Is gold going to $6,300? Dylan Grice, an analyst with Societe Generale, says it’s possible, given the decline in central bank credibility. But investors need to keep one thing in mind: Gold is merely a vehicle to protect the purchasing power of money.
Gold is surging because investors see that the Federal Reserve — more concerned with deflation and unemployment than sound money — may be trapped in a never-ending cycle of monetary accommodation.
Ben Bernanke says he won’t monetize debt, but he already has. His Fed has bought $300 billion of Treasuries and is on pace to buy $1.45 trillion of government-backed mortgage debt all of which is being salted away indefinitely on the Fed’s balance sheet.
Why indefinitely? Because the Fed has no intention of unwinding its balance sheet so long as the economy is stressed. Witness comments this week from Bernanke, Fed Vice Chairman Don Kohn and San Francisco Fed President Janet Yellen all suggesting that the Fed’s “extended period” of low interest rates can be measured in years, not months. Today St. Louis Fed President James Bullard said rates aren’t going up till 2012.
So long as deficit spending continues, if the Fed wants to avoid deflation, it will be forced to monetize more debt.
Elsewhere, capital controls are being erected in emerging economies like Brazil, Taiwan, and possibly Indonesia in order to keep speculative waters at bay. As Hong Kong’s chief executive remarked last week, a dollar carry trade spawned by low rates threatens to inflate dangerous asset bubbles in emerging markets the same way low Japanese rates did in the ’90s.
Exploding debt throughout the developed world means other central banks face similar pressure.
(Click chart to enlarge in new window, reprinted with permission)
So confidence in paper currencies is waning.
Some people say it is absurd to buy gold; the metal has no intrinsic value. That may be. But is it any less absurd to hold paper? The best that can be said for paper is that if you lend or invest it, tomorrow someone will give you more paper in return. This is fine so long as its purchasing power is maintained. But it isn’t. A 2009 dollar is worth a 1914 nickel.
Eventually the value of all the paper you’ve accumulated goes to zero. The trick is to turn that paper into tangible assets with tangible value.
Gold may be volatile, but at least it maintains its real value:
(click chart to enlarge in new window, reprinted with permission)
Grice contends that the price of gold could reach $6,300 an ounce. He explains: “The U.S. owns nearly 263 million troy ounces of gold (the world’s biggest holder) while the Fed’s monetary base is $1.7 trillion. So the price of gold at which the U.S. dollar would be fully gold-backed is currently around $6,300. Gold is very cheap — at current prices, the USD is only 15 percent gold-backed.”
Absurd you say? It happened 30 years ago. President Nixon ended the Bretton Woods global monetary system and his compliant Fed Chairman Arthur Burns let inflation run wild. So by 1980 gold spiked to a level at which the dollar was “overbacked” according to Grice.
Did gold overshoot in 1980? Sure, but only because Paul Volcker was willing to hammer the economy to re-establish the Fed’s credibility. Today’s Fed has been very clear that it isn’t willing to put up with a recession of any kind in the service of sound money.
All of that said, investors should be careful. Grice’s chart shows that, over the long run, gold is likely to do no better than protect your purchasing power. An ounce of gold today buys a good men’s suit; in 100 years, it is likely to buy the same.
So gold won’t make you rich. But it may protect you from becoming poor.
Executive Order 6102, anyone?
If you’re just worried about inflation, there are all sorts of things to put your money in besides gold (TIPS, plain old equities, agricultural commodities, etc.). The prices of these things will rise with inflation, so you get some protection. If you’re worried about defaults you can buy CDS… my point is that there are lots of instruments that you can buy that let you hedge different types of risk, so why is gold spiking?
The only answer I can think of is that, unlike the assets mentioned above, gold is totally free of counterparty risk. If gold is mainly pricing in counterparty risk fears, then isn’t that kind of scary? In other words, gold could be a sort of CDS on the entire system, but without the worry that your counterparty on that contract won’t be able to deliver.
If this is the case, then the question is: what level of systemic risk is it pricing in? Does $1,150/oz still correspond to just a basis point or two of traditional credit risk, or is it a few hundred basis points?
ZeroShrubbery…..I think you have it exactly right. Lots of gold investors aren’t worried about conventional inflation. They’re buying crisis insurance. They literally want to be out of the system….
Gold transactions are easier to make without being taxed, for one.
Gold is a huge bubble and is worthless as a store of value. As noted in a comment I recently read, a shotgun will be a better store of value than any amount of gold if the dollar goes to zero.
Gold is a barbaric relic because it recalls those times men could not trust other men. As folks kept their word, folks started believing in promises, and accepted currency (promise money). In time, financial sociopaths started playing on this confidence, lyin’ and stealin’ by making promises they knew they could not keep. Folks converted those promises to gold as they could. Therefore, the barbaric relic becomes popular when men cannot trust other men. Instead of currency (promise money) we’re forced back to barter. Gold and silver are highly-trade-able assets, but it’s still barter. When financial sociopaths are removed and the lyin’ and stealin’ is stopped, physical gold and silver will start being converted back into promises.
So a rush to gold is, then, a rush to the exits. It’s not a conventional investment vehicle–it’s more like a non-investment vehicle, a decision to cash in your chips and get entirely out of the game. No wonder the investing community hates it. Every other asset class is enmeshed in a web of contract and hence has value in the system and to the system. Even real-estate, which has no counterparty risk but which exists in the system as a bundle of rights (mineral, water, development,e tc.), obligations (taxes, upkeep, etc.), and cash-flow (from rent or cultivation), derives most of its investment value and fungibility from this web of contract. Not so gold; once value is converted to gold, it’s essentially private, singular, invisible. It’s like the dark matter (antimatter?) of the market. Barbarous indeed.
If agree with me, Rolfe, then your headline needs to be nuanced. What the Fed is doing with debt monetization is sending /the stock market/ higher (with stock prices and PEs reflecting inflation fears). If the Fed is sending gold higher, it’s because large investors with deep pockets are nervous about the impact of the Fed’s actions on the entire (credit-based) system.
So it’s not as simple as:
1) Fed prints money 2) Gold goes higher on fear of inflation.
It’s more like:
1) Fed prints money 2) Stocks and other assets go higher on fear of inflation 3) Gold goes higher on fears that the asset bubble that the fed is blowing will burst and take down the entire system with it, and no counterparty will be left standing to deliver on any of the contracts that were written as insurance against the mother of all bubbles bursting.
If the market were pricing in a normal crisis, step #3 would look like:
3) Rates go higher on instruments meant to insure against a bubble burst.
Am I wrong?
The gold in FED’s balance sheet is not audited since 1950’s. Plus the gold stored in fort Knox is not pure, it was collected from the american people during great depression and it was in coins, so it was not 99% pure gold, so its value is less than it is estimated.
John,
I believe that your observation is particulary germane here. The Elephant in the room is that a primary source of Gold since the world went off the goldstandard is likely going away. That is central bank supply. If gold mining and scrap were the only source of supply we would have genuine shortage. For those not familiar with the work of the Gold Anti Trust Action Committe (GATA) there seems to me to be evidence that the Fed and other central banks may have been involved in Gold Swaps and possibly leases and that the reported physical gold in the central bank vaults may be significantly less than is in the vaults. Even if GATA’s conclusions were completely wrong, something I very much doubt, the fact remains that demand is increasing even as mining supply is decreasing as are the long term hords of gold that have at one time comprised the national treasure of many nations and their central banks and which for years have made up the supply deficit.
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