Why Gold No Longer Shines As A Long-Term Investment. (NYSEARCA:GLD)

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Gold Underperforms In Times Of Low Interest Rates And Loose Monetary Policy

A key argument for gold’s appeal is that the resurgence of Quantitative Easing (QE) and Zero Interest Rate Policy (ZIRP) will boost its value. This makes sense, as devaluing fiat currency typically enhances the worth of hard assets.

Going one step further, during low interest rate periods, zero-yield assets like gold theoretically should become more appealing compared to those with a yield. For instance, if interest rates were at 10%, gold’s opportunity cost would be significant due to the 10% yield loss. But at ~2% interest, the gap narrows to just 2%, making gold more attractive.

However, this has not happened when looking at past data.

The chart above displays average US federal funds interest rates over the past 84 years, with highlights in yellow indicating:

1. A very loose monetary period from 2008 to 2023, marked by Quantitative Easing post-2008 recession and the introduction of ZIRP policy.

2. A loose monetary period from 1940 to 1960, during and after World War II, when the US (and Europe) maintained low interest rates to stimulate and rebuild the economy.

3. A tight monetary period from 1965 to 1985, covering the high inflation era of the 1970s, Volcker’s policies, and the US dollar’s departure from the gold standard.

Gold should be expected to excel during the first two periods of loose monetary policy, while likely underperforming equities in the tight monetary environment of 1965 to 1985. Yet, the data contradicts these expectations:

In the past 15 years (from 2008 to 2023), the S&P 500 and Dow Jones have performed respectively at +470% and +335%. Gold, in comparison, has only performed at +160%, despite having reached all-time highs.

From 1940 to 1960, gold, again, underperformed. From 1940 to 1960, gold’s price decreased from 750 USD / Oz to 370 USD / Oz, while the Dow Jones has performed at +461%. Note that I am using the Dow Jones as a comparison for this time period because the S&P 500 was only introduced in 1957.

During 1965 to 1985, a period featuring the highest interest rates in the last 84 years, gold actually outperformed the S&P 500.

Data shows that the more monetary policy is loose, the more gold underperforms relative to equities (while its nominal value expressed in fiat currency increases). How does this make sense? The reasons are ultimately debatable and rooted in the human behavior of market players, but these are dynamics that might explain it:

• In an environment with low interest rates and the specter of inflation, investors may simply prefer to chase returns and take higher risk. This trumps the fact that a rational investor should prefer gold, given the limited opportunity cost. Investors are not always rational, and between 2010 and 2020 they often preferred to invest in unprofitable startups rather than in gold or in dividend stocks.

• During periods of loose monetary policy, gold’s nominal value expressed in fiat currency goes up. The more gold’s nominal value goes up, the more miners extract gold. This exerts a downward pressure that keeps gold’s prices artificially low and determines its underperformance. The ultimate issue here is that gold is not really scarce and can be mined at will.

• Gold is an asset that does not generate a cash flow. In a yield-starved economic environment, investors may prefer assets that generate a cash flow and that can adapt quickly to inflation. A company can raise its prices, a landlord might increase its rent. Gold does not have a similar mechanism and can only rely on its perceived scarcity to thrive in an inflationary environment.

If you believe that QE and ZIRP are not reversible and that one way or another the US will keep spending way more money than it can afford, then gold is not the asset you should choose. You can still argue that things might be different next time, but data so far has always shown that the loser the monetary policy is, the worst gold performs relative to other assets.

Gold Is Not Scarce In Nature

The World Gold Council has found that humanity mined approximately 212,582 tonnes of gold throughout history, with two-thirds of this total extracted since 1950.

The BBC estimates that approximately 50,000 tonnes of gold are currently reachable and can be mined with relative ease. This figure represents 20% of all gold, and it is known as “below-ground stock” of gold. However, this is only gold that we have in current, existing mines. Even barring any technological improvements, new mines could be opened in new areas of the world to mine more gold.

The real question is, how much gold can humanity access with current technology? We can get to a figure following this logic:

• From a geological standpoint, gold’s rarity stands at ~4 parts per billion. Sources for this figure include the 1991 study by Crocket, J.H. titled “Distribution of gold in the Earth’s crust – Gold metallogeny and exploration”, the Australia governmental agency “Geoscience Australia” and the University of California, Berkeley. This means that 4 parts of gold can be found for each 1 billion part of the Earth’s crust. Given that the mass of Earth’s crust is at 2.6 * 1022 kg, there are approximately 400 billion tonnes of gold available on our planet. For reference – given Earth’s surface is 510 million square kilometers, that is enough gold to cover the whole surface of our planet with a 4 meter thick layer of gold.

• Much of this gold is beyond our current technological reach – but how much can be extracted with current technology? Considering the world’s deepest mine in South Africa extends 3.9 km underground, let’s assume that, with sufficient economic incentive, we can extract all gold from up to 4 km beneath the Earth’s surface. Current estimates suggest there are 122 billion tonnes of gold in the first 4 KM of Earth’s crust. This is over 550 thousand times the amount of gold mined in human history.

• This figure includes gold in Earth’s crust beneath the oceans. We can mine oceans for gold with current technology, but to remain conservative, let’s assume we can only mine gold from land. Given that 30% of Earth is covered by land, then 36 billion tonnes of gold would be accessible to us (30% of 122 billion). This figure is 162 thousand times the amount of gold that has ever been mined.

• It is reasonable to assume that new gold mines will not be opened in urban areas, natural parks and areas with active volcanoes. So, let’s limit that number by a further 10%, down to 150,000% (150 thousand times) the amount of gold that has ever been mined.

To recap, humanity today can easily extract 20% of the whole gold that it has ever mined to date. On top, relying on current technology and given enough economic incentive, humanity can access ~ 150,000% more gold than what has ever been mined.

To be clear, this figure does NOT consider:

• The possibility we might access gold from asteroids in the near future, as Neil Degrasse Tyson mentioned in a 2017 interview.

• The possibility we could start digging deeper and deeper to access more gold, as technology improves.

No matter the exact figures – whether we are talking about 150,000% or 50,000% or even 10,000% – for the scale of humanity today, gold is just not that scarce. There are enough accessible gold reserves on Earth to obliterate the rarity of gold itself.

Gold Supply Increases With Demand – No Matter The Nominal Cost To Extract It

One argument for gold’s value is that high mining costs will limit its supply. Yet, historical data, shown in the chart comparing gold prices to mining output from 1969 to 2023, refutes this claim.

Gold production has steadily risen over the past 60 years. Simply put, as long as gold prices warranted, miners have consistently raised wages, opened new mines, and upgraded equipment to extract more gold.

This phenomenon is clearer if we look at a broader time frame. Recently, a chart was published by Visualcapitalist.com, showing gold production for the last 200 years.

Gold production has skyrocketed in the last 200 years:

• Approximately 375 tonnes of gold have been mined during the “gold rush” in the 1840s and 1850s in the USA. For contrast, 3,100 tonnes of gold have been mined in 2023 alone.

• Approximately 86% of gold has been mined in the last 200 years, according to Visualcapitalist.com.

• Approximately 66% of gold has been extracted since 1950 according to the World’s gold council.

To conclude, the relationship between gold’s price and its production underscores a fundamental economic principle: demand and supply. As prices climb, the incentive to mine gold increases, leading to higher production levels. This has always been the case for the last 200 years, and there is no reason why the same dynamics should not apply for the foreseeable future.

Gold Is One Technological Disruption Away From Immediate Obsolescence

Investing in gold carries a further risk: a sudden technological breakthrough could nearly instantly make gold obsolete.

Humanity has, so far, evolved exponentially. The first Homo sapiens appeared somewhere in Africa around 250,000 years ago. We have then proceeded to live as follows:

• For 96% of our time, we lived as hunter-gatherers.

• For 3% of our time, we lived in what we now consider ancient, agriculture-based civilizations.

• For 0.8% of our time, we lived in agriculture-based civilizations that we at least know something about.

• 0.08% of our time, we lived after the Industrial Revolution.

• For 0.01% of our time we are now living in a world with relative peace, no widespread famines and the highest standard of living in history.

The human brain is not wired to truly understand and grasp what exponential growth means – after all, there is very little exponential growth in nature.

Now, back to gold… gold worked well for the past 10,000 years (4% of humanity’s time on Earth), but can it keep working for the next 10,000? This is extremely unlikely. A multi-planetary species that can easily mine asteroids would find gold to be just too easy to retrieve to have any value. It would be like if, today, we were to use salt as a store of value. Salt has historically been very expensive to produce and was used to pay salaries, hence the root of the modern word to define a stipend given to an employee. Today, it is virtually accessible at any time for cheap by anyone living on Earth. Courtesy of our technological evolution.

I understand that 10,000 years is a time horizon that is likely a bit too long for the average Seeking Alpha reader. So, when will gold die? It may be sooner than you think.

Take Fracking. It is often brought as an example of a disruptive technology that changed the world’s geopolitical landscape. Before fracking technologies became available, the USA was a net importer of gas and oil. In 2020, the USA became a total petroleum exporter for the first time since 1949, according to the US Energy Information Administration.

The most obvious example of technological disruptions that could render gold obsolete overnight is asteroid mining:

• Astroforge, a pioneering startup, embarked on its inaugural mission to a rocky body in 2023, and thus far, the mission appears successful in reaching its target.

• In 2021, NASA awarded contracts to four companies to extract small amounts of lunar regolith – which is expected to happen in 2024.

• Although asteroid mining is still in its nascent stages, consider the potential: “Asteroid Psyche,” located in the asteroid belt, is believed to contain gold worth approximately 700 quintillion USD at today’s prices. When compared to the current gold market cap of 13 trillion USD, the sheer volume of gold available on Psyche could, if tapped, effectively make gold redundant.

In any case, for gold to lose its status as a reserve asset, there does not need to be a sudden, technological disruption. This is just an added level of risk. Even if mining technology stays exactly the same as it is today for the next 100 years, there is technically enough gold to be mined with current technology to bring its value to (close to) zero.

Other Arguments For Gold’s Underperformance

Population Growth

Gold advocates might claim that a rising global population boosts gold demand and its price. Indeed, in developing nations-where most population growth occurs-gold is more accessible than real estate or other assets tied to financial institutions. However, this argument faces several limitations:

• It does not change the fundamental issue that gold is not scarce and can be mined at will, as we have seen previously.

• People in developing countries have limited spending and saving power.

• People in developing countries are gaining rapid access to banking, according to the world bank. So, it is reasonable to expect that demand will increase for other asset classes as well.

More importantly, once again, data refutes this thesis. The world has grown by almost 1 billion people in the last 15 years. Yet, this has been a time frame where gold has underperformed relative to other assets, as we have seen previously.

Government Intervention

Gold proponents argue that governments and institutions, holding significant reserves of the metal, may intervene to prevent its value from declining. One potential strategy they could employ is prohibiting the extraction of new gold.

This presents a tangible political risk. Yet, the challenge lies in the necessity for worldwide cooperation among governments to make such a measure effective. There’s always the possibility of a dissenting government choosing to exploit gold mining for its own advantage, as history has shown. For instance, ancient Roman Emperors like Nero debased their currency by diminishing the precious metal content in coins, and Great Britain in the 16th and 17th century clipped and debased silver coins to fund wars. Considering how polarized the world is today, it is difficult to think that governments worldwide could agree on a ban on gold mining and actually adhere to it.

More importantly, gold’s role as a reserve asset is anchored in trust, which itself stems from its scarcity. Politically enforcing scarcity-and by extension, trust-in an asset is almost pointless. It would shift gold’s foundation from its inherent scarcity to a dependence on political support, making it indistinguishable from fiat currencies.

Gold’s Use As A Collateral

Gold currently serves as a significant collateral in the global economy, with institutions and governments leveraging it to secure credit. Yet, I anticipate its role as collateral will decline as swiftly as its comparative underperformance to other assets intensifies.

The essence of gold as a reserve asset lies in trust. Should it become increasingly apparent that gold is not as scarce as once believed, institutions may become increasingly reluctant to accept it as collateral. This could potentially lead to a liquidation crisis for gold, marked by institutions no longer recognizing its value.

Gold’s Actual Scarcity

Finally, consider that there is a long list of minerals that are far more scarce than gold in nature. For example:

• Platinum group minerals are more scarce than gold at 1 part per billion or less

• Osmium is more scarce than gold at 1.5 parts per billion

• There are 70 rare-earth materials, from Scandium to Lutetium, that are all more scarce than gold

• Of course, many of these elements are scarce but do not have other characteristics needed to make them good candidates as reserve assets – such as portability, durability, divisibility, fungibility and more. However, there are literally tens of minerals that have all these characteristics and have a higher degree of scarcity than gold

So, why gold? Because 10,000 years ago, it struck a balance between being mineable with the technology of the time and not too easily obtained. It’s unreasonable to think that as a modern civilization, we should adhere to a standard set by ancestors from agricultural societies.

Risks To My Thesis

Governments Might Artificially Limit Gold Mining

While a comprehensive, global ban on gold mining may appear impractical and futile, governments could still opt to mitigate gold’s potential decline should it begin to falter as a global reserve asset. Governments might also impose a ban on gold mining for reasons that extend beyond controlling its supply, such as environmental concerns.

Even a partially implemented ban by certain governments could significantly impact and constrict gold’s supply, thus representing a political risk worth considering.

A Severe Recession Might Make Gold More Appealing In The Short Term

Gold’s performance lagged behind equities during periods of relaxed monetary policy. Yet, it often excelled in times of recession (see chart below). As investors shy away from equities, they frequently turn to gold as a safe haven, at least in the short to medium term.

Should a severe recession impact the global economy in the near future, gold could outperform equities temporarily. Although my long-term outlook on gold remains bearish, this potential for short-term outperformance is a risk investor, particularly those nearing or in retirement, should take into account.

Accessing Gold Might Be More Difficult Than I Assumed

Determining exact figures for the amount of gold accessible to us is challenging due to the scarcity of scientific research on the subject. In composing this article, I started with gold’s abundance in nature. I am convinced that for a technologically advanced civilization, gold’s rarity-at 4 parts per billion-isn’t a factor of sufficient scarcity.

Adopting what I consider conservative estimates regarding our technological capability to extract gold, I’ve concluded that, with current technology, we can access approximately 150,000% more gold than has ever been mined.

Yet, opening new gold mines may prove more difficult than I assumed. The 150,000% estimate incorporates a substantial margin of safety. Even if this figure were overstated by 90%, it implies that we could still access 15,000% more gold than has historically been mined-a quantity sufficient to challenge the perceived value of gold. Nonetheless, acknowledging this potential overestimation in my assumptions is important, as it impacts the core argument of my thesis: the true abundance, rather than scarcity, of gold.

Conclusion – Cash Flow Generating Assets Are Preferrable

The core problem with gold is its lack of true scarcity; as its price rises, mining can increase accordingly. This leads to its historical underperformance compared to equities, especially in loose monetary conditions, where its nominal price surges more rapidly.

I view gold as unsuitable for medium to long-term investors, anticipating its eventual abandonment as a global reserve asset. Though this may occur far in the future, I regard gold as an inferior asset likely to underperform compared to those generating cash flow, even in the medium term.

Hence, my preference for assets that generate cash flow over gold, especially those adaptable to inflation, like real estate or equities. Rental income can quickly adjust, and companies can swiftly adapt their pricing. Conversely, bonds are more influenced by central bank decisions and slower to respond to interest rate changes.

Put simply, in a scenario where fiat currency’s reliability is in question, my trust leans towards companies and landlords who can increase prices in response to inflation. I am skeptical of relying on gold’s scarcity to effectively combat inflation.

In this article, I have not touched on something that some might consider an elephant in the room: Bitcoin. I believe Bitcoin is too immature of an asset to draw conclusions on whether it could replace gold as a reserve asset. Most importantly, Bitcoin does not generate a cash flow, exactly like gold. Bitcoin, in my view, remains an interesting albeit speculative bet.