Wednesday, July 22, 2015

What's the right price for gold?

For the past 100 years, gold prices have been all over the map: from a low of $17/oz. in 1931, to a high of $850 in 1980, to a low of $255 in 2001, then up to its recent high of $1900 in 2011, and today down to just under $1100. Gold has lost over 40% of its value in the past four years, and along the way, it has paid zero in the way of interest. As an investment, gold is not for the faint of heart. You can make or lose a fortune, depending on your entry and exit points. So is now a good time to buy gold?

To help answer that question, I put together the chart above, which shows the real price of gold (using the CPI) over the past century. For the entire period, the average real price of gold was about $550/oz. For the period beginning 1965 (when the Fed began cheating on the gold standard by not raising interest rates to counter gold outflows) through today, the average real price of gold was about $725/oz. The inflation-adjusted, compound annual rate of return to holding gold over the past 100 years is about 0.9%. Yes, gold is a store of value, but just barely, and only over very long periods. 

As a partial answer to my question, I think gold still looks expensive right now, because relative to the prices of other things, gold today is still significantly above its long-term average. Buying gold today means paying a premium. If history is any guide, it could well drop to $700 or maybe even $500 before embarking on another long rally. And in the meantime, an investment in gold yields nothing. For gold to pay off, I think it would take another huge scare: another big recession, a big and unexpected rise in inflation, another crisis of confidence in the world's central banks, or something that would make people think that The End of the World As We Know It is just around the corner. Barring another major scare of some sort, gold prices are likely to drift lower, possibly for years to come.


William said...

One publication this week referred to Gold as "a Pet Rock".

John McCormick said...

Gold is money. Why does the US Treasury hold it? Why don't we give the Germans back their gold? Our Federal Government lost control of their spending in the 60's and now they are forced to tell us that US Federal Reserve Notes are real money. Joke.

The last sentence is enough for me to hold some gold. Store of value is a key component of money. The US dollar has no store of value and it currently earns zero in the bank.

Our government can not have deflation and will go to any length to stop it. After saying that, the likelihood of the Fed getting inflation just right at 2% is very very remote (unless of course they continue to massage the data to get the intended results).

As commodities fall to decade lows, the concern is deflation and the worlds largest debtor will not stand for it. They will create inflation at any cost.

"In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value."
Alan Greenspan

Next week is Q2 GDP. Negative retail sales this past month... Are the ports still shut down? Bad weather in Boston? The economy is tipping the wrong way. Can't wait for the excuses...

steve said...

gold is NOT money. gold HAS BEEN money. like in the dark ages before currencies. gold as an investment is an anachronism. it's time has come and gone.

Benjamin Cole said...

The yellow metals have it tough. Check out copper prices---down steadily since January of 2011.
Funny, the bubble mongers never say gold or copper is in a bubble. But obviously they were in a bubble four years ago.
For gold, where is bottom? Maybe all gold is fool's gold.

Hans said...

Ben jamin, Au declined nine months later..And yes you correcteo, that both
were bubblicious..

Mr Grannis, is correct that Au will be dead money for years..

"For gold to pay off, I think it would take another huge scare: another big recession, a big and unexpected rise in inflation, another crisis of confidence in the world's central banks"

Sorry, none of the above..It will require another financial crisis of both the economy
and our dear governmental units..

It is almost a certainty within the next decade..

Benjamin Cole said...


The world's major central banks (with the possible exception of the People's Bank of China, and lately the Bank of Japan) have become hyper-squeamish, with near fetishism about inflation. How will there ever been inflation?

The last time the US even had bare minimum double-digit inflation (let alone anything close to hyper-finlfation) was 1981. Then, we had a Fed Chief (Burns) who openly declared he could not fight inflation, and an economy much more inflation-prone than today. (Actually, Burns preceded the 1980s, but you know what I mean).

Today we have a Fed that effectively targets 1.5% inflation (PCE), and talks about raising interest rates even when we have headline deflation! And slow growth!

Speaking of the right way to do things, the Bank of Japan has been doing QE for the last year.

From the FT:

"A weaker yen, a boom in cruise holidays and a surge of Chinese shopaholics have pushed Japan across a historic threshold: for the first time in nearly half a century, it is receiving more tourists than it is sending abroad....
In the first six months of 2015, according to new estimates by the Japan National Tourism Organisation, 9.1m people visited Japan, 46 per cent up on the same period in 2014. In the same period, 7.6m Japanese travelled overseas."


A 46% jump in tourists to Japan YOY in H1 2015?! Now that is a boom! That is how you do it.

The yen is cheaper than a year ago, the Nikkei 225 up about one-third.

Meanwhile, in tight-money Singapore, there is deflation and economic contraction as we speak.

You know, tight money just does not work. Japan tried it for 20 years (1992-2012) and it did not work.

It is not a matter of politics, ideology, gold-worship, or theories.

I am just saying what happens.

Thinking Hard said...

Benjamin – I agree! Tight money is not conducive to high growth rates. We need growth! This is one reason I favor waiting for inflation to actually pick up speed before raising rates. Low inflation, low growth, and higher rates? Hmm, doesn’t quite add up in my mind. One thing that could potentially balance out tightening monetary policy is pro-growth fiscal policy, which has been missing in this recovery. I am hopeful we will see some pro-growth fiscal policy within the next 2 years.

On a side note – the Federal Reserve’s balance sheet holds approximately $400 Billion of maturing UST over the course of 2016 and 2017. Raising rates in the face of foreign yoy UST buying going negative, intra-gov yoy UST buying going negative, and $400 Billion in maturing UST for the Fed over the next 2 years does not make much sense. Did QE really end as we continually rollover maturing debt to maintain a static balance sheet? Doesn’t seem so to me, and doesn’t warrant a rate increase at this time. How about the Fed just allows maturing debt next year to not rollover and see what that does to rates as other sources of buyers have turned to net sellers.

Interesting times…

puffer said...

Scott -

How would you respond to this comment by "sponge" on a different forum who made this post after reading your piece on gold --

"You can't adjust gold for CPI because gold's value is stable. That chart has no meaning.

From 1792 to 1971 the U.S. was on a gold standard with a devaluation from $20.67/oz to $35/oz in 1933. That means the dollar was defined at a specific weight of gold and their value was the same. Just like 4 quarters are defined as 1 dollar. You wouldn't sell a dollar bill and purchase 4 quarters as an investment (Unless you believed the supply of quarters would become limited and the value of a quarter would rise in relation to a dollar bill) because there is no difference in value. Similarly, when the dollar is defined at a specific weight of gold, gold is not considered an investment, except if one believes the government will no longer honor the link. So from 1792 to 1971, with the exception in 1933 (and a period during the Civil War when the dollar was floated against gold and then returned to the same value after the war), gold cannot be considered an investment. Only after Nixon severed the gold dollar link in 1971 did gold become an investment hedge against a devaluing dollar. Any analysis of gold's investment potential can only be considered during this 44 year period--with the limited exception in 1933. Gold has done pretty well as a hedge against Fed error since 1971, rising from $35 to its current value of $1100. That's a pretty good return and the Fed is just getting started with transmitting the next round of monetary error into the economy."

Scott Grannis said...

The author you cite has a valid point when arguing that when on a gold standard it makes no sense to adjust gold for inflation, since inflation in a strict gold standard would likely be zero or close to zero.

I calculated the average real price of gold from 1965 on because 1965 marked the beginning of the end of the gold standard. Inflation started rising then, and the Fed avoided raising interest rates despite continued and rising outflows of gold. I don't think it's fair to use 1971 as a starting point for gold as an investment.

But I think it is reasonable to say that when gold was first worth $35/oz. in the early 1930s that would be equivalent to almost $600 in today's dollars.

And thanks to the fact that our "gold standard" wasn't a very rigid standard (i.e., it was worth $19 in 1904, $21 in 1920, and $35 in 1934), inflation in the early 1900s was all over the map (both very positive and very negative). So I think my chart is informative and useful in gauging the value of the dollar vis a vis gold over time.

Hans said...

Ben Jamin, is it not the over expansion of the money
supply which leads to inflation?

Hans said...

Ben Jamin, is it not the over expansion of the money
supply which leads to inflation?