The Death of Gold?

I have been following goldbug chatter since 1998 when I took up a position in the Depository division of the Perth Mint. At that time it was all doom and gloom with the price in a downward trend, helped along by Gordon Brown with his auction.

This unheard of method of selling central bank gold (usually it was done on the quiet and announced later) was not endorsed by anyone and really only left two conclusions: either he was stupid or it was a conspiracy.

For an example of the latter, see this 25 May 1999 posting by GATA:

A political decision was made by the British to make sure the price of gold did not rise above the key $290 gold carry trade borrowing point of the bullion dealers and to make sure that the price would tank when the first pre-gold sale announcement in more than 20 years was made.

Since that time the the gold price has risen from $250 to $1000, which implies a very unsuccessful manipulation. In some sense this is true. Consider that around 2001/02 the total amount of gold leased out was estimated between 10,000 and 16,000 ounces (see this Golden Sextant commentary) compared to approximately 30,000 ounces of central bank holdings.

One could conclude the increase in gold from 2002 to 2009 is proof the manipulators ran out of firepower (ie gold to lease to support short selling) over that time.

If indeed central banks have leased all they can, then one would assume that the market is finally poised at the crucial tipping point that the commentators from those early days have been waiting for, where further physical buying that is already in excess of mine and scrap supply will overwhelm supply from short sold leased gold, resulting in a parabolic rise in the gold price as the shorts are broken, scrambling to cover their positions being unable to post sufficient collateral to cover the huge rise in gold.

This is the 1980 spike revisited, but at a much higher inflation adjusted price. How high? There are as many guesses as their are commentators - $2200, $5000 or more? This is the end game that many goldbugs have been waiting for, when they can shout "we won"!

But will they have won? I would argue not. I would argue that such a scenario would actually be the death of gold.

Those who welcome a 1980s spike have lost sight of the real war. There are others who are driven by base greed. They have fallen into the trap of seeing gold as an investment. It is no such thing. It has no power to create wealth - it is an inert thing. It is only the entrepreneur and inventor who create wealth. Hawking gold as an investment is bubble behaviour, no different to the debt fueled bubbles in stocks and real estate. Such people are no friends of gold.

Gold is money. Often stated, but what does it mean? Gold is for storing wealth, not making it. I can only suggest reading Whither Gold? by Antal Fekete if you want to get what I am talking about. Those who understand this understand that the real war is gold as money versus fiat as money. The winner is the one that can demonstrate an ability to store wealth.

One may argue, how can fiat win when it has lost 95% of its value since the Federal Reserve came into power in 1913? This is too broad a sweep of time for the average person. They look only year to year, and single digit inflation looks stable to them. There is some vague understanding that money loses value, but it is not dramatic and anyway, the way to deal with this is to "invest".

To beat gold in this war, all you have to do it make it look unstable. This is why a parabolic rise in the gold price is counterproductive. It makes the average person see gold as a speculative investment, worst still, one that does not pay a dividend. Parallels to 1980 will be drawn, focusing on the bust after that bubble. This does nothing for gold's image as a stable store of wealth.

From this point of view, the theory of suppression of the gold price misses the point. To kill gold you don't manipulate its price, you manipulate its volatility. If gold looks unstable, it is unlikely that a gold standard will ever be accepted.

Therefore, at the one moment in time when people may lose faith in debt based investing as a way to beat inflation and preserve wealth, when they are looking for something else more stable, gold will fail to win them over.

I mentioned earlier about a tipping point. I would like to conclude with one last idea: one other advantage of manipulating volatility rather than price is that your firepower lasts longer. All you need to do is start a trend, or help a trend along. Herd behaviour and chartist momentum will do the rest. Bullish or bearish, it doesn't matter. As long as the price moves wildly, your ends are served. For those that believe in manipulation this thesis means we are not at a tipping point and the manipulation has many more years to run.

Disclosure: long gold.

Comments

[Chandragupta:]

Good article. You have made valid points. However, you need to go one step further and answer the following question - how does one define 'volatility'? If one is measuring Gold's volatility against other fiat currencies, it only gives volatility of those other currencies when measured in Gold! Thus, one needs to measure volatility vis-a-vis 'purchasing power' - against other goods, services and commodities which have utilitarian value.

Jun 28 07:44 AM

[DONE_SONZ:]

Chandragupta-Gold's volatility against fiat currencies.The fiats are what's looking unstable.

Jun 28 08:12 AM

[Roger Knights:]

"To kill gold you don't manipulate its price, you manipulate its volatility."

Very acute.

"Therefore, at the one moment in time when people may lose faith in debt based investing as a way to beat inflation and preserve wealth, when they are looking for something else more stable, gold will fail to win them over."

But a central bank like China's, which is looking for a safer place than fiat to park its reserves, could, at a minimum, adopt a policy of buying only on dips.

Furthermore, for such a large central bank, volatility would not matter as much as for a private investor or fund. Its own purchases would suffice to put a floor under the price and dampen the volatility. China, being flush with cash, is in the enviable position of being able to overawe the market, gold being a thin market. It can set its own terms, which used to be the prerogative of the dollar. (Once California defaults, the dollar is going to take a big hit, and China will have the excuse it needs to start shifting its holdings elsewhere.)

Lastly, China, if it intends to become an economic hegemon in Asia, will need to back the Yuan with something more substantial than fiat. Therefore, it has a strategic interest in holding gold, not just an investment interest.

Jun 28 08:25 AM

[Roger Knights:]

PS: Gold has one new attraction to investors: it dampens the volatility, or beta, of the rest of a portfolio. It unexpectedly performed much better than other diversifiers during last year's meltdown, with the result that it is now on the verge of becoming standard practice for portfolios to include at least a sliver of gold or gold mining stocks. This should help dampen volatility in gold, and raise its price level.

Jun 28 08:29 AM

[vati01776:]

He talks about central bank lending of 10,000 to 16,000 ounces to the carry trade. That range may be correct, but the term is tonnes, not ounces. Those numbers of ounces would be peanuts in the scheme of things.

Jun 28 09:24 AM

[capt Brian:]

I am buying gold when I can scrape together enough of our wonderful currency to get more, silver too for that matter. I try to buy 10 times value [current price] more silver than gold, and I am selling off all un-needed items around the house, and changing into gold.

Right or wrong, that new gold eagle sure feels good in my hand, and knowing it is in the bank vault. I have pleanty in 'cash investments' so what is wrong with holding a 'proper amount of gold'?

Happy grins
Capt Brian

Jun 28 09:58 AM

[secmaven:]

Gold as money. What a concept. It is only 6,000 years old.

Jun 28 11:03 AM

[Boxed Merlot:]

"How high? There are as many guesses as there are commentators - $2200, $5000 or more? This is the end game that many gold bugs have been waiting for, when they can shout "we won"!
But will they have won? I would argue not. I would argue that such a scenario would actually be the death of gold.
Those who welcome a 1980s spike have lost sight of the real war. There are others who are driven by base greed. They have fallen into the trap of seeing gold as an investment. It is no such thing. It has no power to create wealth - it is an inert thing. It is only the entrepreneur and inventor who create wealth. Hawking gold as an investment is bubble behaviour, no different to the debt fueled bubbles in stocks and real estate. Such people are no friends of gold"

I see this as the same paradox alchemists would face if able to create gold in a test tube. (However, as a base element, I understand it’s kind of like a prime number, it can’t be reduced.) But, like the story of aluminum, if new stores and/or methods of extraction were increased / improved in such a scale to bring about making it more plentiful, (supply and demand), then the value per unit would adjust accordingly. I just don’t see it happening anytime real soon.

Nor do I see the other side of the equation as being fiat money, but rather the “good faith and credit” of the entity the fiat is tied too. That’s the rub. This is the element that’s tied to Law. The stability of societies is not in the amount of Au, (or even fiat), that’s possessed, processed or printed but in whether the right of possession, due process and free press will be honored.

As an illustration, what good would it be if China backed their currency to a gold standard but remained a closed system? Having their currency tied to it necessarily carries with it the definition that their printed instruments can be redeemed for it which carries with it the risk it could be transported outside of their jurisdiction, thereby reducing their store or ownership of it. This sounds complicated, but it's actually extremely simple. Wealth equals obedience to this law, and this element of risk, (or freedom if you will) is its foundation. I'm glad the US is based as a Republic, (honoring the rule of law) and to the extent we lose our commitment to this ideal, we suffer. Our currency just reflects this reality.

End of rant 2

Jun 28 11:16 AM

[HardMan:]

Gold is an established currency from ancient times. It is a finite metal that has held value through all of mans folly. Mans manipulation of Gold’s value, through what ever means, will only lead to a parabolic price pattern based on demand and greed. Wealth can be achieved by recognizing this fact and buying low and selling high. Although gold’s value is presumed constant adjusted to fiat currencies change, mans greed will drive it to excessive prices when the manipulation efforts fail. Why not take advantage of this once or twice in a lifetime opportunity.

Good Fortune, HardMan

Jun 28 11:21 AM

[ilc:]

Great article. Gold is a store of value, not an investment, and "the manipulators" are nowhere near done trying to keep people trapped in their shabby fiat currencies.

Jun 28 12:23 PM

[knight:]

Oil doesn't pay any dividends but it is used an a tool for investment so why not gold? You believe the world is printing to much money you buy gold 1. To preserve your wealth 2. So it can multiply vs fiat currencies.

Jun 28 02:44 PM

[HA65MPH:]

gold , ...is the only thing the govt. fears we have , they want us tied to fiat- dead presidents ...if you hold gold ''the real stuff'' in your hand , and a gun in the other , we can remain free !..jmho..

Jun 28 03:17 PM

[ducat:]

I have a couple of bones to pick with the article. First, the comment: "This is the 1980 spike revisited, but at a much higher inflation adjusted price. How high? There are as many guesses as their are commentators - $2200, $5000 or more? This is the end game that many goldbugs have been waiting for, when they can shout "we won"!"

Let me point out that gold was priced at about $40/oz in 1960. It rose in bumps and bounces to a blowout spike of $800/oz...and then "crashed" to average about $400. for two decades. A factor of 20x to the peak and a retreat to 10x. I suggest that a burst from $500 times twenty would put that 1980s blowout look like $10,000/oz today. A 50% retrenchment would take us back to $5,000/oz. This my friends shows that periodic readjustments take place relative to gold and the denominated fiat currency.

The second issue is this old mantra of "gold pays no interest". What kind of logic is that? Microsoft has paid no interest and only one surprise dividend last year(?) over it's exciting (and profitable) lifetime. The value of the shares (think ounces) was and is supported by the underlying value of the company assets. Why is it so hard to grasp the possibility/fact that gold's underlying value has and will increase because it is simply worth more in the denominated currency. The currency is/will buy less essential goods as time goes by and the amount of new gold grows at a significant lower percentage rate than the the world population and commercial monetary needs. I think this "volatility" crash theory is fools grasping at a straw.

Jun 28 03:43 PM

[Mad Hedge F...:]

I see you're a newcommer. Brace yourself for the impending gold shortage. Gold shortage? Yup. Last year, South Africa suffered its steepest decline in gold production since 1901, falling 14%, to a mere 232 tons. It now ranks only third in global production of the yellow metal, after China and the US. Severe electricity rationing, a shortage of skilled workers, and more stringent mine safety regulations have been blamed. Choked off credit has frozen the development of new capital intensive deep mines, as it has for everybody else. Rising production costs have driven the global breakeven cost of new gold production up to $500 an ounce. In the meantime, the financial crisis has driven flight to safety demand for gold bars and coins to all time highs. Last year, the US Treasury ran out of one ounce $50 American Gold Eagle coins, now worth about $980. Competitive devaluations by almost every central bank, except Japan, mean that currencies are not performing as the hedge that many had hoped. It all has the makings of a serious gold shortage for the future. Could last year’s downturn be a blip in the eight year bull market? When we break $1,000, which could happen any day now, watch out above!

Jun 28 04:01 PM

[5142152-337:]

Capt Brian: GET THAT GOLD OUT OF THE BANK VAULT!!!!!!!! You want that gold/silver for YOU, not in Obama's pocket. He will be ransacking those boxes real soon! Do yourself a favor and get that outta there, seriously! Bury it in the backyard, buy a safe, anything but a bank safety deposit box. This is a public service announcement!

Jun 28 05:01 PM

[The Honest ...:]

Is Gold (GLD) a Buy Here? Technical Analysis

This dude is pretty popular on the net and indicates right now on the charts an entry in the GLD is about as good as it gets.

thehonesttrader.blogsp...

Jun 28 05:09 PM

[billyboy54:]

Very good points, and just to complete the anti-gold bugs' argument: You can't take a share of MS to the store and buy groceries, and also, MS if not good to eat or drink.

Like the author of this article, all the anti-gold people regurgitate the same old tired arguments, as gold steadily increases my portfolio value.

Harry Schultz advised two years ago to have AT LEAST 30% of the portfolio in gold and PM and PM stocks.

I took his advice and now have more money than I did at the height of the market in Oct 07, and that includes withdrawals over those years.

THAT's why I hold gold and silver.


On Jun 28 03:43 PM ducat wrote:

> I have a couple of bones to pick with the article. First, the comment:
> "This is the 1980 spike revisited, but at a much higher inflation
> adjusted price. How high? There are as many guesses as their are
> commentators - $2200, $5000 or more? This is the end game that many
> goldbugs have been waiting for, when they can shout "we won"!"
>
>
> Let me point out that gold was priced at about $40/oz in 1960. It
> rose in bumps and bounces to a blowout spike of $800/oz...and then
> "crashed" to average about $400. for two decades. A factor of 20x
> to the peak and a retreat to 10x. I suggest that a burst from $500
> times twenty would put that 1980s blowout look like $10,000/oz today.
> A 50% retrenchment would take us back to $5,000/oz. This my friends
> shows that periodic readjustments take place relative to gold and
> the denominated fiat currency.
>
> The second issue is this old mantra of "gold pays no interest". What
> kind of logic is that? Microsoft has paid no interest and only one
> surprise dividend last year(?) over it's exciting (and profitable)
> lifetime. The value of the shares (think ounces) was and is supported
> by the underlying value of the company assets. Why is it so hard
> to grasp the possibility/fact that gold's underlying value has and
> will increase because it is simply worth more in the denominated
> currency. The currency is/will buy less essential goods as time goes
> by and the amount of new gold grows at a significant lower percentage
> rate than the the world population and commercial monetary needs.
> I think this "volatility" crash theory is fools grasping at a straw.

Jun 28 05:47 PM

[TinyTim:]

interesting article, even for a student economist, not a gold bug.
Antal E. Fekete link was very good.

Gold is a store of value, not an investment. It has no intrinisic rate of return. The only reason a rate of return (or investing for that matter) is necessary is because of inflation. Otherwise, simple saving would be sufficient. The difference between saving and investing is risk. So inflation forces risk taking behavior.

In a market with non-fiat currency and no fractional reserve banking, inflation would be non-existant. Gold or paper money would be a reliable store of value and value would not decline over time, so only savings would be necessary.

In our current situation, as the thesis of this article, gold is an investment because of its price volatility and this creates marginal use as a store of value. If gold prices were non-volatile and followed the general price levels (an unlikely event), it would make a good store of value and savings instrument.

Jun 28 06:25 PM

[Bron Suchecki:]

vati01776: yes, the 10,000 "ounces" should have been "tonnes".

Chandragupta: yes it may be the volatility of fiat, but the point is that the average person doesn't see it this way, all they see is that gold is "risky".

Roger Knights: the World Gold Council has been pushing the portfolio argument for many years, but it goes over the head of most simple investors, unfortunately.

billyboy54: "Like the author of this article, all the anti-gold people" Why do you think I am anti-gold? If so, what is my name doing here: www.goldstandardinstit...

Tiny Tim: "inflation forces risk taking behavior" Excellent point, worth an article alone on this point.

Jun 28 09:15 PM