTechnical Status Quo“Great investors possess seven cardinalvirtues: curiosity, skepticism,discipline, independence, humility,
patience, and above all courage.”
John Templeton

Key Takeaways• The performance of mining shares in the previous year

was disappointing. The operating development, on theother hand, was excellent. Within the commodities
sector, no other subsector currently shows higher
margins than the precious metal producers.
• The value proposition of mining stocks has further

improved, but so far the rediscovered profitability has
been largely ignored. Sooner or later, generalists andvalue investors will rediscover the value proposition of
the mining sector. What matters is that the sector
produces significant free cash flows.
• If the gold price remains strong in 2022, miners should

continue to achieve (record) high margins despiteongoing cost inflation.
• In the short term, we believe the technical situation isbattered. After large losses had to be accepted in thepast weeks – contrary to the actually positive
seasonality – a summer setback could offer excellent
entry opportunities in line with the seasonal course of
the miners.

Mining Shares – Fundamental and Technical Status Quo

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Introduction
You make most of your money in“Golden Opportunities in Mining” was the title of last chapter ona bear market, you just don’t

mining stocks.81 However, since the publication of our last year’s In Gold We

realize it at the time.

Trust report, mining share prices have performed much weaker than expected. The

Shelby Cullom Davisgold bugs index (HUI) fell 21%, while junior miners (GDXJ) have lost 30% andsilver miners (SIL) 39%.

Gold, Silver, HUI, GDX, GDXJ and SIL, 100 = 05/27/2021, 05/202105/2022
110

100

90

80

70

60

50
05/2021

07/2021Gold

09/2021

Silver

11/2021

HUI

01/2022GDX

03/2022

GDXJ

SIL

Source: Reuters Eikon, Incrementum AG

Last year we came to the following conclusion:“The potential rates of return over the next several years could
surprise even the most ardent gold bugs. However, in advocating
mining stocks, we are still reminded of “The Dancing Sasquatch Guy”82. Right
now, it seems that we are at minute 1, but as can be seen in the video, once acertain degree of awareness is reached, it can turn into a mass movement
quickly.”83
Do it big, do it right, and do it

However, the atmosphere in the sector still reminds us of the earlywith style.

phase of Dancing Sasquatch Guy. But it seems as if the number ofFred Astaireinterested spectators is slowly increasing. However, it is not yet enough to
be called collective dancing.

The stock market is a device for

As far as fundamentals are concerned, one year later we can justifiablytransferring money from theclaim that the sector has delivered. The value proposition of mining stocks

impatient to the patient.

has continued to improve, although so far the profitability that has been

Warren Buffett

rediscovered has been largely ignored. But at some point, generalists and value
investors will (re)discover the value proposition of the mining sector. Whatmatters is that the sector produces significant free cash flows.

—

81 “Golden Opportunities in Mining,” In Gold We Trust report 2021
82 A great interpretation of this video can be found here: Eight Leaves: “The Dancing Guy at Sasquatch!” or also:“Ideas Into Execution: Giving Away An Idea To Make It Happen”
83 “Golden Opportunities in Mining,” In Gold We Trust report 2021, p. 297

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The commodities sector as a whole generated negative free cash flows
in the years 2013–2016. Even after that, free cash flow was marginal andlimited to low-cost companies; but by spring 2021 at the latest, companies in
the commodities sector became true cash flow monsters.

Aggregate TTM Free-Cash-Flow of Commodity Producers*,
in USD mn, Q1/1996-Q1/2022
350,000

300,000
250,000x4

200,000
150,000
100,000
50,0000-50,000-100,000
1996

1998

2000

2002

2004

2006

2008

2010

2012

2014

2016

2018

2020

2022

Aggregate TTM Free-Cash-Flow of Commodity Producers
Source: Crescat Capital LLC, Tavi Costa, Bloomberg, Incrementum AG*Companies with market cap above USD 1 bn. in the Canadian and US stock exchanges

And within the commodities sector, no other subsector is currently
showing higher margins than precious metals producers.

Median Operating Margins by Commodity*, Q1/2022
30%

27%
24%

25%

24%
21%

20%
13%

15%

10%
5%
5%

0%
Precious Metals

Wood/Lumber

Base Metals

Oil & Gas

Coal

Agricultural

Median Operating Margins
Source: Crescat Capital LLC, Tavi Costa, Bloomberg, Incrementum AG*Companies with market cap above USD 1 bn. in the Canadian and US stock exchanges

In addition, it is worth taking a look at the relative valuation of mining
stocks compared to gold. In bull market environments, gold stocks tend to
trade at a premium to gold. The HUI/gold ratio indicates that gold stocks havebeen trading one standard deviation below the mean for 9 years now. Also basedon this indicator, gold stocks appear to be undervalued.

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HUI/Gold Ratio, 01/1997-05/2022
0.70
0.60
0.50
+1σ
0.40
Average: 0.30

0.30
0.20

-1σ

0.10
0.00
1997

1999

2001

2003

2005

2007

2009

2011

2013

2015

HUI/Gold Ratio

2017

2019

2021

200d MA

Source: Reuters Eikon, Incrementum AG

Perseverance is rewarded sooner

Before we take a closer look at the performance of mining stocks overor later – but usually later.

the past few years, let’s briefly turn to the longer-term perspective. The

Wilhelm Buschfollowing chart shows the performance of mining stocks (XAU) relative to equity
markets (S&P 500) and illustrates how low gold mining stocks are valued relative
to the broader equity market. Even if there has been a stabilization of the ratio
since 2015, the current ratio is one-fifth of the 2011 peak.

XAU Index/S&P 500 Ratio, 01/1999-05/2022
0.20
0.18
0.16
0.14
0.12
0.10

0.08
Median: 0.056

0.06
0.04
0.02
0.00
1999

2001

2003

2005

2007

2009

2011

2013

2015

2017

2019

2021

XAU Index/S&P 500 Ratio
Source: Reuters Eikon, Incrementum AG

Markets tend to return to theThis underperformance of mining stocks becomes particularly clear if

mean over time.

we make an even longer-term comparison. The oldest available gold mining

Bob Farrell

index, the Barron’s Gold Mining Index (BGMI), is currently trading at 0.50x, miles
below the long-term median of 1.43x.

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BGMI/Gold Ratio (log), 01/1950-05/2022
10Median: 1.43
1

0
1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

2020

BGMI/Gold Ratio
Source: Reuters Eikon, Nick Laird, goldchartsrus.com, Incrementum AG

All we need is just a little

Well, what happened in the last 12 months? The ups and downs tested

patience.

even volatility-hardened gold investors. The HUI fell to 225 points inGuns N’ Roses

mid-September 2021, then rallied back to more than 330 points byApril 2022. Since then, it has been trending much weaker again. It is
worth noting that while the gold price almost reached a new all-time high in early
March, the HUI was still trading nearly 50% below its all-time high of 635 in
September 2011 on the same day. The equity dilution of recent years, which in partdwarfs the central banks’ brisk monetary inflation, is certainly partly responsible
for this.

HUI Index, 01/2004-05/2022
700

1,899
Red Circles: Gold in USD

600

1,002

500
712

2,039

400
1,363
300
200

1,865

100

720

0
2004

2006

2008

1,195

1,087
2010

HUI Index

2012

2014

2016

2018

2020

2022

200d MA

Source: Reuters Eikon, Incrementum AG

In the meantime, interest in the mining sector increased noticeably.
Since fall 2021, however, disinterest and apathy have predominated, as described
during a popular Kitco interview at the Precious Metals Summit in Beaver Creek. If
we look at the relative strength of mining stocks (GDX) compared to the former
leading sector of the stock market, technology stocks (QQQ), we can see thatmining stocks have gradually gained relative strength. To be fair, however, it
should also be noted that this is due to the weakness of the technology stocks, notthe strength of the miners.

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GDX/QQQ Ratio, 01/2007-05/2022
1.4
1.2

1.0
0.8
0.6
0.4
0.2
0.0
2007

2009

2011

2013

2015

2017

GDX/QQQ-Ratio

2019

2021

200d MA

Source: Crescat Capital LLC, Tavi Costa, Reuters Eikon, Incrementum AG

Furthermore, if we analyze the relative strength within the mining
sector, it seems that risk appetite is stagnating. Junior miners (GDXJ) haveshown relative weakness compared to seniors (GDX) in recent months.

GDXJ/GDX Ratio, 01/2010-05/2022
2.8
2.6
2.4
2.2
2.0
1.8

1.6
1.4
1.2
1.0
2010

2012

2014

2016

2018

GDXJ/GDX-Ratio

2020

2022

200d MA

Source: Crescat Capital LLC, Tavi Costa, Reuters Eikon, Incrementum AG

One silver lining could be that large institutional investors, so-called
generalists, are slowly entering the playing field among the major gold
miners. For example, industry leader Newmont rose to an all-time high of
USD 85 per share in April on high volume. The development of the large-cap
miners Barrick, Agnico Eagle, Newmont and Newcrest is no embarrassment inrelation to the (former) technology high flyers Facebook (Meta), Amazon, Netflix
and Google (Alphabet).

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FANG (Facebook, Amazon, Netflix and Alphabet) and BANN
(Barrick, Agnico Eagle, Newmont, Newcrest), 100 = 01/2016,01/2016-05/2022
380
340
300
260
220
180

140
100
60
2016

2017

2018

2019

2020

FANG

2021

2022

BANN

Source: Reuters Eikon, Incrementum AG

A look at the Sprott Gold Equity Sentiment Index84 confirms ourconfident basic stance. Sentiment reached a low point in March 2021, with theindicator almost reaching its second standard deviation. Since then, both theSprott index and the GDX have recovered, but they are still far from the euphoric
levels of August 2020. Currently, the index is in neutral territory, though it
recently weakened again significantly. Thus, the technical starting position forfurther price increases seems to be good.

Sprott Gold Equity Sentiment Index (lhs), and GDX (rhs), 01/201405/2022
100

50

90

45

80

40

+2σ

70

35

60

30

50

25

40

20

30

15

20

10

-2σ

10

5

0
2014

0
2015

2016

2017

2018

2019

2020

Sentiment Index

2021

2022

GDX

Source: Sprott Asset Management, Incrementum AG

A slightly different indicator, the Optimism Index (Optix) from
Sentimentrader, on the other hand, is already at panic level. With areading of 7.39, the mood is about as low as in a London pub after the lost
European Championship final last year.

—

84 The data was kindly provided by our Premium Partner Sprott Asset Management.

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Optix index and mining stocks (GDX), 2007-2022

Source: Sentimentrader.com

The great merit of gold is

The global all-in sustaining costs (AISC) of gold producers increased in the

precisely that it’s scarce, that its

previous year in line with general inflation. According to the WGC, they were

quantity is limited in nature, that

USD 1,007 in Q4/2020, but one year later they were already at 1,129, an increase

it’s costly to discover, to mine,of 12.2%. This striking year-over-year cost increase is due to several factors,

and to process, and that it cannot

including the cost inflation, additional costs associated with the Covid-19

be created by political fiat or

pandemic, and a decline in average gold grades. Average margins have been

caprice.

pressured by these rising costs, but remain high by historical standards. Should

Henry Hazlitt

the gold price remain robust in 2022, gold mining companies should
continue to achieve record high margins despite further pressure fromongoing cost inflation.

All-in Sustaining Costs (AISC), in USD per Troy Ounce, and Gold,in USD, Q1/2020-Q4/2021
2,000

1,885

1,800

1,600

1,896

1,781

1,828

1,770

1,757

1,707
1,571

1,400

1,200

1,000

986

972

974

Q1 2020

Q2 2020

Q3 2020

1,007

1,057

1,085

1,131

1,129

Q3 2021

Q4 2021800
Q4 2020

Q1 2021All-in Sustaining Costs (AISC)

Q2 2021Gold

Source: World Gold Council, Reuters Eikon, Incrementum AG

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Funding Trends in the World of Junior Miners
Let’s now take a look at the funding activity in the junior mining sector
over the past 12 months. Last year, our friend Kai Hoffman provided us with an
introduction to and interpretation of his proprietary Oreninc Index. The index
measures the financial health of the junior mining sector on a weekly basis,tracking and logging up to 41 data points per financing.85
Don't act like you're not

Looking at junior miner financing activity, 2021 nearly matched theimpressed.

levels seen in the record year 2011, with the sector raising over CAD 6.8bn in

Ron Burgundy

financing. Considering the market sentiment in the junior mining sector as well as
the general underperformance compared to many other sectors, this is aremarkable achievement.

Total CAD Raised, in bn, 2011-2021
9
8.0
8
6.9

7
5.5

6
4.8

4.6

5
4

4.6

3.2

3

2.8

2.4

2.3

2.5

2
1
0
2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

Source: Oreninc.com, Incrementum AG

The 100 most important junior mining financings of 2021
The top 100 financings raised a total of CAD 3.25bn. Mining companies,
project developers and junior companies focused on gold accounted for 55% of thetransactions. Of the 10 largest financings in 2021, eight were goldrelated.
A speculator is a man who

Copper attracted the second greatest interest from investors. Investors

observes the future, and acts

have recognized the trend towards electrification and have jumped on it. Copper

before it occurs.

mining companies have received more than CAD 531mn from investors,

Bernard Baruch

representing about 16% of total financing. Financing in the battery metals
sector, such as lithium, graphite and vanadium, ranked third. This groupraised CAD 324mn from investors. Silver and uranium round off the top 5.

The trends continue in 2022
The first three months of the current year showed a clear continuationof last year’s financing trends. The share of gold-related projects remained—
85 You can sign up for the weekly newsletter at www.oreninc.com.

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Mining Shares – Fundamental and Technical Status Quo

314

stable at 54%. The top three financings of 2022 (as of March 24) were all from thegold sector. AMEX Exploration raised CAD 49.5mn for its exploration activities inQuebec. It is followed by Argonaut Gold with CAD 40.3mn and Liberty Gold withCAD 30mn in fresh capital. As can be seen from the index, however, the market
environment has clouded over significantly in recent weeks, so we assume thatinvestors’ risk awareness and thus also their appetite for financing will weaken
further in the coming months and that investors will become much more selective.
Oreninc Index

Source: Oreninc

Outlook for 2022
Going in one more roundWe mentioned in the In Gold We Trust report 202186 that the mining

when you don’t think you can –sector is in better shape than one would expect based on the sharethat’s what makes all the

price development. The war in Ukraine has increased general investor

difference in your life.

skepticism; and while the majors like Newmont have marked all-time highs, theRocky Balboa, Rocky IV

juniors are still largely ignored. But relative to the overall market, we would
imagine that miners could now enter a period of (relative) strength. This is alsosuggested by the chart below.

S&P 500/GDX Ratio, 01/2007-05/2022
180
160
140
120
100
80
60
40
20
0
2007

2009

2011

2013

2015

2017

S&P 500/GDX Ratio

2019

2021

200d MA

Source: Crescat Capital, Tavi Costa, Reuters Eikon, Incrementum AG—

86 See “Golden Opportunities in Mining,” In Gold We Trust report 2021

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Mining Shares – Fundamental and Technical Status Quo

315

Conventional wisdom results in

The market does not yet seem to have sufficiently realized that many

conventional returns.

miners have significantly strengthened their balance sheets, their

Mario Gabellimargins, and their financial strength in recent years. We believe the newcommitment to assessing true costs, greater financial discipline, and shareholder
value is an essential – although very late – realization by the sector. Whether or
not this new focus is mere lip service will be seen in the coming quarters. We
therefore think that gold stocks have a clearly asymmetric payoff
profile at the moment.

The intelligent investor is a

In the short term, the technical situation seems depressed. The

realist who sells to optimists andchallenging seasonal environment is also confirmed by the chartbuys from pessimists.

below. The second half of the year tends to be weaker for mining stocks, with theBenjamin Grahamseasonal weakness being particularly pronounced in July and October. After large
losses had to be accepted in the past weeks – and contrary to the positive
seasonality – a summer setback could offer excellent entry opportunities in linewith the seasonal course of the miners.
Seasonality of Amex Gold Bugs Index (HUI) since 1997

Source: Seasonax

Chance favours only the

We continue to strongly believe that the bear market of the last few

prepared mind.

years has resulted in a majority of mining companies now being on a

Louis Pasteur

more solid footing. Operational efforts have led to producers deleveraging,
becoming leaner, and therefore benefiting more from rising gold prices. A
comparison of some metrics as of December 31, 2021 shows how
attractively the miners (NYSE Arca Gold Miners Index – GDM) arevalued compared to the broad overall market (S&P 500).

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Mining Shares – Fundamental and Technical Status Quo

316

Different valuation ratios for S&P 500 and GDM
S&P 500 Index

GDM Index

Price/Earnings

24.59

18.02

Price/Cash Flow

17.46

9.15

Price/EBITDA

14.59

7.87

Price/ Sales

3.08

3.14

Price/Book

4.76

1.79

Ent. Value/EBIT

20.96

15.04

Ent. Value/EBITDA

16.15

8.43

Ent. Value/Sales

3.41

3.36

Gross Margin

35.28%

37.47%

Operating Margin16.13%

22.52%

Profit Margin

13.07%

13.34%

Return on capital

10.15%

8.88%

Free cash flow yield

3.92%

3.49%

Dividend Yield

1.27%

2.24%

Total Debt/Ent. Value

0.22

0.11

Total debt/total equity

111.83

20.12

Total debt/total assets

23.63

13.20

Net debt/EBITDA

0.98

0.17

Source: Trey Reik, Bristol Gold Group, Bloomberg, Incrementum AG, figures as of Dec. 31, 2021

We expect that producers’ bubbling cash flows will lead them toreplenish their shrinking reserves through acquisitions and mergers.
The biggest beneficiaries of this development will be junior producers, fully funded
developers, and explorers with world-class discoveries in Tier 1 regions.
Therefore, we are currently focusing our research and investment
allocation on this segment in particular.
Inside of a ring or out, ain’t

Contrarian investors will find an attractive niche with an excellent risk-reward

nothing wrong with going down.

ratio in the precious metals sector over the next few years. The focus should

It’s staying down that’s wrong.

continue to be on conservatively operating companies that do not only have growth

Muhammad Ali

at any price on their agenda, but where the interests of the shareholders are in theforeground.
After this brief analysis of the status quo of mining companies, we will turn ourattention in the following two chapters to the current challenges facing the mining
industry and the exciting segment of royalty-and-streaming companies.

LinkedIn | twitter | #IGWTreportWE ARE TRUSTEDTO UNLOCK THE FULL
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LSE:EDVTSX:EDVCompany Descriptions

318

The Challenges of the Gold
Mining Industry“Either you understand your risk, oryou don’t play the game.”
Arthur Ashe

Key Takeaways• Although there are some exceptions, the gold miners asa group tend to underperform gold in the long term.
• The main reasons for the underperformance have been

CAPEX overruns, growing production costs, problems
with permitting of new mines, governments wanting abigger share of the pie, political instability, and declining
reserves and a lack of new major discoveries.
• It is possible to expect “all-in sustaining cost” (AISC) to

keep on growing in the foreseeable future, due to risingenergy and construction materials prices, wage
demands, and inflation in general.
• A segment of the mining industry that should do well in

the inflationary environment are the royalty & streaming
companies.

The Challenges of the Gold Mining Industry

319

As history demonstrates, every gold rush has ended up in vain for thevast majority of participants. Thousands and thousands of people left theirhomes and wandered to the far ends of the Earth to find gold and secure a better
life for themselves and their families. But only a small fraction of them really found
what they were looking for; Gold, wealth, and a better life.
The history book on the shelf,

Times have changed, and modern-day gold rushes do not take the form

Is always repeating itself.

of thousands of prospectors crossing a continent. Today, the hordes ofABBAprospectors have been replaced by hundreds of mining companies of all sizes. And
hundreds of thousands of investors are betting on the success of these companies.
But as the chart below shows, the gold mining sector as a whole is not a good longterm bet. Although there are some success stories – just as there are also many
companies that deliver to their investors only losses, or at least long-term
stagnation and frustration. Thus, when investing in gold mining stocks, two things
are important: 1) pick the mining company wisely, and 2) have good timing. It is
optimal, of course, to combine both.
The following chart shows the long-term development of gold prices and theBarron’s Gold Mining Index (BGMI). As can be seen, the difference in yield has
widened over the years to a very high level. While between January 1970 and
December 2021 the gold price increased by 4,937%, the BGMI grew by “only”
1,027%. The difference in performance was relatively small for decades – bothcurves were moving in the same direction without any major deviations. However,
over the last 15 years the situation has changed rapidly. The gold miners have
lagged behind the gold price.87

Gold and BGMI, 0% = 01/1970, 01/1970-05/2022
6,000%

5,000%

4,000%

3,000%

2,000%

1,000%

%
1970

1975

1980

1985

1990

1995

Gold

2000

2005

2010

2015

2020

BGMI

Source: Nick Laird, Reuters Eikon, Incrementum AG

In the early phases of the Global Financial Crisis of 2008, the gold pricefell. However, it started to recover very quickly, erased its losses in early 2009,
and continued in 2011 to new record highs just below USD 2,000. However, at thesame time, the gold miners were barely able to return to the pre-crisis highs. But
when the gold price again started to decline, they declined even more strongly. And
during the current gold market, as gold prices have broken the USD 2,000 barrier—

87 We did discuss this problem in: “Mining Stocks: The Party Has Begun,” In Gold We Trust report 2020

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The Challenges of the Gold Mining Industry

320

and set new record highs, the BGMI has been unable to even approach its previous
highs.
Over the whole 52-year time period, the correlation between gold and the BGMI
was 0.56, which is a relatively strong positive correlation. But the numbers start tobe really interesting when the time period is divided into two subperiods. Between
January 1970 and August 2008, the correlation was 0.9, which is very strongly
positive. However, between September 2008 (with the collapse of Lehman
Brothers and official start of the Global Financial Crisis) and December 2021, thecorrelation was only 0.35.
Being right, but early in the call,This trend is also confirmed by the performance of the popular investment

is the same as being wrong.

products SPDR Gold Trust ETF (GLD), VanEck Vectors Gold Miner ETF (GDX),

Howard Marksand VanEck Junior Gold Miners ETF (GDXJ). The observed time period starts on
November 11, 2009, when GDXJ (the youngest of the three ETFs) was established.
While the gold price grew by 54% over the 12-year period, GDX, focused on the
bigger gold producers, declined by 33%; and GDXJ, focused on smaller producers,
explorers, and developers, declined by 50%. But despite the overall declines, there
were subperiods when good timing of the market could result in very pleasant
gains.

GLD, GDX and GDXJ, 0% = 01/2010, 01/2010-05/2022
100%
80%
60%
40%
20%
0%
-20%
-40%

-60%
-80%
-100%
2010

2011

2012

2013

2014

2015

GLD

2016

2017

GDX

2018

2019

2020

2021

2022

GDXJ

Source: Reuters Eikon, Incrementum AG

Why the poor performance of the gold miners? Actually, there are several
reasons. Some of the companies are impacted by only one or two of the factors,
while some, the less lucky ones, are burdened by all of them. The main factors thatneed to be mentioned are CAPEX overruns, growing production costs,
environmental constraints and problems with permitting, governments wanting abigger share of the pie, and political instability, as well as declining reserves and achronic lack of new “major discoveries”.

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The Challenges of the Gold Mining Industry

321

Environmental Constraints and Problems with
Permitting
The chains that cuff humanity

Permitting a mine is becoming ever more challenging. Even in mining-friendly

are made of office paper.

countries, the procedure is becoming increasingly complex and time-consuming.

Franz Kafka

Thus, obtaining permits takes ever more effort and resources. And sometimes eventhose efforts and resources are not a warranty of success. A good example isTaseko Mines’ New Prosperity project, situated in British Columbia, with reservesof 11mn toz gold and 4.2bn lb copper. Back in 2010, the project received provincial
permits – but not federal ones. Taseko modified its development plans andresubmitted the application, but unsuccessfully. Now, more than 10 years later, theproject is still frozen, without any meaningful progress having been made.
Well-known is the story of the giant Pebble deposit in Alaska. Its resources containcopper, gold, silver, molybdenum, and rhenium worth more than USD 600bn atcurrent metal prices. However, there is strong opposition against the project, due
to the potential damage that could be caused to the salmon population in Bristol
Bay. As a result, the permitting process turned into a never-ending story.
Also worth mentioning is the story of Lydian International. The company wasbuilding the Amulsar gold mine in Armenia. Yet shortly before the mine wascompleted, some of the locals who opposed the mining project initiated a roadblockade that disrupted construction activities. An Armenian court declared theblockade illegal, but the Armenian government was unable to enforce the law andend the blockade. As a result, Lydian went bankrupt, as it was unable to start
repaying the debts it took up to fund mine construction.

Resource Nationalism: Governments Want a(Much) Bigger Share of the Pie
The more the state "plans" theAnother problem miners have to face are growing government demands. In

more difficult planning becomesdeveloped countries it is harder and harder to get a mine permitted; but at least,

for the individual.

after permission is granted and the mine built, ownership rights are well protected.

Friedrich August von Hayek

On the other hand, in emerging and developing countries it is often easy to build amine; however, it is harder to keep it, as governments want bigger and bigger
shares of the pie. Besides increasing production taxes, they sometimes decide to
seize a mine.
The latest example is Centerra Gold and its Kumtor mine. The mine is located in
Kyrgyzstan, a central-Asian former Soviet republic. The giant mine has been in
production since 1997, and over the last 5 years it produced 561,000 toz gold peryear on average. Moreover, all-in sustaining costs (AISC) are only around
USD 700/toz gold, and reserves should be sufficient for another 10 years of mining
at current rates. Centerra has long had problems with local authorities, who
accused the mine of violating environmental regulations. Moreover, the Kyrgyz
government demanded higher taxes. The situation escalated in spring 2021 when atailor-made law enabling the government to impose external management over the
Kumtor mine was adopted by the Kyrgyz parliament, and the mine was

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The Challenges of the Gold Mining Industry

322

subsequently nationalized. An arbitration between Centerra and Kyrgyzstan isunderway, but the damage to Centerra’s share price was already done.
But this is no exception. Barrick Gold has been in disputes with the government ofPapua New Guinea over the Porgera mine for years, and Freeport-McMoRan wasforced to give away the majority stake in the Indonesian Grasberg copper-gold
mine.

Political Instability
Boy, that escalated quickly.

Politics does not impact the miners only through higher taxes and mine

Ron Burgundy

seizures. For example, Africa has recently been hit by a wave of coups. In 2021,
coups occurred in Mali, Sudan, Guinea, and Chad, and also Burkina Faso in
January 2022. The coups bring a lot of insecurity, as they are usually accompanied
by some violence that may escalate rather quickly. Moreover, it is usually hard to
guess what policies to expect of the new government, which is often led by militaryleaders whose ability to throw their weight around far exceeds their ability tounderstand simple economic mechanisms. This is why investors tend to punish
mining companies operating in politically unstable countries, even if theiroperations are not affected, or at least not directly.

It is not the strongest who

Of the Western gold miners with notable exposure to Russia, Kinross issurvive, nor the most intelligent,

the biggest. The Kupol mine was projected to produce 350,000 toz of gold

but the most responsive toequivalent in 2022, which would equal to 13% of Kinross’ overall production.

change.

However, Kinross also owns the feasibility-stage Udinsk project. According to thisCharles Darwin

prefeasibility study, Udinsk was meant to produce nearly 300,000 toz gold peryear at an AISC of USD 580/toz on average, over a 7-year mine life. Shortly after
the beginning of the war, Kinross has suspended its Russian operations. The initial
market reaction to the war in Ukraine sent Kinross’ shares down 10% , but thelosses were recovered in less than two weeks. According to the latest news, Kinrossmade an agreement with Highland Gold, to sell Kupol and Udinsk for USD 600mn.

Share Dilution
I cannot forecast to you theAnother potential problem is share dilution. For mining companies, equity

action of Russia. It is a riddle,

financing is often the only option for financing common operations and further

wrapped in a mystery, inside an

development of mining projects. The negative impacts of share dilution are mostenigma; but perhaps there is a

visible in the case of the explorers and junior miners. They often have only very

key. That key is Russian national

limited access to other financing options; and due to the risky nature of theirinterest.

business, they often have to undergo equity financings at very unfavorable terms.

Winston ChurchillThat means they must issue new shares at very low prices, and they often have to
add some warrants in order to attract more investors. As a result, their sharecounts may grow by hundreds of percent in only a few years.

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The Challenges of the Gold Mining Industry

323

Basic Weighted Average Shares Outstanding, 100 = 2012, 20122021
180
170
160
150
140
130
120
110
100
90
2012

Newmont

2013

2014

Barrick Gold

2015

2016

Yamana Gold

2017

2018

IAMGOLD

2019

2020

Eldorado Gold2021

New Gold

Source: Company Annual Reports, Incrementum AG

The chart above demonstrates that share dilution also impacts the bigger players in
the gold mining industry. They are less dependent on equity financings, as they
have much better access to debt financing. However, they often use shares ascompensation for their managers and directors. And, sometimes, they encounter
operational issues, and as their debt capacity is exhausted, equity financing is the
only option for getting out of trouble. For example, CAPEX overruns during Rainy
River mine construction were a major factor behind New Gold’s 47% growth inshare count between 2012 and 2021. And Eldorado Gold was negatively affected byoperational issues at the Kisladag mine, which contributed to 31% growth in sharecount over the same time period.
Moreover, the mining companies commonly pay for acquisitions of
new projects or whole companies with their shares. As can be seen in thechart above, Barrick Gold’s share count grew by 78% over a 10-year period.
However, the majority of the growth is attributable to the merger with Randgoldthat was completed in 2019. Similarly, the majority of Newmont’s share countgrowth is attributable to the merger with Goldcorp. In these cases, share dilution
doesn’t have to be a bad thing. Of course, that assumes that the asset that is being
acquired is reasonably valued and the acquirer is not overpaying.

Declining Reserves and Number of New
Discoveries
Discoveries cannot be planned,

A big problem of the gold mining sector is the declining number of new gold

they pop up, like Puck, in

discoveries, regardless of the volume of exploration budgets.88 As shown in theunexpected corners.

chart below, although exploration budgets are more than twice as high as in the

Max Perutz

1990s or early 2000s, the volume of discovered gold is much smaller. This meansthat in general it has become significantly more expensive to discover an ounce ofgold. As a result, it has become more and more difficult – and also more expensive– for the gold miners, especially the big ones, to replenish the extracted ounces.

—

88 See “Gold Mining Stocks –After the Creative Destruction, a Bull Market?,” In Gold We Trust report 2019

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The Challenges of the Gold Mining Industry

324

A study by S&P Global Market Intelligence shows that in recent years thecompanies focused more on exploration of known deposits, i.e.brownfield
exploration, instead of grassroots exploration. Therefore, out of 329 gold deposits
discovered between 1990 and 2020, only 29 were found over the last decade.
Moreover, they contain only 8% of all gold discovered since 1990. This is the main
reason why S&P expects gold production to be relatively flat in 2022 and 2023 andto start declining in 2024.
…the gold price has to rise (toAs can be seen in the next chart, even the biggest gold miners, despite theirstimulate more exploration andexpertise and deep pockets, have problems replenishing reserves. Out of the top

make more projects economic) or

five gold miners, only Polyus Gold did not experience a decline over the past

we have to either be

decade. The reason is the giant Sukhoi Log deposit, where reserves of 40mn toz

smarter/more efficient atgold were outlined in 2020. Newmont’s reserves experienced only a slight decline,

exploration.

thanks to the merger with Goldcorp back in 2018. The main reasons for declines

Richard Schodde

are depletion of deposits; sale of assets, usually the non-core ones; and, in 2012–2013, following the steep gold price decline, updating reserves figures using lower
gold prices, as a smaller portion of resources is now economically mineable andcan thus be classified as reserves.

Volume of Gold Reserves, in mn Troy Ounces, 2011-2020
160
140
120
100
80
60
40
20
0
2011

2012

2013

2014

2015

2016

Newmont

Barrick Gold

AngloGold Ashanti

Kinross Gold

2017

2018

2019

2020

Polyus Gold

Source: Compnay Annual Reports, Incrementum AG

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The Challenges of the Gold Mining Industry

325

CAPEX Overruns
Inflation takes from the ignorant

A study prepared by McKinsey and PDAC investigated 41 gold minesand gives to the well informed.

established between 2008 and 2018 that had a CAPEX of USD 0.5bn or

Venita VanCaspel

higher. According to their results, only 20% of investigated projects experienced
no cost overruns. On the other hand, 44% of projects experienced 15-100% cost
overruns, and 19% of projects suffered even greater than 100% cost overruns.
A notorious example of a giant cost overrun is Barrick Gold’s Pascua
Lama project. Its initial CAPEX was, back in 2000, estimated at USD 1.2 bn. By
2004, the estimate grew to USD 1.4–1.5bn. In 2009, when mine construction
started, CAPEX was estimated at USD 2.8–3.0bn. In 2011, Barrick announced thatmine construction would cost USD 4.7–5.0bn. However, in 2012 the number
increased further to USD 7.5–8.0bn. In 2013, rumors that the CAPEX would
exceed the USD 10bn mark started to spread. This is when Barrick decided to halt
Pascua Lama mine construction indefinitely. Barrick blamed the cost overruns on
construction delays and higher labor, energy, material, and project-management
costs.
The latest example, although much less dramatic, is Argonaut Gold and its Magino
project. When mine construction started in early 2021, CAPEX was projected at
USD 510mn. However, in December 2021 Argonaut announced that the price tag
had increased to USD 800mn, that is, by 57%. And investors should prepare to see
similar announcements more frequently in the near future, as prices of steel,copper, and other materials needed for mine construction are rising, just likeenergy prices. Furthermore, current inflation levels will soon lead to increasing
wage demands. Thus, the probability of CAPEX overruns is growing rapidly,
especially in the case of mining projects that are in the construction phase, but for
which feasibility studies were completed a year or two ago, or even earlier.

Growing Production Costs
A similar problem is growing production costs. This indicator is hard to follow on alonger time span, because the generally accepted methodology of reporting
production costs, AISC, was adopted only in 2012. Before 2012, gold miners useddifferent reporting methods and it was hard to compare their actual production
costs. However, it is not hard to see how much those costs have gone up. Today,the biggest gold miners, except for Polyus Gold, have AISC in the USD 1,000/toz
range. But only 20 years ago, in 2002, the gold price was around USD 300/toz.
Therefore the AISC (although no one used the measure back then) had to be below
USD 300/toz. At the current AISC, the whole industry would have been dead.
Inflation is like toothpaste. Once

The next chart shows the development of AISC of major gold producers

it’s out, it’s hard to put back in

between 2012 and 2021. Between 2012 and 2016, the miners were able to pushagain.

AISC down. They were able to do so because of weak construction materials

Karl Otto Pöhl

markets, declining energy prices, and a low-inflation environment. Declining gold
prices helped as well, as a lower gold price means that the miners pay lower
royalties. Moreover, declining gold prices forced some of the higher-cost miners toLinkedIn | twitter | #IGWTreport

The Challenges of the Gold Mining Industry

326

suspend some operations or to re-evaluate their mining plans and focus on highgrade sections of the deposits. Of course, this cannot be done forever. After sometime, the strategy fails, as the high-grade material gets extracted, there is only the
low-grade material left, and costs shoot back up. After 2016, AISC started tostagnate or even began to rise.

All-in Sustaining Costs (AISC), in USD per Troy Ounce, 2012-2021
1,600
1,400

1,200
1,000
800
600
400
200
0

2012

Newmont

2014

Barrick Gold2016

Polyus Gold

2018

2020

AngloGold Ashanti

2021

Kinross Gold

Source: Compnay Annual Reports, Incrementum AG

This trend was exacerbated by the Covid-19 pandemic, as some miners had tointerrupt production, which pushed production volumes lower and production unit
costs higher. Moreover, even miners that were not impacted by the pandemic
directly had to adopt some pre-emptive measures that added to their costs.
Moreover, over the past year or two, energy prices increased significantly,
construction materials prices did too, and inflation came roaring back; thus, we
may expect that escalating wage demands are only a matter of time. Add to thishigher gold prices and therefore higher royalties to be paid by the miners,
declining gold grades and the need to extract gold from greater depths or from
deposits located in remote places with extreme weather conditions, and we could
see an AISC of over USD 1,000/toz become the new normal.

The Current Inflation Environment and Related
Challenges
What are you going to do about

The last two factors, CAPEX overruns and growth of production costs,

inflation?

are poised to be especially haunting to the mining industry in the

Print more money!

foreseeable future. The reason is that the genie of inflation has escaped theWe can’t do that, sire!

bottle. The chart below shows the evolution of annual inflation rates in some of the

There is no more gold to back itmajor gold-producing countries over the last 10 years. The current trend in all ofup!

the seven countries is clear. Prices are growing strongly. For countries like Russia,

Whew! For a moment there I

Mexico, or South Africa, this situation isn’t new. But that cannot be said about thethought we were out of paper.

US or Canada, where in April 2022 the inflation rate increased to 8.3% and 6.8%

Wizard of Id

respectively. For the US, this is the highest inflation rate since the early 1980s. For
Canada, inflation is at its highest point since 1991.

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The Challenges of the Gold Mining Industry

327

Inflation, yoy%, 01/2012-04/2022
23%

18%

13%

8%

3%

-2%
2012

2013

2014

2015

RussiaMexico

2016

2017

Chile
Canada

2018

2019

2020

2021

USA
South Africa

2022

Peru

Source: Reuters Eikon, Incrementum AG

Inflation is like a drug in more

According to a study by Goldmoney, the biggest operating cost of the top gold

ways than one. It is fatal in theminers is labor (39%), followed by fuel and power (20%), consumables (20%),

end, but it gets it votaries

maintenance (11%), and other costs (10%). Fuel and energy costs have already(devout adherents) over many

increased. Oil prices crossed the USD 100/bbl level, a level last seen back in 2014.

difficult moments.

Given current inflation levels, more meaningful growth in labor costs is also only a

Lord D’Aberon

question of time. Thus, investors should be prepared for gold production costs tokeep on growing for some time.
The industry is already feeling the impacts. The table below shows thedevelopment of AISC of major gold producers during 2020 and 2021. As can beseen, companies like AngloGold Ashanti, Kinross Gold, and Polyus Goldexperienced significant AISC growth in 2021. Newmont and Barrick Gold havemanaged to keep their costs under control for now; however, given the growing
inflation pressures and oil prices reaching their highest level in more than adecade, this shouldn’t last for much longer.

All-in Sustaining Costs (AISC), in USD per Troy Ounce, Q1/2020Q4/2021
1,600
1,400
1,200
1,000

800
600
400
200
0
Q1/2020

Newmont

Q2/2020

Q3/2020

Barrick Gold

Q4/2020

Polyus Gold

Q1/2021

Q2/2021

Q3/2021

AngloGold Ashanti

Q4/2021

Kinross Gold

Source: Compnay Annual Reports, Incrementum AG

The growing labor and energy costs will also push mine construction expenditureshigher. Moreover, prices of other goods important for construction are rising,according to the data of the Construction Association.

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The Challenges of the Gold Mining Industry

328

Prices Change for Important Construction Goods, in %, 2021
60%

54.9%

50%

44.9%
36.9%

40%
30%
17.6%

20%
10%

8.5%

10.1%

11.2%

Construction
MachineryandEquipment

Trucks4.2%0%CementConcrete
Products

Lumber and Sheet Metal FabricatedPlywood
Products
Structural
Metal

Diesel FuelSource: Construction Association, Incrementum AG

The increased costs may be partially reflected in feasibility studies thatwere completed in Q4 2021 or in 2022, but all of the older studies used
lower prices. As a result, investors should be prepared for a wave of negative
surprises in the form of CAPEX overruns. And subsequently, after the projects get
into production, actual production costs will most likely be notably above original
projections. Some companies may decide to delay mine construction and prepare
an updated feasibility study first, in order to avoid negative surprises. However,
the resulting delays and, almost certainly, the worsened economics of the projects
will not bode well for the companies’ share prices.
The gold industry is now a real

Of course, the higher-inflation environment should be positive for gold

business.

prices, which should compensate for the higher capital and production

Alex Blackcosts. But there is no guarantee that the gold price will increase enough to fully
offset the higher costs. However, there are also the royalty & streaming companies,
which will benefit from higher gold prices while not having to worry too muchabout inflation, as their “production costs” are more or less fixed.

Conclusion
Prospecting for gold is like

Although there are relatively short time periods when shares of gold

looking for true love: for every

miners record really great returns, over the last 15 years theynugget there’s a ton of rock andunderperformed gold heavily. This wasn’t always the case. For decades,

dirt.

the gold miners were closely correlated with the gold price and the returns were

Lord Richard Headsimilar. The abrupt change came during the Global Financial Crisis of 2008, when
the gold miners as a group started to underperform. Of course, not all of them did.
There are exceptions that are able to outperform gold even over longer-term
investment horizons, but they are just a strong minority.

The value of actions lies in their

The main reasons for the underperformance are CAPEX overruns, growing

timing.

production costs, problems with obtaining permissions for new mines,

Laozi

governments wanting a bigger share of the pie, political instability in somecountries where gold mines are located, as well as declining reserves and numbers

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The Challenges of the Gold Mining Industry329

of new discoveries. As not all of the miners are impacted by all of these factors andnot equally, it is important to choose the right company when making a long-term
investment in the gold mining industry.
It is often a long road to quick

The best strategy is to buy shares of a company operating in a safe andprofits.

mining-friendly jurisdiction, with low production costs, reasonable

Humphrey B. Neill

CAPEX, and good exploration potential. And, of course, to buy the shares at
the right price. That means timing the market properly and avoiding buying at the
top of the cycle. As Baron Rothschild once cynically remarked, the best time to buy
is when there is blood in the streets, even if it means holding the shares for several
years without any major gains and waiting for the next bull market.

As an investor, as long as you

In the foreseeable future, inflation should be an important factor

understand something better

impacting the performance of the gold miners. High-cost producers

than others, you have an edge.

especially may get into trouble if their production costs increase further. Some

George Soros

unpleasant surprises may also be encountered by the development-stage
companies, due to the high probability of CAPEX overruns. However, there arealso the royalty & streaming companies, a segment of the mining industry thatshould do very well in an inflationary environment, and that is why we will do a
deep dive into the R&S sector in the following chapter.

•

LinkedIn | twitter | #IGWTreportUnearthing Opportunity.
Discovering Value.
TSX.V: EMX
NYSE American: EMX
Frankfurt: 6E9

52-week High: $3.67 / Low: $1.87

EMX Royalty holds a significant royalty over Zijin Mining’s giant
Timok Copper-Gold Project in the Bor District of Serbia.*

EMX holds a 0.7335%
Net Smelter Royalty on theoperating Caserones CopperMolybdenum mine, where EMX
enjoys current and expects
continued long-term cash flow.

n

n

n

* EMX’s 0.5% NSR royalty is subject to reduction
only as provided in the royalty agreement.

Transformative Cash Flow
Projected In 2022 from Production
Royalties On Gold, Silver, Copper,
Zinc, Molybdenum and Lead
Major Investors In EMX Shares
Include EMX Management, Directors
and Employees, Franco-Nevada,
Newmont Mining, SSR Mining,
Stephens Investment Management,
Sprott Inc, Adrian Day AssetManagement, US Global Investors
and the EuroPac Gold Fund
Incoming Cash Flow From
Production Royalties, AdvanceRoyalty Payments, Milestone
Payments, Managements Fees,
and Annual Property Payments

EMX Royalty holds a 1% gross smelter
royalty over a portion of Nevada Gold
Mines’ Leeville (left), Four Corners andCarlin East deposits, providing theCompany with ongoing cash flow.

EMX Royalty is The Royalty Generator
The Company enjoys cash flow from royalty assets which it generates
organically and through value-driven acquisition. EMX’s royalty generation
business model supports global precious, battery and base metals
exploration leading to the organic creation of mineral royalties.
The Company has royalty and exploration properties in the United States,
Canada, Sweden, Finland, Norway, Serbia, Australia, Turkey,
Chile, Peru, Mexico and Haiti.

Isabel Belger, Manager of Investor Relations for Europe
IBelger@EMXRoyalty.com | +49 178 4909039

Scott Close, Director of Investor Relations
SClose@EMXRoyalty.com | +1 303.973.8585

emxroyalty.com
EMX Royalty Corp | 543 Granville St., Suite 501 Vancouver, BC Canada V6C 1X8

Company Descriptions

331

Royalty & Streaming
Companies: An Excellent
Way of Investing in Gold“We are what we repeatedly do.
Excellence, then, is not an act, but ahabit.
Aristotle

Key Takeaways• The precious metals royalty & streaming companies

represent an attractive way of investing in gold, as theirbusiness model offers some advantages of classicalmining companies while eliminating the majority ofdisadvantages.
• This segment of the mining industry has grown inmarket capitalization from USD 2bn to more than
USD 60bn in 15 years.
• An index of the precious metals royalty & streaming

companies has been able to outperform the precious
metals miners, gold, and silver on a regular basis.
• There are approximately 20 precious metals-focusedroyalty & streaming companies of different sizes andinvestment strategies, which offer investors relatively
rich choice.
• A consolidation of the precious metals royalty &streaming industry is underway.

Royalty & Streaming Companies: An Excellent Way of Investing in Gold332

We truly live in challenging times, that support the importance of gold
as a safe haven asset and inflation hedge. Nowadays, a wide range of options
for investing in gold, as well as other precious metals, is available to retailinvestors. It’s possible to buy physical metals in the form of coins, medals, or bars,
or to invest in one of the financial derivatives with precious metal as the underlying
asset, or to invest in a mutual fund or ETF backed by physical or “paper” gold.
To anticipate the market is to

The advantages and disadvantages of physical metal and financial derivative

gamble. To be patient and react

investing are combined in the stocks of mining companies. These stocks are backed

only when the market gives theby real physical assets but at the same time provide leverage to the metal’s price. In

signal is to speculate.

other words, they are less risky than financial derivatives but riskier than physicalJesse Livermore

metals. Some investors have already recognized that there is, however,
one specific segment of the mining industry which offers attractive
returns at significantly reduced risk: the royalty and streaming (R&S)
segment.

The Royalty & Streaming Business Model
During the gold rush its a good

Royalty & streaming companies (R&S) do not build mines; they do nottime to be in the pick and shovel

produce gold, or silver, or anything else. They do not have to deal with costbusiness.

overruns, growing labor costs, or endless permitting processes. As their nameMark Twain

indicates, R&S companies simply invest in royalties and streams. It is, of course,
somewhat more complicated than it sounds.
It is important to understand what exactly a royalty or a stream is. A royalty is aright that entitles its owner to receive a share of the proceeds from the sale of amine’s production. A stream entitles its owner to buy a portion of a mine’s
production at a predetermined price, usually far below the prevailing market price.
There are, however, further differences between these two asset types.
First of all, it is important to understand the difference in the purpose for whichthese instruments are created. Royalties are usually created in the earlier
development phases of a mining project and form part of the transaction when title
rights are transferred from one party to another. For example, an independent
explorer sells his claims to a junior mining company for USD 1mn and a 2% NSR
royalty. Streams are distinct from royalties in that they are usually created in thelater development stages of a mine and form part of the mine’s financing package.
Take for example: A company needs to fund construction CAPEX of
USD 500mn. It takes on USD 300mn of debt, issues new shares worth
USD 100mn, and sells a 15% gold stream for USD 100mn. This way, the miner
technically gives away a part of the future cash flow generated by the project, butthat is a preferred option to equity financing, whereby they give away part of thecompany. To simplify, royalties are created when a junior explorer needs money tocontinue exploring his land package. Streams are created when a mine developer
needs to raise capital to build a mine.

LinkedIn | twitter | #IGWTreportRoyalty & Streaming Companies: An Excellent Way of Investing in Gold333

If you don’t find a way to makeThe owner of a royalty does not have to make any ongoing payments

money while you sleep, you will

related to the royalty. He pays to acquire the royalty and then he collects

work until you die.

payment on a regular basis. On the other hand, the owner of a stream must makeWarren Buffett

not only an initial investment to acquire the stream but also ongoing payments inorder to acquire his share of the mine’s production. It is important to note that theongoing payments are usually far below the actual market price of the underlying
commodity. This price can be fixed, e.g. USD 300/toz gold, or be a percentage ofthe prevailing market price, e.g. 25% of the average gold price recorded over theprevious 30 days. As additional security for the stream owner, if the ongoingpayments have been agreed at a fixed price, the contract usually includes a security
clause specifying that the stream owner pays either the predetermined price or theprevailing market price, whichever is lower.
Another distinction between royalties and streams is size. While royalties
usually apply to a very small portion of production, generally only up to 3% of all
extracted minerals, streams routinely apply to 10-30% of a mine’s production.
When a stream applies to a byproduct of the mine, the number often goes up to
100%. However, there are cases where royalties are much higher than 3%. Thismay cause some problems as it inflates production costs and may discourage
miners from investing in further exploration and mine development.

The trouble is, you think you

Another consideration is the time factor. While royalties are usually applicable forhave time.

the entire lifetime of the mine, streams often apply only until a prespecified

Buddhavolume of production is delivered. After this threshold is reached, the stream
ceases to exist or is modified. For example, after 100,000 toz of gold is delivered, astream is reduced from 30% to 15% of gold production and the ongoing payment
increases from 20% to 35% of the prevailing gold price.
There are several basic types of royalties. The most common is the net
smelter return (NSR) royalty. It entitles its holder to receive a certain share ofgross revenues generated by the mine, minus transportation, smelter, and refining
costs. Less common is the gross return (GR) royalty that is calculated as apercentage of gross revenue from the sale of mine production, with no additionalcosts deducted. A net profit interest (NPI) royalty entitles its holder to receive ashare of profits generated by the mining asset. Its owner usually starts receiving
payments only after the mine operator recovers his development costs. This type ofroyalty may be quite complex, and the cash flows may be hard to predict due to theaccounting practices of the mine operator. There are also production royalties thatare based on a fixed price per unit of production, e.g. USD 10/tonne of processedore. Although these types of royalties are typically for iron ore mines, they do exist
for gold mines, too.

Advantages and Disadvantages of theBusiness Model
The R&S model is unique, as it exploits some of the positive features of a classicalmining company, like exposure to potential exploration success and rising metal
prices, while it eliminates some risks, especially the risk of cost overruns during

LinkedIn | twitter | #IGWTreportRoyalty & Streaming Companies: An Excellent Way of Investing in Gold334

the mine construction phase and growing production costs. It is possible tosummarize the advantages of the business model in several points:• R&S companies face only a limited risk of growing production
costs: As there are no ongoing payments related to royalties andpredetermined ongoing payments related to the streams, the R&S company
does not have to be concerned about growing production costs at the mine.
Its cash flows will remain unaffected. However, this applies only as long as
the mine remains in production. If the production costs increase to such an
extent that the mine operator decides to halt mining operations, the R&S
company will be negatively impacted as well. No production means no
income from the stream or royalty.
• The risk of cost overruns is limited: If the mine construction becomes
more expensive than anticipated, the mine operator must find additionalsources of financing. This could create an opportunity for the R&S company
to acquire an additional stream or royalty on the project. Even if the CAPEX
grows to such an extent that the mine developer goes bankrupt, if the projectis viable, another mine developer will emerge to complete the project.
Although such delays may be uncomfortable, real trouble only starts for the
R&S company when there is no one willing to complete mine construction.
•

R&S companies are “happy campers”:89 If the mine operator decides toexpand the mine, the R&S company is not obliged to contribute any funds;
however, it will reap the benefits from the expanded mining operation in theform of higher cash flows. Similarly, the R&S company doesn’t have tocontribute to exploration expenses incurred by the mining company; but if
the exploration program is successful and the mine’s reserves increase, theR&S company will share in the benefits. The same can be said if a completely
new orebody is discovered on the property.

• Diversification is a tool for reducing risk: It is important to rememberthat the vast majority of exploration projects turn out to be unsuccessful.
Even if an economically attractive deposit is discovered, it does not mean thatbuilding the mine is a certainty. There are numerous technical andadministrative hurdles that need to be overcome first. R&S companies,
especially the big ones, hold streams and royalties on tens or hundreds ofproperties. This helps to diversify their risk significantly.
• The R&S companies can be very cost-efficient: While a traditional
mining company has hundreds or even thousands of employees, a R&S
company typically employs far fewer people. For example, the world’s biggest
R&S company, Franco-Nevada, had only 40 employees as of the end of 2021,
while its revenue was nearly USD 1.3bn. This amounts to USD 32.4mn per
employee. For comparison, the world’s biggest gold miner, Newmont
Corporation, had 14,400 employees and revenues of USD 12.2bn, or roughly
USD 850,000 per employee. As can be seen in the chart below, R&S—

89 They can just sit and wait for the others to do the work, and then reap the benefits.

LinkedIn | twitter | #IGWTreportRoyalty & Streaming Companies: An Excellent Way of Investing in Gold335

companies generate significantly higher revenues per employee than
traditional gold miners.

Revenue per Employee, in USD mn, FY2021
Franco-Nevada

32.44

Wheaton Precious Metals

27.31

Royal Gold24.18

Osisko Gold Royalties

6.35

Sandstorm Gold

4.60

Newmont Corporation

0.85

Barrick Gold

0.56

Kinross Gold

0.40

Agnico Eagle Mines

0.33

AngloGold Ashanti

0.13

0

5

10

15

20

25

30

35

Revenue per Employee
Source: Own processing, Macrotrends, Seeking Alpha, Incrementum AG• And last but not least, R&S companies maintain leverage to
growing metal prices.
Three things ruin people: drugs,

However, the business model also has some disadvantages. The leverage

liquor, and leverage.

to the metals prices is lower than in the case of the classical mining companies.

Charlie Munger

And the diversification, while decreasing the risk, at the same time limits theupside potential, as the R&S companies cannot bet everything on one card, even if
the card is a highly profitable multigenerational world-class project in the making.
Another disadvantage is lack of control. While the mining company can decide
what to mine and when to start mine development, when to expand the mine andwhen to shut it down, the R&S company can only sit and wait, as it has only limited
tools, if any, to affect decision making.

Man does not control his own

The lack of control may be problematic, especially when the stream orfate. The women in his life doroyalty is high, which may demotivate the mine operator. It limits thethat for him.

profitability of the mine, and the operator may start to neglect investments in

Groucho Marxfurther development, especially if he has other, more profitable projects. For
example, Maverix Metals owned a 7.5% NSR on Karora Resources’ Beta Hunt minegold production. This was an unusually high royalty that was created back in times
when Beta Hunt was a nickel mine with some gold byproducts. Therefore, the highroyalty on gold didn’t bother the old mine operator too much. However, Beta Huntlater evolved into a gold mine; and due to the high royalty, Karora was hesitant toinvest in production growth. As a result, Karora and Maverix renegotiated theroyalty and agreed to reduce it to 4.75%. Over the following year, Karora prepareda multiyear growth plan to increase the annual production volumes significantly.
But in general, under normal circumstances, the advantages of the R&S
business model outweigh the disadvantages. Therefore, the R&S companies
tend to outperform the classical miners, and their popularity keeps on growing, as
evidenced by the growing number of companies in this mining industry segment.

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336

History and the Present
Acting on a good idea is better

The pioneer of the precious metals R&S industry is Franco-Nevada.

than just having a good idea.

However, not today’s Franco-Nevada but its predecessor, established back in 1983.

Robert Half

The old company created the royalty business in 1985 when it acquired its
Goldstrike mine royalty. As time has shown, this transaction gave birth to acompletely new industry. Of course, the guys from Franco-Nevada did not inventroyalties themselves. The royalty business model had been widely used in the oil &gas industry. But Franco-Nevada was the first company that applied it to the gold
mining industry. By the way, Franco-Nevada’s Goldstrike royalty was a massive
success. The mine is still in production; Franco-Nevada still owns the royalty andcollects around USD 20mn per year.
Further royalties followed, and Franco-Nevada was the leader of the precious
metals R&S industry when it was acquired by Newmont in 2002. But in 2007,
Newmont decided to sell a big royalty portfolio that included many of the assets
formerly owned by the original Franco-Nevada. Franco-Nevada’s old management,
including Pierre Lassonde, its founder, decided to hit the jackpot once again. They
established a new Franco-Nevada and acquired the royalty portfolio offered by
Newmont. The new company followed up on the success of the old one, and now,
almost 15 years later, Franco-Nevada is the biggest player in the R&S industry,
with a market capitalization of more than USD 24bn, roughly equaling the GDP of
Iceland. When asked about the success of Franco-Nevada and its business model,
Pierre Lassonde responded:“We get a free perpetual option on the discoveries made on the land by theoperators, and we get a free perpetual option on the price of gold. It’s theoptionality value of the land, the value of the operator spending money on ourland, and the optionality to higher gold prices. And that is worth so muchmoney. When you buy a stream, on the other hand, you get price optionality.
You’re buying, say, 100,000 ounces of gold for the next 25 years. So you get
optionality on the price of the commodity, but you don’t get much optionality
on the land.”Silver, gold – I don’t

Wheaton Precious Metals, the second biggest company in the precious

discriminate! I like sparkly

metals R&S industry with a market capitalization of around USD 20bn,things.

was established in 2004, as Silver Wheaton. As the name indicates, itsCharlaine Harris

primary focus was silver, which has changed over time. The first asset was a 100%silver stream from Wheaton River Minerals’ Mexican Luismin mining operations.
This mine was producing approximately 8mn toz silver per year, which meant astrong start for Silver Wheaton. Further streams followed soon after. In 2004,
Silver Wheaton acquired a 100% silver stream from Lundin Mining’s Zinkgruvan
mine, which was supposed to deliver around 2mn toz silver per year. The company
kept on growing, but it didn’t focus purely on silver, and the share of gold in its
revenues kept on growing. In 2016, after the acquisition of the gold stream from
Vale’s Salobo mine, the revenues became almost equally split between gold andsilver. Subsequently, in 2017, Silver Wheaton changed its name to Wheaton
Precious Metals. Today, the company maintains bigger exposure to silver than its

LinkedIn | twitter | #IGWTreportRoyalty & Streaming Companies: An Excellent Way of Investing in Gold337

peers; however, its main source of revenue is gold. In 2021, Wheaton’s attributableproduction equaled 342,546 toz gold, 26mn toz silver, and 20,908 toz palladium.
The third biggest company, Royal Gold, was established in 1986, when oil & gas
company Royal Resources acquired Denver Mining Finance Corporation. The
merged company wanted to become a gold mining company; however, it quickly
refocused on the royalty business model. Its cornerstone asset became the Cortez
mining complex royalty. Although restructured, it is still held by Royal Gold today.

Market Capitalization of the Precious Metals R&S Industry, in USD
bn, 2004-2020

70

61
60
50
40

33

32
27

26

30

23

20
10
2

5

7

0
2004

2006

2008

2010

2012

2014

2016

2018

2020

Market Capitalization of the Precious Metals R&S Industry
Source: Own processing, Bloomberg, Company Reports, Scotiabank, Incrementum AG

Over time, numerous new precious metals-focused R&S companies
emerged. And the overall market capitalization of the industry grew as well, from
USD 2bn in 2004 to USD 66bn as of April 2022.
Today, there are approximately 20 R&S companies primarily focused on precious
metals. However, only 6 of them have a market capitalization of over USD 1bn:
Franco-Nevada, Wheaton Precious Metals, Royal Gold, Osisko Gold Royalties,
Triple Flag Precious Metals, and Sandstorm Gold. The rest are well below the
USD 1bn mark. And the smallest ones, Star Royalties and Empress Royalty, eachhave a market capitalization of well under USD 50mn.

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338

Market Capitalization as of April 30, 2022, in USD mn
Franco-Nevada

28,923Wheaton Precious Metals

20,245

Royal Gold

8,565

Osisko Gold Royalties

2,273

Triple Flag Precious Metals

2,240

Sandstorm Gold

1,424

Maverix Metals

664Gold Royalty

483

Nomad Royalty

467

Metalla Royalty and Streaming

257

EMX Royalty Corporation

214

Trident Royalties

178

Great Bear Royalties

109

Vox Royalty

108

Elemental Royalties

89

Altus Strategies

86

Sailfish Royalty Corp

80

Orogen Royalties

62

Star Royalties

38

Empress Royalty

21

Source: Own processing, money.tmx.com, Incrementum AG

M&A Wave Ahead?
Too many companies are looking

As the number of precious metals R&S companies increased notably infor a Brad Pitt when in the rightrecent years, the question of the inevitability of an industry-widecircumstances, they might beconsolidation emerged. Investors didn’t have to wait for long. On June 21,

able to settle for a Bart Simpson.

2021, Gold Royalty, one of the smaller players, established only in 2020,

Liam Twigger

announced the acquisition of ELY Gold Royalties. And in September it alsoacquired Abitibi Royalties and Golden Valley Mines. Due to the acquisitions, Gold
Royalty’s market capitalization increased from approximately USD 200mn tonearly USD 700mn, and its number of assets grew to more than 190. But Gold
Royalty remained hungry. In December, it decided to make another acquisition.
This time, it elected Elemental Royalties. However, while the first two transactions
were friendly, this attempt was hostile and so far unsuccessful. On the other hand,recently announced Sandstorm Gold’s friendly acquisition of Nomad Royalty will
most probably come through. It should help Sandstorm significantly boost its
near-term growth prospects. Given the number of smaller players, it is possible toexpect that the consolidation will continue and further deals will emerge sooner orlater.

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339

Mergers are like marriages.

The growing number of R&S companies means that various investment

They are the bringing together ofstrategies have also emerged. The big players have a large number of royalties

two individuals. If you wouldn’t

in their portfolios; however, their main assets are streams. A typical stream

marry someone for theprovides a bigger cash flow than a typical royalty, which is more suitable for big‘operational efficiencies’ they

companies. A royalty that generates USD 2-3mn per year may be very interesting

offer in the running of afor the smaller players like Empress Royalty or Star Royalties, but not so much forhousehold, then why would you

Franco-Nevada or Wheaton Precious Metals. Another advantage for the bigger

combine two companies withplayers is that the streaming segment is not so crowded. There are only a limited

unique cultures and identities fornumber of companies that can afford to acquire a substantial stream valued atthat reason?

several hundred million USD, therefore there is lower competition. On the other

Simon Sinek

hand, almost every one of the abovementioned 20 companies can afford to acquirea royalty valued at USD 20mn or less. The desire to start making bigger deals is
probably one of the reasons why Gold Royalty pursues the growth path soaggressively.

In order to achieve superior

Some of the smaller companies have developed specific strategies

results, an investor must be able

when it comes to acquiring new assets. For example, Empress Royalty– with some regularity – to findstresses that it prefers creating new royalties to acquiring the old ones. Therefore,

asymmetries: instances when theit collaborates directly with the mining companies. Vox Royalty elected to takeupside potential exceeds thequite the opposite route. Its main competitive advantage is a proprietary database

downside risk. That’s whatof more than 8,000 royalties. Vox claims that it is the largest database of this kind

successful investing is all about.

in the world, and that it enables it to better identify and approach potential sellers

Howard Marksof these royalties. That may be true, as shown by Vox’s recent acquisition of aroyalty on Sibanye’s Limpopo project, with measured, indicated, and inferredresources of 36mn troy ounces of platinum, palladium, rhodium, and gold.
Royalties and streams on such attractive assets are usually held by the bigger
players. Moreover, Vox acquired the royalty at a very reasonable price.
There are also companies that create their own royalties. They technicallycombine the project generator and R&S business models. They originally started as
project generators, but as the projects started maturing, their portfolio of royalties
kept on expanding and became the more important part of their business. A typicalexample is our dear premium partner EMX Royalty, formerly known as Eurasian
Minerals. Today, EMX owns nearly 150 royalties on projects in different parts of
the world, but it also has numerous exploration projects and keeps on selling themto other companies.

Diversification is a protection

And then there are companies that adopted, or tried to adopt, a hybrid

against ignorance. It makes very

model. That means they not only invest in streams and royalties but also try tolittle sense for those who know

develop their own mining projects. Although this model may provide attractive

what they’re doing.

upside potential, it also brings back some of the operational risks that the typical

Warren Buffett

R&S business model eliminates. This is why the hybrid model is not too popularamong investors. A good example of the challenge is Osisko Gold Royalties. In late2019, after the acquisition of Barkerville Gold and its Cariboo project wasannounced, Osisko’s shares started lagging behind its peers. The situation began
improving in the autumn of 2020 when a spin-out of the exploration project into aseparate entity called Osisko Development was announced and completed.

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A vegan in a Hummer has a

Attention should also be paid to the newest trend in the R&S industry,

lighter carbon footprint than acarbon credit streaming. The recent surge in carbon credit prices attracted thebeef eater in a Prius.

R&S companies. For example, Star Royalties established a daughter company

Michael Pollan

called Green Star Royalties that is investing in carbon offset projects. The carbon
streams and royalties work in the same way as the gold streams and royalties. The
difference is that the cash flow is not generated by a mining project but by a carbon
offset project. The carbon offset projects, e.g. forest planting, reduce the volume ofcarbon dioxide in the atmosphere. The project operator receives carbon credits
equivalent to the volume of eliminated carbon dioxide. The carbon credits aresubsequently sold to companies, e.g. steel makers, coal plants, etc., that need themto compensate for the carbon dioxide they release into the atmosphere. StarRoyalties is just a a small player entering the carbon streaming industry. The
leader of this R&S industry segment right now is Carbon Streaming
Corp. Further IPOs are expected in this segment.

The performance of the R&S industry
As mentioned earlier, the R&S companies have numerous advantages
in comparison to the common mining companies. This makes them anattractive investment option. However, what is probably the most important istheir performance in comparison to other assets, whether the mining stocks or
physical metals.
In order to be irreplaceable, one

The chart below shows the performance of a simple R&S index calculated as anmust always be different.

average return of the top 5 industry players – Franco-Nevada, Wheaton Precious

Coco Chanel

Metals, Royal Gold, Sandstorm Gold, and Osisko Gold Royalties (added as of July
7, 2016). As can be seen, over the last 10 years, the R&S index outperformed gold,
represented by the SPDR Gold Trust ETF (GLD), and silver, represented by theiShares Silver Trust ETF (SLV), as well as gold and silver miners, represented by
the VanEck Vectors Gold Miners ETF (GDX) and VanEck Vectors Junior Gold
Miners ETF (GDXJ). The outperformance of the precious metals miners is
especially impressive: When the R&S index grew by 90%, the GDX declined by 41%
and the GDXJ by 64%.

Performance of GLD, SLV, GDX, GDXJ, and R&S, 0% = 12/2011, in%, 12/2011-04/2022

150%

100%

50%

0%

-50%

-100%
12/2011 12/2012 12/2013 12/2014 12/2015 12/2016 12/2017 12/2018 12/2019 12/2020 12/2021

GLD

SLV

GDX

GDXJ

R&S

Source: Own processing, YahooFinance, Incrementum AG

LinkedIn | twitter | #IGWTreportRoyalty & Streaming Companies: An Excellent Way of Investing in Gold341

In any investment, you expect to

The R&S companies have recorded superior performance on shorter time periods,

have fun and make money.

as shown in the chart below. They outperformed GLD, SLV, GDX, and GDXJ overMichael Jordan

the 5-year, 3-year, and also 1-year time periods. The only exception is GDX overthe last 3 year, as it grew by 67,5%, while the R&S index grew by 67.46%.

103%

Performance Comparison, in %, 04/2017-04/2022
120%

57%

29%
8%

2%

7%

40%
20%

33%

46%

46%

60%

50%

46%

80%

67%

67%

100%

1 Year

GLD

-9%

-20%

-12%

0%

3 Years

SLV

GDX

5 Years

GDXJ

R&S

Source: Own processing, YahooFinance, Incrementum AG

Conclusion
Investing is not about a once-in-

R&S companies are an important segment of the mining industry.

a-lifetime opportunity. It is a life-

There are approximately 20 precious metals-focused R&S companies

long journey of prudentof different sizes and with different business strategies, which offers

investments that grow with time.

investors diverse options. In general, the precious metals R&S companies offer

You need to start small and let

an attractive way to invest in precious metals. They offer exposure to growing

the magic of compounding do its

metals prices, while eliminating operational risks related to classical mining

trick.

companies. Moreover, as the historical data shows, this mining industry segment isNaved Abdali

able to outperform gold and silver, as well as gold and silver miners, on a regularbasis.
There is space for further growth of the R&S industry. Moreover,investors may also benefit from adopting some new trends, such as carbon-offset
streams, or from taking advantage of the consolidation that is ongoing in theindustry right now.

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343

The New Low-Emissions
Economy: Gold as a Savior“The ESG push and related green
transformation effort have so muchpolitical capital behind them that
failure is simply not an option. The best
analogy to me is the euro.”
Steen Jakobsen

Key Takeaways• COP26, a call to a new economic paradigm: shifting to a

low-CO2 economy driven by the energy transition• Gold producers are well positioned to profit from theintroduction of a carbon tax.
• In the new low-emission economy, a new economic

metric must be created for the mining sector: all-in
emissions cost (AIEC). This metric will translatenonfinancial into financial, actionable costs forinvestors and stakeholders.
• Jurisdiction risk has evolved into one of the mining

industry’s primary sources of concern.
• Raising the gold allocation in an investor’s portfolio has

a notable positive impact on the carbon footprint andemissions intensity of the overall portfolio. Increasing
the gold allocation decreases the CO2 footprint of aportfolio even when compared to an allocation to the
S&P 500.

The New Low-Emissions Economy: Gold as a Savior

344

The current impact of

We start this year’s article where we left the In Gold We Trust report

decarbonization on prices is2021: the road to the Paris Accord, -1.5oC by 2030.90 We will be discussing

minimal - be it from emissions

COP26, the resulting paradigm shift to a low-emissions economy and its meaning

trading or carbon taxes. We

for gold-producing companies. We will be introducing a new metric for gold

must complete the green

producers: all-in emissions costs.

transition of the economy toprevent the Earth from turning

We will then look at gold’s competitive advantages over other asset classes with

into a frying pan.

regards to CO2 emissions and how gold can balance a portfolio’s emissions

Christine Lagarde

footprint. Finally, we will focus on a recurring theme for the past 18 months:
jurisdiction risk.

COP26: Driving the Change for the New
Economic Paradigm
To improve is to change; to be

After a 12-month pandemic delay, the UN Climate Change Conference (COP26)

perfect is to change often.

was held in Glasgow in October 2021. This was the international stage on which

Winston Churchill

the main ESG objectives for the next five years, if not decades, were defined. The
summit concluded with the unanimous adoption of the Glasgow Pact,
which aims to increase climate-control ambitions and actions by keeping the 1.5°C
target alive, better defining the urgency of tackling global warming and, in doing
so, reducing greenhouse gas emissions (GHG). This will require vigorously
pursuing the 2050 path to net zero emissions with actions rather than mere
promises.

Energy transition cost

Source: Way, Rupert, Penny, Mealy and Farmer, Doyne J: “Estimating the costs of energy transitionscenarios using
probabilistic forecasting methods,” INET Oxford Working Paper, No. 2021-01, p. 12

I am anti-tax, but I am pro-To achieve net zero, an unfathomable amount of capital will have to becarbon tax.

continuously deployed for decades. Consequently, where will the funds

Elon Musk

come from?

—90 See “ESG and Your Portfolio – Building a More Sustainable Future,” In Gold We Trust report 2021

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The New Low-Emissions Economy: Gold as a Savior

345

Will the New Low-Carbon Economy Save thePlanet or Governments?
I’ve got 99 problems, but the new

You guessed it: Funds will flow from the central banks’ printing presses. As

low-carbon economy isn’t one.

quantitative easing would gradually give way to quantitative tightening,

Not Jay-Z

central banks are on the lookout for new means to artificially boost theeconomy to avoid an economic meltdown and continue the endlessly
ballooning growth. No government leader wants to be admitted to an austerity
rehab program. In this vein, COP26 has provided the ideal escape route: saving theplanet, one tonne of CO2 at a time, by focusing on energy transition and reducing
CO2 emissions, whatever the cost. The new economy will avoid CO2 as much as
possible.
Financing the energy transition will allow governments to undertake new debtcreation objectives:• Raise monetary velocity: higher number of times one unit of currency isspent to buy goods and services per unit of time
• Create high-skilled employment opportunities• Replace lost opportunities in fossil fuels• Increase taxes: implementation of unified carbon credit system

So, I came up with ‘eMMT’,

To meet these objectives, money will have to flow differently than it has since QE

which stands for Environmental

was first implemented. Money will not go to bankers and a select few, as

Modern Monetary Theory.

previously, but to consumers, contractors, project owners, and financiers who are

Marin Katusa

assisting in the fight against climate change. As discussed in last year’s In
Gold We Trust report,91 we believe that gold miners should benefit
from such new financings and should focus on financing the energy
transition, with the main goal of maximizing emissions reduction.

Gold Miners and CO2 Emissions
The way in which mining

Gold mining companies emitted an average of nearly 1 tonne of CO2 per ounce oforganisations position

gold produced in 2019. However, strong differences exist both regionally andthemselves today in preparation

between open-pit versus underground mining methods. Underground mining

for this more sustainable future

operations have on average lower CO2 emissions than open-pit or hybrid mining,

could redefine competitive

as seen in the following chart.

advantage over the next decade.
Steven Walsh—

91 See “ESG and Your Portfolio – Building a More Sustainable Future,” In Gold We Trust report 2021

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The New Low-Emissions Economy: Gold as a Savior

346Gold mines emission average as function of mine type

Source: S&P Global: “Greenhouse gas and gold mines – Emissions intensities unaffected by lockdowns”

The following case provides an interesting insight into emission-reduction
possibilities, but also underlines that many other factors influence the emissions ofa gold mine:• Barrick/Newmont Nevada JV: Due to a rise in Scope 2 emissions fromelectricity purchased rather than produced on site, the joint venture’s 2020
emissions were 3.6 MtCO2e, a 25% increase year over year. The mine’s coalfired TS Power Plant has now been converted to run on natural gas by Barrick
and Newmont. The transition should eliminate around 650,000 tCO2e, orabout 24% of the site’s 2020 Scope 1 emissions, once completed.

Introducing a New Concept: All-In Emissions
Cost (AIEC)
These numbers are increasingly

Comparing gold mining companies or future gold mines solely on emissions isimportant – carbon taxes could

extremely difficult, as emissions are reported as nonfinancial information. The

come in, so you need to establish

incorporation of nonfinancial data into financial reporting is simply deficient.

your exposure.

Investors must sift through sustainability reports for hours to determine the costs

George Cheveley– both present and future – of Scope 1 and Scope 2 emissions. In the new lowemission economy, a new economic metric must be created for themining sector: all-in emissions cost (AIEC). This metric will translatenonfinancial into financial, actionable costs for investors and stakeholders.
AIEC = Scope 1 & 2 emissions times carbon credit price, divided bytotal ounces produced
The AIEC is the total of all Scope 1 and Scope 2 emissions of a gold mining
company, multiplied by the projected regional carbon credit price, divided by theamount of gold produced. Scope 1 emissions occur directly in the company, while
Scope 2 emissions are indirect GHG emissions associated with the purchase ofelectricity, steam, heat, or cooling. (Scope 3 emissions are those that occur in the
upstream and downstream supply chain. They are not included in AIEC.) For

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The New Low-Emissions Economy: Gold as a Savior

347

gold miners, we believe AIEC will be widely adopted throughout theindustry in short order.

EU ETS, in EUR, and UK ETS, in GBP, 01/2021-05/2022
100
90
80
70
60
50
40
30
20
01/202104/2021

07/2021

10/2021

01/2022EU ETS

04/2022

UK ETS

Source: ember-climate.org, Incrementum AG

We are looking at climate stress

As seen in the above chart, current carbon credit prices vary in different regions oftests. I think it’s very likely thatthe world and could accordingly lead to financial benefits and improved

climate stress scenarios, as we

economics, depending on the jurisdiction. We believe AIEC should not be included

like to call them, will be a key

in AISC, but rather be seen as a stand-alone metric. This will become one oftool going forward.

the most important metrics for new gold mining project financing, as it

Jerome Powellindicates long-term capital exposure and allows investors to easily translate CO2
emissions into US dollars and incorporate the result into their financial models.
AIEC will also allow investors to understand their current exposure and movecapital according to the actual costs of emissions rather than solely on the basis ofgeneric ESG scores regarding emissions.

Negative Impact of the Carbon Credit Tax, in % of EBITDA
IAMGOLD Corp

Coeur Mining
Newcrest Mining
Oceana Gold
SSR Mining
Pan american Silver
Eldorado GoldNew Gold
Endeavour Mining
Agnico Eagle Mines
Lundin Gold
-65% -60% -55% -50% -45% -40% -35% -30% -25% -20% -15% -10%

100$

-5%

0%

50$

Source: Bloomberg, S&P, Reporting Companies, Incrementum AG

For most gold mining companies, the imposition of a carbon tax would
have limited impact on their balance sheets. Additionally, forcompanies with high emissions, the tax would serve as an incentive torapidly plan and execute their energy transition.

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The New Low-Emissions Economy: Gold as a Savior

348

Portfolio Allocation: CO2 Impact of Gold as a
Financial Asset
Ignoring the need for ESG-

Gold has a significant advantage over other metals and, more broadly, most

focused knowledge and talentfinancial assets. When tracking a product’s CO2 exposure, most of the impact is

can have an effect on thefrequently attributed to Scope 3. However, Scope 3 emissions from goldcompany’s technical analysis,

mining companies are almost nonexistent, because their product, gold bars,

risk management, auditing, andwill undergo very little transformation, mostly through jewelry making anddisclosure capabilities. We can’t

minting. Also, and counterintuitively, gold has extremely low Scope 1 and 2 CO2wait on this. We’ve got to do it

emissions per ounce of gold produced for such large operations.

today.
Jennifer Reynolds

Consequently, increasing gold allocation in an investor’s portfolio results
in a notable positive impact on the carbon footprint and emissions
intensity of the overall portfolio.

Gold allocation and portfolio carbon intensity (tCO2e/USD 1mn)

Source: World Gold Council: “Gold and climate change – Decarbonising investment portfolios”, p. 2

Today, buying gold or gold

For a portfolio of 70% equities and 30% bonds, introducing a 10% allocation toequities is not only a good

gold (and reducing other asset holdings by an equal amount) lowered theinvestment from an ESG

emissions intensity of a portfolio by 7%, and a 20% holding in gold lowered it byperspective, but given its work in

17%, as calculated by the World Gold Council in a report titled “Gold and climate

remote, poor an otherwisechange – Decarbonising investment portfolios”.

neglected areas of the world, it
can also be one of the best impact

Even more interesting, studies have shown that not only does gold allocation haveinvestments you can make.

a positive impact on portfolio CO2 emissions, it also maintains its advantage

Peter Sinclair,against the S&P 500 and even the carbon-efficient version of the S&P 500.

Advisor, World Gold Council
Depending on how emissions calculations evolve over time, physical gold could be
the only truly neutral emissions asset, as physical gold has zero emissions because
all emissions are produced when mining and refining the gold. Holding physicalgold produces no emissions. This means that soon physical gold could
improve the emissions impact of a portfolio even more, and increase
its CO2 diversification.

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The New Low-Emissions Economy: Gold as a Savior

349

One problem with many green

Should investors now consider only emissions when investing in a gold

bonds is that they are issued bymining company? Such thinking would be extremely reductive of all issues

governments or government

regarding ESG. Even if the consequences of the COP26 resolution adoption is toagencies, making them harder

focus mainly on emissions, gold miners are facing increasingly difficult external

for central banks to buy at afactors, rendering investment decisions for all stakeholders, from producers togood price.

bankers or investors, increasingly more complex.

Jarno Ilves,
Bank of Finland

ESG and Credit Risk Opportunity…the possible causality between

The correlation between ESG score and stock performance has beensustainability and credit risk

well documented and established.92 Mining stocks with higher ESG ratings

could convince regulators tohave outperformed the market and demonstrated greater resilience, a correlation

allow banks to hold less capitalthat has persisted throughout the Covid-19 outbreak. However, as we are looking

against loans to companies withat the aspects of a low-carbon economy, how does ESG translate in terms of loan-

high ESG metrics.

default rates for bankers? Is there an incentive for both the creditor and theBain & Company

borrower to finance top-tier ESG-rated companies and projects at better rates andlending conditions? The answer is yes, as the percentage of commercial
loan clients in default is directly proportional to the debtor’s ESG
score.

Proportion of Commercial Loan Clients in Default Based on their
ESG Score
50%
45%
40%

35%
30%
25%
20%
15%
10%
5%
0%

0-20

21-40

41-60

61-80

81-100Source: Bain & Company, Incrementum AG

Even more interestingly, when directly comparing companies a year after they
started at the same risk rating, low ESG performers were roughly twice as likely ashigh ESG performers to fall behind on payments over the course of the year.

—

92 See “ESG Compliance and Financial Stability,” In Gold We Trust report 2020

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The New Low-Emissions Economy: Gold as a Savior

350

Commercial Loan Customers in Default Based on the Same
Average Risk Rating in the Previous Year

5%

4%

3%

2%

1%

0%
Low ESG Performers

High ESG Performers

Source: Bain & Company, Incrementum AG

There is a growing body ofInvestment committees will have to dig even deeper into their ESG analysis toevidence to demonstrate that

increase the accuracy of their risk models and improve their client’s’ risktaking ESG matters seriously

evaluation. This could translate into better financing terms andimproves business performance;

conditions and improve funding costs for top-tier ESG performers.

ESG best practice must become

Investors’ demand for sustainable assets currently outstrips supply, and a bankintegral to the business andthat can securitize and sell its ESG-intensive loans will be able to obtain cheaper

should be a given.

funding from governments. This will result in better terms and conditions for their

Kamran Ahmad

clientele.

Jurisdiction Risk: Opportunity or Damnation?
Jurisdiction risk, which has always been among the biggest risks inmining investment, has now risen to third place, and is still rising.
There are currently over 50 gold-producing countries. Of these, only 15 countries
account for almost 75% of current world production. None of these countries haveclear targets on how to achieve net zero by 2050, and most of them present highpolitical and economic risk.

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The New Low-Emissions Economy: Gold as a Savior

351

Risk Assessment of the 15 Major Gold Producing Countries, 2020
Country

Production, in
TonnesJurisdictional Risk
(Economic and Political)

CAT Net Zero

Scope 1, 2 & 3 Absolute Emission
per Tonne of Gold

China

368

High

Bad

n.a.

Russia

331

High

Bad

14,421

Australia

327

Low

Bad

16,449

USA

190

Low

Average

15,031

Canada170

Low

Average

9,795

Ghana

138

Moderate

Bad

13,333

Brazil

107

High

Bad

6,452

Uzbekistan

101

High

Bad

n.a.

Mexico

101

High

Bad

17,211Indonesia

100Moderate

Bad

n.a.

South Africa

99

Moderate

Bad

23,710Peru

97Moderate

Bad

10,268

Mali

93

High

Bad

n.a.

Burkina Faso

93

High

Bad

n.a.

Sudan

83

High

Bad

n.a.

Source: Climate Action Tracker, World Gold Council, Mining.com, Emission (tCO 2e) per Ton of Gold, Incrementum
AG

These countries’ gold mining companies have the best opportunities to move fromplanning to action and embrace the energy transition, both for self-produced andpurchased energy. By committing to phase out fossil fuels as soon as
possible, these companies will be seen as change agents in theircommunities, setting an example of responsible behavior and avoiding
a massive increase in the price of carbon credits. As previously stated, theincentive is significant because current demand for financing such projects exceeds
supply, putting downward pressure on financing costs.

Political Risk
Sometimes, the easiest way to

Geopolitical paradigm shifts are underway, and the mining industry issolve a problem is to stopat the center of many of them. Jurisdictional risks, more specifically politicalparticipating in the problem.

and economic risks, are now one of the top three concerns when a vetting

Albert Einstein

committee examines a new investment.

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The New Low-Emissions Economy: Gold as a Savior

352

2021 Country Economic Risk Index

Source: MarshNature, when left to universal

As discussed previously, many gold mining companies have been impacted bylaws, tends to produce regulation

political unrest and government interventionism in the past year, or are expected

out of chaos.

to be impacted in the near future:

Immanuel Kant
• Papua New Guinea: The government revoked Barrick’s “social licence” tooperate. Only after Barrick ceded 51% control interest back to the PNG
government was the mine put back into production.
• Mali: A coup d’état has had no direct consequences for gold miners for the
moment.
• Sudan: The prime minister resigned over tensions between civilians and thearmy, with no direct consequences for gold miners at present.
• Kazakhstan: The government resigned in January 2022 after mass protests
and riots over oil price increases, with no immediate consequences for gold
miners.
• Kyrgyzstan: The government seized Centerra’s Kumtor gold mine.
• Russia: As a result of the invasion of Ukraine by Russia, central banks
temporarily suspended buying Russian gold production. Russian gold
producers have been excluded from the FTSE equity indices. There has beenmassive divestment by strategic investors such as BlackRock.
• Chile: The supreme court forced the closure of Barrick’s Pascua-Lama mine.
Moreover, Chile is currently looking into the possibility of nationalizing
copper and lithium mines and has increased their tax rate to as high as 80%.

Best and Worst in Class, 2021
Gold actually has a much better

It is always difficult to establish best and worst in class based strictly

standing at actually providing

on ESG scores. Diving deeper into ESG scores, we identified the best and worst

negative correlation.

performers per GHG emissions per ounce of gold produced, as well as per total

Chris Brycki

Scope 1 and Scope 2 emissions.

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The New Low-Emissions Economy: Gold as a Savior

353

Greenhouse Gas Emissions per Ounce of Gold Produced, in
Tonnes per Ounce, 2020
2.5
2.0
1.5
1.0
0.5
0.0

Greenhouse Gas Emissions per Ounce of Gold Produced
Source: Bloomberg, S&P, Reporting Companies, Incrementum AG

There seems to be correlation between companies’ ESG scores and emissions, both
per ounce of gold and per Scope 1 and Scope 2 emissions. As seen in the graphbelow, two companies, AngloGold Ashanti and Barrick Gold, are emitting massive
amounts of CO2. These companies mostly use coal to produce electricity andshould focus on rapidly transitioning to renewable energy.

Gold Miner Emissions by Scope 1 and Scope 2, in mn Tonnes
CO2e, 2020

10
9
8
7
6
5

4
3
2
1
0

Scope 1

Scope 2

Source: Bloomberg, S&P, Reporting Companies, Incrementum AG

Traceability: Sooner Rather than Later
How can investors know if the gold bar they bought came from one of
the best or one of the worst ESG-performing gold producers? They must
be able to assess where, how, and with which type of energy their gold was mined.
Investors want to stay clear of any gold mined by criminal gangs or in conflictzones. To answer this growing need, the World Gold Council is developing, withthe help of the London Bullion Market Association (LBMA) as well as aXedras andPeer Ledger, a digital system to track gold through the supply chain. Using
blockchain technology, all transactions and movements will be tracked on a ledger.

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The New Low-Emissions Economy: Gold as a Savior

354

This ledger will not be fully public in the way that Bitcoin’s is, but will be madeavailable only to stakeholders. This initiative, with a focus firstly on simple
traceability, will evolve into a fully transparent supply and custody chain for gold
bars and coins.

How to Navigate Around All These Risks
The investment landscape comprises a spectrum of approaches,
including a growing number of ESG factors. Strategies that use ESG as anadditional consideration in the investment process, rather than relying onscreening-based investment restrictions, are gaining in popularity. Events in theoil and gas sector in May 2020, when a Dutch court ruling accelerated Royal Dutch
Shell’s goal to reduce carbon emissions from 20% to 45% by 2030, and on thesame day Exxon Mobil Corp. was forced to accept two board members chosen byEngine No. 1, an activist hedge fund, perfectly demonstrate how ESG is not only
here to stay but will shape corporate behavior from now on.
The ESG and green

To assist this transition, the UN Principles for Responsible Investment (UNPRI)

transformation is simply theprovides a highly practical framework. It lists six principles to help asset owners

single largest policy bet ever

and managers structure an approach to ESG that is consistent with international

undertaken, and the main

peers, while remaining broad enough to avoid confining them to an unrealistic

consequences will be inflation

mandate. Since its inception in 2006, the UNPRI has gathered almost 4,000

and ever lower real

signatories, with just over USD 120trn in assets under management as of 2020.

rates.

Clearly, investors are no longer staying on the sidelines and waiting for the perfect

Steen Jakobsen

solution, but are taking part in shaping tomorrow’s world in a more sustainablefashion.

Conclusion
Forget the “super-cycle”, this is

Government intervention is on the rise all over the world. Given how

bigger.

difficult it is to assess the true outcome of COP26, the resulting paradigm shift to a

Robert Friedland

low-emissions economy and mining nationalization, gold mining companies must
commit to planning and implementing net-zero-by-2050 strategies. If not for thesake of saving the planet, they should do so in order to be able to access current
favorable financing conditions.

Everybody complains about the

To conclude, investors should prepare for the oncoming inflationary

weather, but nobody does

storm while avoiding the additional costs of the low-carbon economy.

anything about it.

They should actively consider investing in gold miners with good ESG ratings andMark Twain

increase their gold allocation.

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Sprott has a defining focus on precious metals
and real assets investment strategies.

Please contact the Sprott Team for more information at
invest@sprott.com • 888.622.1813 • sprott.com

Contrarian. Innovative. Aligned.®
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356

Technical Analysis“Patience is very bitter, but its fruits
are sweet.”Jean-Jacques Rousseau

Key Takeaways• Since gold’s all-time high in 2020, a consolidation has

taken place, which should provide a healthy foundation
for further price increases.
• The Coppock indicator generated a long-term buy signal

at the end of 2015. The cup-handle formation is stillintact, but the breakout attempt has failed several times.
The price target of this formation would be USD 2,700.
• The Optix Gold Index is at 49 and thus in neutral

territory. Although sentiment has clouded recently, an
extreme bearish washout has not (yet) taken place.
• Seasonal analysis of the gold price shows that in years

with US midterm elections, seasonal headwinds set infrom the end of May but reverse again in early July. Juneis, after May, the second weakest month in midterm
election years.
• The Midas Touch Gold Model™ switched into bearish

mode on April 19. The initial situation has deteriorated
further since then, and a sustainable bullish signal is notdiscernible at the moment.

Technical Analysis

357

After our comprehensive macroeconomic and fundamental analysis, we now turnto the technical analysis of the gold price. Last year we wrote in this space:“The analysis of market structure, sentiment, and price patterns leads us to a
positive technical assessment. Since the all-time high in August last year, aspeculative shakeout has taken place, which should provide a healthyfoundation for further price increases. ... In this respect, the conditions for thecontinuation of the new bull market seem excellent from a technicalperspective.”93
This assessment has turned out to be partially correct. A few days after the
publication of the In Gold We Trust report 2021, a downtrend started, which only
bottomed at USD 1,680 (38.2% Fibonacci retracement of the uptrend from 2015 to2020). This was followed by several months of consolidation, which ushered in arally to near all-time highs in early 2022, before the gold price – at least on a
USD basis – went into reverse gear again from early April.
Time is more important than

What is our current technical assessment of the gold price? For the long-price. When time is up price willterm assessment, we once again refer to the Coppock curve, which has proved to bereverse.

a reliable momentum indicator.94 A buy signal occurs when the indicator, being

W. D. Gannbelow the zero line, turns upwards, i.e. assumes a positive value. The advantage ofthis indicator is that you can reliably detect major trend changes. Since the end of
2015, the indicator has been on “buy”. From summer 2020, the curve tendedslightly south, but since December 2021 it is now back on an upward trend. The
KST95 , on the other hand, has turned downward but is still in positive territory.
The long-term cup-handle formation, which could now soon be
resolved, seems particularly interesting. The correction since August 2020
appears as the handle part of the formation. The price target can be estimated bymeasuring the distance from the right edge of the cup to the bottom of the cup andthen extending further in the direction of the breakout area. The price target ofthe formation remains at around USD 2,700.

When all the experts andLet’s now take a look at market sentiment. Naturally, analysts become

forecasts agree, something else isincreasingly optimistic as a bull market continues, and vice versa. In the course ofgoing to happen.

the ups and downs of recent months, price targets have now been lowered in the

Bob Farrell

usual procyclical manner. Looking at the forecasts from the beginning of May 2022
for the end of 2022, a median price of USD 1,900 is expected. The price targets forthe end of the following years are: USD 1,800 (2023), USD 1,787 (2024),
USD 1,700 (2025) and again USD 1,700 (2026). De facto, the analysts therefore
expect a sideways movement. This would be a development that – if you look atmarket cycles – seems extremely unlikely.

—

93 “Technical Analysis,” In Gold We Trust report 2021, p. 322
94 Specifically, we have two time-weighted momentum curves that are added together and whose long-term moving

average is the Coppock line. We use a somewhat modified Coppock with slightly longer periodicities.
95 Martin Pring’s Know Sure Thing (KST) indicator measures the price momentum of four different price cycles.

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358

Bloomberg: Analyst consensus for gold: 2022-2026

Source: Bloomberg

Nothing moves in a straight line,

The picture is similar for silver. At the end of the year, a median price ofis the point. But picking bottoms

USD 24 is expected, followed by a drop to USD 22.94 in 2023 and a minimum riseis best left to the proctologists.

to USD 23 in 2024. However, the consensus is no longer really meaningful, as theDave Rosenberg

number of active coverages on the part of the banks has been significantly reduced
in recent years. This confirms our hypothesis that silver is as popular in
the financial sector as a pork knuckle and a pint of beer are for veganteetotalers.
Bloomberg: Analyst consensus for silver: 2022-2026

Source: Bloomberg

The one who follows the crowd

Now let’s take a look at the sentiment situation in the sector. One of ourwill usually get no further thanfavorite sentiment indicators is the Optix Index from Sentimentrader.

the crowd. The one who walks

This tracks the most common sentiment indicators as well as data from the futures

alone is likely to find himself inand options market. The logic underlying this barometer is a simple one. Whenplaces no one has ever been.

public opinion forms a strong consensus, this broad consensus is a good contra-

Albert Einstein

indicator. The market is usually too bullish when prices have already risen(sharply) and too bearish when they have already fallen (sharply).

Man is not a rational animal; he

If the Optix Index rises above the red dotted line at 75 points, it is time

is a rationalizing animal.

to become more cautious. If it is at 30 points or below, on the other hand,

Robert A. Heinlein

pessimism is pronounced and the downside risk is limited. Currently, the Optix
Index is at 49 and thus in neutral territory. It can also be seen that no sentimentlows were marked in the course of the correction in recent months. This confirms
our assessment that sentiment in the sector is basically constructive, but that afurther washout seems possible.

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359

Optix indicator and gold price, 2002-2022

Source: Sentimentrader.com

Never invest on the basis of a

Regarding the mood in the silver sector, we wrote last year: “In silver, the party

story on page one. Invest on thehas apparently not really started yet, although the guests are now slowly

basis of a story on page sixteen

arriving.”96 Further party guests have actually arrived in the meantime, but others

that’s headed to page one.

have quickly left the party again in frustration. The Optix Index for silver is

Don Coxe

currently trading at 39, close to bearish territory.
Optix indicator and silver price, 2002-2022

Source: Sentimentrader.com

This year, we also want to take a brief look at seasonal patterns. The
following chart shows the annual development of gold in US midterm election
years. It can be clearly seen that seasonal headwinds set in from the end of May,but reverse again at the beginning of July.97 June is, after May, the second weakest
month in election years. From a seasonal perspective, further headwinds cantherefore be expected in the coming weeks.

—

96 “Technical Analysis”, In Gold We Trust report 2020, p. 331
97 The seasonal charts were provided to us by our friends at www.seasonax.com.

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360

Seasonality of gold in midterm election years

Source: Seasonax.com

In silver, a strong seasonal uptrend can be seen from July. June marks the weakest
month, and on a weekly basis, Monday seems to be predestined for anticyclicalbuying.
Seasonality of silver in midterm election years

Source: Seasonax.com

The Midas Touch Gold Model™

98“Nothing has such power to expand the mind as
the ability to systematically and truly examine
everything you observe in life.”
Marcus Aurelius
As always at this point, it is time for an update on the current status of
the Midas Touch Gold Model™99 as well as a short to medium term outlook
from Florian Grummes. The Midas Touch Gold Model™ illuminates the gold
market from many different perspectives through a rational and holistic approach.
It convinces with its versatility as well as its quantitative measurability. Although—

98 We would like to thank Florian Grummes for this digression. Florian Grummes is the founder and CEO of Midas

Touch Consulting (www.midastouch-consulting.com). Our readers can sign up for free updates and the associatednewsletter at the following link: http://eepurl.com/ccKg2r
99 A detailed description of the model and its philosophy can be found in: “Technical Analysis,” In Gold We Trust
report 2016.

LinkedIn | twitter | #IGWTreportTechnical Analysis361

the model is based on a lot of data, it succeeds in summarizing an extensive
analysis compactly and clearly in a table and comes to a clear conclusion.
Gold in USD (monthly chart)

Source: Midas Touch, Tradingview

To anticipate the market is to

The gold price reached a new all-time high on August 7, 2020 withgamble. To be patient and react

prices around USD 2,075, which remains the high. The correction that has

only when the market gives the

been going on for almost two years is therefore not yet finally over; and comparedsignal is to speculate.

to price reported in the In Gold We Trust report 2021, the gold price is currently

Jesse Livermore

only USD 32 higher. After the support around USD 1,680 withstood the bears’attacks three times last year, the price was able to gain a good USD 390, or 23.2%
in total, from August 9, 2021 to March 8, 2022 i.e. within eight months. However,this remarkable upward movement could only develop real momentum from theend of January 2022. Before that, the gold price mostly traded trickily sideways
and thus created a mood of abandonment shortly before the turn of the year.
In the meantime, however, prices have fallen back significantly, by
USD 270 or 13% from the spring high of USD 2,070. In particular, sinceApril 18, when a first major recovery movement on the gold market failed justbelow the USD 2,000 mark, the gold price went down to its knees and was mostrecently mercilessly passed through to the downside during the liquidation wave
on the financial markets.

Try to see it my way. Only time

Neither the 200-day moving average (currently USD 1,836) nor thewill tell if I am right or I am

broad support zone around USD 1,830 could stop the sell-off so far. At

wrong. While you see it yourthe current weekly closing price, however, the gold price was at least able to saveway, there’s a chance that we

itself into the weekend above the uptrend line that started in August 2018, which

may fall apart before too long.

increases the chances for an imminent countermovement or recovery.

The Beatles,“We Can Work It Out”

In the big picture, the gold price is therefore still in a consolidation or
correction phase. Since the consensus of precious metals fans was, until the lastminute, clearly on the believed-to-be-safe immediate breakout from the large cuphandle formation, the exact opposite had to happen, as so often does in themarkets. Nevertheless, the breakout to new all-time highs has most likely not beencanceled but only postponed. However, this would require sustained prices above
USD 2,000. Then it could happen quickly. In view of the imminent price weakness,

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362

however, it is better to plan for a time frame of one to three years before thebreakout above the bulwark between USD 2,000 and USD 2,070 will actually
succeed.
Midas Touch Gold Model™

Source: Midas Touch, Tradingview

The first principle is that you

The Midas Touch Gold Model™ switched into bearish mode on April 19.

must not fool yourself – and you

The initial situation has deteriorated further since then, and a

are the easiest person to fool.

sustainable bullish signal is currently a long way off. In retrospect,

Richard Feynman

numerous building blocks switched into bearish mode as a result of the price slide
below USD 1,940 between April 18 and April 22. In particular, these were new sellsignals on the daily and weekly charts for the gold price in US dollars as well as inIndian rupees and on the GDX Gold Mines ETF. In addition, there was a sell signal
from the Dow Jones/gold ratio. The gold/silver ratio turned due to the weakdevelopment of the silver price that had already occurred on April 11, thus giving
an early announcement of the drama of the last weeks. Only the monthly chart for
the gold price in US dollars, the Bitcoin/gold ratio, and negative real interest rates
in the US currently contribute bullish signals.
Overall, the following conclusions can currently be derived from theMidas Touch Gold Model™:• On the monthly chart for the gold price against the US dollar, a buy
signal is still active. This would currently only be negated at prices below
USD 1,722. On the upside, however, prices above USD 2,041 are needed to beable to classify the weekly chart as bullish again. Until then, USD 230 are
missing. We must therefore assume that the gold price will probably need a lotof time until a new sustainable bullish setup is established on all three decisive
time levels (monthly, weekly and daily).

• The sharp rise in the gold/silver ratio also makes it clear that wewill have to be patient. It may still take a long time before the silver priceheralds the next exaggeration phase on the upside with a clear outperformanceagainst gold.

• The weakness of gold against the other commodities is also striking.
Since a significantly weaker oil price is not foreseeable for the time being in

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363

view of the difficult geopolitical situation, and many other commodities will
increasingly suffer from supply difficulties, a new buy signal for the gold pricewill probably take longer.

• Although Bitcoin has mercilessly outperformed gold in recent
years, the Bitcoin/gold ratio currently favors gold. It currently takes
just under 16 ounces of gold to equal one Bitcoin.

• The US Dollar Index rose by a good 17.3% in the last 12 months.
Thanks to the steep rally, the DXY is currently trading at its highest level in
21.5 years. However, the strongly overbought, overheated situation could soon
force a countermovement, which would allow at least a temporary recovery in
the gold price. Should the DXY fall below 103.40, this component within theMidas Touch Gold Model™ changes to bullish.
Gold in USD (daily chart)

Source: Midas Touch, Tradingview

We believe that now is the time toOn the daily chart, the gold price fell from USD 1,998 to USD 1,799

start layering in gold exposure,without much resistance in the last 20 trading days. Thus, the large dark

not when the rest of the world

green upward trend line was reached on Friday, May 13, and was not undercut attries to do so.

least per daily and weekly closing prices. Despite this sharp price slide and a clearlyJohn Hathaway

oversold situation, however, hardly any signals for a bottom and a possible
recovery are discernible so far. Rather, the support zone around USD 1,850 was
cracked within five trading days. The 200-day line (currently USD 1,836)
withstood the pressure of the bears for only two trading days. The stochastic
oscillator would actually be strongly oversold, but has nestled below 20 for 10
trading days, thus tightening the downward trend for the time being.
Since the consequences of the bursting of the tech bubble are not yet
fully foreseeable and a merciless liquidation wave has been pulling the rug out
from under all markets on a large scale for weeks, significantly lower prices arealso conceivable on the gold market. In the short term, the action-and-reaction
principle should ensure a steep interim recovery around the December low of
USD 1,750 at the very latest. This could even start now and lift the gold price atleast back above the 200-day line in the direction of the USD 1,850 mark. In asecond recovery step, a presumably unsuccessful attempt at the new downward
trend line in the area of 1,900 USD would then be possible. Subsequently, the gold

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364

price would have to undergo a second test of its slightly rising 200-day line until
midsummer – after all, it is better to stand on two legs.
Great opportunities do not come

Alternatively, the crash on the financial markets will continue more or

every year.

less straightforwardly. However, the bombed-out sentiment speaks against

Charles Dow

this. The gold price would certainly not be able to escape this crash scenario,
similar to 2008’s, and would probably reset to at least about USD 1,680. Therefore,
in the current environment one must continue to drive cautiously and on sight.
Only those who still have sufficient liquidity at the final low will be able tosuccessfully exploit the opportunities that arise.

The waiting is the hardest partAll in all, the gold price is in very difficult waters, not only in chart

Every day you see one more card

terms but also seasonally. A bullish expectation has rarely paid off in the past

You take it on faith, you take it tobetween March and July. The best thing to do as a gold bug in this phase is tothe heart

simply, patiently keep your feet still, because only from August onwards would the

The waiting is the hardest part.

start of a new multi-month upward wave in the precious metals sector be

Tom Petty

conceivable.

Conclusion
Despite some weaknesses, technical analysis is a useful tool for determining thelocation and timing of investments. It is always important for us to understand thebig picture, not only from a fundamental but also from a technical perspective.
The secret to being successful

The analysis of market structure, sentiment and price patterns leads us

from a trading perspective is toto a rather mixed technical assessment. Since gold’s all-time high in August

have an indefatigable and an

2020, a speculative shakeout has taken place, which should provide a healthy

undying and unquenchable thirstfoundation for further price increases. The Coppock indicator generated a long-for information and knowledge.

term buy signal at the end of 2015. The resolution of the long-term cup-handle

Paul Tudor Jones

formation is proving to be much tougher and more protracted than expected.
Although sentiment has clouded recently, an extreme bearish washout has not(yet) taken place.
From a seasonal perspective, the next few weeks could still bring headwinds. The
recent increase in the relative strength of gold versus silver and mining stocks also
makes us cautious. In this respect, the conditions for the continuation of
the bull market seem clouded from a technical perspective in the shortterm, and we expect a difficult market environment in the coming
weeks.

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366

Quo Vadis, Aurum?
“Our New World Disorder will becharacterized by greater volatility,
higher inflation and deeper financial
repression.”
Alexander Chartres

Key Takeaways• Monetary policy has its back to the wall. It is forced to atleast pretend to stand up to wolfish inflation withoutcausing a recessionary bear.
• The Federal Reserve is acting late but (for now)decisively. Internationally, this is increasingly putting
central banks under pressure to follow suit.
• The balancing act of fighting inflation without triggering

distortions on the markets is doomed to failure. The
vehemence of the tightening cycle that has begun
threatens to end the Everything Bubble in an Everything
Crash.
• The current wave of inflation could peak this year in thewake of rising asset price deflation. However, a reversalof monetary policy could already usher in the next wave
of inflation.
• The price of gold has also been affected by the Federal

Reserve’s tightening. Even though gold is doing wellrelative to all other asset classes this year, further
headwinds are to be expected for gold in the short term.
• We are sticking to our long-term price target of USD

4,800 by 2030. For the gold price to remain on track until
the end of the year, it would have to rise to around
USD 2,200. Provided that monetary policy departs fromthe announced hawkish path, we consider this to berealistic.

Quo Vadis, Aurum?

367

Everything Bubble, Stagflation, Everything
Crash...
A financial crisis is a great time

For years, the news has been dominated by reports of global crises. One

for professional investors and adisaster seems to follow the next: financial crisis, euro crisis, climate crisis,

horrible time for average ones.

pandemic, and now, since February, a war in the middle of Europe. The seemingly

Robert Kiyosaki

chaotic and fragile times in which we live are causing increasing uncertainty anddisenchantment with the news among large sections of the population.
Remarkably, however, this uncertainty has so far manifested itself on the capital
markets only in the short term. If you look at the long-term development of global
stock and bond markets, you might think that all these crises had never happened.

Aggregated Balance Sheet of Fed, ECB, BoJ, and PBoC (lhs), in
USD trn, and Global Stock and Bond Market Price Development*(rhs), 01/2000-04/2022
35

280

30

250

25

220

20

190

15

160

10

130

5

100

0
2000

70
2002

2004

2006

2008

2010

2012

Aggregated Balance Sheet

2014

2016

2018

2020

2022

Global Stock and Bond Market

Source: Reuters Eikon, Incrementum AG*consisting of 60% MSCI ACWI and 40% FTSE Global Gov. Bond Index

Don’t become a mere recorder of

A major reason for the spectacular returns for stock investors, but also for realfacts, but try to penetrate theestate and bond investors, especially in the past 25 years, is that every crisis was

mystery of their origin.

answered with ever more extreme monetary policy measures in line with theIvan Pavlov

prevailing interventionist zeitgeist. Market participants have been conditioned like
Pavlovian dogs to the Fed put. The true costs of this policy of monetary
largesse remained hidden for a long time.

An essential point in the social

The prerequisite for maintaining this deception was, first andphilosophy of interventionism isforemost, the strong, structurally disinflationary forces. The flood of

the existence of the inexhaustible

liquidity created out of nothing initially spilled into the capital markets andfund which can be squeezed

increasingly inflated asset prices. This everything bubble gave the impression that

forever. The whole system ofgrowth could continue unabated, that deficits and monetary expansion were not ainterventionism collapses whenproblem, and that even global lockdowns and production stoppages could harm

this fountain is drained off: The

the economy only in the short term. However, the interventions in response to the

Santa Claus principle liquidates

Covid-19 crisis ushered in a change. What we call monetary climate change

itself.

was the beginning of a paradigm shift toward an inflationary

Ludwig von Mises

environment. The war in Ukraine and the accompanying sanctions andexport restrictions are just another accelerant.
Now we are at the beginning of a major disappointment. While at least asmall part of the population was able to enjoy rising asset values in times ofLinkedIn | twitter | #IGWTreport

Quo Vadis, Aurum?

368

disinflation, consumers as well as investors are finding life increasingly difficult ina time of increased inflation rates.
Will fiat currencies survive the

The omnipresent inflation means a noticeable reduction in the standard of living ofpolicy dilemma that thethe majority of people. When the real pie becomes smaller – whether in the form

authorities will experience asof higher prices, smaller package sizes, or thinner soups – this has far-reaching

they try to balance higher yields

consequences for consumer behavior and investment activity. Distributional issues

with record levels of debt? That’s

will be fought even harder socially, contributing to national and international

the multi-trillion dollar question

tensions and further exacerbating the polarization that already exists. The returnfor the years ahead.

of the wolf and all the calamities associated with it are increasing the

Jim Reidpressure on monetary guardians to actually guard the purchasing
power of the currency.

The Fed is attempting a

Monetary policymakers therefore have their backs to the wall. They arecontrolled demolition with a highforced to at least pretend to face the wolf. However, tentative attempts topotential for butterfly effects.

stem the tide of liquidity are beginning to expose problems that have been masked

Paul Wongfor years, if not decades, by emergency measures. Just as in 2018, when we warnedof the inevitable consequences of the attempted turning of the monetary tides, weare now issuing another explicit warning. In addition to wolfish inflation, abearish recession now looms.

The Doomed Balancing Act
In view of the decade highs in various inflation indicators – consumer
prices, core inflation, producer prices, import prices – many amonetary policy dove has mutated into a hawk in recent months. In theUS, there is currently the impression that the Federal Reserve cannot raise interest
rates fast enough. This is hardly surprising in view of an inflation rate of 8.3%.
Courtesy of Hedgeye

The real key interest rate has never been as low as it currently is. The
first interest rate hikes have done nothing to change this. If the calculation of thereal interest rate is based on the core inflation rate, the real key interest rate is at
its lowest level since 1971.

Fed Funds Target Rate minus CPI, and Fed Funds Target Rate
minus Core CPI, 01/1971-04/2022

10%

6%

2%

-2%

-6%

-10%
1971

1976

1981

1986

1991

1996

2001

2006

2011

2016

2021

RecessionFederal Funds Target Rate minus CPI
Federal Funds Target Rate minus Core CPI
Source: Reuters Eikon, Incrementum AG

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Quo Vadis, Aurum?

369

The last duty of a central banker

According to official unemployment and inflation statistics, the Federal

is to tell the public the truth.

Reserve, which pursues a dual mandate regarding employment andAlan Blinder,

price stability, should have acted long ago. The spread between the CPI and

Former Federal Reserve

the unemployment rate in the US is currently higher than it has been for four

Board vice chairman

decades. Back then, however, the key interest rate was 15 percentage points (!)
higher than today.

Federal Funds Target Rate (lhs), and CPI minus Unemployment
Rate (rhs), 01/1971-04/2022

20%

10%

5%

15%

0%
10%
-5%
5%

-10%

0%
1971

-15%
1976

Recession

1981

1986

1991

1996

2001

Federal Funds Target Rate

2006

2011

2016

2021

CPI minus Unemployment Rate

Source: Reuters Eikon, Incrementum AG

Volcker couldn’t achieve a soft

Remarkably, even Jerome Powell has recently admitted that the Federal Reserve islanding when he raised

now too late: “If you had perfect hindsight you’d go back and it probably would

aggressively during highhave been better for us to have raised rates a little sooner.” Therefore, to preserve

inflation with markets valued atwhat was left of its credibility, the Federal Reserve had no choice but to announce

40% vs GDP & US debt at 30% vsaggressive interest rate moves and start implementing them. The pace andGDP, but we are confident wevehemence of the expected tightening cycle that has already begun – a Fed Funds

can achieve a soft landing

Rate of nearly 3.50% by the summer of 2023 and an annualized QT pace ofraising aggressively with

USD 1.14trn – would be the most aggressive monetary tightening since Paul

markets valued at 190% vs GDP

Volcker.

& debt at 124% vs GDP.
Sven Heinrich

In addition to curbing inflation, the declared further goal is to manage
the turnaround in monetary policy without triggering a recession.
However, in our view, this balancing act of a soft landing is doomed to failure fromthe outset. A look at history and the latest In Gold We Trust reports100 confirms
our doubts .
As a reminder, since the early 1980s, every interest rate hike cycle has
ended below the peak of the previous cycle. This would mean that,
according to the old pattern, rate hikes would stall at the very latest at an interest
rate spread of 2.25–2.50%. Thus, in Q4/2018 the Federal Reserve was forced bymarkets to make a monetary policy U-turn towards a looser policy. The S&P 500

Courtesy of Hedgeye

gave up more than 20% in the meantime; and already by January 2019 Powellabandoned the “autopilot” mode, which he had only announced at the beginning ofDecember 2018, to the financial markets’ consternation.

—

100 All previous In Gold We Trust reports can be found in our archive.

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Quo Vadis, Aurum?

370

But this time everything is supposed to be different – at least that is what theFederal Reserve and large parts of the economists’ guild want us to believe.
However, the following chart tells a different tale, as only 3 out of 20
interest rate hike cycles did not end in a recession.

Federal Funds Rate, 01/1915-05/2022
20%

12 13

18%
16%
14%

11

12%
10%
8%
6%

14

10
2
1

4%

15

5

16

3 4

8 9
6

2%
0%
1915

1925

1935

1945

17

7

1955

18?
1965

1975

Recession

1985

1995

2005

2015

Federal Funds Rate

Source: Reuters Eikon, Incrementum AG

Quantitative tightening: very, very frightening
Dear @federalreserve

The tightening of US monetary policy does not only consist of- we all know that youraggressive interest rate hikes. At the same time, quantiative tightening (QT),

taper/rate hikes will trigger ai.e. a reduction of the Federal Reserve’s balance sheet, is also planned. In ourrecession and market crash. Can

opinion, the QT plans are ambitious, not to say illusory. The Federal Reserve’s

we just fast forward to NIRP andbalance sheet is to be shortened by USD 522.5bn in 2022 alone and byeven more QE that always

USD 1,140bn in 2023. That would be a reduction of nearly 6% in the current year

follow?

and another 13% or so next year. This process is set to continue until the Federal

Zero Hedge

Reserve decides that the balance sheet has "normalized" or until the next crisis
forces a turnaround. The latter is definitely more likely to occur.

As a QT footnote, it is instructive

Let’s take a look at the past. The Federal Reserve’s QE programs to date

to note that the Fed has never

have had the following effects on capital markets:demonstrated much skill in
reducing its balance sheet –almost every instance has led
directly to US recession.
Trey Reik• Rising stock markets• Increasing risk appetite• Falling yield spreads (corporate bonds, junk)• Falling interest rates• Subdued price inflation• Record low volatility
It seems obvious that QT has exactly the opposite consequences as QE.
As a reminder, the last tightening process was gradual and cautious. The Federal
Reserve began QT in October 2017, almost two years after the first rate hike. QT
volume was increased only slowly, from USD 10bn per month to USD 50bn permonth in Q4/2018. The sharp equity market correction in December 2018 forced

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Quo Vadis, Aurum?

371

the Federal Reserve to suspend rate hikes and announce a quick end to QT. Just a
few quarters later, the Federal Reserve’s balance sheet grew again.

Fed Balance Sheet Path, in USD bn, 01/2007-01/2024e
10,000

9,000
8,000

QE1

QE2

OT

QE4

QE3

7,000
6,000
5,000
4,000
3,000
2,000
1,000
0
2007

2010

Fed Balance Sheet
Projection 2012
Projection 2022

2013

2016

2019

Projection 2010
Projection 2013

2022

Projection 2011
Projection 2018

Source: Reuters Eikon, Federal Reserve, Incrementum AG

If Mike Tyson gave me fairCan the reduction of the central bank balance sheet succeed this time

warning that he was going towithout causing a recession and/or a replay of a financial crisis?

punch me in the face, no matter

Considerable doubt is warranted. In its 109-year history, the Federal Reserve has

how prepared I’ll be, I’m still

attempted to reduce its balance sheet exactly seven times (1921-22, 1928-1930,

going to hit the floor.

1937, 1941, 1948-1950, 2000, and 2017-2019).101 The 2017-2019 episode can bePeter Boockvar

virtually disregarded, because the Federal Reserve had to quickly abandon its
tightening policy. Prior to this experience, five of the Federal Reserve’s six
historical QT efforts were followed by a recession, with 1941, the year of US entry
into World War 2, being the only exception.

Financialization is profit margin

The Federal Reserve runs the risk of overestimating the impact of rate

growth without labor

hikes and balance sheet reductions on containing inflation, just as it

productivity growth....

has underestimated the impact of rate cuts on boosting inflation. This is

Financialization is the

because the US consumer’s dependence on high and rising asset prices is greater

zombiefication of an economy

than ever. As of Q4/2021, household equity holdings were at a new all-time high ofand the oligarchification of a

USD 50trn. This amount is equivalent to twice the annual US economic output,

society.

well above the historical average of 77%. A decade ago, households owned only

Ben Hunt

USD 12.8trn worth of stocks or about 80% of GDP. For this reason, a 20%
correction today feels like a 60% plunge 10 years ago.

—

101 See Reik, Trey: “Broad Equity Valuation and Market Internals,” Bristol Gold Group, March 31, 2022

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Quo Vadis, Aurum?

50

372

Value of Equities Held by Households and Nonprofits (lhs), in
USD trn, and as % of GDP (rhs), Q1/1960-Q4/2021

250%

45
40

200%

35
30

150%

25

20

100%

Average: 77%

15
10

50%

5
0
1960

0%

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

2020

Recession
Value of Equities Held by US Households & Nonprofits
as % of GDP
Source: Federal Reserve St. Louis, Incrementum AG

Liquidity is like the tide. When

While the Federal Reserve is attempting to pull back on monetary

the tide rises, all the boats

policy, monetary surrealism is being blithely practiced elsewhere. The(financial assets) tend to float

QE programs of the other major central banks, such as the ECB and the BoJ, arehigher. When the tide goes out,

still ongoing, although here, too, there are increasing voices in favor of a cautious

all the boats (financial assets)exit. The next chart clearly shows that the balance sheets of the BoJ and the SNB

tend to sink into the mud.

are significantly larger relative to GDP than those of their counterparts. It can also

Richard Duncan

be seen that – with the exception of the Chinese central bank – central bankbalance sheets have expanded massively in relation to GDP.

Central Bank Balance Sheets, as % of GDP, 2007 and 2021
160%

150%

134%

140%
120%
100%
80%

64%
56%

60%

45%

42%

39%

40%
22%

21%

16%

20%

6%

5%

0%
SNB

BoJ

ECB

2007

BoE

Fed

PBoC

2021

Source: Central Bank Statistics, World Bank, Incrementum AG

An ornithological tutorial seems

While central bankers in the US, the UK, and other countries have been late inin order, as fewer hawks are

getting the cycle of interest rate hikes underway, ECB President Christine Lagarde

now found in the ECB thanand many other representatives of the Governing Council seem to have no idea atchamois in the Netherlands.

all what a monetary policy hawk is. An ornithological-economic tutorial
seems in order, because there are now fewer hawks in the ECB thanchamois in the Netherlands. With the supposed gentleness of the dove, i.e. thegreatest possible monetary policy passivity, the ECB hopes the inflation problem
will disappear of its own accord. However, this view is not gentle or naïve, butrather incendiary. In the euro area, for example, producer prices are now

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Quo Vadis, Aurum?

373

rising at a rate of 5.3% per month, which is stronger growth than there
used to be for the whole year.
Will hiking rates off the near-

The hope that this wait-and-see approach will prevent another euro crisis will

zero line make a difference inprove to be false. The bitter losses of the euro against the US dollar –economic behaviors? Oh yes!

which only further increase inflationary pressure in the euro area –Just not the behaviors that theand the resulting performance of the gold price on a euro basis show

Fed (and the White House)

this impressively.

Ben HuntGold (lhs), in EUR, and ECB Balance Sheet (rhs), in EUR bn,
01/2002-05/2022

2,000

9,000

1,800

8,000

1,600

7,000

1,400

6,000

1,200

5,000

1,000

4,000

800

3,000

600

2,000

400

1,000

200
2002

0
2004

2006

2008

2010

2012

2014

ECB Balance Sheet

2016

2018

2020

2022

Gold

Source: Reuters Eikon, Incrementum AG

I've reached a point where I feelAmong the industrialized countries, monetary loosening seems to havethe only asset I have confidence

progressed furthest in the Land of the Rising Sun. One should therefore

in is gold.

pay particular attention to monetary policy developments in Japan, as they could

Thomas Kaplan

serve as a blueprint for the Western world. The escalating yield curve control inJapan is already having an effect. The gold price recently marked numerous
all-time highs in JPY.

Gold (lhs), in JPY, and BoJ Balance Sheet (rhs), in JPY bn,
01/2007-04/2022
300,000

800,000
700,000

250,000
600,000
200,000

500,000

400,000

150,000

300,000
100,000
200,000
50,0002007

100,000
2010

2013

BoJ Balance Sheet

2016

2019

2022

Gold

Source: Reuters Eikon, Incrementum AG

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Milliarden

expect.

Quo Vadis, Aurum?

374

The Powell pivot is alive and well

The central banks thus face an insoluble dilemma, a dilemma theyand it is coming very soon.

themselves caused by their ultra-lax monetary policy and aggravatedRaoul Pal

for months by their denial of the inflation surge. They are now sitting inthat pit they dug for themselves.102 The big question is: What happens if central
banks have to hit the monetary policy pause button and then punch rewind? In ourview, this would usher in the next wave of devaluation and inflation and further
fragilize the currencies of the Western world. In this case, nothing less thanthe credibility of central banks would ultimately be at stake. And withit, confidence in fiat money itself.

Stagflation 2.0 – the Nightmare for Balanced
Portfolios?
For a long time, the topic of inflation was as important to the capital
markets as studying the snow report in the Sahara; so long that many
investors forgot or never had to think about how certain asset classes behave in ahighly inflationary environment.
Inflation is like kryptonite for

For a large proportion of mixed portfolios, simultaneously falling stocks and bonds

bonds.

are the absolute worst-case scenario. In the last 90 years, there have been

Jason Zweig

only four years in which both US stocks and bonds had negative
performance in the same year. Currently, all indications are that 2022
could be the fifth year.
Year

S&P 500

UST10Y

1931-43.84%-2.56%

1941-12.77%-2.02%

1969-8.24%-5.01%

2018-4.23%-0.02%

2022 YTD-15.57%-9.04%

Source: NYU, Reuters Eikon (as of May 13, 2022), Incrementum AG.

But what were actually the reasons for this double whammy backthen?103• In 1931, in the midst of the Great Depression, the British pound, then theworld’s reserve currency, was devalued and taken off the gold standard. This
had an inflationary effect.

• In 1941, the US was attacked by Japan and drawn into World War 2. Shortly
thereafter, explicit yield curve control (YCC) was introduced, which was also
inflationary.104• 1969 marked the beginning of a highly inflationary era, with the US devaluing
the US dollar only 18 months later and Nixon releasing the US – initially
temporarily – from the gold redemption obligation. This again had an
inflationary effect.

—

102 See Stöferle, Ronald, Taghizadegan, Rahim and Hochreiter, Gregor: The Zero Interest Trap, 2019
103 Gromen, Luke: FFTT, February 18, 2022
104 See “The Status Quo of Gold,” In Gold We Trust report 2021, pp. 43–45

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Quo Vadis, Aurum?

375• In 2018, the Federal Reserve was forced to end its interest rate hike program
after heavy losses on the stock markets. Seven months later, the next ratecutting cycle began. In response to the rise in repo rates, the Federal Reserveagain began to expand its balance sheet. The effect was again inflationary.
Inflation was a sleeping dragon;

It can be seen that inflation played a central role in all the cases

this dragon has now awoken.

mentioned. But it is not only assets that are devalued by inflation but also theOtmar Issing

business models of many companies. This is why we have repeatedly pointed
out in previous years that selecting the right equity sector or the rightcompany becomes significantly more important when inflation isabove the “feelgood zone” of around 4%. The fact that high inflation rates
initially represent a headwind for equities is also confirmed by the next chart,
which shows the monthly valuations of the S&P 500 based on the Shiller P/E ratio
and the associated inflation rate.

50

CPI Inflation Rate (x-axis), and Shiller P/E Ratio (y-axis), 01/190004/2022
Typically high valuations only inmoderate inflation environments

45
40
35

Current Situation

30
25
20
15
10
5
0
-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

Source: Robert J. Shiller, Incrementum AG

It turns out that equities usually perform poorly in strongly
deflationary and highly inflationary environments. This is mainly because
companies’ sales and margins come under pressure. Because of the current highinflation rates, the S&P 500 is still too highly valued, with a Shiller P/E of justunder 34. In order to remain true to the previous empirical pattern, theShiller P/E ratio would have to be roughly halved if the inflation rate
remained constant.
The US stock market today looks

To return to a value within the general statistical pattern, therefore,

a lot like it did at the peak before

either prices, the inflation rate, or both would have to fall. We expect

all 13 previous price collapses.

inflation in the USA to reach its interim high in the course of this year. Driven byThat doesn’t mean that a bear

weakening demand, increasingly recessionary tendencies, and fading base effects,

market is imminent, but it does

inflation will slow down but is expected to remain above 5% yoy this year. In thisamount to a strong warningcase, a continuation of the correction on the US equity market would

against complacency.

be entirely appropriate from a valuation perspective.

Robert J. Shiller
The following chart shows the course of 10-year annualized real
returns of stocks (S&P 500 TR) and bonds (10-year US Treasuries) overthe past 140 years. It is noteworthy that the returns are mostly symmetrical,

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Quo Vadis, Aurum?

376

suggesting a positive correlation between the two asset classes over the longer
term. But while equities are still yielding high returns, the annualized real returnon bonds is in negative territory for the first time in almost 40 years.

10-Year Annualized Real Returns of Stocks and Bonds*, 01/188104/2022

25%
20%
15%
10%

?

5%
0%
-5%
-10%
1881

1901

1921

1941

1961

1981

Stocks

2001

2021

Bonds

Source: Robert J. Shiller, Incrementum AG*Stocks = S&P 500 TR/Bonds = 10-Year US Treasuries

In the past 140 years, stock returns have slipped into negative territory
only four times. The triggers were the two world wars, stagflation in the 1970s
and the financial crisis of 2007/08. And each time before the long-term returncollapsed, the stock market had previously been in a phase of euphoria,
characterized by annualized returns of well over 10% in some cases.
I think the biggest potential

The high of the current cycle dates from September 2021 with a returnsurprise out there is that theof 14.3%. Since then, the return has gone slightly downhill. The question

stock/bond correlation – which

now is, what is the alternative or ideal portfolio companion to the broad equity

everyone assumes will go tomarket when bonds, with a high positive correlation to equities, have a negative

negative one in a crisis – instead

long-term real return in the stagflationary environment? Our quantitative

goes to one.

evaluations show that gold, silver and mining stocks have historically

Kevin Muir

outperformed in stagflationary times.

Average Annualized Real Returns of Gold, Silver, and BGMI
During Proprietary Calculated Stagflation Periods and 70s
40%
33.1%

35%

32.8%
28.6%

30%
25%

21.2%

20%
15%
10%

7.7%
3.4%

5%
0%

Proprietary Calculated Stagflation Periods

Gold

70s

Silver

BGMI

Source: Reuters Eikon, goldchartsrus.com, Incrementum AG

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Quo Vadis, Aurum?

377

One thing is certain: You will not be able to defeat a wolf and a bear in
combination with a classic 60/40 portfolio. The historical performance ofgold, silver and commodities in past periods of stagflation argue for acorrespondingly higher weighting of these assets than under normal
circumstances. But also, the relative valuation of technology companies tocommodity producers is an argument for a countercyclical investment in the latter.
BoA’s market strategists are already talking about FAANG 2.0:

• Fuels• Aerospace• Agriculture• Nuclear and renewables• Gold and metals/minerals
Market Capitalization of NASDAQ 100, MSCI Global Materials, and
MSCI World Energy, in USD trn, 03/2012-05/2022

20
18
16
14
12
10
8

6
4
2
0
2012

2013

2014

2015

NASDAQ 100

2016

2017

2018

MSCI Global Materials

2019

2020

2021

2022

MSCI World Energy

Source: Bloomberg, Incrementum AG

For gold, recessions are typically a positive environment. As our analysis
in the In Gold We Trust report 2019105 has shown, times when the bear dominatesin markets and the real economy are good times for gold. If we look at performanceover the entire recession cycle, it is notable that in each of the four recessionary
periods106 gold saw significant price gains on average in both US dollar and euro
terms. In contrast, equities as measured by the S&P 500 were only able to makesignificant gains in the final phase of the recession. Thus, gold was able tosuperbly compensate for equity losses in the early phases of therecession. Moreover, it is striking that, on average, the higher the price losses of
the S&P 500, the stronger gold performed. Once again, this worked wellduring the most recent recession in 2020.

—

105 See "Portfolio characteristics: gold as an equity diversifier in recessions," In Gold We Trust report 2019.
106 Phase 1: Entry phase; Phase 2: Unofficial recession; Phase 3: Official recession; Phase 4: Last quarter ofrecession.

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Quo Vadis, Aurum?

378

S&P 500

st

1 Recession
2ndRecession

3rd Recessionth

4 Recessionth

5 Recession
6th Recessionth

7 Recession
8th Recession

Recession
duration
Q1/1970 Q4/1970
Q1/1974 Q1/1975
Q2/1980 Q3/1980
Q4/1981 Q4/1982
Q4/1990 Q1/1991
Q2/2001 Q4/2001
Q1/2008 Q2/2009
Q1/2020 Q2/2020
Average:

Gold in USD

Gold in EUR

Phase 1

Phase 2Phase 3Phase 4Phase 1

Phase 2Phase 3Phase 4

-1.8%

-4.6%

-7.0%

7.0%

-8.9%

-6.6%

0.0%

5.9%

-8.0%

0.3%

-15.0%

16.6%-10.9%

58.5%

89.7%

-1.1%

7.1%

-2.1%

7.7%

10.0%

70.1%

-22.8%

-5.9%

21.8%

-7.4%

2.9%

12.8%

15.9%

-14.6%

0.8%

1.2%

14.2%

-10.7%

-0.1%

13.8%

13.9%

7.1%

-3.3%

-7.9%

-5.7%

1.3%

-8.1%

0.5%

-1.5%

3.8%

5.4%

0.5%

-10.2%-50.4%-18.0%

21.6%

14.3%

8.5%

-20.0%

-4.0%

20.0%

3.1%

3.6%

-2.2%

-4.1%

-6.3%

8.2%

8.2%

6.0%

Phase 1

Phase 2Phase 3Phase 4

4.6%

11.1%

3.0%

7.2%

51.8%

51.0%

-6.2%

27.5%

0.5%

20.2%

-1.6%

2.6%

-4.8%

21.0%

10.4%

-4.7%

4.6%

-9.3%

-12.2%

-3.6%

1.3%

-0.8%

8.3%

5.5%

-4.4%

16.3%

24.0%

2.2%

12.2%

31.4%

19.8%

17.4%

13.3%

0.2%

5.3%

17.1%

11.2%

14.5%

9.3%

6.2%

8.6%

18.1%

3.6%

Source: Federal Reserve St. Louis, World Gold Council, Incrementum AG

95% of all financial history

Overall, it can be seen that gold has largely been able to cushion sharehappens within two standard

price losses during recessions. For bonds, the classic equity diversifier, on thedeviations of normal, andother hand, things look less good. The high level of debt, the zombification of theeverything interesting happens

economy, and the still very loose monetary policy reduce the potential of bonds as

outside of two standard

an equity hedge. Gold will therefore remain an indispensable portfolio

deviations.

component in the future, allowing investors to sleep soundly in

Ric Kayne

stressful situations in financial markets.

Cold War 2.0 as a Structural Inflation Driver?
The princess winced and spoke: I

In his bestseller The Great Illusion, published in 1911, Norman Angell, who wasreally do not understand whylater to be awarded the Nobel Peace Prize, made the game-theoretical argument

men cannot live without wars;

that wars between industrialized nations, in view of international economic

all Moscow speaks only of war.

interdependence, would entail such high economic and social costs that it would

Leo Tolstoy

henceforth be irrational to start one. Accordingly, the great illusion was sufferedby the state leader who expected a positive payoff for his country from a war.

Illusions recommend themselves

It is distressing how, after more than a hundred years, a large part ofby sparing feelings ofthe public and the political elite could once again have fallen underdispleasure and letting us enjoy

exactly the same delusion. Until February 23 of this year, the belief in a world

satisfactions in their place.

order persisted, in view of which, according to Peter Sloterdijk, people in large

Sigmund Freudparts of Europe convinced themselves that “we had left the epoch in which wars
take place”, while Putin mobilized his forces before everyone’s eyes but in the blindspot of this world view.
We hope and believe that an escalation to the extreme between NATOand Russia will be avoided. But entering into a protracted, expensive andgrueling second Cold War seems increasingly likely. Turning point, paradigm
shift, and caesura are among the terms that have recently been used in an almost
hyperinflationary manner. The fact is that numerous asset classes have alreadypriced in a geopolitical (war) premium and that the heyday of globalization and its
disinflationary effect have come to an end.

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Quo Vadis, Aurum?

379

I am an old man and have

Russia will be a pariah state for the Western community for many

known a great many troubles,

years to come. In reaction, Russia will turn more and more to Asia economicallybut most of them neverand politically. The planned 2,600km long gas pipeline Power of Siberia 2, forhappened.

example, will enable Russia to supply Western Siberian gas from the Yamal

Mark Twain

Peninsula to China in the future. Currently, only exports to Europe are feasible via
the existing pipeline network.

I have seen the future and it isThus, it seems likely that a Western community of shared values and a pan-Asianvery much like the present, only

community of convenience dominated by China and Russia will contest world

longer.

affairs in the future. Regions that traditionally have not hewn to either of the two

Kehlog Albran

blocs (Latin America, the Gulf states, Southeast Asia, Africa) will presumably
enter into temporary alliances on a situational basis andopportunistically, or will decide for or against strategic integration into
one of the two spheres after weighing up their economic, political andcultural interests.
The striving for block self-sufficiency will prove to be almost
impossible, especially for Europe, and in any case very expensive. The
commodity leverage that Russia, but also China, have vis-à-vis Europe
is underestimated.107 Zoltan Pozsar highlights the case of Germany, wherecommodity imports – mainly energy imports from Russia – worth USD 27bn
support economic activity worth USD 2trn. However, the leverage effect ofcommodities has a striking impact not only on economic development
but also on inflation.

Europe is not an entity that could

For the EU, for example, Russia is a major supplier of palladium, an important

live for itself. Europe is only

element for chemical and automotive catalysts, fuel cells and electronic

possible within the world andapplications. According to the US Geological Survey, the EU imports 98% of its

within the world economy.

rare earth elements (REEs) from China. Rare earths are indispensable components

Gustav Stresemannof many high-tech products, including military equipment and renewable-energy
equipment. However, the shift from carbon-based forms of energy to socalled renewable energies, which are now also referred to as "theenergy of freedom", only exchanges one dependency (Russia) for
another (China).
From energy to base and battery metals to precious metals and agriculturalcommodities, the Ukraine war is now further disrupting supply chains and longestablished supply/demand patterns. This will cause commodity prices tosettle at a new, higher level.

—

107 See 13D Research: What I learned this week, April 21, 2022

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Quo Vadis, Aurum?

380

Commodity Prices*, 01/1915-04/2022
559%

?

800

400

256%

200

323%
170%

100

50

25
1915

1925

1935

1945

1955

1965

1975

Recession

1985

1995

2005

2015

Commodity Prices

Source: Alpine Macro, Federal Reserve St. Louis, Reuters Eikon, Incrementum AG*1913-1934 US PPI Industrial Commodities, 1935-1949 Spot Price 28 Commodities, 1950-1969 Spot Price
22 Commodities, since 1970 S&P GSCIIn the short term, the situation on the commodity markets looks
overbought. As long as the Federal Reserve makes no move to leave the path ofinterest rate hikes, the general environment for risk assets will remain difficult. A
reversal of monetary policy or the Federal Reserve’s pushing themonetary policy pause button will give the starting signal for the next
upward cycle. This will probably be accompanied by a weaker US dollar. The
upward momentum in recent months despite the firm US dollar has beensurprising to us and at the same time a sign of the inherent strength of thecommodity bull market. An increasingly expansionary China – after all, a newpresident will be elected by the National People’s Congress in the fall – should also
provide further support for the sector.

Gold and the weaponization of money
Geopolitics rarely matters to

The emerging bloc formation will fundamentally reshape the existing

investors as it is akin to the slow

global monetary order. The weaponization of money through the freezing ofgrinding of great tectonic plates.

Russian foreign exchange reserves has further accelerated the process of de-However sometimes things speed

dollarization. Certainly, new multinational institutions and arrangements do not

up and earthquakes follow.

emerge overnight. But confidence in the existing US dollar-centric

Russell Napiermonetary order is likely to become passé in many strategicallyimportant countries.
Given the multipolarity that can be expected, the new world monetaryorder will need an internationally recognized anchor of trust, and gold
seems predestined for this purpose for several reasons.
• Gold is neutral•

The US dollar, hitherto the global reserve and trading currency, has, withthe freezing of Russia’s currency reserves, given up the appearance of politicalneutrality that is necessary for this status. Gold, on the other hand, belongs to
no state, no political party, no dictator. In a new world monetary order, gold
can thus represent the unifying element in a multi-polar world that has
become much more fragile.

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Quo Vadis, Aurum?

381• Gold has no counterparty risk•

Financial assets have a counterparty risk. If the debtor does not want to

pay or cannot pay, the creditor’s claim is worth nothing. Gold, on the other
hand, has no counterparty risk. And the risk of the owner being prohibitedfrom accessing his gold is easily solved for states by storing their gold within
the state’s borders or with a friendly state.
• Gold is liquid•Gold is one of the most liquid assets worldwide. In 2021, gold was tradeddaily to the tune of almost EUR 150 billion. In a study, the LBMA showed thatgold has higher liquidity than government bonds in some cases.

Best of In Gold We Trust Report 2022
Other key findings from this year’s In Gold We Trust report,
Stagflation 2.0, include the following:• Debt: Appearances are deceptive - this is how the development of the debt
situation in 2021 can be summarized. The decline in (government) debt ratios
is primarily attributable to the fact that economic growth in 2021 was well
above average due to the pronounced economic slump in 2020. The decline indebt ratios due to this base effect is by no means an indication that the trend
toward ever higher debt (ratios) has been broken. Nominal debt, on the other
hand, exceeded USD 300trn for the first time.

• Inflation: Even though we think it likely that inflation rates will slowly pullback in H2 2022, we expect successive waves of inflation – analogous to the
Covid-19 waves. And it seems that the next inflation virus variant is alreadybeing announced. One thing is certain: The era of the "Great Moderation" isdefinitely over.

• De-dollarization: The freezing of Russian currency reserves is comparable inits impact on the global monetary order to Richard Nixon’s closing of the gold
window in 1971. And while the Ukraine war preoccupies the West, Moscow and
Beijing are expanding their cooperation. The long-unchallenged (petro)dollar
is battered, as evidenced by the fact that the relationship between Saudi Arabia
and the US has rarely been worse than it is right now. What the global
monetary order will look like when the dust settles is unclear. What seems
certain is that gold and commodities will gain considerably in importance.

• Bitcoin: The stock-to-flow model (S2F model) has been able to explain theprice development of Bitcoin remarkably well historically. In the current cycle,
however, Bitcoin’s price is significantly below the range assumed by the model.
Although Bitcoin is currently back in a veritable bear market, its adoption
continues to grow, particularly among institutional investors but also among
governments.

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Quo Vadis, Aurum?

382• Silver: The price of silver has disappointed many investors in view of the
explosion of inflation. Is silver no longer a monetary precious metal that
hedges against inflation? There were two weighty reasons for thisdisappointment. First, real interest rates stopped falling in August 2020. The
inverse correlation of silver and real rates stopped the price rise. Second,
consumer price inflation does not necessarily equate to monetary inflation. The
good news – at least for silver investors – is that the probability of an
inflationary decade is high.

• Mining stocks: The main reasons for the weak performance of the gold
mining sector are capital expenditure (CAPEX) overruns, rising production
costs, problems with permitting new mines, political instability, and declining
reserves and new discoveries. Due to rising energy and construction material
prices, increasing wage demands, and general inflation, all-in sustaining costs(AISC) are expected to increase further in the foreseeable future.

• Royalty and streaming companies: The market capitalization of thissegment of the mining sector has increased from USD 2bn to more than
USD 60bn in 15 years. An index of royalty and streaming companies in the
precious metals sector outperformed gold and silver mining companies.

• ESG: In the new low-emissions economy, a new economic metric needs to becreated for the mining sector: the all-in emissions cost (AIEC). This metric willtransform nonfinancial costs into financial costs for investors andstakeholders. In principle, an increase in the proportion of gold in an investor’s
portfolio will translate to a significant positive impact on the CO2 footprint andemissions intensity of the overall portfolio.

• Technical analysis: The analysis of market structure, sentiment and pricepatterns leads us to a rather mixed technical assessment in the short term.
Although sentiment has clouded recently, an extreme bearish wash-out has not(yet) taken place. From a seasonal perspective, the next few weeks could stillbring headwinds.

Quo Vadis, Aurum?
This is gold, Mr. Bond.

For gold investors, 2021 was disappointing due to the sharp rise in

All my life I’ve been in love with

inflation. Perhaps expectations were also too high, as 2019 and 2020

its color... its brilliance, its divine

were fantastic years for chrysophiles. But in the last couple of months, gold

heaviness.

fulfilled its role quite well, in our opinion, even if its 2021 performance lagged

Auric Goldfinger

general expectations. It has provided stability and calm to portfolios in the wake ofrecent volatility. The gold price has stood up to collapsing equities, bonds, andcrypto markets, as well as the rallying US dollar.
However, real upward momentum in the gold price can only be
expected again when a turnaround to ultra-loose monetary policy isonce more heralded. When that will happen is the crucial question.

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So how seriously can the Federal Reserve’s hard line be taken? During
his semi-annual questioning before the Senate Banking Committee, Jerome Powell
was asked by Senator Richard Shelby (Rep): “Volcker put the economy in arecession to get inflation under control. Are you prepared to do what it takes to
get inflation under control?”, to which Powell replied, “I hope history will recordthat the answer to your question is yes.”
If stocks don’t fall, the Fed needs

The Federal Reserve seems to be serious. However, if theto force them.

communicated tightening is implemented consistently, the Everything

Bill Dudley

Bubble threatens to end in the Everything Crash. Stocks, bonds andcryptocurrencies have already fallen victim to the tighter monetary policy. Realestate would be next on the list.

It seems long, but it won’t lastInternationally, too, distortions are to be expected as a consequence of monetary

forever.

policy tightening in the US. The euro area, but also Japan, could be threatened

Bambi’s motherwith trouble due to rising yields. In the short term, gold holders should
therefore probably still expect headwinds, especially if further pricedeclines trigger a panicky situation in markets. However, the bigger the storm on
the financial markets, the more likely it is that there will be a renewed
abandonment of tight monetary policy.
As soon as the Federal Reserve is forced to deviate from its planned
course, we expect the gold rally to continue and new all-time highs tobe reached. We believe it is illusory that the Federal Reserve can deprive themarket of the proverbial “punchbowl” for any length of time, and we seriously
doubt that the transformation of doves into hawks will last. Most hawks will
merely turn out to be doves in hawk’s clothing and will shed their hawkish garb
sooner rather than later as a result of the inevitable consequences of monetary
tightening: recession, rising yields, stock market corrections, bankruptcies,
unemployment.

Bottoms are better to watch thanIf the downward trend on the stock and bond markets that has

to try and catch.

persisted since the beginning of the year continues, a brash counter-

Rebecca “Becky” Quick

reaction by the Federal Reserve seems to be only a matter of time. Whatmight a new U-turn look like? What novel rabbit can central bankers pull out of
their capacious hat? The following instruments are still in the toolbox of monetaryand fiscal policymakers:• Yield curve control• Renewed QE or QQE• Financial repression• Other fiscal stimuli• MMT or helicopter money• CBDCs• In the euro area: further communitization of debt via issuance of additional
eurobonds
The use of one or more of these instruments is a foregone conclusion, with thefurther merging of monetary and fiscal policy proceeding inexorably. One thing is

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384

certain: The coming rescue measures will take on increasingly larger, moreaggressive, and more abstruse features.
Gold’s properties as a portfolio

A successively higher share of deficits will be financed via the digitaldiversifier have been

printing press. The longer and closer this liaison between monetary and fiscal

institutionally forgotten by thosepolicy continues, the greater the stagflationary forces and the higher the

who have spent a lifetime

probability of a complete loss of confidence.

confusing the declining cost ofmoney with investment genius.

Many portfolios still seem inadequately prepared for Stagflation 2.0.

Charlie Erith

This is probably due in part to the fact that there are almost no fund managers inservice today who have experienced an inflationary, much less a stagflationary
environment during their investment careers. In addition, most portfolio
approaches are based on backtesting strategies that go back 10, 20, or at most 30
years. However, very few portfolio strategies take into account the stagflationary
environment of the 1970s.
In the current phase, which is characterized by the resurgence ofstagflation, the positive correlation between equities and bonds meansthat a portfolio diversifier is needed that works. History suggests that gold
has fulfilled this role admirably. Whenever the traditional portfolio experienced adrawdown, gold proved its capabilities as a reliable portfolio hedge.

Gold Performance During Classic Balanced Portfolio* Drawdowns,
01/1920-04/2022

200%
150%
100%

50%
0%

-50%
-100%
1920

1930

1940

1950

1960

1970

1980

1990

Classic Balanced Portfolio

2000

2010

2020

Gold

Source: Bridgewater, Reuters Eikon, goldchartsrus.com, Incrementum AG*60% Stocks (S&P 500 TR)/ 40% IG Bonds

Our New World Disorder will be

Two years ago, on the occasion of the transition into a new decade, we presented

characterized by greater

our gold price forecast until 2030 in the In Gold We Trust report 2020.108 The

volatility, higher inflation, andcentral input factor of this estimate was the gold coverage ratio of the money

deeper financial repression.

supply. In our base case scenario at that time, we assumed an annual M2 money

Alexander Chartres

supply expansion of 6.3%. The resulting price target was around USD 4,800.

And trust is everything.

So far, gold has aligned itself quite well with our predicted price trend.

Paul Volcker

For gold to remain on track through the end of the year, it would needto rise to USD 2,187. Taking into account the developments discussed in thisyear’s In Gold We Trust report, we firmly believe that this is a realistic target,—

108 See “Quo vadis, aurum?”, In Gold We Trust report 2020

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385

provided that monetary policy moves away from the announced hawkish path.
Likewise, we maintain our long-term price target of around USD 4,800
by 2030.

Intermediate Status of the Gold Price Projection until 2030: Gold,and Projected Gold Price, in USD, 01/1970-12/2030

5,000

4,500

Gold Price Projection until 2030:
USD 4,821

4,000
3,500

Intermediate Target End 2022:
USD 2,187

3,000
2,500
2,000
1,500
1,000
500
0
1970

1975

1980

1985

1990

1995

2000

Actual Gold Price

2005

2010

2015

2020

2025

2030

Projected Gold Price

Source: Reuters Eikon, Incrementum AG

Keep cool.

The coming years will undoubtedly be challenging for investors. Wolf

Erasmus (1466-1536)

and bear are fascinating predators, but in the economy they are a duo
infernale that will demand everything from investors during
Stagflation 2.0. Volatility in capital markets, in global politics, in the economy,
in interest rates, and especially the volatility of inflation will be with us for sometime. We are firmly convinced that gold increases the resilience of a broad
portfolio, especially in this environment, and should be an indispensable portfolio
component in the context of Stagflation 2.0.

Watch out, be cautious and don’t

We look forward to continuing to analyze gold-related developments

take any crap.

for you and to sharing our thoughts with you. Together we will master

Dr. Kurt Ostbahn

these challenges. Because, even more so in the maw of Stagflation 2.0:

IN GOLD WE TRUST

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About Us
Ronald-Peter Stöferle, CMT
Ronnie is managing partner of Incrementum AG and responsible for
Research and Portfolio Management.
He studied business administration and finance in the USA and at the Vienna
University of Economics and Business Administration, and also gained work
experience at the trading desk of a bank during his studies. Upon graduation hejoined the research department of Erste Group, where in 2007 he published his
first In Gold We Trust report. Over the years, the In Gold We Trust report has
become one of the benchmark publications on gold, money, and inflation.
Since 2013 he has held the position as reader at scholarium in Vienna, and he also
speaks at Wiener Börse Akademie (the Vienna Stock Exchange Academy). In 2014,
he co-authored the international bestseller Austrian School for Investors, and in
2019 The Zero Interest Trap. He is a member of the board of directors at Tudor
Gold Corp. (TUD), a significant explorer in British Columbia’s Golden Triangle.
Moreover, he is an advisor to Matterhorn Asset Management, a global leader in
wealth preservation in the form of physical gold stored outside the banking system.

Mark J. Valek, CAIAMark is a partner of Incrementum AG and responsible for Portfolio
Management and Research.
While working full-time, Mark studied business administration at the Vienna
University of Business Administration and has continuously worked in financial
markets and asset management since 1999. Prior to the establishment of
Incrementum AG, he was with Raiffeisen Capital Management for ten years, mostrecently as fund manager in the area of inflation protection and alternative
investments. He gained entrepreneurial experience as co-founder of philoro
Edelmetalle GmbH.
Since 2013 he has held the position as reader at scholarium in Vienna, and he also
speaks at Wiener Börse Akademie (the Vienna Stock Exchange Academy). In 2014,
he co-authored the book Austrian School for Investors.

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387

Incrementum AG

Incrementum AG is a boutique investment and asset managementcompany based in Liechtenstein. Independence and self-reliance are thecornerstones of our philosophy, which is why the five partners own 100% of thecompany.
Our goal is to offer solid and innovative investment solutions that dojustice to the opportunities and risks of today’s prevalent complex andfragile environment.

https://www.incrementum.li/en

We would like to thank the following people for their outstanding
support in creating the In Gold We Trust report 2022:
Gregor Hochreiter, Richard Knirschnig, Jeannine Grassinger, Lois Hasenauer,
Stefan Thume, Florian Hulan, Theresa Kammel, Handre van Heerden, Katrin
Hatzl-Dürnberger, Philip Mastny, Peter Young, Andreas Merkle, Thomas Vesely,
Fabian Grummes, Niko Jilch, Florian Grummes, Heinz Blasnik, Hans Fredrik
Hansen, Julien Desrosiers, Dietmar Knoll, Emil Kalinowski, Elizabeth and Charley
Sweet, Marc Waldhausen, Max Urbitsch, Trey Reik, Alexander Ineichen, Herwig
Zöttl, Tom Pohnert, Keith Weiner, Brent Johnson, Grant Williams, Markus
Hofstädter, Jochen Staiger, Ilse Bauer, Paul Wong, Fabian Wintersberger, Leopold
Quell, Hans Engel, Match-Maker Ventures, Harald Steinbichler, Richard Schodde,
David Schrottenbaum, Offroad Communications, our friends at the World GoldCouncil, the whole wonderful team at Incrementum and of course our families!

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The In Gold We Trust Report Team

Gregor Hochreiter

Richard Knirschnig

Jeannine Grassinger

Stefan Thume

Editor-in-chief

Quantitative analysis &Assistant

Webdesign & media

388

chartsPeter Árendáš

Julien Desrosiers

Fabian Grummes

Florian Grummes

Contributor

Contributor

Contributor

Contributor

Lois Hasenauer

Katrin Hatzl-Dürnberger

Handre van Heerden

Philip Hurtado

Quantitative analysis &Proof reading

Contributor

Contributor

Nikolaus Jilch

Emil Kalinowski

Theresa Kammel

Philip Mastny

Contributor

Contributor

Contributor

Social MediaCharley Sweet

James TwadellPeter Young

Proof reading

Contributor

Contributor

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Contact
Incrementum AG
Im Alten Riet 102
9494 – Schaan/Liechtenstein
www.incrementum.li
www.ingoldwetrust.li
Email: ingoldwetrust@incrementum.li

Disclaimer
This publication is for information purposes only, and represents neither
investment advice, nor an investment analysis or an invitation to buy or sellfinancial instruments. Specifically, the document does not serve as a substitute forindividual investment or other advice. The statements contained in thispublication are based on the knowledge as of the time of preparation and are
subject to change at any time without further notice.
The authors have exercised the greatest possible care in the selection of theinformation sources employed, however, they do not accept any responsibility (andneither does Incrementum AG) for the correctness, completeness or timeliness of
the information, respectively the information sources, made available, as well as
any liabilities or damages, irrespective of their nature, that may result there from(including consequential or indirect damages, loss of prospective profits or theaccuracy of prepared forecasts).
Copyright: 2022 Incrementum AG. All rights reserved.

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Company Descriptions
Agnico Eagle
Agnico Eagle is a senior Canadian gold mining company with operating mines
located in Canada, Australia, Finland and Mexico, and exploration anddevelopment activities in these countries as well as in the United States andColombia.
www.agnicoeagle.com

Asante Gold
Asante Gold is an emerging gold producer in Ghana, West Africa. We target growththrough organic exploration and focused acquisitions. We believe in responsible
development and strive to be Ghana’s foremost gold producer and employer ofchoice.
www.asantegold.com

Aurion Resources
Aurion is a well-funded, Canadian exploration company operating in an emerging
gold camp in Finland’s Central Lapland Greenstone Belt. The Company’s focus ison advancing its Flagship Risti and Launi projects, and JVs with B2Gold andKinross.
www.aurionresources.com

Caledonia Mining
Caledonia Mining is a profitable, dividend-paying gold miner. It acquired an
additional exploration project in late 2021 and continues to evaluate otheropportunities with the aim to become a multi-asset, Zimbabwean gold producer.
www.caledoniamining.com

Dakota Gold
Dakota Gold (NYSE American: DC) is a South Dakota-based responsible gold
exploration and development company with a specific focus on revitalizing theHomestake District of South Dakota.
www.dakotagoldcorp.com

EMX Royalty
EMX has shined for nearly 20 years with a track record of smart deals.
With more than 300 royalties and holdings, EMX is poised for a revaluation withits diversification into gold, copper, battery metals, strong partners such as Franco
Nevada and new cash inflows.
www.emxroyalty.com

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391

Endeavour Mining
As a leading global gold producer and largest in West Africa, Endeavour iscommitted to the principles of responsible mining and delivering sustainable value
to all stakeholders. Endeavour is listed on the LSE and TSE under the symbol EDV.
www.endeavourmining.com

Endeavour Silver
Endeavour Silver is a mid-tier precious metals mining that owns two underground,silver-gold mines in Mexico, and has a compelling pipeline of exploration anddevelopment projects to facilitate its goal to become a senior silver producer.
www.edrsilver.com

Hecla Mining Company
Hecla Mining Company (NYSE: HL) is the largest primary silver producer in the
United States and the fifth largest gold producer in Quebec. Hecla is also the thirdlargest US producer of both zinc and lead.
www.hecla-mining.com

Matterhorn Asset Management AG
MAM is a global leader in the acquisition and storage of gold, providing investors
direct personal access to the biggest and safest private gold vault in the world,
located in the Swiss Alps. We offer unique and exceptional personal service andadvice to our clients.
www.goldswitzerland.com

Minera Alamos
Minera Alamos is a new gold producer going through the ramp up of its first gold
mine with commercial production expected in 2022. Specializing in low capexbuilds the Minera model remains insulated from inflationary pressures.
www.mineraalamos.com

Münze Österreich
Internationally renowned for its precious metal processing, Münze Österreich AG
produces Austria’s circulation coins, Vienna Philharmonic bullion coins in gold,
platinum and silver, and gold bars.
www.muenzeoesterreich.at

New Zealand Bullion Depository
Our mission is to provide the best in gold bullion storage, with unparalleled service
and discretion. Your gold is allocated, segregated and secured in our purpose-built
world class New Zealand facility, giving you secure peace of mind.
www.nzbd.com

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philoro EDELMETALLE
philoro is one of the market leaders in Europe in the field of precious metals
trading and your reliable partner for investments in gold and silver, platinum andpalladium.
www.philoro.com

Reyna Gold
Reyna Gold is focused on district-scale exploration on the major gold belts in
Mexico, with a property portfolio of over 57,000 hectares, a world class explorationteam and proven management team.
www.reynagold.com

Solit
As a leading precious metal trading company, the SOLIT Group offers precious
metal savings plans, safe storage concepts and asset-based investment funds
focusing on gold and silver.
www.solit-kapital.de

SprottSprott Inc. is a global asset manager providing investors with access to highlydifferentiated precious metals and real assets investment strategies.
www.sprott.com

Tudor Gold
TUDOR GOLD Corp. is an Exploration company in the Golden Triangle region in
B.C., Canada, which is advancing the Treaty Creek project that hosts a resource of
19.4 MOz AuEq (M+I) plus 7.9 MOz AuEq (Inferred).
www.tudor-gold.com

Victoria Gold
Victoria Gold (VGCX) is Leading Yukon’s New Gold Rush. The Eagle Gold Mine incentral Yukon, Canada is increasing production rate to 250K oz/Au in 2023. 2022
Exploration Program at nearby Raven target starts.
www.vgcx.com

Ximen Mining
Ximen Mining (TSX.V XIM) is focused on responsible development, sustainable
mining and exploration of its precious metals properties in southern BC, Canada,
as it advances its Kenville Gold mine.
www.ximenminingcorp.com

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