Ronald Stoeferle, commodities analyst from Vienna based Erste Group Bank, released today his new gold report, „In GOLD we TRUST.“ In the following comprehensive interview, Stoeferle outlines the major aspects of the report such as a renaissance of investment demand and why some features of the financial/economical situation provide the perfect environment for gold, the antagonist of uncovered paper currencies.
By Lars Schall
Ronald Stoeferle, born October 27, 1980 in Vienna, Austria, is a Chartered Market Technician (CMT) and a Certified Financial Technician (CFTe). During his studies in business administration and finance at the Vienna University of Economics and the University of Illinois at Urbana-Champaign, he worked for Raiffeisen Zentralbank (RZB) in the field of Fixed Income / Credit Investments. After graduating, Stoeferle joined Vienna based Erste Group Bank (http://www.erstegroup.com), covering International Equities, especially Asia. In 2006 he began writing reports on gold. His first four benchmark reports on gold drew international coverage on CNBC, Bloomberg, the Wall Street Journal and the Financial Times. Since 2009 he also writes reports on crude oil. The latest oil report by Stoeferle, entitled „Force Majeure – Middle East,“ was published earlier this year – see “The Smouldering Political Risks are not Fully Priced into the Oil Price” under:
Highlights of the new special report on gold are:
* The foundation of a return to „sound money“ has been laid
* Guilt without atonement? Excessive structural debt suggests further appreciation of gold
* Negative real interest rates continue to provide gold with perfect environment
* No reason for „AUROPHOBIA“
* Adieu „Exorbitant Privilege“
* US Treasuries: from the risk-free fixed income paper to the risky no-income paper
* Why gold is (still) no bubble
* Excursus: the creation of money from the perspective of the Austrian School of Economics
* Gold and silver as official means of payment vs. „Gresham’s Law“
* The monetary system at the crossroads – on the way to a new gold standard?
* Gold as portfolio insurance
* Renaissance of investment demand – institutionals as „elephant in the room“
* Gold mining shares with historically low valuations
* Risk/return profile of gold investments remains very favorable
* Next target price at USD 2,000
* At the end of the parabolic trend phase we expect at least USD 2,300/ounce.
Mr. Stoeferle, what is the most thrilling aspect for you in analysing the gold market?
Ronald Stoeferle: Conducting interviews with you, Mr. Schall (laughs). Joking aside, I probably love my job so much, because analysing gold is basically about analysing EVERYTHING: monetary, economic, socio-economic, historical, technical, fundamental and political aspects. In my reports I try to get a picture from all of this different aspects, that’s what makes it interesting for me.
Okay, then let us go down to the nitty-gritty related to the world of gold. Are we experiencing these days the first indications of the re-monetarization of gold? And what is your attitude towards gold as legal tender?
Ronald Stoeferle: Yes, I think there is a big paradigm shift going on right now. The thought of a currency not pegged to gold would have probably been absurd 100 years ago. That’s how illusory a gold standard sounds to us today. However, 20 years ago mobile telephones with internet connection, digital cameras, and a digital music collection were equally illusory. And we are in a similar situation with regard to the gold standard today. Today even the thought that back in 1971 every 35 US dollars were backed by one ounce of gold is absurd.
It had formerly been up to a handful of critical minds to question our monetary system, high-profile politicians and central bankers have meanwhile offered their opinion, too. Last year we saw numerous signals that indicated the fact that gold was gradually becoming “politically correct”. Robert Zoellick, President of the World Bank and former member of the Bush cabinet, had this to say about the gold standard:
“The system should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values. Although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today. The development of a monetary system to succeed ‚Bretton Woods II,‘ launched in 1971, will take time. But we need to begin.”
Such statements would have been unthinkable only a few years ago! Since the mid-1970s hardly any high-ranking US politician has mentioned the gold standard in a positive context. This confirms the broad paradigm shift we are currently going through. Unfortunately many people interpreted the World Bank President’s statements wrongly, and he was immediately discredited. He did not argue in favour of an explicit return to the gold standard, but he commended its stability. On top of that he just wanted to launch a discussion and critically question our monetary system.
We assume that Zoellick is thinking of a basket of goods that among other goods contains gold. Thomas Hoenig, President of the Federal Reserve Bank of Kansas City also called the gold standard a “legitimate monetary system”. Moreover, Prof. Robert Mundell – the “Father of the Euro” – urged gold convertibility for the euro and the dollar (i). Steve Forbes, publisher and former Republican presidential candidate, was also optimistic that the USA could return to a gold standard because of its fiscal imbalances.
Therefore I think that the foundation of a return to “sound money” seems to have been laid. We believe that a return to the gold standard is no major economic or organisational problem. Rather, what we have on our hands is a highly political and philosophical question of principle that has to be answered. We therefore believe that the strain has to become much bigger still before specific action will be taken. Who knows, but perhaps we will see a future where rather than asking for the price of gold, people will much more often ask for the price in gold.
An essential step towards that direction is the point in time when the Middle East countries will no longer sell their oil and natural gas for paper money. When do think will they be paid for it with precious metals?
Ronald Stoeferle: I think we are slowly seeing the unspectacular farewell of the greenback as global reserve currency. The self-confidence of emerging markets and oil-exporters is definitely on the rise. From my point of view, the axis of Beijing-Moscow should gain further clout. The two countries intend to only use their own currencies for bilateral trade transactions. At the end of 2010 the renminbi was listed at the Moscow Interbank Currency Exchange (MICEX). This is the first listing outside of China or Hong Kong and confirms that the speed of internationalisation is increasing on a daily basis. China is already the most important trade partner of Japan and Australia. Here, too, the settlement of bilateral transactions in local currency would seem likely.
Furthermore, the Shanghai Cooperation Organization (SCO) will be gradually assuming a bigger role in this context. (ii) The goal is to promote cooperation in politics, trade, and economic affairs. As an interesting side note, the region accounts for a significant share of global gold production.
If it seems absurd and illusory today to think that the US dollar could lose its status as leading global currency, a look into the history books might help. Portugal (1450-1530), Spain (1530-1640), the Netherlands (1640-1720), France (1720-1815), and Great Britain (1815-1920) were coining leading global currencies for centuries and have in the meantime lost more or less all of their former monetary splendour. (iii) Interestingly, these cycles tend to last about 90 to 100 years, which would also suggest the imminent changing of the guards for the US dollar.
Why do you argue that the bull market in gold is a marathon – and what does this imply for investors?
Ronald Stoeferle: I think that this bulltrend is a marathon and not a sprint, because right now we’re seeing the perfect environment for gold. Gold, as antagonist of uncovered paper currencies, remains an excellent hedge against worst-case scenarios. Low real interest rates and high counterparty risk provide the perfect environment for gold. Both are clearly the case at the moment, and we expect this scenario to last.
At the current real interest rates, gold is an obvious alternative to short-term government bonds, current accounts, or time deposits. After many years of a chronic low-interest-rate policy, we do not believe that interest rates, along the lines of Paul Volcker’s, would be possible without the system collapsing. Therefore this time the gold bull market should end for different reasons than at the beginning of the 1980s.
At the end of every trend phase, a parabolic acceleration tends to occur, a phase of euphoria that is also called “blow-off top”. We expect our price target of USD 2,300 to be reached within the framework of said phenomenon. The current motto seems to be to “buy the dips”. Especially in India and China, purchase patterns are decidedly more anti-cyclical than in the West.
Consolidations, as part of the bull market, become shorter every time, correcting less than the previous consolidation (in terms of percentage). We have seen exactly this development since 2009. As soon as no major corrections occur anymore, the market will probably switch to the final phase of acceleration.
Do you see a renaissance for the investment demand in gold?
Ronald Stoeferle: Definitely! In 2000 investment demand accounted for only 4.8% of total demand, while by 2010 that share had increased to almost 40%. From our point of view this indicates a clearly bullish trend reversal and heralds a new phase of the bull market. We believe that from now on investors – and especially institutional investors – will dominate the demand side. Especially insurance companies and pension funds should step up their gold allocation, seeing as the correlation to equities and especially to bonds is low or even negative.
Gold seems to be gradually losing the nimbus of “investment for doomsayers and backwoodsmen”. Not only vintage gold bugs, but also numerous hedge fund icons such as John Paulson, David Einhorn, Paul Tudor Jones, or Ray Dalio have nowadays developed a soft spot for gold. Even though many interpreted the sales of George Soros as the end of the bull market, a closer look reveals that he just disposed 99% of his positions in the Spyder gold ETF. And at the same time, Soros increased his positions in Barrick Gold and Great Basin, and opened new positions in Goldcorp and Eldorado Gold.
I think the potential for institutional demand for gold is huge. At the moment global pension funds manage about USD 30 trillion worth of assets (iv). To put this into context: this is about twice the economic output of the USA. According to Shayne McGuire, the commodity allocation currently amounts to slightly less than 3%. (v) If those funds for example were to hold the S&P GSCI or the Dow Jones-UBS Commodities index, they would allocate only 5% within these commodity indices to gold.(vi)
This means that gold accounts for a marginal 0.15% of total allocation in pension funds. An increase to 0.3% would translate into an additional demand of USD 45bn. The allocation in insurance companies (USD 18.7 trillion of assets under management), hedge funds (USD 2 trillion), and sovereign wealth funds (USD 3.8 trillion) is of a comparably low magnitude. We do not expect a significant change of heart towards gold in this case – not the least for regulatory reasons. However, even a marginal increase in the weighting of gold by the institutional investors would support the gold price significantly.
What are your thoughts related to the long lasting observations that the gold price is rigged?
Ronald Stoeferle: I can basically refer to what I wrote in my last gold report 2010.(vii) I said that there is a thin line between intervention (normally by the government, government-related institutions, or more generally, politicians) and manipulation (negative connotation – as in “influence”). The (sometimes massive) interventions on the bond and currency (foreign exchange) markets are official and legitimised.
In my report of 2009 I’ve pointed out that in a speech in July 1998 Alan Greenspan addressed this context, saying that “central banks stand ready to lease gold in increasing quantities should the price rise.“ The article “Gibsons’s Paradox and the Gold Standard” by Lawrence Summers is another example. In this article, Summers explains the connection between low key lending rates and the gold price. Paul Volcker, former chairman of the Federal Reserve (1979 to 1983) and currently member of the economic advisory staff of President Barack Obama, pointed out, “Joint intervention in gold sales to prevent a steep rise in the price of gold, however was not undertaken. That was a mistake.” (viii) It would therefore be naïve to think that this was not happening in the gold market.
Do you pay attention to what people like GATA say in that respect?
Ronald Stoeferle: I think GATA claims that anything between 12,000 and 15,000 tonnes are leased out. I do not know if this number is accurate, but it’s definitely possible. Recently there were confirmations of that. Belgian central bank Vice Governor Francois Masai was quoted as saying that about 41% of the central bank’s 216 tonnes of gold was out on loan. (ix) According to Masai the return on its loans of physical gold amounted to only 0.3%. What an impressive return!
James G. Rickards told me recently in an interview that the Fed is managing am ‚orderly‘ rise in gold. (x) Do you see this, too?
Ronald Stoeferle: From my point of view, Mr. Rickards is one of the brightest minds out there. He has got an impressive track record, therefore I think that one should take his statements seriously.
Is the debt situation of the nations beneficial for gold?
Ronald Stoeferle: Absolutely! Given that the majority of debt has neither been written off nor paid off but simply transferred, the problem of excessive debt is still waiting to be resolved. There has been no deleveraging, only an adjustment of booking entries from the private to the public sector. The quantitative easing has left monetary stability short on credibility, and it will be very difficult to remedy this situation. In this fragile environment gold will continue to thrive.
The debt of the USA currently amounts to USD 14.3 trillion. (xi) Debt in terms of economic output is 93%, i.e. the highest ratio since the end of the 1940s. The new debt taken out since 2008 alone accounts for more than 40% of the aggregate government debt amassed in the past 240 years. Inclusive of the debt and entitlements of the States, authorities, pension funds etc. the situation is dramatic, painting a picture of vastly excessive debt. The fiscal gap amounts to USD 200 trillion, i.e. 14 times GDP. (xii)
But let’s have a look at the next 10 years. The Congressional Budget Office (CBO) forecasts deficits until at least 2021. (xiii) The aggregate deficit will hit USD 8,400bn in the next ten years. For the first time since WWII, the US debt will exceed the GDP, and the long-term outlook is “discouraging” according to the CBO. By 2035 the government debt could increase to 185% in terms of GDP.
These numbers sound disillusioning, and the CBO forecasts are actually based on very optimistic estimates. The Office expects real economic growth of +4.4% until 2014 and of +2.4% subsequently. It also assumes a continuous decrease in the unemployment rate to 5%, low interest rates, and a moderate increase in spending. The CBO model does not allow for another recession. Given that from our point of view the forecasts are unrealistic, we expect the new debt to climb much higher than to the estimated USD 8,400bn.
And why is this bullish for gold?
Ronald Stoeferle: Because there are only a few ways out of the debt trap: growing out of one’s debt much like the USA did after WWII, or alternatively drastic spending cuts and rigid budget consolidation like Scandinavia in the 1990s. Massive tax hikes, the repeated calling on seigniorage, the creation of inflation, the depreciation of the currency as in 1934 in the USA (Gold Reverse Act), a continuous dose of financial repression in combination with negative real interest rates, or ultimately, national bankruptcy. We expect gold to benefit in practically all of these scenarios.
Can you explain to us, please, why you consider the relationship of “stock-to-flow” as essential?
Ronald Stoeferle: Yes, because the stock-to-flow ratio distinguishes gold from commodities. The aggregate volume of all the gold ever produced officially comes to about 170,000 tonnes. This is the stock. Annual production was 2,586 tonnes in 2010 according to the World Gold Council. That is the flow. Dividing the former by the latter, we receive the stock-to-flow ratio of 65 years.
Now what does this mean?
Ronald Stoeferle: Well, global gold reserves grow by an annual 1.5% and thus at a much slower rate than all the other money supply aggregates around the globe. The growth rate is vaguely in line with population growth. The trust in the current and future purchase power of money or any means of payment not only depends on how much is available now, but also on how the quantity will change over time. If mining production were to increase by 50% (which is highly unlikely), this would only translate into an annual increase of 3%. This fact creates a sense of security as far as the availability is concerned and prevents natural inflation. If production were down for a year, this would also have little effect on the overall situation.
On the other hand, if the copper production were to be disrupted for an extended period of time, the stocks would be exhausted after about 30 days. For example, if a huge new mine were to come online and supply doubled, this would come with huge repercussions for the copper price, but with hardly any for gold. This stability and safety is a crucial prerequisite for the creation of trust. And it is what differentiates gold and silver as monetary metals clearly from commodities and the other precious metals. Commodities are consumed, whereas gold is hoarded. This also explains why traditional supply/demand models are only of limited use for the gold market.
Therefore gold is considered that precious because the annual production is so low relative to the stock. This feature has been acquired in the course of centuries and cannot be undone anymore.
In your report you question the official all-time-above-ground-gold stock of 170.000 tonnes. Why so?
Ronald Stoeferle: I don’t say that this number is wrong, but I’m entertaining some doubt about the alleged amount of 170,000 tonnes of above-ground stock. The figure is based on the calculations of a National Geographic article of 1998. Since then, practically all institutes, magazines, and analysts have based their models and assumptions on that figure. The conclusion of the article was that only 10,000 tonnes were produced in the whole 5,850 years prior to the California gold-rush. That amounts to only 1.7 tonnes a year which seems to leave a large question mark over the estimate.
On top of that we believe that almost 30% of annual gold production ends up in the private/black market rather than the official market. The volumes of artisan mining should not be underestimated, especially in Latin America, Africa and Asia. Therefore we entertain doubts about the 170,000 tonnes and we think it makes sense to at least question the figure and to entertain the idea that substantially more gold than claimed might be around. On the other hand, this would only add to the power of the stock-to-flow ratio of gold.
You argue also that gold is no bubble. What are your reasons to argue against it?
Ronald Stoeferle: In the previous reports we have discussed the alleged “gold bubble” at length…
Ronald Stoeferle: …and our conclusions have always been that the gold price is still attractive. It seems that any market participants and commentators find it difficult to differentiate between a bull market and a bubble. One look back into history shows that gold is definitely no bubble. While the money supply amounted to USD 200bn at the pinnacle of the last gold bull market in 1980, the monetary base has meanwhile increased to USD 2,600bn. This represents an increase by the factor of 13x. If gold were to rise by the same multiple, it would have to rise to USD 11,050 (850 x 13).
A look to the media of the previous bull market also discredits the bubble myth. In January 1980, Time Magazine described a veritable buying panic in physical gold. The supply side had dried out completely, while demand was continuously increasing. Thousands of people were queuing up for hours outside mint shops in Europe and the USA after gold and silver had frequently made it to the front page of the biggest newspapers.
At the crest of the bull market in 1980, the German Spiegel magazine wrote that it was in fact no bull market anymore, but rather hysteria, panic, and a case of gold rush. Newspapers such as Le Monde Diplomatique were talking about “gold fever and the disease of capitalism”, whereas the FT regarded it as “a myth that has been resurrected”. The gold rush benefited mainly from an apocalyptical fear of the crises in Iran, Afghanistan, and the run-away inflation. When comparing this to the current media coverage, we can see a clear demarcation line. Although gold has set new all-time-highs, the coverage by the media was largely negative.
And why do we see, hear and read so often that gold is a bubble?
Ronald Stoeferle: I really cannot understand this “Aurophobia,” especially in the financial sector. It seems there are only two opposing fronts here: people who love gold (aka gold bugs), and people who hate it. There are only very few shades of grey between these two fronts, and people are extremely hesitant to defect from one to the other.
Perhaps it’s because gold has been ridding itself of its reputation as a “barbarous relic,” emphasized in the 1980s and 1990s, and will ultimately turn into an own investment class again. (xiv) The paradigm shift definitely has psychological reasons. The unshakeable myths and misunderstandings (gold does not pay interest, the purchase of physical gold is expensive, gold is speculative and volatile…) are currently subject to demystification and reassessment. Given that after the bear market that lasted 20 years many such arguments, defamations, and convictions ended up sticking in people’s minds, achieving a change of mind is tedious and time-consuming.
The fact that not many market participants actively participated in the last high of the gold price in the 1970s is a positive aspect. This is probably also why the majority of investors still doubt the sustainability and justification of the bull markets although we are in its tenth year. In the 1970s it was an unwritten law to invest at least a fifth of one’s portfolio in gold.
What is your price target for gold? Is more or less the sky the limit?
Ronald Stoeferle: You know that I am an “Austrian Austrian”…
Ronald Stoeferle: …and according to Carl Menger’s theory of subjective value, the value of a good is derived from the marginal utility with regard to the set goal. (xv) This means that the value of a good or a service is therefore no objective value, but the result of a subjective process of valuation (“Value does not exist outside the consciousness of men“). Therefore the question of price targets is difficult to answer.
But again: given the fact that the majority of debt has neither been written off nor paid off but simply transferred, the problem of excessive debt is still waiting to be resolved. As far as the sentiment is concerned, we definitely do not see any signs of euphoria. Scepticism, fear, and panic never line the final stretch of a bull market. Therefore we believe that our long-term price target of USD 2,300/ounce, as formulated a few years ago, could come out on the conservative side.
What does this mean for the price of silver?
Ronald Stoeferle: We do not have any official coverage and price targets for silver. I just think that within this gold-bull-market, silver will outperform gold.
Thank you very much for taking your time, Mr. Stoeferle!
Ronald Stoeferle: You’re welcome, Mr. Schall!
i Compare Ralph Benko: “The Emerging New Monetarism: Gold Convertibility To Save The Euro“, published June 13, 2011 at Forbes under:
ii The organisation currently consist of the member states China, Russia, Kazakhstan, Kyrgyzstan, Tadzhikistan, Uzbekistan, and states holding observer status, i.e. Mongolia, India, Pakistan, and Iran. Partners in dialogue are also Belarus, Afghanistan, Turkmenistan, and the Association of Southeast Asian Nations, ASEAN.
iii Compare Hongyi Chen and Wensheng Peng: “The Potential of the Renminbi as an International Currency“, China Economic Issues, published November 2007 under:
iv Jeff Clark, Casey Research, March 2011.
v Shayne McGuire: “Hard Money, Taking Gold to a higher investment level”, Wiley, September 2010.
vi Compare “Gold: a commodity like no other”, World Gold Council, April 2011.
vii Ronald Stoeferle: “In Gold We Trust”, Special Report published June 2010.
viii Compare Chris Powell: “Austrian bank’s gold report cites market manipulation“, published July 2, 2009 at GATA.org under: http://www.gata.org/node/7553. See also related to Alan Greenspan’s statement Reg Howe: “Gold Leasing by Central Banks: Reaching the Limits”, published September 18, 1999 at: http://www.gold-eagle.com/editorials_99/howe/091899.html. Howe wrote: “By 1998, with net gold derivatives rising in step with the increased leasing of gold by central banks, concern about the risks involved were rising too. Certainly they were on Fed Chairman Alan Greenspan’s mind. On July 28, 1998, testifying before the House Banking Committee looking into the regulation of over-the-counter derivatives, he distinguished financial derivatives from agricultural derivatives, saying that it would be impossible to corner a market in financial futures where the underlying asset (e.g., a paper currency) is of unlimited supply. The same point, he continued, also applied to certain commodity derivatives where the supply was also very large, such as oil. And he further volunteered: ,Nor can private counterparties restrict supplies of gold, another commodity whose derivatives are often traded over-the-counter, where central banks stand ready to lease gold in increasing quantities should the price rise.’ Needless to say, this statement provoked considerable comment in the gold community, much of it having to do with a conspiracy by central banks to control the gold price. The real question, however, is to what extent and at what risk central banks ’stand ready to lease gold,‘ whether into rising prices or otherwise.”
ix Compare Chris Wood “Greed and Fear”, CLSA, and “41% of Belgian Central bank Gold has been lent out”, Zerohedge.com, June 20, 2011.
x Compare Chris Powell: “Fed managing ‚orderly‘ rise in gold, Rickards tells Schall“, published June 9, 2011 at GATA.org under: http://www.gata.org/node/9996
xi Total Treasury securities outstanding, as of May 2011.
xii Financing gap between net present value of all future expenditure and all future tax revenues.
xiii “The Long-term Budget Outlook”, Congressional Budget Office, June 2010
xiv Note that it was originally John Maynard Keynes who referred in 1923 to gold, as a monetary standard, in his book “Monetary Reform“ as a “barbarous relic.” Compare James Turk: “The Barbarous Relic—It Is Not What You Think”, Committee for Monetary Research and Education, Inc., Monograph Number 55, published January 2006 under: http://goldmoney.com/documents/barbarous-relic.pdf
xv Carl Menger: “Principles in Economics“, 1871.