Gold: Connecting the Dots Tocqueville Gold Strategy Fourth Quarter 2017 Investor Letter Gold rose 11.63% in US dollar terms in 2017, an excellent year for the metal. More important, it has been the top-performing asset since the dawn of radical monetary experimentation by world central banks in 2000 (better than equities, bonds, and other key commodities). The US dollar, anointed “King Dollar” by Larry Kudlow – a view shared by most leading economists at the beginning of 2017 – has been a bust. It suffered its worst annual performance in 14 years, down 9.84% (DXY, an index of the dollar against major currencies). Still, gold is shunned by mainstream investors. Nonetheless, our outlook for gold for 2018 and beyond is positive. What we believe is a compelling case for investing in gold now is summarized in the bullet points below. We discuss each at greater length in the following paragraphs and attempt to connect the dots from a gold perspective: 1. Extreme Valuations of Financial Market Assets 2. Worsening US Fiscal Position 3. Rising Inflation 4. Precarious Financial Market Structure 5. Bullish Supply and Demand Outlook for Physical Gold 6. Expected Further Weakening of US Dollar 7. Gold as an Ideal Portfolio Diversifier and Risk Dampener 8. Potential Boost from Bitcoin 9. Brief Comment on Gold Mining Shares
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Market Valuation “Nothing sedates rationality like large doses of effortless money.” –– Warren Buffet We believe that renewed interest in gold will be triggered by financial-market losses. Valuation is a notoriously poor aid to market timing, but there can be little debate that financial asset prices now sit at valuation extremes that have been, without exception, followed by periods of meaningful disappointment. In our view, valuation excesses signify systemic risk. Identifying the precise precipitants and timing of events that would lead to an unwinding of the “wealth” perceived by the investment consensus to exist in the current valuation mania would be pure speculation. One only needs to know that the aftermath of ultra-expensive is cheap, and that now is the time to be deploying strategies that are proven to curtail risk.
Source: Horizon Kinetics Q3 Investment Commentary
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Gold has a long and unambiguous history of dampening risk. If the valuation extremes depicted in the chart below persist, or even exceed current stretched levels, gold exposure may be no worse than “dead money,” and would likely cause only a minor drag on overall returns. Because the cost and risks associated with physical gold exposure are low, we believe it can be seen as cheap insurance on a possible significant retreat from current valuation extremes.
US Fiscal Position The federal deficit is rising rapidly late in a mature business cycle when, according to normal historical patterns, it would have been expected to decline. The deficit will rise even faster under the new tax bill. According to the Tax Foundation, the average annual loss of revenue over 10 years would be $147 billion on a static basis and $45 billion on a dynamic basis. Dynamic scoring assumes a pickup in average annual GDP growth of 1.7% over the next ten years. Even under dynamic scoring, however, revenue loss to the government is front-loaded due to accelerated tax writeoffs for certain forms of capital investment.
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The fiscal deficit for 2017 was approximately $700 billion, and for the first time public debt surpassed $20 trillion, only 9 years after it topped $10 trillion, a level not exceeded in the previous 200 years. The math is daunting and the path geometric. However, investment world concern is at Alfred E. Neuman levels: