Nothing New under the Sun

By Joshua Rotbart, Managing Director, J. Rotbart & Co.

In the year 301 AD, the Roman emperor Diocletian issued his famous “Edict on maximum prices”. This law attempted to fix the prices of commodities, wages and freight rates throughout the empire.

It named the prices of no less than a thousand different products, from grain and wine to the prestigious purple silk, used for aristocratic robes. Copies of the edict were displayed in every town square, and any violation was punishable by death. Diocletian believed that fixing prices would stop the inflation ravaging the economy at the time. Needless to say, his attempt failed miserably as merchants preferred risking death than sell their products at a loss. The edict was largely ignored and eventually abandoned.

The inflation plaguing the Romans did not happen overnight; It was the result of a century of political turmoil and currency debasement. Starting in 193 AD, with five different emperors vying for control, the Roman empire faced civil wars, epidemics and barbarian invasions. To cope with these crises, its leaders gradually reduced the silver content of the denarius, the coin of the realm. Originally made of almost pure silver, it slowly turned into a bronze coin, with only a thin silver coating. Over time, merchants noticed that the new denarii were less valuable than the old ones and increased their prices accordingly. However, they were not responsible for the inflation; the expanding money supply was strictly the fault of the government. While most people were impoverished by this inflation, those who kept their savings in gold remained immune.

CENTURIES HAVE PASSED, BUT THE PRINCIPLES THAT GOVERNED THE ECONOMY DURING THE DAYS OF THE ROMAN EMPIRE STILL APPLY.

Centuries have passed, but the principles that governed the economy during the days of the Roman empire still apply. After World War II, delegates of the 44 allied nations convened in Bretton Woods, New Hampshire and agreed that from then on, the US dollar would serve as the global reserve currency. The US would back its currency with gold, and the rest of the nations, which were devastated by the war and had very little gold reserves left, would back their currencies with dollars. The link between the various national currencies and gold was weak and indirect, but it existed nonetheless. This gave them enough credence to support the post-war reconstruction, and the world economy was able to prosper once again.

DURING THE 1950S AND 1960S, THE US GOVERNMENT RESORTED TO EXCESSIVE MONEY PRINTING TO FUND WARS AND SOCIAL PROGRAMS, DEBASING THE DOLLAR.

However, during the 1950s and 1960s, the US government resorted to excessive money printing to fund wars and social programs, debasing the dollar. As a result, the rate of inflation in the US started to creep up, from an average of 1% during the early 60s, to 4.5% at the end of the Lyndon Johnson presidency. Led by France, America’s trading partners began to convert their overvalued dollars to gold. During that period, the reserves at Fort Knox declined from about 20,000 metric tonnes to just under 10,000.

In 1971, President Richard Nixon severed the link between the US dollar and gold. Few people remember, but also imposed a 90-day freeze on all wages and prices, just like emperor Diocletian did 1,670 years earlier. Unsurprisingly, this had no long-term impact on inflation. It abated for a short while, but then started to rise again, reaching no less than 12% in 1974, and over 14% by 1980. Yet again, those who were wise enough to keep their savings in gold were protected from inflation. During the 1970s, the price of gold rose from about $40 an ounce to $800 an ounce, compensating its holders for the dramatic decline in the purchasing power of the dollar.

Today we are living in a fiat world, where currencies are no longer backed by tangible assets but exist as digital entries on bank servers. As many in the sound money community have predicted, the rapid expansion of the money supply in the past decade has led to inflation. This fact can no longer be denied, even by the most ardent Keynesian economist. Governments and central banks across the western world may try to blame it on the war in Ukraine, or on the disruptions to the supply chain that followed the COVID-19 pandemic. But the rate of inflation in the US was already 7.5% before the Russian invasion of Ukraine, and to our view, the disruptions in the supply chains were the result of the brewing inflation, and not the cause of it. Unchecked money printing has increased aggregate demand, above and beyond what suppliers could possibly handle.

The only surprising aspect of the current financial situation is that the price of gold has not moved substantially higher. In the summer of 2020, it reached an all-time of $2,075, but since then it has entered a prolonged period of consolidation. Lately, it briefly touched this level again, against the backdrop of the developing banking crisis in the US. However, it is yet to break out of this trading range and resume its upward trajectory. This has left many precious metals investors perplexed. How come the performance of gold has been so underwhelming in the face of such persistently high inflation?

First, this consolidation comes after an impressive 70% rise in the price of the metal between 2018 and 2020. It seems as though the price of gold anticipated the inflation and reacted to it in advance. Therefore, it is only natural for it to consolidate in preparation for any future move.

Furthermore, although the price of gold has been moving sideways in dollar terms, it has been setting record highs in terms of other currencies. The price of gold is at all-time highs in terms of euros, British pounds, Japanese yen, Canadian dollars and Australian dollars. We believe that citizens of these major economies, who happen to be holding gold, are quite pleased with their investment. It is mainly to Americans that gold’s performance appears lacklustre. Indeed, due to a decisive tightening campaign by the Federal Reserve, the US dollar remained remarkably strong in 2022. But as Fed chair Jerome Powell recently signaled, this tightening cycle is drawing to its end. We suspect that the current turmoil in the banking sector will not permit rates to go much higher, and that the dollar will no longer be a headwind to the price of gold.

Finally, a new factor that may impact the price of precious metals positively has recently became relevant. Most asset portfolios are currently managed according to the 60/40 model, which divides the capital between two asset classes – stocks and bonds. Stocks are considered as the risky and volatile portion of the portfolio, while bonds are supposed to be stable and boring. Stocks are expected to perform well in good times, and provide most of the growth, while bonds are supposed to perform well in bad times and compensate investors for any declines in the stock market. However, this theory has worked well only in a high growth, low inflation environment, the kind of which we’ve had continuously since the early 1980s.

But now circumstances have changed: there’s an inverse ratio between the yield of a bond and its price. In the past three years, interest rates across the world have risen considerably, pushing the price of these bonds down. To illustrate this point, consider the price of the ishares TLT ETF, which invests in long-dated US treasuries. Since its all-time high reached in March of 2020, this ETF has lost over 40% of its value. That is a tremendous loss of capital for an investment vehicle that is supposed to be the safest in the world and the cornerstone of every retirement portfolio.

Thus far, the losses in the bond market have been substantial, but they haven’t triggered a complete collapse. Investors seem to expect the bond market to rally in response to the banking crisis and a falling rate of inflation. As a result, the US treasury yield curve is deeply inverted, with long-dated bonds trading at a lower yield than short-term treasury bills. But if for some reason, these expectations do not materialise – for instance, if inflation turns out to be hotter than expected or if a major issuer suffers a default – the bond market may enter a protracted bear market. In such a scenario, asset managers will need to ask themselves: what safe and reliable alternative is there to bonds? We believe that there is nothing new under the sun and that gold will once again serve as a safe haven. Currently, the allocation to precious metals in the average portfolio is negligible. If only a small fraction of the roughly $200 trillion invested in financial markets across the world finds its way to gold, this could have a dramatic impact on the price.

JOSHUA ROTBART (LLM, MBA) is the founder and managing partner of J. Rotbart & Co., a bullion house providing global solutions for HNW who invest in physical precious metals. Joshua started his career as a corporate lawyer before entering the precious metals industry in a senior position with one of the world’s largest vault operators. In 2015 Joshua founded J. Rotbart & Co., which has traded over USD 1bil worth of bullion.