Why $1,900 Gold is the New Floor, Not the Ceiling

June 4, 2021

Everything is Relative (particularly in investing)

Why $1,900 gold is the new floor, not the ceiling...

This week we explore:

• The GII Indicator (Gold Inflation Index) – a revolutionary financial modeling tool that indicates a true valuation for gold

• Why gold is a screaming buy at $1,900 today

• The true relationship between gold and the US Federal Reserve

Our entire monetary system is built on the balancing act of the pendulum of faith. It swings from extreme to extreme only to eventually find its true center of gravity. These monetary scales are balanced on one side by the Federal Reserve, and by gold on the other.

The Federal Reserve’s sole role is to manipulate the money supply, and even more simply, the dollar. On the top of every dollar are three words, “Federal Reserve Note.” The gravity on the other side of the dollar is gold. This makes gold the anti-dollar.

Understanding this relationship best allows us to understand the future prospects for both. When the Fed is at its “strongest,” or most overvalued, gold tends to be “weaker,” and thereby is at its most undervalued. The converse is also true. When the Fed is weak and undervalued, gold has been at its strongest and most overvalued.

Which leads us to our ultimate question. Is today’s $1,900 gold price the same as 2011’s $1,900 gold price?

On the surface they are identical. It’s the future then, versus gold’s future now that we believe is in polar opposition. While it may be tempting to draw conclusions from one identical data point, it does not tell the entire story. In this month’s acclaimed Full Faith & Credit Newsletter, we gave an example about how the similarities between two men do not define their mutual outcomes.

Consider two 50 year old men, born at the exact same time on the exact same day at the exact same hospital. Let’s assume that both men measure 6 feet tall and 200 pounds and even live in the same neighborhood.

While these circumstances may be identical, it’s simply not enough information on how well each will fare in the future.

One man may have high cholesterol while the other falls into a normal healthy cholesterol range. The same man suffering from high cholesterol may also struggle with a high body fat composition around 30% and high blood pressure, while the second man may be quite fit at 8% with healthy blood pressure due to his low body fat and low cholesterol.

Assuming that both men’s future health prospects are the same would be foolish without factoring in the other data. The same can be said for gold.

The price may look the same, but in truth, to answer this question, we need only refer to Brentwood Research’s groundbreaking Gold Inflation Index (GII) Indicator to see the difference.

It is critical to note that all indicators are relative measures. Much like a person's credit score is an indicator for their creditworthiness, and a balance sheet is an indicator for the creditworthiness of a business, and the Warren Buffett Indicator shows market capitalization-to-GDP ratio (aka how overvalued or undervalued relative to history a market is), and the debt-to-GDP ratio acts as a barometer to determine the relative fiscal health of a country, our GII provides a window into the true worth of gold based on the true leverage ratio of the Federal Reserve when including the actual market value of their gold collateral.

Think of it like a credit score for our central bank that indicates leverage risk and whether gold is undervalued, fairly valued, or overvalued. We must also consider that ‘credit acceptability’ is itself relative.

When looking at gold as the anti-dollar, one may think that gold has always kept the Federal Reserve in check, but our indicator actually reveals gold's bigger function, not only keeping the Fed in check but also indicating the Fed’s acceptable leverage.

Today’s world has temporarily accepted a higher GII, much like it accepted the subprime lending issues before the housing market collapsed, or the fast and free money created by the loose policies of Greenspan that led to the dotcom bubble.

Each of these times, the Fed told us “no problem, everything is fine.” And each time the pendulum of opinion swung back toward and through the mean, only to wind up on the extreme opposite side after each bubble collapsed

And now we’re hearing the same quote today as inflation continues to soar, with no signs of being “transitory” as Jerome Powell continues to indicate. Meanwhile, the Fed continues to transfer risk and liabilities from individuals and corporations to their own balance sheet.

But the Fed has never been this levered. As a result, their balance sheet looks very similar to a subprime borrower just before the housing bubble collapsed. Our GII Indicator allows us to measure the Federal Reserve’s actual leverage by properly valuing the gold the Fed holds as collateral “marked to market.”

While an individual credit rating has a perfect score (850 points), the GII’s “perfect” score is 1.5, representing a 1.5X leverage ratio on its balance sheet as JP Morgan originally designed the system to be. This perfect score was necessary for the world to have faith in the dollar itself.

The higher the GII number, the higher the risk, and the more undervalued the price of gold. It’s worth noting that the GII Indicator currently stands at 13.46 and is near its all-time high of 14.70, indicating a significant undervaluation in the price of gold.

In 2001, well before the Fed began their massive balance sheet expansion, the GII was at 6.53. Back then the total assets on the balance sheet of the Federal Reserve were $598 billion with equity of $14 billion for an apparent leverage ratio of 42X. But when factoring the market value of gold, the GII stood and the Federal Reserve's actual leverage was 6.53X.

On September 5th, 2011 the intraday price of gold eclipsed $1900 per ounce. As this occurred the GII was actually at its lowest number of 4.7 in many decades. It’s no coincidence that gold hit its highest price to date as the GII was at its lowest total, signaling that gold was at its most overvalued.

It’s of little surprise that gold prices would decline over the next five years falling to lows of $1,059 per ounce in 2015 before climbing back to all time highs.

This is critical to note because a decade later, gold prices are once again sitting at $1,900, but with a GII score more than triple what it was then.

We know gold dropped nearly 50% in the years after 2011 when the GII Indicator was at its lowest level. This signals, in our opinion, a tremendous buy signal for gold today and that gold price at $1,900 is the floor, not the ceiling.

In recent years, as the Fed’s balance sheet has increased nearly 3X from $2.58 trillion in 2011, to $7.9 trillion in late May of 2021, gold prices have not kept pace. This indicates that the Federal Reserve has never been more overvalued, and gold never more undervalued, and is why the smart money is looking to move into gold to prepare for the next decade.

The conclusion we draw from the GII is that we expect a reversion to the mean. Think of it in terms of a pendulum. If a strong, overvalued Fed (with corresponding undervalued gold price) is at 9 o’clock, and overvalued gold with a corresponding weak Fed is at 3 o’clock, we must assume that a pendulum will take us from one extreme to another before settling in the middle at 6 o’clock.

Our indicator has been spot on recently. Gold prices were their most undervalued relative to the size of the Fed’s balance sheet on March 8th, 2021 when the intraday price of gold dropped to $1,672.

Our GII index reading at the time was its highest in history at 14.70, indicating tremendous undervaluation for the price of gold, and thus why we were adamant that gold was poised for a big move higher.

Today, just two months later, gold prices are above $1,900 and the GII index has dropped to 13.46. It has a lot further to fall in our opinion, and represents a bull flag for long term investors.

If we take what Jerome Powell has said at face value, the Federal Reserve balance sheet will continue to grow at a pace of $120 billion per month at least through the end of this year.

A 13.46 GII applied to the end-of-year balance sheet of $8.7 trillion would indicate gold prices near $2,117. This is our base case assumption. Over the past year, as the balance sheet has nearly doubled, the GII has risen from roughly 10 to over 14. We think this is much too fast, and much too high and that the success the Fed has enjoyed pumping up the market will soon revert to the mean. That mean number over the past decade is roughly a GII Indicator of 10.

However, assuming the GII simply stays at these levels on the expected year-end 2022 balance sheet, we are left with a gold price of $2,428. (This by the way is our minimum prediction for the end of year 2022.)

We believe the Fed has never been as powerful as today, and that over the course of the coming years we will see lower GII’s and significantly higher gold prices.

It’s why we expect one of two scenarios to play out in the coming years

We expect the market to require a lower GII and higher gold price, causing a gradual but consistent rise in the price of gold.

If that does not occur, it gives the Fed all the more opportunity to use gold as a tool and reprice it down the road with the stroke of a pen, as the next crisis forces the Fed’s hand, or the Fed manipulates the price with the stroke of a pen, resulting in a sudden and significant rise in the price of gold.

Remember, the Fed’s strength and the price of gold move in opposite directions. So when the Fed is at its weakest, gold is at its strongest. Another way to think about this is that when the GII is high, the Fed is the most overvalued and gold is most undervalued.

Let us reiterate that the Fed was at its weakest in 2011 with a 4.78 GII. Gold prices thereafter dropped from $1,900 to nearly $1,000 as the GII Indicator rose from 4.7. Today’s Fed finds themselves in the opposite position. They’ve rarely ever been more powerful than today, with a GII of 14.

It’s why $1,900 gold prices in our opinion, and by virtue of the GII Indicator, tell us that gold prices at $1,900 are a launching pad for higher prices in the coming years.

As a result, while $1,900 per ounce in 2011 was the ceiling, today it may be gold’s new floor.

For those interested in fully understanding the depth of the GII Indicator, its accuracy, and full predictions, we invite you to read this GII Special Report.