By Neland Nobel
The year 2021, will certainly go down as an odd one for gold. As the chart below shows, gold spent most of the year in negative territory. It has not been a substantially negative performance, but more of a sideways move with modest losses. Gold was never very positive at any point in the past year.
Given the extreme monetary and fiscal stimulus during the year, such an outcome seems out of touch with our common understanding that gold tends to do well when money is in trouble. What the heck is going on?
Demand for gold actually held up pretty well, in a year where the world had to stumble back from the reduction in demand caused by governmental lockdowns.
While final demand will not be known until early next year, 2021 showed a clear recovery through the third quarter with jewelry demand up 33% year over year, while coin and bar demand were up 18% year over year. Central bank purchases were also positive, with third quarter data indicating banks added around 400 metric tons. Industrial demand was also in recovery mode, up 9% year over year and was back to levels before governments around the world bashed the world economy with lockdown.
So, with basic demand showing decent gains, why the punk performance? Was there a surge in supply of gold? No, global mine production was up only about 5%, but that was more than offset by drop in gold supplied by recycling, which dropped 12%. Therefore, there was no bulge in supply to account for weaker prices.
The answer seems to be that these positive increases in demand, and little change in supply, were more than offset by dishoarding of gold by investors, especially investors that purchase their gold through ETFs, or Exchange Traded Funds. For example, Q3 flows into bullion ETFs was a positive 274 metric tons in 2020, while Q3 numbers for 2021 showed an outflow of 27 tons. That is quite a swing.
If we break the data down even further, it is clear that demand from Western investors accounts largely for the outflow of gold from ETFs. Getting even more granular and we find dishoarding was most prevalent in North America, while demand for gold was positive for ETFs that serve Europe and Asia. In fact, only North America showed net outflows from global ETFs.
This appears a bit odd as well. Coin and small bar demand was up in most Western markets, including the US but demand for paper gold in ETF form was down. This suggests that investors who buy physical have either motivations or time horizons different than those that trade paper gold. It appears fair to say that largely US paper gold investors were the cause of the relatively poor showing for gold this year and that their actions are different than those investors that buy coins and small bars.
Here are some possible explanations: Those who trade “paper gold” have short term time horizons. With gold not doing much on the upside, they put their money into stocks, which had another very good year. It is also clear that North American investors may have played out their inflationary concerns by venturing into crypto currencies, which have diverted investment flows from gold ETFs into the rapidly multiplying crypto space.
Something may have to occur to alter perceptions about the attractive features of crypto currencies. This could come from two different areas. One area could be prominent cases of fraud, which undermine belief in these new and relatively untested “currencies”. Some of that may already be occurring. A number of state and Federal agencies are stepping up their concerns about fraud in the crypto space, which you can read further about here. In 2019, there were over 67 investigations into fraud, but that number has now more than doubled. Besides fraud, moves by major governments could curtail the trading and function of crypto currencies. It is always been our opinion that governments will not give up their monopoly on money. Money is the mother’s milk of politics. Controlling money is to control power. It is difficult to see governments giving away this power to private actors, those that produce private currencies that government finds hard to trace or tax.
It is significant that China, the world’s largest gold producer, would crack down. This is especially important because of China’s size, perhaps second in the world in GDP. Meanwhile in India new legislation will crack down on crypto currencies likely early next year, which you can read more about here. India does not have that big of an economy, but between India and China, certainly a large new market for crypto seems unlikely among these two top population leaders.
The evolution of regulatory control seems also to have started in the United States, see more about it here. The new and recently passed Infrastructure Bill contains provisions subjecting cryptos to the same kind of $10,000 reporting requirement enforced on cash, click here for more information. These kinds of regulations will surely reduce the allure of cryptos which have had the reputation of being secret and allowing anonymity.
We think in the end, governments will perhaps go to a fiat digital currency (you could argue we are already there), but they are not going to allow private players to take the enormous power which comes from controlling the money.
At this stage of the game, things that make crypto currency look less attractive, will help direct flows back to more traditional havens like gold. We are not predicting the destruction of cryptos, we are just saying we don’t think governments will allow them to develop in a way which reduces governmental power. In that sense, cryptos will be damaged and their ecosystem based on secrecy and limited quantity will likely be upended.
Inflation is the way government has to finance itself without the pain of raising taxation. Depreciating money is a form of secret taxation that allows government to move wealth from some groups in society to others.
This is what governments do and that is why no governmentally issued paper currency has ever held its value for very long. It is really not a question of whether the fiat currency is paper or digital. Government simply cannot control its spending. It was only after multiple governments had wrecked their currencies and bankrupted their people that governments were forced onto a gold standard. Since they are now no longer constrained by gold, it is highly unlikely they will allow themselves to be constrained by cryptos.
Neland D. Nobel, is a retired portfolio manager and Certified Financial Planner with 45 years of market experience in the securities and gold industry.