What history teaches us about gold in economic crises

Deflation as well as inflation can cause conditions in which gold is an attractive acquisition.

What we can learn from history is becoming important now that we are in unprecedented times of zero interest rates — and with the Federal Reserve signalling this could ensue until 2024.

The inflation case is clear: gold, rather than paper money, maintains its value.

But, anyway, let’s daydream for just a few moments about a world where gold is the one trusted store of wealth (as it was during the Great Depression).

Huge dividends from gold miners during the Great Depression

Gold’s role in deflation was amply demonstrated by Homestake Mining in the US which saw its shares rise each year between 1929 and 1935 and so, too, its dividends to shareholders.

During the six years of the Great Depression, Homestake Mining paid out US$128 per share in dividends. If you bought Homestake Mining shares from your Wall Street broker in October 1929 they cost US$80, but by 1935 Homestake stock was worth US$495 per share.

But there was also another big story of the time that should resonate and bring comfort to the gold sector — the formation in March 1933 of what would become one of the giants of Australian mining, Western Mining Corporation.

Remember: this was possibly the worst year of the slump, the Dow Jones by the end of 1932 having lost 82% of its worth since the 1929 crash.

The depression, and the increased value of gold, had an extraordinary effect on the industry in Australia.

According to the 1935 Australian Year Book, the value of the gold yield in the country in 1929 was the lowest recorded since the discovery of the metal in 1851.

There was a slight increase in production in 1930 as gold prospecting started to pick up and operators looked to start working over old mining areas.

But then the price of gold paid to miners started to get a move on.

London-based Wiluna Gold Corp (mining in Australia) in 1934 paid a dividend equivalent to 22.5% of the face value of its £1 shares.

Gold continues rising despite increased production

What you have to remember is that, in parallel with this substantial increase in the gold price, prices of almost everything else – labour, fuel, food, etc – were actually falling (that is, deflation), which must have significantly improved margins for the mining companies.

But what is significant is that the gold price kept rising during the slump in the face of not only increasing mine production but the sudden surge in scrap supplies.

Gold recycled from jewellery and other items soared as owners needed money.

In the year to September 1932, British India exported the equivalent of 11.5 million ounces salvaged from fabricated items.

Germany was another big source of gold from scrap.

In other words, the world in the 1930s just could not get enough gold.

Behaviour of gold under inflation

Long before people began to think about, and worry about, deflation as the 2008 global financial crisis hit.

In 1996 a hedge fund consultant named Sam Hewitt wrote a paper, The Behaviour of Gold Under Inflation, showing that, in every instance of deflation since President Andrew Jackson, Americans had preferred gold to paper money.

He studied the deflationary periods following the panics of 1837 (after land speculation), 1857 (post-railway construction), 1869 (Civil War finance), 1873 (railway construction), 1893 (Free Silver Movement), 1920 (post-Great War commodity boom), 1929 (the stock market collapse) and 1931 (the panic as the Great War debt imploded due to the worldwide depression).

Of the historic deflationary episodes he reviewed, currency hoarding was a common feature as individuals focused on capital preservation — think, in present days, about the disappearance of Australian $100 notes into deposit boxes and safes.

But they always preferred gold to paper money because gold did not represent the liability of any institution, and therefore was (is) unique among currency alternatives.

In 1932, when severe deflation was kicking in, people not only hoarded gold – they wanted to dig more out of the ground.

“Never before has the world been so thoroughly grubbed for gold,” reported Time magazine on 12 December 1932.

Old time prospectors swarmed to abandoned goldfields and minor gold rushes were reported to be happening in Australia, South Africa, Chile, the Philippines and Venezuela. (In the early ‘30s, the South Australian Government provided transport to get prospectors to the Tarcoola area.)

In February 1933, The Wall Street Journal reported the world mine production in 1932 had reached a new record of 23.9Moz – up 7.8% on 1931 output, and valued at $494.2 million.

Not only that, India had unlocked much of its gold reserves to meet global demand for the metal; it was estimated that British India between 1873 and 1931 had accumulated gold worth as much as £600 million (about £40 billion now).

By the end of 1933, the Los Angeles Times was reporting that California had embarked upon a new era of gold mining, and there were more than 800 mines operating in the state with around 12,000 men prospecting in the mountainous areas.

This was in spite of the US Government banning private ownership of the metal. (President Roosevelt’s Executive Order 6102 forced Americans to hand over their gold to the government and made the possession of monetary gold by any individual, partnership, association or corporation a criminal offence.)

In 1932, not only had the world produced more gold than ever before, the central bank holdings rose to their highest level ever.

By the 1 January 1933, the US and France between them held 61.5% of the world’s gold stocks and European central banks were keen to retrieve their bullion stored with those two countries. In the first quarter of 1932, Washington repatriated 23.3% of gold under its care.

Austria passed an emergency law forbidding gold being taken out of the country.

The government even prohibited dental supply houses buying the metal (dentists were being used by investors and speculators as a front to buy the metal legally).

Italy launched a “battle of gold” to encourage people to turn over their metal in return for paper money.

I’ll leave you to detect any parallels or portents for today’s situation.