"Everything you need to know about gold"
Kelsey Williams We know that inflation is the debasement of money by government. The effects of inflation show up in the form of rising prices over time. The rising prices are a reflection of the loss of purchasing power of the currency involved. For our purposes, that means the U.S. dollar.
The chart below depicts increases in the Consumer Price Index, year-to-year, dating back to 1914…
FEDERAL RESERVE AND MARKET RISK
Analysis and opinions of the financial markets vary depending on who is doing the analyzing. The most critical element that affects the song is the singer.
There is nothing wrong with that. But we should be aware that our own prejudice clouds our perspective. However, there is more that is not so obvious. With that in mind, lets take a look at things.
Today, more than ever before (at least it seems that way), focus is on the Federal Reserve. Even economists and the general public have joined the throngs of interested observers.
Stocks and bonds fell significantly over the past several days, partly in response to statements by Chairman Powell. The Chairman’s remarks indicated the intention of the Fed to continue its push to raise interest rates more aggressively, and without seeming regard to any deleterious effects on the economy and the stock market.
So, we hear criticism that the Fed is guilty of policy error. “The Fed needs to be more accommodative at this time.” Maybe; maybe not.
One of the earliest articles I wrote was “A Loaf Of Bread, A Gallon Of Gas, An Ounce Of Gold”. The information contained in the article is basic to a fundamental and accurate understanding of gold.
The convolution and complication of basic fundamentals reigns supreme in almost all analysis of gold. That is unfortunate, because it obscures the simple truth.
The simple truth is that gold is real money. Even that simple truth, however, deserves some further explanation.
Most technical analysis of gold boils down to “what the charts tell us about gold’s next move”. The next move according to most seers of the trade – is “imminently bullish” and represents one, last chance for investors to save their financial souls.
The problem is that more people have lost more money by ‘investing’ in gold upon the advice of those who proffer it, than will likely ever be made up going forward.”…Kelsey Williams
There are several reasons for that.
It is very difficult to let go of someone – or something – when we have invested so much time and energy in it. It is even harder when we have invested so much of ourselves in it; when the outcome is not what we expected; when our reputation is at stake.
In this particular case, that something is gold and silver.
The emotional proclamations just a few weeks ago seemed quite strong, almost being religious in their fervor. But after two thrusts of the dagger to the heart, the explanations afterwards seem a bit hollow.
GOLD AND US DOLLAR
“Even in the U.S., where the wish for a stable currency is strong, the dollar has fallen a staggering 86% in value since 1965, when I took over management of Berkshire…” — Warren Buffett Feb2012
During that same period (1965 – 2012) the price of gold increased from $35.00 per ounce to more than $1800.00 per ounce – a whopping 5000%.
A wakeup call can seem like quite a jolt when it happens, but, usually, we are grateful for it. And even if we didn’t ask for a wakeup call, it can still prove fortuitous. Maybe this will be the case for some of you when you read this.
If you are a long-term holder of physical gold for the right reason, i.e., ‘gold is real money’, and you understand that gold is not an investment, and you are not currently speculating/trading gold with short-term objectives for higher prices, then this could be a benign event for you.
If, on the other hand, you are an ‘investor’, trader, or speculator with expectations for higher gold prices; if you are a long-term investor who is overcommitted to gold financially and emotionally; if you are still waiting for the impending ‘moonshot’ that will bring you wealth untold; if you would like to spare yourself some unnecessary remorse; then you might want to continue reading.
After recently perusing some gold charts for some historical perspective, I was relatively nonplussed; but continued my search. When what to my wondering eyes should appear…
The above chart is a 5-year history of gold prices (inflation-adjusted) from August 2013 to August 2018. As you can see, it is not a pretty picture.
Below is the same chart without the inflation adjustment…
After looking at both charts, there are a couple of differences that are apparent:
1) the overall result of the price action for the entire period is a loss of slightly more than three hundred dollars per ounce on an inflation-adjusted basis; the second chart’s nominal amount is less than two hundred dollars per ounce
2) a break below $1200.00 per ounce would be a clear violation of the pattern of successively higher lows since December 2015 when viewing the inflation-adjusted chart; the pattern remains intact on the second chart even if gold were to break below $1200.00 and go a bit lower
What is clear on either chart is that gold has broken below a line of support dating back to its price-point low in December 2015. Maybe just as important, the price of gold has been held below a declining line of overhead resistance going back five full years.
How low can gold go? A lot lower than most want to admit. Under reasonably normal conditions, my guess would be $850.00-900.00 per ounce. ($850.00 was the January 1980 high point.)
There is the possibility that it could go lower, too. Or, it might find a floor at $1000.00 per ounce. There are several scenarios but there is only one thing you need to focus on – the U.S. dollar.
If the dollar heads lower and accelerates its long-term decline, then the price of gold will reflect that by moving higher. If, on the other hand, the dollar continues to stabilize and strengthen, then gold’s price will reflect that by continuing to move lower.
It IS that simple. (also see The Case For Gold Is Not About Price)
Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED!
GOLD AND USD/CNY
My last article, Gold And The Elusive Chase For Profits/The Case For Gold Is Not About Price, generated the following anonymous comment:
“Gold is now pegged to CNY not USD.”
I responded as follows…
The United States is currently the number one stockpiler of gold in the world with a total of 8,134 tons as of the second quarter of 2018. Since former President Richard Nixon took the U.S. Dollar off the gold standard in August of 1971, stockpiles of gold have grown, while historically, the dollar’s value has generally decreased.
The Federal Reserve has helped cause this erosion in value through less than stellar fiscal policies. One of these is the cancellation of international convertibility of the U.S. Dollar into gold.
Between the years 1971 and 2011, the price of gold went from $42.00 per ounce to $1900.00 per ounce – a forty-five fold increase. This is depicted on the chart below…
Looking at the chart, it would appear that gold is in a long-term bull market and that continually higher prices over time can be expected. Proponents of this approach to gold cite fundamentals such as a weakening U.S. dollar, social unrest, wars (combat and trade), political instability, etc.
And the numbers seem to bear this out. For the forty-year period between August 1971 and August 2011, the price of gold was up forty-four hundred percent.
But are we really making any money? The chart below paints a clearer picture…
The inflation-adjusted chart immediately above seems to support a severely modified view of gold from that which we mentioned earlier. Rather than long-term, ever-higher, onward and upward, we see strictly defined periods of extreme volatility. Indeed, it appears almost cyclical.
And our previous total return of 4,400 percent for the forty-year period August 1971 to August 2011, is reduced to 900 percent. Even so, that is the equivalent of a 6% average annual return, net of inflation. Which is huge.
(In case you are interested, the average annual return for the S&P 500 – with dividends reinvested – for the same exact time period, is 5.13 percent. That relatively small differential on an annual basis is magnified considerably when you compare cumulative total returns: Gold at 900% vs. S&P 500 at 639%)
So, does the nine hundred percent total return/6% annual return represent a profit? Yes, most definitely. Net of the effects of inflation, the price of gold increased ten-fold; all of which represents added value. Here’s why…
In 1971, the cost for one loaf of bread was $.24. The average cost for one gallon of gasoline was $.36. With gold at $42.00 per ounce, you could purchase one hundred seventy-five loaves of bread or one hundred seventeen gallons of gasoline (or some combination of the two).
Forty years later, in 2011, the average cost for one loaf of bread was $2.42; and one gallon of gasoline was priced at $3.52. Hence, again, using only one ounce of gold (this time priced at $1900.00 per ounce) you could purchase seven hundred eighty-five loaves of bread or five hundred thirty-nine gallons of gasoline.
The additional six hundred ten (785-175) loaves of bread or four hundred twenty-two (539-117) gallons of gasoline represent an increase in real value/purchasing power for gold for the years between 1971 and 2011.
All of this sounds good. But there are some other issues. Looking again at the first chart, we can see that the price of gold increased from $850.00 per ounce at its 1980 high point to $1900.00 per ounce at its 2011 high point. This translates to a gain of $1050.00 ($1900.00 – $850.00) per ounce, or one hundred twenty-three percent.
Unfortunately, on an inflation-adjusted basis, you would have a negative, net return of ten percent. In real terms, the price of gold did not even match its 1980 high. And this result is after waiting for thirty-one years.
Owning gold from January 1980 until August 2011, a total of thirty-one years (during which its price rose from an all-time high of $850.00 per ounce to a subsequent, new all-time high of $1900.00 per ounce), resulted in a cumulative, net loss of ten percent in inflation-adjusted, real terms.
That doesn’t sound good, but it is even worse considering the decline in gold’s price since 2011. With gold currently priced at $1240.00 per ounce, the cumulative net loss balloons to forty-four percent (certainly not a supporting factor for the argument that gold is a long-term inflation hedge).
Another way of looking at it is that all of the real profits – nine hundred percent cumulative total return – from the forty-year period (1971-2011) came in the first nine years, 1971-80.
When President Nixon suspended convertibility of the U.S. dollar into gold in 1971, his action ushered in a decade-long period of U.S. dollar weakness and rejection. The effects of inflation created over the previous four decades, initially in an attempt to extricate us from the economic depression of the thirties, then to fund the country’s expenses relative to its involvement in WWII, etc. came roaring to life in the form of higher prices for all goods and services.
The 1970s were a catch-up period for the price of gold relative to the U.S. dollar’s loss in value over the previous four decades. That, and the anxiety and anticipation created by the realization that things were far worse than we had previously known, led to outsized gains.
Gold’s failure to make a new, inflation-adjusted high in 2011 is perfectly reasonable. This is because gold’s upward price movement reflected the extent of ongoing U.S. dollar devaluation that had occurred since the eighties. Whereas, the price movement upward in the seventies reflected U.S dollar devaluation that had occurred over the prior forty years – a period more than twice as long.
Gold’s price is not an indication of its value. The value of gold is constant and does not change. Its price is a reflection of the value of the U.S. dollar. Nothing more. Nothing less. Nothing else.
And what is happening to the US dollar? It is in a state of constant deterioration, punctuated with periods of relative stability.
And the peaks and low points for those periods are seen clearly on both charts (1933, 1971, 1980, 2001, 2011) and correspond with highs and lows for the price of gold, both in nominal and real terms.
Gold is not an investment. When gold is characterized as an investment, the incorrect assumption leads to unexpected results regardless of the logic. If the basic premise is incorrect, even the best, most technically perfect logic will not lead to results that are consistent.
In light of all this, what can we expect from gold looking ahead? Or, better phrased, what can we expect from the U.S. dollar; and how does that translate to expectations for the price of gold?
One possibility is that the U.S. dollar could continue to stabilize and strengthen along with an improving economy. The price of gold would stabilize and move lower reflecting the dollar’s relative strength. This is similar to what happened between 1980 and 2001, and what we are currently experiencing since 2011. And it could go on this way for years. During periods like this, you should not expect gold’s price to increase.
Another scenario is that the dollar could renew its long-term decline in rapidly accelerating fashion, eventually ending in complete rejection and repudiation. In which case, owning gold is imperative for wealth preservation and financial survival. But any profits would be elusive. At a time like that, the U.S. dollar price of gold becomes meaningless. What does matter, and what is critical, is how much gold you own.
Lastly, attempts by the Federal Reserve to unwind its horrendously bloated balance sheet and encourage a return to a relatively normal level of interest rates could backfire. We could see a another credit collapse. This one would be much worse than anything we have experienced to date, and the unwinding of prices for all assets (stocks, bonds, real estate, commodities) denominated in dollars would trigger a full-scale depression and lead to a suppression of most economic activity. Don’t look for gold to save you. The U.S. dollar would increase in value; thus, gold’s price in dollars would decline significantly. The US dollar would actually buy more, not less. But the supply of US dollars would be significantly less. This is true deflation, and it is the exact opposite of inflation.
There are, of course, variations and combinations of the above scenarios that may play out. Any actions or responses by government and the Federal Reserve will affect the magnitude and duration of various crises.
Whatever the course of events, or how they unfold, there is no fundamental reason for gold to make new inflation-adjusted highs.
The case for gold is not about price. It is about value. And its value will become readily apparent when governments and individuals are scrambling amid the ruins of our financial system looking for something, anything, to replace worthless paper currencies. which are nothing more than substitutes for real money.
Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED!