Paul Goncharoff

Paul Goncharoff

Russia and China’s Gold Age?

February in Moscow is like a sweet & sour dish, one day frigid and snowy and the next balmy and rainy, either way it is a treat that keeps surprising. One good thing about Russian winters is that you get a chance to sit down and talk with people in depth and at length in the toasty indoors. As an executive, this is invaluable as it can indicate trends and potential changes before they might occur. One rule of thumb to keep in mind is that if you hear a similar story from three of more people who don’t know each other, even if it sounds bizarre don’t discard it out of hand – chances are there is some truth to it and is worth a review.

What has been making the rounds these days inside the city is the likelihood that Russia’s Finance Ministry is seriously considering making physical gold more accessible for individuals and companies by eliminating the current 20% VAT charge on purchases. It looks likely that this is in the cards in real time.

Imagine if the global spot price for a one-ounce gold mini ingot is $1300, the VAT surcharge of $260 makes the real cost of buying it $1560. Not a positive incentive by any measure. In fact, those individuals who can, have historically salted away their physical gold holdings outside of Russia, usually priced in dollars for that very reason.

Today Russians invest in gold either by trading through the MOEX (Moscow Exchange) futures contracts, or most individuals do so by using bank supported retail metals accounts. These retail accounts are known as Unallocated bullion accounts (UBA) and are accounts reflecting the customer’s precious metal in grams without specifying the individual details (number of bars, rate, manufacturer, serial number, etc.). The holder of the account receives income from the growth in the value of precious metals in roubles. It is not physical gold ownership, it is securing the value of your roubles by linking it to the market value of the precious metal. There are some benefits to these UBA’s which are:

  1. earning income, or preserving wealth linked to the value of gold or other precious metals;
  2. instant purchase/sale of metal;
  3. no VAT on the purchase and sale of gold in such unallocated form;
  4. The possibility to convert and obtain gold in physical bullion form (today 20% VAT is then imposed).

 The Russian Finance Ministry’s initiative would give Russian savers a very real reason to invest in physical gold, and disinvest in default dollars or other foreign fiat currencies. Removing the heavy VAT charge would also be a gold volume trigger as that tax has literally stalled physical purchases of gold ingots by private individuals inside Russia to less than 3 tons per year. Professionals in the precious metals markets here expect that without this onerous tax, actual gold purchases and holdings inside the country will quickly reach between 75 to 100 tons or more annually, even in the first year.

This would also play a small role in further de-dollarizing the Russian economy and attracting some funds back into Russia for rouble priced physical gold accounts. It is viewed as strong stable insurance against the current and expected currency related trade volatility. One only has to look at the price of gold over time in the many sovereign currencies of the planet, especially the rouble, to appreciate how well it has served to secure value especially against the U.S. dollar.

Whatever one thinks about gold as an investment or wealth insurance vehicle, there are objective reasons why central banks have been buying up gold at a rate not seen since the end of the Bretton Woods agreement in the early 1970’s. See this as a response to geopolitics, the politics of trade and the strong dollar making gold yet again the premiere risk-managing asset. A number of events have led the financial world back to appreciating anew gold as a monetary instrument. They include geopolitical risk, concerns about government debt, supply issues, and the perception that gold gives a longer-term independent security over other assets.

The U.S. Dollar, which has and does dominate the financial world, is increasingly suspect with its inviolability increasingly questioned. Add to this the record levels of dollarized government debt in the US, which makes other potential risk-free assets such as T-bills and similar fiat paper look less than wholesome.

Gold looks quite attractive when one considers dollarised world debt, which as of this writing is close to a record $244 trillion, which is greater than three times the size of the global economy, according to the Institute of International Finance. The global debt-to-GDP ratio exceeded 318% in the third quarter of 2018. Something is likely to give way eventually, and probably not to the benefit of fiat currencies.

It is not only Russia and its central bank that has been accumulating gold at a record pace; China has also joined a global central bank gold rush in the last two months by increasing its official gold reserves. According to the World Gold Council, the amount of gold bought by central banks in 2018 reached the highest annual volume on record since 1971, the year that U.S. President Nixon scrapped the dollar’s peg to bullion, effectively ending the Bretton Woods era.

Looking at the U.S., and the dollar, last month, the Congressional Budget Office warned that it sees U.S. debt growing by $12 trillion between 2020 and 2029 due to more government spending and weaker economic growth. That is on top of today’s national debt that has broached the $22 trillion level – the highest in recorded history.

Russia may very well be the canary in the coalmine, especially as general investors worldwide increasingly view gold assets as a necessity. This in view of the steadily growing debt eroding the value of dollarized assets and related fiat currencies.

Now this systemic problem does not look like it will be positively resolved politically, hence little leadership economically. The more likely scenario over time is higher inflation through further ‘QE’ (despite the current Fed efforts at continued QT), which is more politically palatable, but is a sure path to weakened, even debased currencies. The outsider, in this case gold, remains as ever throughout history a secure and independent store of value.

There are quite a few Russians whom I have spoken with who can hardly wait until the VAT surcharge on gold buying is removed. It will not replace the “almighty” dollar or Euro, but it will afford a level of wealth security long sought after among individual Russians, and play a role in stemming the outflow of capital from the country.