After having taken a break from writing articles for a while and resolving not to write about gold (NYSEARCA:GLD) for a bit, this week I finally got back to working on an article on why I think this market continues to give strong bullish stock market signals through 2014, with a modest possibility of a dust-up in the fall of this year.
But, Ben Bernanke's comments about gold before the Senate Banking Committee today have got my dander up (whatever that means), and I just cannot resist saying something about them.
Here is Bernanke's quote on gold, according to Reuters:
Gold is an unusual asset. It's an asset that people hold as disaster insurance. A lot of people hold gold as an inflation hedge. But movements of gold prices don't predict inflation very well, actually. But anyway, the perception is that by holding gold you have a hard asset that will protect you in case of some kind of major problem. I suppose that one reason gold prices are lower is that people are less concerned about extreme outcomes, particularly negative outcomes and therefore they feel less need for whatever protection gold affords...
Gold price going down is not necessarily a bad thing from that perspective. It suggests people have somewhat more confidence, and are less concerned about really bad outcomes. But let me just end by saying that nobody really understands gold prices, and I don't pretend to understand them either.
I have commented on the relationship between gold prices and inflation and "extreme outcomes" before, but what bothers me about this remark from Bernanke is that, despite what he says, there certainly seems to be a consensus about what drives gold prices amongst his fellow academicians, including some who are purported front-runners for the Chairman's job when he steps aside.
Their favorite explanation is real interest rates. Summers and Bob Barsky wrote the standard treatment of gold prices (as well as metal prices more generally) in the early 1980s, an explanation that has been restated in simplified form by more voluble economists like Brad DeLong and Paul Krugman in recent years.
It is interesting, therefore, that Bernanke should say that "nobody really understands them."
On the one hand, I agree. I do not believe anybody does "understand" gold prices. But, I would go so far as to say nobody understands commodity prices (NYSEARCA:GSG) at all (although there are something like six billion people on this planet whose opinions on commodity prices are generally foreign to me). What does seem likely, however, is that (real) gold prices--like real commodity prices for the last 140 years--have been intimately connected to the earnings yield since gold prices have been set by the market.
And, as I have argued before, it is likely that commodity prices have been highly correlated with the earnings yield as far back as 1730, the beginning of what Keynes called "Gibson's Paradox," the correlation between producer prices (read: commodity prices) and interest rates under the gold standard.
The Barsky-Summers real interest rate solution clearly no longer holds up, but the connection between commodity prices (including gold) and the earnings yield has been going strong for centuries. (See charts below).
It's true, I think, that we don't understand what drives gold and other commodities, but it would certainly help if we started looking in the right direction.
Charts: Real interest rates or the earnings yield?
(Source: Real gold data from Jastram's; real yield data from Robert Shiller)
(Sources: Shiller, World Bank Pink Data)
Additional disclosure: I am long Dow futures and short gold.