How much do you love gold? / by Adam Howard

I want to take a quick lurch towards pure data.

I have recently read a book by Loretta Napoleoni, a pretty sharp and well respected Italian economist and author, detailing most of the major events over the decade 2001 to 2011.  This included data around global GDP, food prices, global population, etc.  It was pretty interesting so I took this data, added a bit about Australia and some commodity prices and dropped it into the attached table.  Some pretty interesting results really.

All of the stats I talk about from here on will be for the period 2001 to 2012, which I will just call “the period”.

This week I want to talk about where our economy has come from and where it is heading regarding past growth industries and future potential growth industries.

During the period global population grew from approximately 6.1bn to 7.1bn, an increase of just under 14%.  Although annual growth was pretty consistent at about 100m, the forecast is for population growth to really slow down up to 2050 on a proportionate level, as developing nations’ populations become better educated and wealthier, and choose to watch TV at night instead...

Anyway, on its own this isn’t very interesting, but it gets a bit more so when we put it next to Global GDP growth over the period, which grew by a whopping 119%!!!  In raw numbers this meant growth from $32bn to $73bn. 

What the....? I thought the GFC was meant to have put a stop to all that growth and things were going backwards from 2008 onwards!  At least that what Kochie and Alan Kohler and Tom Petrovksi and all the finance talking heads on TV told me!

So, where did the money go?  Well, a lot of it went to the developing nations around the world, like China, Brazil, India, etc. whose populations as a whole now enjoy, on an averaged basis, a much better standard of living than they did at the start of the century.

But, guess how much Australia’s GDP grew by over the same period?  265%.  YEP!  That’s right, 265%! $380bn in 2001 to $1.565tn in 2012.  Now, that’s impressive, particularly when you compare it to the US (47%), Japan (44%) and Germany (92%).

Even if you allow for inflation it’s still an awesome result.

And what was the secret?  You guessed it...China.  Chinese GDP grew by 428% over the same period from $1.3tn to $8.4tn.  Whoa!!!

And what was China buying from us? Stuff dug out of the ground.

Now, I have provided some information about commodity prices in the past and I am going to again now, and I want to be clear I am not deliberately trying to frighten anyone. 

Over our period, in US $s, gold increased in value by 413%, crude oil by 200% and Australia’s cash cow, iron ore, by 1285%. 

Like I said, I am not in the business of scaring people, but I would ask, is it reasonable to suggest the above commodities were in such a trough in 2001 that they all had the potential for such amazing upsides?  Maybe not...

If the answer is, they probably didn’t, then this leads one to think that maybe, just maybe, these commodities are a little overpriced.  We have already seen gold come back a little, and we saw iron ore dip to as low as the mid $80s late last year.

Now, we all kind of know the demand for commodities is cooling, with senior execs from Brazil’s Vale noting recently that iron ore markets are “oversupplied”.  So, it’s probably reasonable to think that commodity prices will continue to drop over the coming months and years.

Gold?  Well, its value shot up in the aftermath of the GFC in 2008 and 2009, and again in 2012 when everyone was terrified that the US would default on its Federal debt.

On that topic, why does this happen?  Simple.  Money is something we invented so it was no longer necessary to carry around bales of hay or 3 pigs.  First, we decided gold and silver were good replacements for real goods.  Next we decided notes were good enough as a replacement for gold and silver, and now we feel that numbers on a screen or a plastic card are good enough.

All the notes, numbers and cards really represent is a promise that if it came to the crunch we have the material assets to pay someone.

When there is a major event that casts doubt on whether someone actually does have the capacity to pay, people choose to put their money into assets that have some real value, like gold.

The rather perverse nature of money these days is reflected in a comment by a Hong Kong based statistical economist from 2012 when the US debt ceiling debate was first an issue, where the comment was that in order for the US government to repay all its Federal debt from revenues generated by a hypothetical sale of all US government gold stocks, gold would need to be selling for $7,000 US per oz.

In a normal economy, no one really cares about this as the US government was regarded as risk free (hence a US Treasury Bond being called a “risk free asset”).

But, when the proverbial hits the fan and even risk free assets are found to carry risk, people buy gold as they know that it’s actually worth something.

Sorry for the brief divergence into gold price volatility.

Even the politicians and mainstream economists are open about the fact commodity prices have had their day in the sun and keep on asking what is going to happen now to fill the void in economic growth.

One answer I have been hearing mentioned a lot is agriculture, which is funny as there is also a lot of reporting about how tough things are for farmers, particularly those in drought affected areas.

Why would agriculture and food production be the next big growth engine?  Well, one of the numbers provided in the book I mentioned above was a global food price index based on the average price globally of a standardised basket of goods.  This index used its base year as 2003, with base being 100.

The index increased from 93 in 2001 to 230 in 2011, or an approximately 250% increase in global food prices over the period.

From we are sitting it might not seem the case, but that’s because there’s also a big imbalance globally in food supply.  Western, developed countries have more than enough food and it’s affordable for the middle and upper classes.

It’s a completely different story for the working poor and for inhabitants of developing or third world nations where there are growing food shortages.

As China sees approximately 300mn people move from rural to urban areas over the next few years the big concern for their government will be ensuring security of food supply.  Hence the number of Chinese purchases of Australian agricultural interests.

Examples include the Chinese backed consortium proceeding with Ord Stage 2, the Chinese backed purchase of Australia’s largest water consumer, Cubby Station in Qld and numerous purchases of dairy stations.

Despite Australia being a dry place there are actually large tracts of land that receive substantial rainfall such as the Riverland in SA and Vic, the Great Southern and South West in WA, Cape York in FNQ, as well as the North Rivers system that stretches across Qld, NT and WA.

There have always been two main issue for farmers or water users:  what to grow in tropical areas and economies of scale.

Economies of scale basically means a venture being so large and requiring so much capital that it can only be undertaken by large bodies that can absorb up front losses, make the necessary capital investments and wait long enough for the commercial return to be realised.

As Australia is a nation of only 23m people there has never really been economies of scale large enough here to justify the level of investment needed to make some of these projects work.  But the Chinese, with 1.6bn people and cash reserves of US $3tn, probably have the capacity and self-interest to make them work.

A perfect example the impact this emerging market can have on primary industry is WA’s Western Rock Lobster industry.

Prior to the emergence of the Chinese market, the majority of the catch was frozen and exported to Japan and the US and sold in bulk in a lumpy market which created big cash-flow problems for the vendors here.

Now between 95% and 99% is sold into China as fresh crays in many small shipments on cash terms.

Result?  The vendors are now cash rich and no longer need working capital assistance and also have a better idea of the price they are going to receive as there is only about a week between catch and payment.

Food for thought….