What is Gold Seeing?

|Peter Boettke|

A good friend of mine sent me this graph.  He points out that gold is up 500% over the last decade, the only other thing up that much is debt at all levels.  How would you interpret the graph?

HT: Ed Weick

Comments

[knapp]

The opportunity cost of hoarding gold has steadily declined due to disappointing returns on financial and other real assets.

[Dave Prychitko]

Going from roughly $250 in 1998 to $1000 today is a 300% increase, not 500%.

[Tyler Watts]

4 words: "Flight to real values."

[Vangel]

The average gold price in 1971 was $36. By 1979 the average price had moved to $306 only to explode to $615 by 1980. Clearly the move higher was warranted but the latter stages of the gold market had turned into a bubble that could not be justified by the fundamentals.

The gold bull market was followed by a relentless triple waterfall that took the price down to $271 in 2001. Most of the decline was driven by relentless selling on the part of bullion banks, which were borrowing physical metal from the central banks and selling it in the spot market, and by producer hedging, which was aiding the short sellers by adding future supply to the markets. But once the selling was done, reality set in and investors that were negative on the metal began to worry about the reserve currency status of the USD. Many investors no longer believed that the debt financed, big-government move could end well. They began to hedge by adding bullion to their portfolios as insurance.

At the same time, the internet allowed more investors to improve their educations. The Mises Institute made the fiat currency issues more accessible to ordinary investors and many analysts that could not get on the MSM were given a forum to voice their contrarian views. Many Americans discovered the European financial networks and BNN in Canada provided people like Peter Grandich, John Embry, Eric Sprott, Frank Holmes, Paul van Eeden, the Coffin brothers and others a place to make their arguments in favour of holding hard assets.

The current gold moves are beginning to reflect the sentiment that has been building for the past dozen years. If certain technical barriers are breached and the price takes off, it will signal that the Fed is losing the war and that the days of the USD as a safe haven are over. Sadly, once the rout of the USD finally resumes the market will price in the inability of the US government to meet its obligations and we will see the USD trade at levels that reflect a probability of a partial default.

[Barkley Rosser]

Graph is not quite accurate as it does not quite show that gold has been over $1,000 per ounce twice before right about now (when it is sort of oscillating around 1,000). Looks to me like a period of distress prior to a crash.

Vangel does not get the earlier peak, which was over $800 per ounce in 1979, without doubt a speculative bubble. The price was down to around $300 by the early 1980s, where it stayed for 20 years. This is a bit above the fundamental given by the industrial use price, which still holds, but looks like what is more reasonable in the longer run (maybe somewhat higher now).

The story about "bullion banks" driving the price down is fantasy land stuff. The British and French central banks have been gradually selling their gold off for some time, but at a low rate so an not to "disturb the market." The stuff is not money and does not earn a yield.

Probably the only thing propping the price up now is the rumor that the Chinese have been "buying on dips" since it first hit 1,000 in early 2008. Maybe they will keep it substantially above the fundamental down around 300, but what for? Diversifying out of dollars to the euro and the yen look a lot safer. Gold could crash and crash hard, as it did in 1979.

As it is the huge stocks held by the US, UK, French, and Russian central banks are such that even a mild selloff from any of them would tank the price (they hold about 205 of world gold stocks). Anyone who has thrown all their assets into gold should worry and probably readjust to diversify their portfolios. Much of what is coming out of Auburn on this is just hysteria.

[Angel Martin]

Pete, I have put together both indicators: gold price and federal debt. Here: http://amartinoro.wordpress.com/2009/10/05/deuda-federal-y-el-precio-del-oro/

You can see a couple of remarkable correlation points.

[James Oaksun]

What it's saying? We're about halfway through a prolonged down cycle. By the end I think gold will be much higher; US equities much lower. Double digit inflation implies double digit interest rates... what will be the impact on US equities if "profits" are capitalized at rates several hundred basis points higher than today's?

[Barkley Rosser]

Angel,

Take a close look at your figures. The debt is most definitely soaring at an accelerated rate near the end. What is gold doing? Diddling around going nowhere.

Warning: latest news reports have gas prices going down to $2 per gallon in the near future. May not pan out in the near future (and the stock market may have gotten overly bubbly recently and due for a "downward correction"), but gas and oil are a lot more fundamental than gold, which is a total periphery (except for those who worship it of course). Look at 1979 and think carefully about what drove that bubble up and what killed it for two decades.

[Angel Martin]

Barkley,
You're right that there is no perfect (or even close in some points) correlation between the two graphs. Besides, if you extend the period backwards, the correlations fade off. Although I noticed one thing more: after about 1975 (several years after the end of Bretton Woods) federal debt "begins" to rise notably in the graph (and then skyrockets...). Also, by the same years the gold price starts to go up and reaches 750 about 1980. Well, maybe just a couple of curious "facts".

Putting both graphs together I was just figuring out if there was some kind of relationship between federal debt and the gold price.

[acai]

From my point of view gold is the best investment alternative than any other investment instrument. Its the safest investment in the world.

[Ned Netterville]

Contra BARKLEY ROSSER: Gold, and to a lesser extent silver (because its service as money currently and historically is significantly less important than gold's), are the only MONETARY hedges against the debasement (viz., increases in the supply) of fiat currencies, or at least the only ones of which I am aware. The relationship between the price of gold and the US government's debt reflects a rightly perceived (by market participants) correlation between the nation's level of debt and its monetary authority's predilection for inflating its fiat currency to screw its creditors. There are, of course, many other factors that influence markets for gold and fiat currencies, but the relative size of a nation's debt and its perceived ability to repay its creditors through taxation rather than inflation looms large.

I don't think gold owners need worry about any LONG-TERM, negative impact on the fiat-currency-denominated price of gold as a result of nations with large gold holdings selling their gold stocks, because gold-market participants will rightly interpret such sales as reducing the value of fiat currencies viz-a-viz gold. It is important to remember that most or all fiat currencies were once backed by gold (or by other nations' gold-backed currencies), which was presumed by monetary-market participants to be the primary factor protecting currencies against devaluation. As the gold backing of currencies was reduced, the value of gold in terms of said currencies generally increased, which is to say confidence in the future value of the currencies declined.

It may also be pertinent to remember that for a period of time in the late 1970s the United States Treasury embarked on a program of selling the nation's gold hoard for the express purpose of "eliminating the monetary role of gold" in the world. Throughout a period of monthly Treasury auctions of millions of ounces the price of gold increased relentlessly. After a period of about 15 months (as my worn-out memory recalls), Treasury awoke to the futility and stupidity of its gold-selling escapade and called it off.

Given the current rapid expansion in US debt combined with the monetary authority's evident commitment to assisting Treasury in servicing its debt by screwing its creditors--increasing taxes sufficiently to service the debt being politically and perhaps physically impossible--I think a dollar-denominated gold price of $2000 is more likely to be realized before a price of $900 is seen again. On the other hand, my market prognostications are worth precisely what I charge for them.

[Angel Martin]

Thanks for your brilliant explanation, Ned.

[Krugerrands]

From the graph it is clear Gold price always burst up.so it is good to invest in gold especially gold coins...