Thursday, April 9, 2009

Long-term gold assessment: still going up

Here's another good update on gold. I think this author is reasoning about the situation from the correct point of view. When the "masses" become acutely aware of the dollar devaluation, interest in owning gold or silver will increase. Once this happens, gold should spike. No one can predict when this will happen, of course, but sooner or later it has to happen, it's inevitable. All the bailouts, all the "quantitative easing" and so on has to ultimately work itself out sooner or later as massive currency devaluation and, when that shows up at the gas pump and grocery store shelves, people will become aware of price inflation and seeking shelter in gold or silver will become more widespread than it is.

One worry could be that the market has already priced this fact in, but I don't think it has for two reasons. First, the price of gold was artificially low during the 90's given the amount of inflation that was occurring. A good deal of the rise in the price of gold since 2005 can be accounted for just in this fact alone. Second, no one knows when prices will spike, so it's impossible to buy/sell futures on this expectation. NYMEX shows gold futures clear out to December at just $886. But it's easy to reconcile low futures prices with the expectation the price will certainly rise: if you predict the gold price will spike 6 months from now (and buy gold futures accordingly), it might spike 6 months and one week from now and you'll have lost money in the meantime. So, gold futures can't reflect this kind of expectation, I don't think futures are of any use in predicting a future spike.

Anyway, while it's scary to say, when gold has already risen more than 200% in just 4 years, "buy gold, it's going higher" (i.e. could this be just another bubble?) it seems that in the face of the largest and fastest increase in the global fiat money supply in the history of the world, buying gold of course makes sense. Even before all this new money was created (back in Fall '08), gold should have been closer to $500 if you follow a "quantity theory of money" for calculating the gold price. Let's take 1990 as a reference point (no major depressions or booms were occurring then, as I understand). The gold price was about $250/oz. back in 1990 when there were roughly $1.8T in existence. By 2004, the gold price had only risen to $400 but there were $4T in existence then - more than twice as many as in 1990 - meaning gold was $100 less than it "should" have been just by virtue of the quantity of dollars in existence.

Today, the gold price is not merely a function of the volume of dollars in existence, it is a function of many factors, but especially uncertainty about currency and banking stability. As the author of the above article notes, what will drive the gold price extremely high is when the "masses" become aware of the currency devaluation, but this won't happen until they see the devaluation in the rising prices of everyday goods and services. Then, owning gold or silver should attract a broader audience and the commodity money metals should become extremely expensive. For the time being, it's a relatively limited number of people in the US who have interest in owning gold or silver. So, this latest deflation to the contrary, I think there is good reason to believe that gold prices will ultimately rise.

What I don't understand - and would like to understand - is why people keep selling gold despite this. What is the reason for these price declines? One explanation could be the stock market. It appears that since mid-February gold prices have been trending down while stock prices have been trending up since early March. This could indicate that day-traders who were scared into gold late last year are moving some of their money back out of gold to take advantage of an anticipated "bear-market rally." But I'm not sure.

My reference information for the money supply is here, and for the gold price is here.

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