Huachu Securities: Gold "Rhapsody" - Price Analysis of Gold in Five Extreme Scenarios

Huachuang Securities released a research report stating that currently, the old global order is gradually fading away, and the establishment of a new order still faces many challenges. Similar to the previous two rounds, the world is currently in a period of order restructuring. The firm believes that there may be opportunities for gold over a ten-year timeframe. Based on current clues, the firm has engaged in extreme imagination, assuming five extreme scenarios and deducing some basic facts and potential price elasticities of gold. The key is not in the quantitative results (measurement is the art of expression), but in discovering that with open thinking, in a true state of "turmoil", the upside potential for gold is likely to exceed imagination. The price of gold implies a discount for "black swans", and studying extreme scenarios can calibrate investors' cognitive biases towards tail risks. The firm reiterates that the global centennial upheaval, the unpredictable era of turmoil, and the low visibility of the global order reconstruction path all suggest that in the medium term (5-10 years), strategic attention should be paid to the upward momentum of gold. Once the visibility of global order reconstruction becomes clear, the sovereign fiat currencies of the new order may quickly step onto the shoulders of gold and move towards the center stage. Huachuang Securities' main points are as follows: Extreme Scenario 1: Reserve Accumulation in Emerging Markets The dominance of the U.S. dollar in the global monetary system is showing cracks: firstly, there are concerns about the sustainability of U.S. debt among emerging markets worldwide; secondly, the Russia-Ukraine conflict has catalyzed fears in emerging markets about frozen U.S. assets. Currently, there are signs of systemic restructuring of foreign exchange reserve patterns in global emerging markets: in 2024, China's gold purchases reached 44 tons, accounting for 13.2% of global central bank demand; the share of gold reserves in India's central bank has also rapidly increased, from 8.09% to 11.35% in just two years; in 2024, the central bank that purchased the most gold globally was the Polish Central Bank (90 tons). The proportion of gold in the reserve assets of major emerging markets is 8.9%, much lower than the average level of developed markets at 26.9%. Considering that the average global gold production in the past 5 years is around 3600 tons, if emerging markets were to increase the proportion of gold in their reserve assets to the same level as developed markets, gold demand would increase by 15,000 tons, meaning that the adjustment of foreign exchange reserves in developing countries would consume about 4-5 years of gold production. If this process gradually takes place over the next ten years, the incremental demand each year would be around 40%. Extreme Scenario 2: Cryptocurrency Collapse Bitcoin may face a crisis due to quantum computing revolution and policy changes leading to a "house of cards" situation. On one hand, the countdown to the quantum revolution is causing the technological foundation of Bitcoin to become shaky. Google's Willow quantum chip released in 2024 can perform operations with 105 quantum bits, increasing the possibility of quantum computing breaching Bitcoin's security. On the other hand, Bitcoin may also be affected by policy changes, such as the liquidity impact of Trump issuing a personal digital currency. In summary, if there is a breakthrough in quantum computing or a significant policy change, it could significantly impact the value foundation of Bitcoin. Bitcoin has a market value of $1.7 trillion, while the market value of gold is $19.6 trillion, making the market value of gold roughly ten times that of Bitcoin. Looking at Bitcoin's history, when Bitcoin prices plummeted at the end of 2017, a small amount of safe-haven funds flowed into gold assets, causing the price of gold to exceed $1270 per ounce. Assuming that the Bitcoin market drops by 20% in just 5 days due to systemic risks, with all Bitcoin funds flowing into the gold market during that time, it would be equivalent to purchasing $380 billion worth of gold each day. However, the daily trading volume of gold is around $250 billion, which would deplete all liquidity in the gold market. Extreme Scenario 3: Change of Reserve Currency The dominance of the U.S. dollar as the global reserve currency may face structural erosion. As of the fiscal year 2024, the U.S. public held $28.2 trillion in national debt; net interest payments on U.S. debt reached $881 billion, exceeding defense spending. This unsustainable debt path has led central banks worldwide to be concerned about the credit of the U.S. dollar. While the U.S. dollar index remains strong in the short term, the proportion of the U.S. dollar in the foreign exchange reserves of central banks and governments is gradually decreasing, accompanied by an increase in "non-traditional reserve currencies" such as the Chinese yuan. Considering the evolution of the global reserve currency weight of the British pound, between 1899 and 1930, the pound's share of international reserves decreased from 64% to 30%. Assuming that the weight of the U.S. dollar reserve decreases from the current 55% to 30% over ten years, and given the 0.8 percentage point decrease in the weight of the U.S. dollar reserve over the past two years, a total of 1000 tons of gold were purchased by global central banks in that period. By linear inference, if the weight of the U.S. dollar reserve dropped to 30% over ten years, global central bank demand for gold could increase by 30,000 tons, which would consume 8-9 years of gold mine production. The incremental demand each year would be approximately 85%. Extreme Scenario 4: Escalation of Geopolitical Conflicts Assuming that geopolitical conflicts escalate into a global military confrontation, gold as the ultimate safe-haven asset will undergo a revaluation of value. If a military crisis intensifies, panic buying will drive up the price of gold: on one hand, the collapse of the currency credit of warring countries will create a wave of private hoarding of gold, while on the other hand, the vicious inflation caused by the military-industrial complex will force residents to seek physical assets for value preservation. The Russia-Ukraine conflict has shown signs of gold soaring after the escalation of geopolitical conflicts: in March 2022, gold purchases by the Russian population surged by 234% year-on-year, and during the escalation of conflicts, the supply-demand gap for gold will further widen, making gold a natural winner in a hot war. In the event of global military confrontation due to escalated geopolitical conflicts, assuming global debt increases by 10% annually and new debt is monetized, it would mean that a total of $91.5 trillion in new currency would be issued globally over a period of ten years. Considering that credit currency would partially fail in the scenario of conflict escalation, if the new monetized debt is ultimately paid off in gold, it would mean that the $91.5 trillion in new debt could be supported by the current supply of 21,000 tons of gold, which is equivalent to each ounce of gold supporting $14,000 of debt. Extreme Scenario 5: Return to the Gold Standard The reconstruction of currency anchor mechanisms is the core drive for the rise in gold prices. The gold standard requires that the currency issuance be linked to gold reserves, which would directly limit the ability of central banks around the world to overissue currency. Although global trade currently relies mainly on credit currencies.However, some countries have already begun to explore or practice gold settlements in specific scenarios, mainly focusing on economies facing financial sanctions or promoting de-dollarization. For example, Russia partially uses gold settlements in energy trade due to being excluded from the SWIFT system; and Iran completes international trade through gold and barter trade due to long-term financial blockade from the United States.The total debt of the world's major developed economies and emerging economies, as well as broad money, is 57 and 102 trillion US dollars respectively. If the major countries in the world were to monetize their debt, it would mean a return to the gold standard era, with a total of 159 trillion US dollars in currency would be supported by the current 21 thousand tons of gold, equivalent to each ounce of gold supporting 2.4 thousand US dollars in currency. Risk warning: 1. Constraints of extreme scenarios probability. 2. Mechanism limitations of quantitative models. 3. Constraints of limited historical samples.