The Newest Case for Gold

The stars are aligning for gold. A combination of geopolitical tumult, supply chain problems and inflation all point to much higher gold prices. Today, I’ll break it all down.

If you believe that the war in Ukraine will end soon, that global supply chains will heal quickly and that inflation is transitory, then you’re probably in for a rude awakening. In fact, none of those things is likely.

Even if the shooting stops in Ukraine soon, something that is not at all assured, the geopolitical consequences will dominate events for years or decades.

Putin will have asserted Russian de facto control over eastern Ukraine, if not outright annexation. Ukraine’s hope of NATO and EU membership will be permanently denied.

And the divisions in the West between the U.S. and the U.K. on the one hand and France and Germany on the other with respect to energy and trade with Russia will be on full display.

The Western alliance will lie in ruins. But Ukraine isn’t the only international security crisis underway.

Simmering Tensions

China has been rattling sabers in the Taiwan Strait and the South China Sea.

Iran is in the late stages of renegotiating the Joint Comprehensive Plan of Action (JCPOA) that deals with Iran’s uranium enrichment plans and efforts to build a nuclear warhead that can be fitted on a missile.

North Korea is again testing intermediate-range missiles and may be preparing to test an intercontinental ballistic missile (ICBM) capable of reaching Guam, Hawaii, Alaska and the West Coast of the United States.

Furthermore, there are ongoing crises in Syria, Lebanon, Venezuela, Sudan, Ethiopia and elsewhere around the world. The bottom line is there are plenty of geopolitical tensions to go around.

Besides the geopolitics, there’s the geoeconomics…

“The War Is Already Damaging Global Supply Chains”

Supply chains will be in even worse shape. The global supply chain crisis was underway well before the war in Ukraine. The pandemic particularly hurt supply chains as buyer and seller facilities in plants, ports, shipping, trucking, warehouses and distribution centers were all closed temporarily (and at different times depending on the location of the outbreaks).

This created tremendous bottlenecks and backlogs. Now comes the war in Ukraine with extensive sanctions, retaliation and physical disruption from the war itself. The war is already damaging global supply chains.

For example, BMW and Volkswagen have both shut down automobile production lines because of their inability to obtain a simple cable wiring harness part that is supplied by production facilities in Ukraine.

In some cases, you can assemble most of the automobile and then install a delayed part near the end of the process. That’s not true for wiring harnesses. They are installed almost at the beginning of the manufacturing process. This means that the assembly line is halted at an early stage of production and nothing else can be done in the meantime.

This is a pointed example but far from the only one. The manufacture of many products all over the world is suffering disruption due to supply chain delays with their origin in Ukraine. Agriculture and wheat exports may be the worst affected.

The Breadbasket Is Empty

The planting season begins soon and Ukraine cannot obtain the fertilizer it needs to plant crops. Those crop shortages will impact global supplies next fall when the harvest season begins.

Ukraine’s nickname is the Breadbasket of Europe. It along with Russia supply about 25% of the global wheat supply and 20% of the global corn supply. What do you think will happen when that supply dries up?

The problem is actually worse than that because most of the grain in the world is not raised for human consumption. It’s raised to feed the animals that we eat. If you want a nice hamburger, for example, it’s going to come from a cow that ate wheat probably produced in Ukraine. And now that’s offline.

Then there’s the impact on semiconductors and strategic metals. Airbus gets 50% of its titanium from Russia and Boeing gets 35% of its titanium from Russia. Russia and Ukraine together control 30% of the global output of titanium, so they’re not going to be getting any new airplanes for a while.

“Good Luck Making Semiconductors”

Meanwhile, we’ve cut off semiconductor shipments to Russia. If you cut off semiconductors to Russia, yes, that will damage their economy. But how do you make semiconductors? You take silicon chips and etch them with lasers.

How do you power a laser? With a processed neon gas. Sixty-five percent of all the processed neon gas in the world comes from one company in Odessa, Ukraine. So Putin says, oh, you’re cutting off my semiconductors? Fine. I’m going to cut off your neon gas. Good luck making semiconductors.

Basically, you’re talking about shutting down much of the world’s semiconductor industry. Think about that for a second. There are over 1,400 semiconductors in your car alone.

Supply chains take decades to build but can be fractured in a matter of weeks when extreme sanctions are imposed, as they have been on Russia.

Pick Your Poison

Meanwhile, Russia’s exports will not stop, but they will be rerouted to China, India and the Middle East instead of Europe and the U.S. The result will be higher costs, longer lead times and persistent shortages.

Inflation is also not temporary or “transitory.” Once prices of oil, natural gas, strategic metals and agricultural exports spike, they do not retreat unless there is something like a global depression.

So, your choices are permanently higher prices or a new great depression. Take your pick. All of these scenarios are bad for the global economy but good for gold. The stars are aligning for gold.

Inflation is obviously also good for gold because inflation generally runs ahead of interest rate hikes. The interest rates do catch up eventually, but for the first year or two, higher inflation with lagging rate hikes means real rates are going negative.

That’s the ideal condition for gold price increases.

A Golden Anchor

Contrary to most investors’ expectations, a serious recession or even depression is also good for gold. Gold prices rose almost 75% during the Great Depression (from $20.67 per ounce to $35.00 per ounce) as the government engineered a dollar devaluation to cause inflation in all commodities as a way to defeat the prevalent deflation.

With this as the investment backdrop, gold investors should get ready for what I call $100 days.

At current price levels, making large profits in gold gets easier by the day. Here’s why: If you own gold and it goes up $100 per ounce, you make $100 per ounce. But each $100 per ounce gain is easier than the one before because it’s a smaller percentage gain from a higher denominator.

If gold is $1000 per ounce and it goes up $100 per ounce, that’s a 10% gain. But, if gold is $2,000 per ounce and it goes up $100 per ounce, that’s a 5% gain.

The Sooner You Buy Gold, the Better

Carrying that logic forward, if gold is $3,000 per ounce and it goes up $100 per ounce, that’s a 3.3% gain. Each increase is easier because it represents a smaller percentage of the new base price.

But you still make $100 per ounce.

That’s why it’s important to buy gold now because this process is just beginning. We’ll see $100 per ounce gains on a weekly basis. Soon, we’ll see those gains on a daily basis. At $5,000 per ounce, a $100 per ounce gain is a 2% gain, which is almost normal daily volatility.

The sooner you buy gold, the sooner you can start to enjoy those $100 days … or maybe $10,000 days if you own 100 ounces.


Jim Rickards
for The Daily Reckoning

The Daily Reckoning