Global Investment Strategy Global Real Assets Strategy Report: Focus on Gold February 27, 17 John LaForge Head of Real Asset Strategy Analysis and outlook for the real assets market» Gold s rich history as both a store of value (investments, jewelry, bars, etc.) and money (coins etc.) is something most other major assets cannot claim. What it may mean for investors» Gold holds a place in most investors portfolios, most of the time.» As with other investments, timing and position sizes are key. Gold s Uniqueness Gold is consistently one of the most asked about assets at Wells Fargo. This makes sense to us because gold has a history like no other contemporary investment asset. Gold was discovered nearly 5,000 years ago and was first coined roughly 3,700 years ago (in the area now known as Turkey). Stocks and bonds, on the other hand, were financial instruments created by the Western world in the last 800 years. Gold also has the unique benefit of literally surviving time. Gold is impervious to both air and water, which means that essentially all of the gold ever mined still sits above ground even if sunk off the coast of Florida. Gold s rich history as both a store of value (investments, jewelry, bars, etc.) and money (coins etc.) is something most other major assets cannot claim. Gold s long history, however, has its downside. Gold has been around so long, surviving all types of social and economic turbulence, that it is easy to claim that gold is a cure-all for all kinds of investment scenarios. But it is not. It may surprise some investors to know that gold has not always been a great inflation hedge, it has not always moved opposite the U.S. dollar, it has not always moved higher when stocks have been clobbered, and it has not always reduced investors exposure against the overprinting of paper currencies. We say all of this not to take exception with gold as an investment. In fact, we believe that gold holds a place in most investors portfolios, most of the time. But, as with other investments, timing and position sizes are key. If history is any guide, gold will likely see a period of flat performance in 17. To help investors better understand gold as an investment, we are releasing one gold publication each day this week (list below). Each publication will revolve around the most frequently asked gold questions. We ll start today with some history behind gold, and why it is unique. Monday Gold s Uniqueness Tuesday Who Owns Gold Wednesday How Gold Behaves Thursday Gold vs. Other Assets Friday Gold & Gold Miners in 17 17 Wells Fargo Investment Institute. All rights reserved. Page 1 of 7
Why Gold is Special Durability, density, and radiance have made gold an ideal store of wealth through time. Durability in that gold is impervious to air and water. Unlike any other element on earth, virtually every ounce of gold ever mined still sits above ground somewhere. Density a cubic foot of gold weighs half a ton. This means that small amounts of gold can function as large money denominations. This comes in particularly handy for, say, refugees trying to cross borders with some wealth in tact to start over. Gold has global value versus the economically and socially torn country that the refugee is fleeing, which likely has a failing paper currency. And then radiance gold is chemically inert, meaning that it shines forever. Even though gold has been found on every continent, the earth does not yield gold easily. Chart 1 highlights the total amount of gold mined in its history, roughly 175,000 tonnes (metric tons). (Chart 1 begins in 1900, but it includes mined gold prior to that year as well.) By comparison, the world produces roughly 159,000 tonnes of aluminum each day (as of February 17). Chart 1. Gold Above Ground 180 160 Total Gold Above Ground 140 1,000 Metric Tons 1 100 80 60 40 0 1900 1905 1910 1915 19 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 00 05 10 15 Sources: Bloomberg, U.S. Geological Survey (USGS), Wells Fargo Investment Institute. Yearly Data: 1900-15. 15 data includes estimates from USGS. Dates selected to show modern growth of gold above ground Sources: USGS (15 estimate), World Steel Association, Bloomberg, Wells Fargo Investment Institute. 17 Wells Fargo Investment Institute. All rights reserved. Page 2 of 7
Of course, this is reflected in price. Gold trades at roughly $1,0 per ounce, while aluminum trades at more than $1,800 per tonne. A fun way of showing how rare, or precious, gold can be is seen in the soda display below. A 12-ounce soda can contains roughly one-half an ounce of aluminum worth roughly $0.03. If the soda can was made of steel instead, the cost would be roughly $0.01. In great contrast to both aluminum and steel, should that same soda can be made of gold, it would cost roughly $600. Gold as a Store of Wealth (Investments, Jewelry, Bars, etc.) Early in its history, as in 4,000-5,000 years ago, gold was primarily used as a store of value or wealth. Most of the available gold was used by priests and monarchs to project power, wealth, and proximity to a god. In ancient Egypt, for example, gold was a royal prerogative, available only to the Pharaohs. Fortunately for the Pharaohs, gold was quite accessible, as most of the gold supplies in biblical times came from mines in southern Egypt and Nubia (today s Sudan, or just south of today s Egypt). Gold as Money (Coins) While gold began predominantly as a store of value, it was not long before it was being used as everyday money. Coins were first produced roughly 3,700 years ago in Asia Minor, or what is today s Turkey. Since then, gold has served two purposes, as a store of value or as money for everyday transactions. But although the two uses are related, the second is more problematic than the first. Businesses and people need money when we want to buy something or want to hire someone. We all use money when we want something today rather than tomorrow. We also borrow from someone willing to wait until later to spend their money (i.e. credit). The main point here is that money seldom sits still. It needs to grow and shrink based on the needs of people, businesses, and economies. And herein lies the struggle with using gold as the world s money, or what we call the base currency the earth only yields so much gold and unpredictably throughout history. Chart 2 shows yearly global gold production in tonnes (red line) versus the price of gold (blue line). It was not until the mid-1700s that gold production surpassed even tonnes in a given year. 17 Wells Fargo Investment Institute. All rights reserved. Page 3 of 7
Chart 2. Gold Production vs. Price Gold Production (Metric Tons) 2560 1280 640 3 160 80 40 10 Gold Production Gold Price 1280 640 3 160 80 40 Gold Price (US dollar/oz) 5 1493 1511 1529 1547 1565 1583 1601 1619 1637 1655 1673 1691 1709 1727 1745 1763 1781 1799 1817 1835 1853 1871 1889 1907 1925 1943 1961 1979 1997 15 10 Sources: U.S. Geological Survey (USGS), Bloomberg, Prices by G.F. Warren and F.A. Pearson, Wells Fargo Investment Institute. Yearly Data: 1493-15. Data shown in log scale. Dates selected to show all available data. Past performance is no guarantee of future results. The Gold Standard When gold was used as a prime source of exchange, a country s economic prospects and flexibility were often tied to how much gold it owned. Countries that held gold could effectively expand credit, while those that did not, could not. To dig out of the Great Depression many western countries were forced to scrap the gold standard during the late 19s and early 1930s in favor of printing paper money with no or little gold backing. Paper currencies not backed by gold are the prime medium of money exchange today. However, some investors believe that today s Central Banks have gone too far printing too much paper money not backed by anything other than the full faith and credit of a country or a region such as the Eurozone. They are arguing for a return to gold-back paper currencies, fearing that excessive paper money printing may eventually lead to hyperinflation and the collapse of the currency. 17 Wells Fargo Investment Institute. All rights reserved. Page 4 of 7
Should world economies return to a gold standard? We re not sold on the idea, at least as it was devised 100 years ago. A gold standard is quite economically inflexible, as the western world learned during the Great Depression. We cannot completely dismiss the fear of excessive money printing, though. Chart 3 emphasizes that global money supplies sit at record highs. Notice the dramatic expansion in money supply, since the 08 Financial Crisis. The extra money supply, however, has not led to higher-thannormal global inflation. In fact, global inflation rates, in recent years, have been running below historical norms. Chart 3. Global Money Supply Global M2 Money Supply (Billions US dollar) 600 500 400 300 200 100 China Canada UK Eurozone Japan U.S. 00 1986 1988 1990 1992 1994 1996 1998 00 02 04 06 08 10 12 14 16 Source: World Bank, Federal Reserve Economic Data (FRED), Bloomberg, Wells Fargo Investment Institute. Monthly Data: 1/31/1986-12/31/16. Dates selected to show modern increase in money supply across major economies. While excessive inflation has yet to rear its head, we still advise closely watching global money supply growth. Higher inflation rates could eventually return, which could be bullish for gold prices. Chart 4 is one way to track whether excessive money supply growth could lead to higher gold prices. The dark blue line is the price of gold. The light blue line is the global money supply divided by global above-ground gold supply. A rising light blue line means that paper money supplies are growing faster than gold supplies, which is one way of saying that Central Banks may be overprinting. In recent years, the light blue line has stopped moving higher, which fits well with gold prices sinking (less fear of overprinting paper currencies). That is it for today. Tomorrow we will go into greater detail on who owns gold and why. 17 Wells Fargo Investment Institute. All rights reserved. Page 5 of 7
Chart 4. Global Money Supply / Global Gold Supply 25 *Global Money Supply / Global Gold Supply Gold Price 00 1800 1600 Ratio 15 10 1400 10 1000 800 600 Gold Price (US dollar/oz) 5 400 0 0 1987 1989 1991 1993 1995 1997 1999 01 03 05 07 09 11 13 15 0 Source: Bloomberg, USGS, World Bank, FRED, Wells Fargo Investment Institute. *Global Money Supply estimated by combining M2 Measures for the U.S.,UK, China, Japan, Canada, and the Eurozone. Ratio is the global money supply divided by the global gold supply. Monthly Data: 1/31/1987-12/31/15. Dates selected to show how the modern increase in money supply and gold have moved in relation to each other. Past performance is no guarantee of future results. Risk Factors There is no assurance that any of the target prices or other forward-looking statements mentioned will be attained. Investing in physical commodities, such as gold, exposes a portfolio to other risk considerations such as potentially severe price fluctuations over short periods of time and storage costs that exceed the custodial and/or brokerage costs associated with the portfolio s other holdings. Products that concentrate their investments in the gold industry increase their vulnerability to international, economic, monetary and political developments affecting the industry. Investments in gold and gold-related investments tend to be more volatile than investments in traditional equity or debt securities. Such investments increase their vulnerability to international economic, monetary and political developments. They are also exposed to the risk of severe price fluctuations in the price of gold bullion. Definitions Tonne/Metric Ton is unit of weight equal to 1,000 kilograms (2,5 lbs). Disclaimers Global Investment Strategy ( GIS ) is a division of Wells Fargo Investment Institute, Inc. ( WFII ). WFII is a registered investment adviser and wholly-owned subsidiary of Wells Fargo & Company and provides investment advice to Wells Fargo Bank, N.A., Wells Fargo Advisors and other Wells Fargo affiliates. Wells Fargo Bank, N.A. is a bank affiliate of Wells Fargo & Company. 17 Wells Fargo Investment Institute. All rights reserved. Page 6 of 7
The information in this report was prepared by the GIS division of WFII. Opinions represent GIS opinion as of the date of this report and are for general informational purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. Additional information available upon request. Past performance is not a guide to future performance. The material contained herein has been prepared from sources and data we believe to be reliable but we make no guarantee as to its accuracy or completeness. This material is published solely for informational purposes and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or investment product. Opinions and estimates are as of a certain date and subject to change without notice. Wells Fargo Advisors is registered with the U.S. Securities and Exchange Commission and the Financial Industry Regulatory Authority, but is not licensed or registered with any financial services regulatory authority outside of the U.S. Non-U.S. residents who maintain U.S.-based financial services account(s) with Wells Fargo Advisors may not be afforded certain protections conferred by legislation and regulations in their country of residence in respect of any investments, investment transactions or communications made with Wells Fargo Advisors. Wells Fargo Advisors is a trade name used by Wells Fargo Clearing Services, LLC and Wells Fargo Advisors Financial Network, LLC, Members SIPC, separate registered broker-dealers and non-bank affiliates of Wells Fargo & Company. CAR 0217-03897 17 Wells Fargo Investment Institute. All rights reserved. Page 7 of 7