by Egon von Greyerz
As we approach the beginning of the greatest wealth destruction in history, it is an absolute certainty that no one will escape the suffering that will be brought upon the world. The ones who will suffer the least financially are of course the poorest since they have very little to lose. At the same time, many of the poor will die of famine and disease. The middle class will also suffer since many will lose their jobs. They will lose pensions as well, since pension funds will become insolvent. Also, there will be no social security since governments will run out of money. In financial terms, the wealthy will lose the most since virtually all the assets they own will go down by at least 90% in real terms. This includes stocks, bonds and property. In addition, a lot of trophy assets like art and collectors’ cars will collapse. The holders of productive real asset like agricultural land will fare a lot better. The holders of physical precious metals such as gold and silver will do extremely well as long as they are held outside the financial system. In the last 100 years, governments, central bankers and bankers have created a supernova.
“A Supernova is an astronomical event that occurs during the last stellar evolutionary stages of a massive star’s life, whose dramatic and catastrophic destruction is marked by one final titanic explosion.” (Wikipedia)
The only question is if this “final and titanic explosion” will be slow or happen very quickly. What is clear is that the $500 trillion of more of debt and unfunded liabilities will need to implode together with the derivatives of $1.5 quadrillion. In addition, central banks will have to print a few additional quadrillions in a futile attempt to save the world. All that will of course disappear too. And as the Supernova of debts explodes, the assets backed by these debts will implode. The consequence will be a wealth destruction of massive proportions, making the world suffer for a very long time.
Debt must be cleansed
But a cleansing of the overindebted and corrupt system is the only way for the world to start from a sound debt free base. It is like a having a fire of an old forest to clear out the deadwood and create the right conditions for green and strong shoots. As long as the debt is still there, the world can never grow soundly. In the last couple of decades, there has been no real growth since for every one dollar increase in GDP several dollars of debt must be created. This is not just the law of diminishing returns but the law of negative returns. We have a world running on empty and until the debt is cleaned out, it will never be possible to show real growth again.
The transition to a sound financial system is likely to take a long time but hopefully not as long as the Dark Ages which took 500 years. The coming period is likely to include social unrest, wars, famine, disease and a major reduction of the world population. But all of this is not new in history. There have been long periods of wars, economic downturn or disease. In the mid-14th century for example half of Europe’s population and at least 25-30% of world population died from Black Death.
For most people, it will be impossible to prepare for this when it comes. Family friends will be the best support system. For the very small group which has some savings, physical gold and silver will be the best form of wealth preservation and money to hold. Ordinary paper money will become worthless as governments print unlimited amounts of currency. Throughout history gold and silver has always been the best form of money in periods of crisis.
Gold and silver markets are corrupt
The gold and silver markets are today corrupt and artificial. Around 3,000 tonnes of gold are mined every year and another 1,500 tonnes of scrap gold are refined. All the physical gold produced annually is absorbed easily by the market. China and India take the majority of the gold produced. There are no stockpiles of gold anywhere or excess stocks that need to be dumped. Thus every year around 4,500 tonnes of refined gold is produced and sold. That equates to $180 billion worth of new gold sold annually.
But the gold price is not determined in the physical market but instead in the paper market. Comex is seen as the most important paper gold market with a major influence on the gold price. It is true that Comex is important for the determination of the gold price but what few people realise is that the trading on Comex is only 8% of global gold trading whereas the London OTC cash gold market accounts for 80%. Thus, whilst many believe that Comex is the big culprit when it comes to gold price manipulation, the real trading takes place in London.
$64 trillion gold traded annually in London
In 2016, 638 tonnes of gold were cleared or settled daily. That means a total volume of 160,000 tonnes is settled annually in London. This is equivalent to all the gold ever produced in history. But the 638 tonnes per day is just the net volume and one can safely assume that the gross daily volume traded is 10x that amount which amounts 6,380 tonnes daily. Remember that annual mine production is 3,000 tonnes so more than 2x that amount is traded in London every day. That makes the annual traded gold volume in London a staggering 1.6 million tonnes or $64 trillion.
Just to put this amount in perspective, global GDP is $70 trillion. The gold traded annually in London is over 500x greater than the annual mine production. Only 5% of the gold settled in London is physical. In addition to the London OTC gold market and Comex, there are other cash and futures markets and the derivative market in gold which increases total global volumes significantly.
The total physical gold held in London is 6,500 tonnes which equals 1 day’s trading. The total gold stock in London is only 0.4% of the annual turnover.
London OTC Gold trading is 500x annual gold production
With just the London Gold OTC market trading 500x annual gold production, total global paper trading including all futures and derivatives will be several times that amount. Since no paper gold market can ever deliver a fraction of physical gold against their commitments, it is totally wrong that the paper market determines the price of physical gold. Without this artificial and corrupt paper gold market, the price of physical gold would be many times higher. Within the next few years, as gold demand increases, we are likely to see the holders of paper gold run for cover. This will lead to defaults in many paper gold markets including Comex and the London market. At that point there will be no physical gold available at any price. Eventually the physical gold market will settle at prices that no one can imagine today.
Trump can easily eradicate US trade deficits
Last week Trump signed another Executive order which calls for examination and punishment of foreign trade abuses. This week, Trump has been meeting with Chinese President Xi Jinping in Florida. He reiterated that the US can no longer have massive trade deficits and job losses due to Chinese dumping. After the meeting, he confirmed that he achieved nothing! Not really surprising that China isn’t scared by US bullying. Because continuous US trade deficits since the early 1970s have nothing to do with Chinese dumping but with the US living above its means and spending money it doesn’t have. There is of course a very elegant solution to this problem. All the US needs to do is to go back to the pre-15 August 1971 days and settle all Sovereign debts in gold. That will eliminate the trade deficit overnight. It will also stop money printing and debt creation or at least reduce it significantly. The trade deficits accelerated from the late 1990s. If the US had settled its sovereign debts in gold from 1999 to date, it would have paid with 453,000 tonnes of gold. (See my article “The US owes the world 3x the gold ever produced”)
The only problem with that amount of gold is that it is 3x all the gold ever produced in history. The official gold holding of the US is 8,000 tonnes whilst the real holding is probably less than half of that. But even if we take the 8,000 tonnes of gold as the real figure, the US would have needed to pay the world 56x that amount in the last 17 years in order to settle their imports. Since only a fraction of that gold would be available, ongoing demand of that magnitude would have led to a gold price which would be multiples of the current price.
So if Trump takes the US back on the gold standard, the trade deficit will disappear and he will devalue the dollar and revalue gold significantly. This must be a very tempting solution for Trump since it would overnight solve many of the US problems of deficits, debts and an overvalued dollar.
Gold acceleration next
As I have previously discussed, gold has been due to accelerate in April and we have today had the required catalyst in the form of a US attack on Syria. It is clearly very unfortunate that war should be the trigger for the expected gold move. Political events seldom create sustained moves in gold. Instead, gold moves primarily due to the debasement of paper money. But the situation in the Middle East is now serious and could easily lead to an extended and serious geopolitical conflict. With or without a major war, gold and silver are likely to move substantially higher in 2017 and in the next 4-5 years.
The combination of the Supernova, geopolitical tension and the extremely limited supply of physical gold, in relation to the paper gold outstanding, will all act as very strong drivers in coming years.
Egon von Greyerz
Founder and Managing Partner
Matterhorn Asset Management AG