By Stephen Leeb, PhD and Megan Davis
After the explosive gains that brought it above $5,500, gold has just experienced its worst week in four decades, leaving it 20% below its high-water mark. This would seem mystifyingly counterintuitive, given the global economic uncertainty from the senseless war in Iran, a war in which the U.S. and Israel are being badly beaten. After all, for more than four millennia, gold has been considered a sacred metal, offering shelter in both economic and military storms. The Book of the Dead, an early Egyptian text, notes that gold amulets were placed in coffins of the dead to assure a safe journey to the afterlife. Yet so far in the current upheaval, the only shelter has been the paper money or credit issued by the U.S., a technically bankrupt nation.
The mystery only deepens as it becomes clear how vulnerable Iran’s regional enemies are. Iran’s missiles easily breached one of Israel’s most protected areas, where Israel’s nuclear research and up to 80 atomic weapons are stored. The missile landed unopposed by ground-to-air defenses. That the missile presumably hit its target strongly suggests that Iran has the ability to destroy these facilities completely, with massive consequences for Israel. Separately, Iran demonstrated the ability to launch missiles with a range that puts many major European capitals within reach.
The likeliest explanation for gold’s behavior picks up from our blog of early March, after gold, in just three trading days, had dropped more than 20% from its high before recovering. In “What Really Lay Behind the Crash In Gold,” I argued back then that China had been largely responsible for triggering the decline, through actions it took to tame speculative excesses in gold trading—the trading in gold jewelry—occurring outside the purview of the Shanghai Gold Exchange. With my thinking further buttressed by a recent YouTube video posted by Lynette Zang, an astute gold analyst who has followed the gold market for decades, I see China’s actions as aimed at eliminating any form of leverage from the trading of gold.
In other words, as China looks ahead to gold becoming central to a new monetary reserve system, it wants gold’s price to reflect supply and demand for the metal itself, not speculative paper trades. Here it is important to explain the role of leverage (margin) in buying stocks vs. buying gold. Most stock traders can buy stocks with 35% to 50% leverage. But for buying, or shorting, gold, margin requirements are far lower—sometimes 10% or less. That’s because gold, when wholly allocated to a particular holder—whether an institution, a mutual fund or an individual—has no counterparty risk. I.e., in contrast to fiat currencies, there’s no risk of default.
But the gold you buy or short still has risk in that gold, like any asset, can fluctuate in value. And if you buy gold on 10% margin and the metal falls by 10%, you are toast—your initial investment goes to zero. In other words, whenever margin is used in the purchase or short sale of gold, there can be massive risk from market fluctuations.
There’s more. Because gold doesn’t pay interest, it can encourage the leasing or lending of gold in return for periodic payments. Whoever borrows the gold then can lease it to another party, with leverage building upon leverage. Some estimates suggest that the potential leverage on gold traded on paper markets can be as much as 100:1.
Back to China and its goal of making gold the center of a global monetary system. In such a system, gold would need to be priced in a market in which there is no leverage—i.e., in a purely physical market as opposed to the paper markets of the West. China prohibits leverage on the Shanghai Gold Exchange, where transactions must be settled by the exchange of physical gold for cash. But as long as any leverage remains within the overall system, gold bought and sold will be a combination of the real thing and a fiat currency, with no way of knowing the real price of physical gold. That leaves fiat currency continuing to play an outsized role in the monetary system.
The upshot is that sharp increases in volatility in financial assets readily translate into volatility in gold thanks to margin calls on both long and short positions on gold. This was true in 2008, when the sharp rise in oil led to extreme volatility in gold. From high to low, which was a matter of months, gold after initially rising fell over 30%, from about $1,000 to $680. Less than three years after that $680 bottom, it was trading near $2,000.
What does all this mean for what comes next for gold? As they say, history does not repeat but it does rhyme, suggesting that gold at $4,000 or even lower—possibly as low as $2,500—can’t be ruled out. Keep in mind that China still hasn’t taken the final step of outlawing any leverage in traded gold. What could somewhat offset the short-term pain is that the dollar will likely come under pressure, which would cushion the downside. Remember, a nearly sure consequence of the war, as discussed in “The Iran Crisis: A Potential Golden Lining,” will be the death of the petrodollar.
But the most important conclusion to draw is that any further short-term pain will be dwarfed by long-term gain. Once physical pricing of gold takes over completely, gold will be free to make up for lost time. The gains gold has made so far this century are nowhere near to making up for years of high inflation and suppression of gold’s price in the paper markets of London and New York. Establishing a physical price for gold requires benchmarking gold to when its price was not encumbered by suppression and by misstatements of the CPI. There’s a wide range for what would constitute a fair price, but in all cases, it surpasses gold’s recent highs near $5,500, and we think that under the most reasonable assumptions, it would surpass it by a lot.
Our working assumption is that gains in gold’s price should roughly match changes in worldwide nominal GDP. Growth in nominal GDP is regarded by most economists as a good proxy for growth in money supply. Using data from the website Our World in Data along with U.S. inflation data is a good proxy for global money supply growth. For most years between 1900 and 1930, our proxy for money supply growth points to a projected 2026 price for gold of about $18,000, implying a nominal growth in GDP of about 5.5%. That nominal growth rate has remained nearly constant between long time frames since the beginning of the last century.
Between 1930 and 1970, gold was fixed at about $35 an ounce. In 1971, when Nixon ditched Bretton Woods, gold was allowed to trade freely. Between August 1971 and August 1980, gold climbed about 19-fold to $670. Clearly gold was making up lost ground. Still, projecting forward from 1980 would indicate a current value of about $12,000, the point being had gold made up all its lost ground to bring its value in line with nominal GDP, gold should have been trading close to $1,000 instead of $670. Most important, instead of rising after 1980, gold went into a 20-year slump, falling to a low of about $270 in 2000. That was a period in which nominal GDP growth remained above 5%. The bottom line is that if the gold/nominal GDP relationship had remained in play, in 2026 gold should have been trading at about $18,000 rather than at its recent peak of $5500.
This suggests that gold has been severely suppressed really since the 1930s. Long periods of fixed gold prices explain some of the suppression, but even when gold was trading freely and began to catch up to what history suggested the price should be, suppression remained a factor. The post-1971 suppression reflects the fiat currency/physical duality in pricing gold. And as long as the fiat element remains, the metal will be easy to suppress. But with the Chinese appearing to be well on their way to creating physical pricing for gold, targets as high as $18,000 become eminently reasonable.
Our argument that gold is a great buy at current levels may seem irrelevant in the face of an ongoing war that could have catastrophic consequences not just for us but for everyone. But there’s no stronger wakeup call than a near-death experience. We have no doubt that China would be willing to broker peace, we just have to be willing to cooperate. China, with its superior technologies, also has the ability to put enough pressure on Netanyahu to get him to accede to peace. In any case, when you’re in a do or die situation, betting on gold seems to have very little downside.
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