It was back in 2004 I wrote about gold for the first time. At that time, it was a neglected and unloved asset class nobody talked about. However, in my understanding, gold was the asset that could best protect investors against exuberant money creation and the effects of central bank policies on the global economy.
Some 12 years on, I’m wondering how to define the money creation efforts of today, considering I already called it exuberant back then. Unlike real assets, currencies are based on faith. There is nothing wrong with that, as long as counterparties trust each other and supply and demand for those bills are more or less in line.
The balancing of this demand can be achieved by aligning monetary supply growth with GDP growth. But once central bankers start to create money according to their convenience, then nobody knows what the consequences might be. As is the case with drug addicts, the markets need ever more stimulus to reach the same highs. As low rates stimulated lending, the flows of cheap money to some places were so big that they served to transform entire sectors, such as the oil industry.
Arguably, the shale oil boom, which is now seen as the main trigger for the oil price slump, wouldn’t have occurred without QE. The mining industry was able to fund ambitious development projects thanks to the extremely low cost of capital.
On a downward spiral
By now we know that excessive capacity growth in these areas brought about a massive supply-demand imbalance, as new demand couldn’t keep up with supply growth. As a consequence, prices have gone lower and lower.
Decelerating growth in emerging markets last year only served to accelerate this process. With global bond and equity prices at historical highs, these were hit as well. Today crude oil is worth a third of what is was two years ago, causing existential problems for oil firms. Not only do most of these firms have huge leverage, current crude prices are far from sustainable for them.
As a consequence, capital expenditure is cut to a minimum now. Huge planned projects are reversed and other capacity will shut down. The companies with the lowest production costs and least leverage will be the winners of tomorrow, while many others will go bust. Survival of the fittest.
Trust arrives on foot but leaves on horseback… so the Dutch saying goes. So while consolidation in the sector is already underway, commodity companies will continue to be treated with suspicion for some time to come. So investors should be prepared for volatility in the short and medium term. But if they invest now, they will benefit in the longer term.
Supply will fall dramatically during the next few years and lately short sellers have started to cover their positions. Reduced output, one of the consequences of cutbacks in investments, will naturally meet demand at a higher price level.