So What's Gold Worth?
Writing from Vancouver, British Columbia, Strategic Investment contributor Ed Bugos estimates the value of gold adjusted for the exploding supply of dollars. He also provides a trader’s perspective on the likelihood of a gold correction.
Gold critics often say that the shiny yellow metal has few industrial uses, compared with, say, silver or copper. That happens to be what we call a half-truth. It’s also beside the point. It is usually lamented by bears refusing to accept the market’s valuation of gold.
The whole truth is that gold has very few industrial uses at current prices. Gold is worth about 55 times silver and more than 3,000 times copper per unit of comparable weight. If it were as cheap as copper, we would have wired our houses with it, as well as the Internet; if it were even cheaper, you’d probably be sitting on it in the bathroom, as that Commie Lenin advocated.
We don’t use gold in more common applications because of its finer qualities: relative scarcity, our vanity, to name just a few. And the bulk of gold’s value is still monetary, a fact that its enemies are loath to admit. Consequently, changes in the price of gold tend to reflect mainly changing monetary factors.
Gold bugs can’t ignore the market’s judgment, either. They must acknowledge that the monetary demand for gold had in fact ebbed during the 1980s and 1990s in favor of the dollar standard – a standard launched by default in the early 1970s.
The waning view of gold as money helps explain why gold didn’t keep up with the CPI through the ’80s and ’90s, despite the three-fold increase in narrow money (M1) and the five-fold increase in broad money (MZM). The bears claim this poor record shows just how bad an inflation hedge it is. But their time horizon is both short and selective. The full record of the Federal Reserve Note (since its 1913 inception) is poor.
I’ll give the bears credit for identifying the drop in the monetary demand for gold as the reason it lagged the CPI in the ’80s and ’90s. But they are hopelessly naïve if they believe that the 35-year-old dollar standard is an evolution in the monetary system, as if it were progress. Gold served as the market’s solution for money for thousands of years.
The government forced the dollar onto the U.S. producer by legal tender and other laws. It forced the dollar onto trading partners by extortion. These partners were already drowning in dollars no longer backed by gold. They had to choose between letting the whole system fall apart and using the new "dollar standard" to their advantage. America had the largest and most developed consumer market in the world at that time, and they all wanted in.
Fast-forward to today: After a couple of decades of experimenting with this system, it is no longer working to anyone’s satisfaction. In order to maintain their trade advantage, America’s trading partners have to inflate at an ever faster pace (than the Fed) and soak up increasing quantities of dollars. This scheme always was untenable, but now it’s falling apart. There’s even talk of the need for a new global reserve currency.
So far, the media spotlight has been on the euro as contender, but the media will see that is untenable too. Gold is really the only alternative to the dollar. But that’s a lesson the gold bull market has yet to teach. Let me know when you can use the euro on the streets of Bombay or in a Wal-Mart in California as easily as you can use the U.S. dollar, or at least when the price of gold stops outperforming the euro. Then I might consider taking it seriously. Meanwhile, we’re likely heading back to where this story left off in 1980.
Before I delve into a rudimentary analysis and probably futile attempt to value gold, let me admit that I don’t know how high it is going to go. No one really does. We’re all just guessing. A bull market in gold basically means that gold’s monetary allure is on the rise. That is, market participants are beginning to prefer it again – either as a hedge against inflation (investment), a measure of monetary value, a means of international settlement, a monetary reference point, or even as a genuine medium. These reasons all constitute what I mean by "monetary demand."
Of course, no such thing as a bull or bear market in gold would exist if gold were already money, because the total demand for money does not fluctuate very much. On the other hand, the total demand for a particular kind of money may. The bull market in gold is a byproduct of the decline of the dollar standard. Not surprisingly, it is outperforming the CPI again.
If the CPI were an accurate measure of changes in the value of money, and the monetary demand for gold were constant, the CPI-adjusted gold price in the first chart above might represent some notion of fair value for gold prices. But the CPI is anything but a reliable measure of change in money values. Chances are it understates this problem.
I have been forecasting "Gold: $2,000-2,650" for many years now. My early forecasts, back in 1999 and 2000, called for a straight-up move to $2,000 per ounce. That forecast overestimated the willingness of investors to grasp the gold story and underestimated their addiction to the prevailing monetary policy, and I scrapped it in 2001 in favor of a more drawn-out affair.
I adopted the view that this bull market would last 10-15 years and include two-three sequences.
We are now on year seven of the current advance – the first primary sequence. There is little doubt in my mind that the dollar standard is on its way out and that the monetary demand for gold will return to the levels of the late ’70s. But the exact prognosis is anyone’s guess.
As a trader, I can tell you that nothing goes straight up. The market tends to change the rules just when most people have become accustomed to a particular set. Hence, every bull market contains surprisingly violent corrections. These corrections convince many latecomers that the bull market has ended.
None of the corrections we’ve seen in gold during the past seven years qualify as this type of correction. The rise in gold prices to this point has been steady and sustainable. For much of its rise, gold has been in a stealth bull market. But the gold price advance is no longer stealth. It’s not as spectacular as oil’s advance or some of the base metals’ advance in 2006, yet. But the chart says it wants to go parabolic.
That’s the good news. The bad news is that such moves bring in weak hands, which set the stage for a big correction. Remember this whether you want to trade the trends or buy and hold.
for The Daily Reckoning
December 13, 2007
Our whirl-wind tour continues… Last night, we arrived in Baltimore, after about 24 hours of travel. A word of travel advice: avoid the American carriers. Their planes seem older…more worn out than, say, Singapore Airlines or Lufthansa – and so do their cabin crews.
The problem with modern travel is that humans were not made for it. During the thousands of generations in which our species evolved, no one ever had to reckon with jet-lag…or airline food…or security checks. All these things are unnatural and should be avoided.
What has happened in the world of money since we got on the plane?
"The Charge of the Central Banks," begins a Bloomberg story. Seems the Fed, the European Central Bank, the Bank of England and the Swiss National Bank got together to announce a program of coordinated inflation. Well, they didn’t call it that. They said they were merely making sure that the markets had credit, by increasing the supply of liquidity.
You see, they’re all caught in a tight spot – between the unstoppable force of inflation and the immoveable object of falling prices. So, into the Valley of Death go the central bankers.
Do you remember the Charge of the Light Brigade, dear reader? The British called Lord Cardigan from his private yacht in the Black Sea. His lordship, being new to the battlefield in the Crimean War, got mixed up…and sent his 600 cavalrymen in the wrong direction – right into the Russian’s guns. "Cannon to the right of them,/ cannon to the left of them,/ cannon in front of them,/ volleyed and thunder’d," says Tennyson, until they were almost all dead. Except for Lord Cardigan himself, who miraculously survived without a scratch and went back to England to be declared a national hero.
Well, here come the central bankers – fresh from their caviar and foie gras – ready to ride into battle. But against what? Inflation? Or deflation? Against the unstoppable force…or the immoveable object?
There’s the problem, isn’t it? They’ve got cannons to the left…and cannons to the right.
For the moment, they regard the artillery of deflation as the greater worry. So Bernanke fired a weak volley in that direction on Tuesday. The markets fired back…saying the Fed wasn’t using enough firepower.
Yesterday, the Dow shot off a few rounds, inconclusively and half-heartedly. And the cannons on the other side opened up again. The CRB, measuring the price of commodities, hit a new high. Oil rose to nearly $95. And gold hit $818.
Still our guess is that the Fed is right. The cannons on the left – the side of deflation – will do the most damage in the near term. The threat of recession is growing. Or maybe we’re already in a recession. How bad will it be? Nouriel Roubini says it will be worse than 2001. We should hope so! That recession was so wimpy it did nothing at all. Consumer spending continued to grow. Nothing was corrected – except the price of tech shares.
This next recession will be worse. Because tech shares affected relatively few people. Now it is the housing market that is going down – and stocks too. A lot more people have houses than had dotcom stock.
It still looks to us as though we were headed for that "Japan-like slump" we were expecting seven years ago. Interest rates will continue to go down – if we’re right. And the U.S. economy will go into an on-again, off-again recession that will last for many years.
And what about the unstoppable force of inflation? We doubt it will stop…not with the central banks all over the world charging in such hell-for-leather fashion. But we will see.
*** The news trails behind us.
From India comes word that the Sensex index has topped 20,000.
We recall the words of our local analyst:
"India is a long-term buy, but maybe not a short-term buy. There is plenty of room for growth. The inflation rate is about 6%. And the economy is growing at 9%. So, you could get 15% growth just by keeping up with everyone else. We tell our investors to expect 20%…because we think we can add another 5% by choosing shares carefully."
American readers might be interested to know – the rupee (INR) is actually stronger than the dollar. So dollar-based investors might pick up a point or two there too.
15%…20%…25% per year? Not bad. Unlike China, India does not depend on U.S. consumers…nor on a banking sector controlled by communists. Both circumstances are bound to cause trouble for China, we believe. And whatever trouble comes to the world economy, India could get through it relatively easily.
We have no news from Australia, which we just left yesterday…but the news from the commodities sector is bullish. And when commodities go up, so do Australia’s profits.
*** Too bad about the gold price. A nice correction – down to, say, $750 – would have given us a welcome opportunity to buy. You know the drill, now, dear reader: sell stocks on rallies, buy gold on dips. Trouble is, we haven’t had much of a dip. Should we wait? Or buy now? We wish we knew. Personally, we’re buying. Not because we think this is the best price we can get, but simply because we have a little money and can’t think of anything better to do with it.
*** A little advice to the Fed:
Stop trying to fight deflation. It’s a losing battle. You’re ‘pushing on a string.’ Instead, fight a battle you can win. Fight inflation!
The Fed could bring a correction on easily…simply by raising rates. Higher lending costs would stifle growth…reduce spending…lower prices…and knock tottering humpty dumpties off the wall. But don’t expect it: there are a lot of humpties; and every one of them has the right to vote in next year’s elections. Not only that, the economics profession has insisted that it can AVOID recessions by adroitly manipulating interest rates and lending standards. If the economy sinks now, Bernanke’s peers are going down to blame him – not only for the recession, but for undermining his colleagues’ pretensions.
But what America – and the world – needs is not a boom, but a correction. So, Feds – wherever you are – listen up: While a central bank clearly has the ability to trigger a recession, it may not have the ability to stop one. Like a hitman, a central banker can always kill a boom; but he can’t necessarily bring his victim back from the dead.
You’re better off pulling the trigger on a boom that needs to die…rather than pretending to heal the poor thing with your voodoo medicine. At least, you’ll look as though you know what you are doing. More tomorrow.
*** We got to Los Angeles this morning and people started yelling at us: Stay behind the yellow line…take laptops out of your bag…throw away any food items, even if they were given to you on the plane… Do this. Do that…. Or you’ll pay a fine…or go to jail.
The regulations are about the same all over the world. But only in America do the security agents yell at travelers as if they were draftees.
The Daily Reckoning