The gold price is not about gold. In fact, it tells us nothing about gold.
So why are people so obsessed with the price of gold? In most cases, it is because people likely view gold as an investment opportunity. “How much can I make and how quickly?”
However, the question which continues to plague gold investors and others is “Why didn’t gold respond the way we expected?”
The answer is found in the term unrealistic expectations.
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.
Here are some examples of inconsistencies when viewed through the lens of faulty logic based on incorrect assumptions…
NO CORRELATION BETWEEN GOLD AND INTEREST RATES
All during the 1970s, while gold was increasing from $40.00 per ounce to a high of $850.00 per ounce, interest rates were rocketing higher. The yield on 10-year U.S. Treasury bonds exceeded fifteen percent. There was a serious lack of demand for higher yielding investments.
Then, during 2000-11, while gold increased from $250.00 per ounce to a high of $1900.00b per ounce, interest rates continued their long-term decline to historically low levels, even approaching zero percent, and, in some cases negative numbers.
Two ten-year periods of outsized gains in the price of gold. And interest rates were doing something exactly opposite during each period. There is no correlation between gold and interest rates.
Here is another example of a faulty assumption that led to disappointment…
GOLD IS NOT A SAFEHAVEN
In late 1990, there was a good deal of speculation regarding the potential effects on gold of the impending Gulf War. There were some spurts upward in price and the anxiety increased as the target date for action grew near. Almost simultaneously with the onset of bombing by U.S. forces, gold backed off sharply, giving up its formerly accumulated price gains and actually moving lower.
Most observers describe this turnabout as somewhat of a surprise. They attribute it to the quick and decisive action and results achieved. That is a convenient explanation but not necessarily an accurate one.
What mattered most for gold was the war’s impact on the value of the US dollar. Even a prolonged involvement would not necessarily have undermined the relative strength of the U.S. dollar.
We saw this sentiment and expectations for gold on several other occasions, too. One of them was when friction between the United States and North Korea was in the headlines a couple of years ago. Gold is not a hedge against world war.
One more example of an incorrect assumption…
GOLD IS NOT (INVERSELY) CORRELATED WITH STOCKS
For five full years, from the fall of 2002 until late 2007, both stocks and gold prices moved in tandem. During that period, stocks were up eighty percent.
The price of gold was up too, much more than stocks. At the end of the five years, gold’s price had increased by more than double.
The next year, in 2008, stocks and gold turned about face and marched together in the opposite direction. Both stocks and gold prices declined by more than thirty percent.
The latest collapse in stock prices and gold’s failure to charge ahead is quite ironic. It speaks volumes that the size and quickness of the stock decline was as great or greater than what not too few ‘experts’ claimed was necessary to propel gold’s price to new highs and beyond. Gold is not correlated, inversely or otherwise, with stocks.
GOLD’S PRICE IS ALL ABOUT THE US DOLLAR
So why does the price of gold change; and what is the value of gold?
Gold is money; original money, real money. Gold’s value is in its use as money; and its value is constant and unchanging.
The US dollar is a substitute for real (original) money, i.e., gold. Gold’s price is a reflection of changes in the value (purchasing power) of the U.S. dollar. Nothing more. Nothing less. Nothing else.
The US dollar is in a state of constant deterioration, punctuated with periods of relative strength and stability. We are in one of those periods of strength and stability for the US dollar right now and have been since 2011.
Here are several incorrect assumptions which are the source of various unrealistic expectations for gold prices…
- The gold price will go up because of various non-fundamentals: low interest rates; declining stock markets; wars, including trade wars; recessions and economic collapse; political instability; social unrest; etc.
- A higher gold price is inevitable even if the US dollar does not decline further in any meaningful way.
- Federal Reserve response to financial crises, such as stock market collapse, credit and liquidity issues, and potential economic calamity will automatically result in a weaker dollar and higher gold prices.
- A decline in economic activity is synonymous with a weaker US dollar and higher gold prices.
- Much higher gold prices will make investors rich.
Regarding no. 1 and no. 2, as we have said before, a higher gold price over time is a reflection of the continuing loss in value of the US dollar. That same US dollar is a paper substitute for gold. A higher gold price will only happen after significant further weakness in the US dollar.
As far as no. 3 is concerned, most observers skipped over the part about a weaker dollar. They assumed that Fed action, itself, would send gold prices higher. That is probably due in part to their expectation that a new round of QE would immediately be interpreted as negative for the US dollar and result in a rush into gold. The US dollar, however, remains strong.
Now, with stocks falling and economic activity slowing rapidly, QE and ZIRP are back again. Some are still expecting lower rates to “boost” gold prices and weaken the value of the US dollar. But that is not happening. Monetary inflation, which is created by the Federal Reserve, continues to lose its intended effect. (see Fed Inflation Is Losing Its Intended Effect)
Re: no. 4… The Great Depression was characterized by huge declines in economic activity and was accompanied by a stronger US dollar. In other words the dollar bought more – not less. A stronger US dollar, by definition, results in a lower gold price.
For more about no. 5, see Scenario B in the section below.
What, then, 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?
WHAT IS NEXT?
Scenario A – One possibility is another credit collapse. The unwinding of prices for all assets – stocks, bonds, real estate, commodities – denominated in dollars would trigger a full-scale depression accompanied by woefully lower levels of economic activity.
Don’t look for gold to save you. The U.S. dollar would increase in value and gold’s price in dollars would decline significantly. The US dollar would actually buy more, not less. The supply of US dollars would be significantly less. This is true deflation, and it is the exact opposite of inflation. This appears to be where we are headed now.
Scenario B – 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. This is what many gold investors were expecting. Any profits would be elusive. At a time like that, the U.S. dollar price of gold becomes meaningless. You would need any paper profits in gold price to pay for the hugely higher price of basic goods and services.
Scenario C – Stock prices could rebound and stabilize before moving higher. Companies could invest in productive efforts that would lead to gains in economic activity and individuals would spend, save, and invest. A relatively stronger US dollar would provide stability. Possible; but not likely at this time.
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.
No matter how things develop, or whatever the ultimate outcome, the only sure thing we can know about gold’s price is that it inversely reflects whatever is happening to the US dollar – and only that. Keep your eye on the US dollar. (see Gold – It’s Still All About The US Dollar)
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!
I follow a lot of your arguments and you make some good points. But rather than address most of them specifically, I’ll focus on the one main point you make, that the price of gold (presumably in US dollars) is inversely proportional to the strength of the US dollar.
I guess one “bird’s eye” question would be why has the price of gold from about 2000 until now (2020) increased from around $250/oz to about $1,700/oz (over 5-fold) while the dollar has increased (measured by the dollar index) only from about 90 to about 100? That doesn’t seem very inversely proportional to me.
Secondly, you completely avoid the political and psychological importance of the gold price on the financial system. As Greenspan famously said (I’m paraphrasing), ‘the number one mistake that was made during the late 1970’s was losing control of the gold price.’ The fact that “paper gold” exists and the rules of shorting it are unclear and/or unenforced is a possible factor for the price of gold being so inconsistent.
Thirdly, the “exorbitant privilege” of the US dollar has been playing out for a long time. The US dollar is only relatively strong compared to other baseless currencies. They can all circle the drain together and yet the US dollar could always be the top most, but that’s no reason gold has to go down with them. Gold is the opposite of them.
Fourthly, your claim that gold is only representative of the purchasing power of the dollar is true but in a different sense: the dollar price of gold increases because the purchasing power of the dollar is constantly decreasing. It takes more dollars to buy the same ounce of gold over time.
Personally, going forward I would rather have a fist full of gold than dollars, although I agree that in a deflationary scenario PHYSICAL cash would also be valuable because of their scarcity (leveraged credit implosion) but not because they’re more valuable than yen or pounds or euros, etc.
Thanks, Bruce, for your excellent questions. Let’s see if I can answer them as clearly as you have posed them.
1)Your analysis on gold’s price re: US dollar for the past twenty years is quite limiting. I prefer to use a one hundred year history that dates back to convertibility, when gold was priced at $20.67 per ounce and paper dollars were convertible into gold and vice-versa. In other words, Twenty paper dollars was accepted as, and expected to be the equivalent of one ounce of gold. The two were interchangeable. Over time, the loss in purchasing power of the US dollar has manifest itself in continually higher price for gold. That decline in the dollar approximates somewhere between 98 and 99 percent, which corresponds to a gold price between $1000 and $2000 per ounce.
All of the political and psychological factors, as well as “paper gold”, price suppression, etc., don’t change the above relationship, although they may create temporary inconsistencies. But the market price for gold allows for most of that. And, besides, anyone who wants to own gold, can do so. And if they are correct in their belief that gold is underpriced in dollars, then they should buy it. But they should be prepared to wait awhile. And they should own it for exactly the same reasons that you imply and which I have stated repeatedly over the years — Gold is real money, original money. The US dollar and all paper currencies are substitutes for real money and are in long-term death spirals.
That being said, there are periods of dollar stability and strength during which the gold price declines (1930s; 1980 – 2000; 2011 – present). If deflation occurs, the collapse in asset prices will result in US dollar strength and lower gold prices; In other words, the exact opposite of inflation.
Also, I have been very clear in my articles about the difference between the US dollar and US dollar index, which tells us nothing about gold.
I’m not sure where we disagree on your fourth point because what you said re: “the dollar price of gold increases because the purchasing power of the dollar is constantly decreasing. It takes more dollars to buy the same ounce of gold over time” is exactly what I have been writing about for the past four years.
Two points which are critically important:
1) the effects of inflation are volatile and unpredictable
2) the VALUE of gold is constant and unchanging. It is the dollar and people’s perception of it that changes; all within the context of its long-term decline in purchasing power.
Finally, I agree about holding gold vs. dollars; of course. And, yes, physical cash. It has nothing to do with other paper currencies.
I believe most gold ‘investors’ are underestimating the extent and duration of potential deflation and, as a result, at least temporarily, further stability and strength in the US dollar; meaning increases in its purchasing power.
Question for you Kelsey, is the US dollar backed by anything? and do you think at some point the Gold standard could be introduced again..
Certainly, a gold standard “could” be introduced again. But governments and central banks will not willingly cede control of the money supply. They will resist any attempts to restrict their ability to create limitless amounts of money substitutes. There is too much power at stake.
I suppose the Gold standard will never happen because the US dollar is already backed by the petrodollar,so ineffect the US dollar is backed by a commodity = Oil..probably another way of looking at it..
Must admit to much at stake as you say the FED love their printing machine..
Kelsey’s last paragraph..All eyes on the US dollar.
240 trillion of global debt mostly in USD, now the question is the powers that be are they going to add more debt and keep the USD elevated,or are they going to add more debt and sacrifice the USD in Hope’s of a last throw of the dice to rescue the economy..
Eyes down let’s see.
O,don’t forget to keep an eye on the pet rock..
Bye for now ….