Some thoughts on gold prices
secondrepublic
Posts: 2,619 ✭✭✭
Some thoughts after looking at this chart from Kitco:
One question we would all like is the answer to is, are we in a 1974-1975 intermediate peak for gold prices, or is this more like 1980? It's obviously impossible to tell. But my hunch is that we're probably more similar to 1974-75 rather than 1980. First, in the period between 1971, when Nixon closed the gold window, and 1974-75, gold prices appear to have about tripled. That looks similar to the increase (though over a longer time period) between around 2001 and 2008 from $300 to $900 an ounce.
As we all know, after a decline in 1976-77, there was a huge jump in prices around 1980 corresponding to widespread inflation in the economy. No one has any idea of whether that will happen again. Still, it's notable that gold prices after 1980 never returned to the level of the early- to mid-1970s. In the late 80s, a time with less economic stress than what we're seeing today, gold returned to around $500 an ounce. Even using the government's official inflation calculator, that's equivalent to a gold price of $925/ounce today.
Some conclusions: it's pretty safe to say we'll never see $300 gold again, just like we never saw anything approaching $100 gold (the low price in 1976) after the bubble in 1980. I still think in a business-deflationary environment we could see $500 or $600 gold, but there seems to be a lot more upside potential than downside. The forces seem to be in place for more and more government borrowing and spending, which will only debase the currency further. In the long run, as others have said, debts which cannot be repaid will be defaulted upon. Or, in the case of the government, debts will be inflated-out-of.
One question we would all like is the answer to is, are we in a 1974-1975 intermediate peak for gold prices, or is this more like 1980? It's obviously impossible to tell. But my hunch is that we're probably more similar to 1974-75 rather than 1980. First, in the period between 1971, when Nixon closed the gold window, and 1974-75, gold prices appear to have about tripled. That looks similar to the increase (though over a longer time period) between around 2001 and 2008 from $300 to $900 an ounce.
As we all know, after a decline in 1976-77, there was a huge jump in prices around 1980 corresponding to widespread inflation in the economy. No one has any idea of whether that will happen again. Still, it's notable that gold prices after 1980 never returned to the level of the early- to mid-1970s. In the late 80s, a time with less economic stress than what we're seeing today, gold returned to around $500 an ounce. Even using the government's official inflation calculator, that's equivalent to a gold price of $925/ounce today.
Some conclusions: it's pretty safe to say we'll never see $300 gold again, just like we never saw anything approaching $100 gold (the low price in 1976) after the bubble in 1980. I still think in a business-deflationary environment we could see $500 or $600 gold, but there seems to be a lot more upside potential than downside. The forces seem to be in place for more and more government borrowing and spending, which will only debase the currency further. In the long run, as others have said, debts which cannot be repaid will be defaulted upon. Or, in the case of the government, debts will be inflated-out-of.
"Men who had never shown any ability to make or increase fortunes for themselves abounded in brilliant plans for creating and increasing wealth for the country at large." Fiat Money Inflation in France, Andrew Dickson White (1912)
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From that chart we could be in either the 1974 or 1978 time frames but I'd say we're closer to 1977 as we have essentially worked off a large down draft. I've seen arguments for all these choices. But let's also add that we had nothing like today's problems occuring back then, the biggest being how to deleverage (and then counter inflate) $1 QUAD in derivatives. If not for the derivatives we'd have several workable solutions out of this mess.
Let's not forget that Volcker has stated that he should have taken steps to control gold's rise in the 70's. So it's clear that we had no govt intervention of note back then compared to whatever you think we have today (intervention or no intervention). But even Greenspan has admitted before Congress that the ESF certainly has the authority to buy and sell gold as needed for market stability. Trying to compare today's manipulated, shorted and hedged gold market to the "purer" one of the 1970's will make it hard to find time frame parallels.
roadrunner
<< <i>Is secondrupublic making a slow shift towards the yellow side? >>
Actually, as I said in a few recent posts, I'm giving harder thought to PMs and have actually bought a little of the stuff recently. As a strict insurance policy against the risk of a catastrophe, it makes sense to hold some. PMs are one of the few things you can tuck under your arm, go anywhere in the world, and have something that is universally valued, regardless of what governments or currencies do. For all practical purposes, very few of us Americans are diversified in any way out of the US dollar. Unless you own a house abroad or have euros or yen in cash, everything most of us own is either physically located in the US (house) or is tied to the US economy and the dollar (stocks, 401k, bank accounts, etc.). Gold and silver is a little measure of true diversification.
It also seems to me, just as an insurance policy, that PMs maybe aren't all that expensive by historical measures. They are not cheap, but they are also not that expensive considering the incredible systemic risks we face. Even using the government's highly suspect inflation stats, they're no more expensive than they were in the mid- to late-1980s (at which time they were already way lower than at the 1980 peak). As long as you buy a reasonable quantity and can afford it, the downside doesn't seem all that great so long as you're not leveraging yourself.
There's a great op-ed in today's New York Times that touches on some of the same points:
The Buck Stopped Then
By JAMES GRANT
CRITICS of the administration’s Wall Street bailout condemn the waste of taxpayer dollars. But the taxpayers aren’t the weightiest American financial constituency, even in this election year. The dollar is the world’s currency. And it is on the world’s opinion of the dollar that the Treasury’s plan ultimately hangs.
It hangs by a thread, if Monday’s steep drop of the greenback against the euro is any indication. We Americans, constitutionally inattentive to developments in the foreign exchange markets, should be grateful for what we have. That a piece of paper of no intrinsic value should pass for good money the world over is nothing less than a secular miracle. We pay our bills with it. And our creditors not only accept it, they also obligingly invest it in American securities, including our slightly shop-soiled mortgage-backed securities. Every year but one since 1982, this country has consumed much more than it has produced, and it has managed to discharge its debts with the money that it alone can lawfully print.
No other nation ever had it quite so good. Before the dollar, the pound sterling was the pre-eminent monetary brand. But when Britannia ruled the waves, the pound was backed by gold. You could exchange pound notes for gold coin, and vice versa, at the fixed statutory rate.
Today’s dollar, in contrast, is faith-based. Since 1971, nothing has stood behind it except the world’s good opinion of the United States. And now, watching the largest American financial institutions quake, and the administration fly from one emergency stopgap to the next, the world is changing its mind.
“Not since the Great Depression,” news reports keep repeating, has America’s banking machinery been quite so jammed up. The comparison is hardly flattering to this generation of financiers. From 1929 to 1933, the American economy shrank by 46 percent. The wonder is that any bank, any corporate borrower, any mortgagor could have remained solvent, not that so many defaulted. There is not the faintest shadow of that kind of hardship today. Even on the question of whether the nation has entered a recession, the cyclical jury is still out. Yet Wall Street shudders.
The remote cause of its troubles is the paper dollar itself — the dollar and the growth in the immense piles of debt it has facilitated. The age of paper money brought with it an increasingly uninhibited style of doing business.
The dollar emerged at the center of the monetary system that took its name from the 1944 convention in Bretton Woods, N.H. The American currency alone was made exchangeable into gold. The other currencies, when they got their peacetime legs back under them, were made exchangeable into the dollar.
All was well for a time — indeed, for one of the most prosperous times in modern history. Under the system of fixed exchange rates and a gold-anchored dollar, world trade boomed (albeit from a low, war-ravaged base). Employment was strong and inflation dormant. The early 1960s were a kind of macroeconomic heaven on earth.
However, by the middle of that decade it had come to the attention of America’s creditors that this country, fighting the war in Vietnam, was emitting a worryingly high volume of dollars into the world’s payment channels. Foreign central banks, nervously eyeing the ratio of dollars outstanding to gold in the Treasury’s vaults, began prudently exchanging greenbacks for bullion at the posted rate of $35 per ounce. In 1965, William McChesney Martin, chairman of the Federal Reserve, sought to reassure the quavering dollar holders. He lectured the House Banking Committee on the importance of maintaining the dollar’s credibility “down to the last bar of gold, if that be necessary.”
Necessary, it might have been, but expedient, it was not, and the Nixon administration, on Aug. 15, 1971, decreed that the dollar would henceforth be convertible into nothing except small change. The age of the pure paper dollar was fairly launched.
In the absence of a golden anchor, the United States produced as many dollars as the world cared to absorb. And the world’s appetite was prodigious. “Balance of payments” crises were now, for this country, things of the past. “Liquidity,” that bubbly speculative elixir, gurgled from the founts of the world’s central banks.
It was the very lack of gold-standard inhibition that permitted the buildup of titanic dollar balances overseas. At the end of 2007, no less than $9.4 trillion in dollar-denominated securities were sitting in the vaults of foreign investors. Not a few of these trillions were the property of Asian central banks. So, although the United States has run heavy and persistent current account deficits — $6.7 trillion in total since 1982 — they have been “deficits without tears,” to quote the French economist Jacques Rueff. The dollars American debtors sent abroad America’s creditors sent right back in the shape of investments in American stocks, bonds and factories.
Under the Bretton Woods system, worried foreign creditors would long ago have cleaned out Fort Knox. But, conveniently, the dollar is uncollateralized and unconvertible. America’s overseas creditors hold it for many reasons. Some — notably Asian central banks — acquire dollars simply to help make their exports grow. But even the governments that scoop up dollars for no better reason than to manipulate their own currency’s value presumably put some store in the integrity of American finance.
As never before, that trust is being put to the test. In the best of times, the Treasury and the Federal Reserve pretended as if the dollar were America’s currency alone. Now, in some of the worst of times, Washington is treating its vital overseas dollar constituency as if it weren’t even there.
Which failing financial institution will the administration pluck from the flames of crisis? Which will it let roast? Which market, or investment technique, will the regulators bless? Which — in a capricious change of the rules — will it condemn or outlaw? Just how shall the Treasury secretary spend the $700 billion he’s begging for? Viewed from Wall Street, the administration’s recent actions appear erratic enough. Seen from the perch of a foreign investor, they must look very much like “political risk,” a phrase we Americans usually associate with so-called emerging markets, not with our own very developed one.
Where all this might end, nobody can say. But it is unlikely that either the dollar, or the post-Bretton Woods system of which it is the beating heart, will emerge whole. It behooves Barack Obama and John McCain to do a little monetary planning. In the absence of faith, what stands behind a faith-based currency?
James Grant, the editor of Grant’s Interest Rate Observer, is the author of the forthcoming “Mr. Market Miscalculates: The Bubble Years and Beyond.”
Link to article.
<< <i>It also seems to me, just as an insurance policy, that PMs maybe aren't all that expensive by historical measures. They are not cheap, but they are also not that expensive considering the incredible systemic risks we face. >>
Ahh, nice to read that.
No, they aren't expensive at all and you've stated an excellent reason for arriving at that conclusion.
Actually, just a few years ago they were downright cheap.
Silver was too good to turn down and over the years it's been very, very good to me.
Several years ago, I sold out and then bought back in at around 55% of what I sold for.
Added to the hoard and pocketed a nice chunk of change in the process.
Of course there was no seeming shortage of investment silver at that time.
I think we are somewhere between '77 and '78 on the chart, but that doesn't mean the bull run will end in 2-3 years.
John Marnard Keynes, The Economic Consequences of the Peace, 1920, page 235ff
Using a base-line for gold in the 1979-1982 period of say $500/oz would net you over $1330 gold today, just to cover CPI stated effects....not necessarily reality. We all know the tweaks made to CPI over the past 25 years that make it quite different from it's 1980 version. Considering that gold is at $900 or so today vs a 1980 CPI-adjusted $1330 gives ample room for growth. More than likely the 4X figure linked to other comparable goods/commodities which leads one to $2,000/oz.
As secondrepublic has said, with all the obstacles in front of us, it's not unlikely that our financial system will undergo further stress to boost precious metal's prices. If we linked all $1.1 QUAD in derivatives to all the gold in the world, we'd need gold at $250,000/oz to cover it (assuming that all 150,000 tonnes of gold ever existing above ground were available to be used).
roadrunner
If those things don't come to pass in the coming years, and PM prices drop, that doesn't mean it was stupid to buy PMs even at these prices. Just like it wasn't dumb to buy homeowners insurance last year, even though your home didn't burn down, or the same with any other kind of insurance in a time period where you pay more in premiums than you get back from the insurer (which is most of the time). You buy insurance to cover risks, not to cover certainties. We have no way of knowing what really lies ahead with the economy, but there is certainly a lot of risk, and PMs can pretty effectively hedge or insure against at least some types of that risk.