Gold prices, measured in US dollars, rocketed to all-time highs last week, reaching a peak $1,970.90 on July 29.
Since the start of 2020, gold prices have risen nearly 30%. And it’s not hard to figure out why, if you consider that gold is the ultimate “anti-dollar” investment.
Here’s a chart of the US Dollar Index over the past six years. The index is a measure of value of the dollar relative to a basket of foreign currencies. Note that the dollar has fallen sharply in recent weeks and is now trading at the lowest level since July 2018.
So, why is gold the anti-dollar? The best evidence is to look at gold-buying trends of the world’s central banks – the ultimate arbiters of monetary policy. It’s telling that these financial institutions – the folks who simply create dollars, euros, yen, etc. out of thin air – are net buyers of gold.
Indeed, as a group, the world’s central banks are buying more gold than they have in more than a half a century. Central banks purchased at least 650 tons of gold in 2019.
But why are they buying gold? The only plausible reason is to hedge against a decline in value of the other assets they hold – primarily US dollars. Indeed, more than 60% of disclosed central bank reserves consist of US dollar holdings.
Central bankers understand that if the dollar takes a hit, the value of their reserves will fall sharply, unless they also hold assets that appreciate as the dollar falls. That’s exactly what gold has done for more than a century. Indeed, gold has a 5,000-year track record as the ultimate asset to hold against debasement of a nation’s currency.
As I pointed out last week, since the Federal Reserve’s creation in 1913, the value of the dollar measured in gold has declined by nearly 99%. The dollar is now at an all-time low relative to gold. And it could go a lot lower if the Fed continues to create money out of thin air or Congress continues to recklessly borrow trillions of dollars each year to bail out politically favored industries, such as airlines that should have been allowed to go bankrupt.
Of course, gold prices could fall back sharply to year-end 2019 levels or even lower. One possible scenario is that central banks begin selling their gold. That’s certainly possible, but flies in the face of the determination by Russia, China, and other countries to dethrone the US dollar as the world’s reserve currency. For these countries to sell their gold holdings would effectively cement the dollar’s entrenched status.
What’s more, the stated intentions of both the Fed and Congress indicate that the Fed’s balance sheet and federal deficits will continue to grow.
Last Wednesday, the Fed announced that it would keep short-term interest rates between 0% and 0.25% “until it is confident that the economy has weathered recent events.” The central bank also continues to buy billions of Treasury debt each week with dollars created out of thin air through its quantitative easing program. Previously, the Fed promised that it would add to its balance sheet, “in the amounts needed to support smooth market functioning and effective transmission of monetary policy.” In other words, infinite quantitative easing.
Meanwhile, Congress continues spending money at the fastest pace in history. The June budget deficit of $864 billion was larger than the deficit for all of 2019. The total federal budget deficit now stands at $27 trillion – nearly $4 trillion more than a year ago. And Congress is now debating yet another stimulus package that will require trillions of dollars in additional borrowed money.
And since almost no one else buying Treasury debt with virtually zero yield, the Fed will simply add it to its bloated balance sheet, now in excess of $7 trillion – an increase of nearly $3 trillion since the beginning of the year.
Thus, there’s zero reason to believe that the Fed and Congress will stop debasing the dollar anytime soon. That’s extremely bullish for gold.
One of the traditional arguments against gold is that it doesn’t earn income. Warren Buffett famously quipped that in comparing the desirability of investing in profitable stocks verses investing in gold, “it's a lot better to have a goose that keeps laying eggs than a goose that just sits there and eats insurance and storage."
But it’s hard to justify buying stocks when valuations continue to hover near all-time highs. Even Warren Buffett is mostly staying on the sidelines.
Nor are bonds much better. With even the junkiest bonds bearing yields under 5%, and another $14 trillion of bonds with negative interest rates, the fact that gold doesn’t generate income doesn’t seem as much of a disadvantage as it once was.
No, the biggest threat to gold isn’t Fed deleveraging or reduced Congressional spending.
Especially in the event of a sharp and sudden revaluation of the dollar relative to gold, there will be calls for a windfall profits tax to punish greedy gold speculators. The windfall profits tax on oil a generation ago could be a model.
In 1980, Congress passed the Crude Oil Windfall Profit Tax Act. The law established a tax imposed at a maximum rate of 70% of revenues politicians deemed to be “windfall profits” of domestic oil producers. If gold prices continue skyrocketing, I’d hardly be surprised if Senator Bernie Sanders (D -Vermont) were to introduce the “Justice to Gold Speculators Act of 2021,” levying a windfall profits tax on gold.
The likelihood of such a tax would increase exponentially in the event of a Biden victory in the 2020 election, particularly if the Democrats retain control of the House of Representatives and also take the Senate.
I see a windfall profits tax on gold as a much more likely scenario than a forced sale of the precious metal, as in 1933, or an outright confiscation. It would be far less controversial and much easier to enforce, especially if gold buyers and sellers are threatened with prosecution under money laundering laws if they don’t comply.
This is one reason why, despite my belief that gold prices could be headed much higher, that I plan to sell a portion of my gold holdings before 2020 ends if the Democrats take the White House and the Senate. I’ll pay capital gains taxes on my profits at a top rate of 28%. Considering that gold is defined as money in our Constitution, I consider paying any tax on gold appreciation as violating our nation’s governing document.
Still, it’s a lot better than paying 70% (or more).