Gold Price Action Emphasizes 'Standard' Status
Source: James West, Midas Letter (10/13/09)
It's fascinating how many economists and bankers argue against the re-establishment of gold as an official monetary standard. An analysis of its price performance over time relative to G7 currencies demonstrates that, as a barometer of national currency health, there is nothing more reliable.
Certainly today's test of yet another all time record high is indicative of the weakening U.S. dollar.
Who can honestly say they are surprised by the state of that declining lucre?
Factors driving the flight to quality that is the essence of the hurry into gold is entirely U.S. dollar and U.S. economy driven. We now occupy a period in history where all of the G7 central banks, likely as a result of collusion on ham-fisted economic policy, have sold off vast chunks of the national financial heritage for what will be remembered as a song. It is foreseeable that once this era of willful self-delusion has passed for the citizens of these nations that new economic theories will emerge to replace what is increasingly discredited academically derived practices.
Deficit spending, the cornerstone of the growth economy according to such vaunted figures as Maynard Keynes and Milton Friedman, is only effective on a temporary basis, and as we have witnessed during the last decade, only nurtures major problems developing systemically. Presidents and Prime Ministers have embraced the practice because it gives them the chance to finance prosperity during their oversight by charging to the next administration's credit card.
Just as ocean birds flying inland portend the advent of a great storm, the strengthening of the gold price during the last decade should have provided a clear signal that monetary inflation was rampant, and that is the condition that always precedes price inflation. Chronic monetary inflation is the condition that precedes price hyper-inflation. Major price appreciation in gold is the clearest indicator of monetary inflation. It's really that simple.
ETFs backed by physical are the biggest drivers of the gold price directly, as investors who want exposure to gold without taking actual delivery of it drive demand for such ETFs. The biggest of them all, SPDR Gold Shares owns 1.109 tons of gold worth US$37.5 billion. Their most recent purchases of gold occurred towards the end of June, and so additional buying now could be pushing prices higher.
China, the world's largest producer of gold and the largest sovereign buyer of gold over the last several years is believed to be soaking up gold on a continuous basis, and some traders feel that there is a sense of urgency to now to acquire gold below $1100, as the sentiment is that much higher prices will prevail over the coming years.
A Bubble? Predictably, the opportunistic financial journalist who's motivation is not so much the pursuit of truth so much as the pursuit of any story that will result in a paycheck has raised the ersatz voice of the contrarian, warning stridently that the gold price is the formation of a 'bubble' and one that must needs burst like a dot com or real estate overleveraged sector. Don't listen to the ramblings of such fad journalists, for they clearly miscomprehend the fundamental reasons for gold's price rise. Barring a sudden reconciliation of all the world's debt and derivatives overhangs, printing currency is the only way for most of the G7 to stay solvent during times of economic contraction.
Since the demise of the gold carry trade, where institutions 'leased' gold from central banks at 1% and then invested the proceeds from the sale of leased gold into better performing asset classes, there is no leveraged way to buy gold, except in the futures markets, which increasingly appear to be on shaky ground, as that market's participants are a) too big to compete or play with, as they influence the price excessively and b) many institutions occupy both sides of a derivatives trade, which facilitates the 'roll over' of underwater positions, thus engendering a completely unreliable market performance visibility.
What other factors would be present to suggest the formation of a bubble?
Well, we would be seeing a lot more 'general public' movement into the purchase of retail gold. The biggest investors in gold ETFs remain institutions such as Paulson and Co, who owns 31.5 million shares of SPDR Gold Shares and is the largest holder of the ETF., and J.P. Morgan Chase, the next largest holder with 6.4 million shares. Retail investors are not the biggest component of the ETF market.
The fact that gold mining companies, and more specifically, gold explorers, have not seen the exponential price appreciation, or the 'buy anything in the sector' mentality that characterized the dot com bubble, is further evidence that this is no mere bubble, but the continuation of a broad macro trend that started in 2001 and hasn't stopped. Gold has averaged $87 per year price growth, and has appreciated by 300% since the beginning of its bull market.
I have never seen a 'bubble' last more than a few years, and so that too is a strong indication that this is no bubble.
We are entering the phase when demand for gold is going to become more broad based, and that will be recognized by shortages of coins and small bars as was witnessed when Bear Stearns collapsed at the height of the commodities bubble, which was real estate bubble driven.
And that is not to say that bubbles in the price of gold may form along the way. Profit-taking is going to see a continuation, if not an aggravation of the see-saw volatility that characterizes an effusive bull market. A prolonged period of profit taking, coupled with a general media impression that the U.S. dollar is making some kind of feeble recovery, could set off enough of a temporary disdain for gold that it may appear to be a bubble collapsing, but make no mistake: those are buying opportunities of the highest caliber.