Among the major fiat currencies in the world today, the U.S. dollar is “the best of the worst.” What that means is that there are no better alternatives.
BRICS – QUESTIONABLE MOTIVES
That is especially true when one considers all of the nonsense and suppositions stemming from statements made by member nation representatives of BRICS. Both Russia and China are foremost in their efforts to talk the dollar into disrespect and disrepute. Their motives, however, have nothing to do with providing a better alternative.
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
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.
Gold bulls have a short memory. Last year at this time, gold was similarly priced and they were quite bullish then, too. But their expectations didn’t ‘pan out’ as expected. In fact, gold prices turned and went in the opposite direction, hitting lows in late summer well below $1200.00 per ounce.
The downturn was unexpected. But it was unexpected because most analysts and investors were looking in the wrong place for the wrong clues.
Gold’s price changes over time in response to changes in the value of the U.S. dollar. But some additional explanation is necessary.
Some say that a weaker U.S. dollar ’causes’ a higher gold price. That is like saying that lower interest rates cause higher bond prices. That’s not the way it works.
Gold and the US dollar move inversely. So do bonds and interest rates.
If you own bonds, then you know that if interest rates are rising, the value of your bonds is declining. And, conversely, if interest rates are declining, the value of your bonds is rising. One does not ’cause’ the other. Either result is the actual inverse of the other.
When you were a kid you probably rode on a see-saw or teeter-totter at some time. When you are on the ground, someone on the other end of the see-saw is up in the air. And, vice-versa, when you are up in the air, the other person is on the ground. Again, one does not ’cause’ the other. Either position is the inverse of the other.
Most of those who comment on gold consider the dollar to be one of several factors contributing to a higher gold price. But, in truth, gold’s price reflects only one specific thing: changes in value of the U.S. dollar.
There are six major turning points (1920, 1934, 1971, 1980, 2001, 2011) on the chart below. All of them coincided with – and reflect – inversely correlated turning points in the value of the U.S. dollar.
Gold Prices: 100-Year History (inflation-adjusted) source
Since gold is priced in US dollars and since the US dollar is in a state of perpetual decline, the US dollar price of gold will continue to rise over time. There are ongoing subjective, changing valuations of the US dollar from time-to-time and these changing valuations show up in the constantly fluctuating value of gold in US dollars.
There is also more talk about inflation recently. So here is an axiom to remember: inflation is the debasement of money by the government.
When you hear someone referring to things such as ‘cost-push’ or ‘demand-pull’ inflation, accelerated wage growth pressure, or an ‘over-heated economy’, listen politely. But know that there is only one cause of inflation – government. And government in this case includes central banks, especially the United States Federal Reserve Bank.
Government creates inflation by expanding the supply of money and credit. They do this intentionally and continually under the pretense of managing the economic cycles.
Since inflation, as practiced by government, is ongoing, the risks are cumulative. As that cumulative risk builds, events triggered by the effects of inflation become more volatile; and they are unpredictable.
When the Federal Reserve responded to the financial crisis of 2007-08 by increasing hugely their monetary expansion efforts, many thought that it would lead to runaway inflation and collapse of the U.S. dollar. It didn’t. But it did drive the prices of assets like stocks, bonds, and real estate, much higher.
Originally, of course, the price of gold surged in response to the Fed’s efforts. Since gold’s price is an inverse reflection of the U.S. dollar, it should come as no surprise that the dollar continued its long decline in value; and significantly so.
But the drop in the value of the dollar and gold’s higher prices from that point forward were mostly in anticipation of damaging effects from the Fed’s inflation in the form of significantly higher prices for all goods and services. In essence, a repeat of the seventies, only much worse, was expected. And the looming threat of U.S. dollar repudiation fanned the flames.
But there was no significant increase in the “general level of prices for goods and services”. And U.S. dollar weakness (possibly overdone) eventually reversed and the price of gold began to decline (2011 – see chart above).
Between 2011 and 2016, the U.S. dollar continued to strengthen and gold’s price continued to decline. At that point the two reversed direction again and that brings us to where we are currently.
Some are convinced that recent dollar weakness will continue unabated and that the price of gold will soar soon. Some are still banking on severely damaging effects from the Fed’s past money creation efforts. And still others are short-term traders who are looking at their charts and want to be “on the right side of the trade”.
Most of them will likely be disappointed – again. There are two reasons:
1)The fundamentals and logic involved are inconsistent and flawed.
2)The effects of inflation are volatile and unpredictable.
Applying investment logic to gold leads to erroneous conclusions. Gold does not react or correlate with anything else – not interest rates, not jewelry demand, not world events.
Changes in gold’s price are the direct result of changes in the value of the US dollar. Nothing else matters.
Since paper currencies and credit can be manipulated by government, expectations and reactions become more volatile and increasingly unpredictable.
That should be relatively clear; especially after what we have experienced in the past ten years. But some are still predicting a gold ‘moonshot’. And they want it now.
Something like that may occur. In fact, it is quite possible. But when? It will only happen if it is accompanied by a complete collapse and repudiation of the U.S. dollar.
The chart above is current. Does it look like we are in the midst of something similar to 1970-80 or 2001-11? Or something worse?
Yes, forewarned is forearmed. But most of those who are the most vociferous in their calls for huge increases in the price of gold are those who were doing so all during gold’s price decline from August 2011 through January 2016. What’s changed?
It is pretty much expected today that any investment analysis with justifiable conclusions will be steeped in technical study that includes lots of charts.
This seems especially true of gold.
Which is all well and good, I suppose; except for the obfuscation:
Inflation is the debasement of money by government. The expansion of the supply of money and its subsequent loss in value results in an increase in the general level of prices for goods and services.
Deflationis characterized by a contraction in the supply of money and a decrease in the general price level of goods and services. (What we are currently experiencing is called ‘disinflation’ which is a lower rate of inflation.)
The purpose of this essay is to clarify and explain accurately what to expect regarding gold prices if deflation occurs.
According to Wikipedia: “Inflation reduces the real value of money over time, but deflation increases it. This allows one to buy more goods and services than before with the same amount of money.”
The United States Government, via the Federal Reserve Bank, has been practicing inflation regularly for over one hundred years. They are good at it. Their efforts have resulted in a ninety-eight percent “reduction in the purchasing power per unit of money.”
The reduction in purchasing power of the U.S. dollar is reflected in the higher price of gold.
In 1913, with gold at $20.65 per ounce, twenty U.S. dollars in paper money was equal to twenty dollars in gold. Today gold is at $1270.00 per ounce, more than sixty times higher than in 1913.
The higher price for gold does not mean that gold has experienced an increase in purchasing power. Rather, its higher price reflects the decline in purchasing power of the U.S dollar.
Deflation is different. It is the exact opposite of inflation. And the results are different as well.
As we said earlier, deflation is characterized by a contraction in the supply of money. Hence, each remaining unit is more valuable; i.e. its purchasing power increases.
Government causes inflation and pursues it for its own selfish reasons. A government does not voluntarily stop inflating its currency. And it certainly isn’t going to reduce the supply of money. So what causes deflation?
Government causes deflation, too. Deflation happens when a monetary system can no longer sustain the price levels which have been elevated artificially and excessively.
Governments love the inflation they create. But with even more fervor, they hate deflation. And not because of any perceived negative effects on its citizens. It is because the government loses control over the system which supports its own ability to function.
Regardless of the Fed’s attempts to avoid it, deflationis a very real possibility. An implosion of the debt pyramid and a destruction of credit would cause a settling of price levels for everything (stocks, real estate, commodities, etc.) worldwide at anywhere from 50-90 percent less than currently. It would translate to a very strong US dollar. And a much lower gold price.
Those who hold US dollars would find that their purchasing power had increased. 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.
The relationship between gold and the US dollar is similar to that between bonds and interest rates. Gold and the US dollar move inversely. So do bonds and interest rates. If you own bonds, then you know that if interest rates are rising, the value of your bonds is declining. And, conversely, if interest rates are declining, the value of your bonds is rising. One does not ’cause’ the other. Either result is the actual inverse of the other.
Inflation leads to a U.S. dollar which loses value over time; hence, this is reflected in a higher gold price.
Deflation results in an increase in value/purchasing power for the U.S. dollar; hence, this is reflected in a lower gold price.
Those who expect gold to increase in price during deflation are wrong for several reasons.
Gold is not an investment. And it does not respond to the various headline items that journalists and analysts continue to repeat erroneously. It is not correlated with interest rates and it does not respond to housing statistics. It is not influenced by world events, terrorism, or the stock market.
Gold is real money. The U.S. dollar is a substitute for real money, i.e. gold.
If deflation occurs, there is no other possibility except for lower gold prices.
(to read more about gold and its relationship to the U.S. dollar, see here)
The emotional adamancy which dominates most analysis of gold contributes to confusion and misunderstanding. For example, “Backdrop For Gold Today Is As Bullish As It Has Been In A Long Time”; or “Precious Metal Sector Is On Major Buy Signal”. These and other similar claims are often supported by reams of technical analysis – the best that money can buy.
And this is on top of general misstatements of fact. It would appear that there is virtually no justification for lower gold prices except when caused by manipulation associated with conspiratorial forces.
Otherwise world tension, terrorism, natural calamities, social unrest, economic weakness, interest rates, inflation, trade deficits, Indian jewelry demand, etc, etc. all put a ‘floor’ under the price of gold. At least this is what we are told.
And the timing: “It’s now (or never).” “Gold has finally broken through its overhead resistance.” “$2,000/oz by the end of 2017.”
Does understanding gold require a degree in cyclical theory or financial mathematics? Or is it related to climate change?
A simpler and better explanation for gold exists. It only requires a bit of historical observation.
1) First, and foremost, is the simple fact that gold is real money.
Its value (purchasing power) is constant and stable. And its role as money came about through trial and error. Gold has stood the test of time.
2) Second, paper currencies are substitutes for real money.
Gold is also original money. It was stored in warehouses and the owners were issued receipts which reflected ownership and title to the gold on deposit. The receipts were bearer instruments that were negotiable for trade and exchange.
3) Third, inflation is caused by government.
One thing that should be clear from history is that governments destroy money. That might sound harsh, but it is true. And when we say “destroy” we mean just that. Inflation is practiced intentionally by governments and central banks. Its effects are severe and unpredictable. The Federal Reserve Bank of The United States has managed to destroy the U.S. dollar by bits and pieces over the past century. The result is a dollar that is worth 98 percent less than in 1913 when the Fed began its grand experiment.
The relationship between gold and the US dollar is similar to that between bonds and interest rates. Bonds and interest rates move inversely. So do gold and the U.S. dollar.
If you own bonds, then you know that if interest rates are rising, the value of your bonds is declining. And, conversely, if interest rates are declining, the value of your bonds is rising. One does not ’cause’ the other. Either result is the actual inverse of the other.
A stable, or strengthening U.S. dollar means lower gold prices. A declining U.S. dollar means higher gold prices.
In other words, higher gold prices are a direct reflection of a weakening U.S. dollar.
And please don’t confuse the U.S. dollar with the U.S. dollar index. The U.S. dollar index(es) do not tell us anything about the price of gold. A dollar index reflects changes in the U.S. dollar’s exchange rate versus other currencies.
The threat of world war is ominously present today. Countries and municipalities are going bankrupt. And acts of terrorism are an almost daily occurrence. This is in addition to an economy that can’t seem to improve enough or sustain an acceptable rate of growth.
So let’s buy gold, right? Maybe, maybe not. You see, gold doesn’t care about those things. It doesn’t care whether or not somebody fires a rocket armed with a nuclear warhead or the state of Illinois declares bankruptcy. And it doesn’t react to comments by Janet Yellen or Donald Trump. Indian jewelry demand is not on its radar. Nor are housing starts.
Gold responds to one thing. Changes in the U.S. dollar. Nothing else.
A continually weaker dollar over time means higher gold prices.
Periods of dollar strength are reflected in a declining gold price.
Lets talk for a moment about North Korea and the threat of war. Its a very scary situation. But even if things get worse, it won’t have an impact on gold prices. Here’s why:
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 US 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 of our forces and the 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 US dollar.
All of which leads us back to a simpler and better explanation:
Insofar as gold is concerned, it is all about the U.S. dollar.
People are obsessed with the price of gold. And the demand for answers to the question “Why?” continues to grow. Why did gold go up/down $20.00 today? Why?
All too eager to provide the answer, journalists respond as follows:
Quote: “A weak U.S. inflation print may be just what gold prices need to finally stay above $1,300.” …WSJ Aug 2016
Seriously? I thought higher gold prices were the result of inflation.
Quote: “Negative interest rates are sweeping the world as countries try to devalue their currencies, and that’s helping the price of gold.” …Feb 2016
The ongoing devaluation of the U.S. dollar has been taking place for over one hundred years. Gold’s continually increasing price – over time – reflects that devaluation. There is no correlation between gold and interest rates.
Quote: “Gold prices were on track for a second straight day of losses Tuesday after United Nations sanctions against North Korea were less severe than many initially expected.” …WSJ Sep 12, 2017
Apparently more severe sanctions would have led (or did lead) to higher gold prices. Why? And why do sanctions that “were less severe” lead to lower gold prices? The answer in both cases is: they don’t.
Quote: Analysts and investors have also said that demand for haven assets has weakened early in the week because damage from Hurricane Irma was less severe than expected. Many investors favor gold during times of geopolitical uncertainty. …WSJ Sep 12, 2017
Another case of unrealistic expectations being dashed on the rocks of reality. Unfortunately, the explanation after the fact is just as bad as the original expectation. Contrary to the statement above, gold is not influenced or affected by “geopolitical uncertainty”; regardless of what investors think.
Quote: Gold prices climbed Thursday after the European Central Bank left its accommodative monetary policies in place. …WSJ Sep 12, 2017
Any other central bank’s actions are still secondary to the U.S. Federal Reserve Bank and its actions concerning the U.S. dollar. Actions by other central banks are more properly viewed in the context of their own respective economies and/or relative to the U.S dollar. Gold’s price is the direct inverse reflection of the value of the U.S. dollar.
The underlying problem is fundamental. Most people either are unaware or refuse to accept the one basic principle that defines and explains gold: Gold Is Real Money.
It is necessary, of course, to understand the principle more fully before attempting to answer questions about the price of gold. Further enlightenment on the subject can found here and here.
The lack of knowledge regarding gold leads to answers and explanations for price action that are illogical and incorrect. In the above examples, another factor is that the explanations are headline driven.
It is presumed that any price action of consequence must have a clear explanation. When an explanation isn’t readily apparent, check the headlines; and make something up.
Why did gold go up? New hurricane offshore. Why did gold go down? Effects of storm after making landfall weren’t as bad as expected. Gold is up again. Well, there is another hurricane offshore and it could be worse than the last one. Nah, find another reason. How about this? The ECB held firm on interest rates/raised rates/didn’t raise rates/changed their mind, etc. If that doesn’t work, reverse the facts to suit the circumstances. Inflation refuses to attend the party. Maybe gold will defy all reasonable logic and ignore core fundamentals. Maybe gold’s price will go up while the U.S dollar strengthens.
Let’s be clear. There are short-term, temporary changes in gold’s price that are not the result of its basic identity as real money. And changes in the gold price occur only when people (traders, investors, etc.) act on their expectations, faulty logic or not.
But those price changes are elusive and will revert to their place within the fundamental trend; namely that gold’s continually higher price over time reflects inversely the continually lower value of the U.S. dollar.
Further, gold’s price decline since August 2011 reflects a strengthening U.S dollar. It is very possible that trend has not reversed yet, although eventually it will.
And the more recent gold price increase since the beginning of this year is tied directly to the decline in value of the U.S. dollar. Any other explanations are simply not applicable.
Beyond that it is mostly a guessing game; at least in the very short-term. And for good reason. A plethora of faulty logic, (non)correlations, and contradictions seem to indicate more than just an ignorance of gold’s fundamental(s).
It just may be that the day-to-day changes in gold’s price are not easily attributable to known facts.
The gold market is relatively thinly traded. Even so, there are many different reasons why someone bought or sold the yellow metal on a certain day. Any specific transaction could have been initiated after weeks or months of deliberation. And if it is spontaneously correlated time-wise with other known events, we still don’t know the reasons or logic that went into that decision.
Also, it is possible (likely?) that the traders who provide explanations to the journalists, are just as much in the dark themselves for an answer.
The only visible, consistently reliable, fundamental indicator of gold prices is the U.S. dollar. The ongoing decline in value of the U.S. dollar is reflected in an ever higher gold price over time.
Periods during which the U.S. dollar shows signs of strength and stability are reflected in lower or more stable gold prices.
Those periods are temporary. And they can last for years. The previous temporary period of U.S. dollar strength lasted for twenty years from 1980 – 2000. Don’t be swayed by the clarion call of impending riches or the fear of missing out on wealth untold.
If you really want to understand gold, focus on the U.S. dollar. And ignore the headlines.
