The Three Types of Gold Buyers

The spectacular rise in gold, now hovering in record territory, has been fostered by three very different conceptions: gold as a trader’s choice, gold as a theoretical proof and gold as a historical metaphor.

For the believers in metaphor the ascent of the metal is an augury for the decline of the West; for the theoreticians it is the only secure defense against inflation; for the traders it is a momentum purchase not to be missed. All three groups are buying gold and, as yet, none have been proven wrong.

If we translate these speculations into currency terms the traders promise a long position with better returns than any other investment. The theoreticians predict a global currency system ravaged by government inflation and a revolving cast of devalued national scripts. And the third intimates the ultimate end of the dollar as the world reserve currency presumably replaced by the yuan. All three foresee a continued fall in the value of the dollar.

The economic logic of the three groups of gold supporters is currently aligned and all are profiting from the rise in prices. But it would be remarkable if three such disparate scenarios remained in tune for long.

The East may indeed replace the West as the dominant global economic center but it will not do so in time for the ‘metaphorical Spenglerians' (so named for Oswald Spengler who published The Decline of the West a long ago as 1918) to take profit on their investment. Even if the dominance of the West has peaked the decline will be slow and erratic and these position takers will miss their profit levels waiting for the final collapse.

For the theoreticians or monetarists, the second group of ‘gold bugs,’ inflation will suddenly spring out of the ground like the product of so many governmental dragons’ teeth. Inflation is inevitable. Increase the money supply and inflation follows.

The problem with this idea is current practice. With prices stationary or in decline in many industrial economies and unemployment at a new and much higher normal, it is hard to see how firms can extract higher prices from consumers when cheaper international goods are so readily available. Whatever the theoretical prospect for inflation, the current empirical evidence points the other way, toward deflation.

For the third group, the traders, theory and metaphor are irrelevant. The global financial system is under a soothing blanket of liquidity. The central bankers who have warmed the world with cash and who are now (we assume) very aware of the danger of prolonged cheap credit will (we assume), sooner or later, begin to draw back the protecting cover of liquidity. But the reabsorption of liquidity by the banks is wholly conditional on economic recovery. The most forthright of the world’s central bankers, Ben Bernanke of the US Federal Reserve has stated this over and over; there is no reason to doubt his word.

The gold buyers in this group believe the Chairman. Until the central bank begins to tighten credit, excess cash and the pursuit of trading profit determines the price of gold. It does not matter that the bankers say they will tighten credit when the proper time comes, what matters is action. Until the banks actually begin to raise rates and subtract liquidity, for them, gold is a solid buy.

Of the three scenarios the first, the ‘Spenglerian,’ is the most impervious to evidence. It exists apart from factual verification. Put it another way, it is always possible to find evidence that the West is declining. It is just a matter of choosing the right statistics. In practical and emotional terms this group will always be long gold, though it is in unsettled times like ours that they do the most buying.

For the monetarists, results depend largely on logic and economic equations. If so much liquidity is loosed on financial markets it must over time (duration unspecified) produce inflation. It is a simple monetary equation; a rising pile of cash chasing a much more slowly rising pile of goods and assets. Over time inflation is the end product. But inflation is not solely the product of a balanced equation between cash and goods. Firms must be able to raise prices and consumers must be able to pay those higher prices and those last factors are now very much absent.

Yet economic stagnation and inflation are not mutually exclusive. If returning American economic growth is not sufficient to reduce unemployment what are the chances that the Fed will commence raising rates regardless of the price index? And if on the other side of the world East Asian economic growth takes off and forces commodity and goods prices higher those prices will shortly be felt in the United States. Irrespective of what the US economy is doing the world’s markets can export inflation to the US.

What would prevent the price of oil from climbing as it did last summer if the Chinese, Indian and Brazilian economies accelerate and that third of the world creates its own economic cycle? Will the US be dragged by East Asia into robust recovery? Unknown. But the effect on the overextended American consumer and economy of $100 oil is not unfathomable. There is no certainty that the world economy will be dynamic enough to force prices higher in the US. But if inflation comes in the US it will probably arrive from overseas and US domestic liquidity will have done little to create it.

For the Fed to raise rates, and by default defend the dollar, US economic growth will have to be strong enough to begin to take down the unemployment rate. This is an entirely unsure prospect.

US consumers are tapped. There has been no sign in retails sales or consumer credit that the drivers of US growth have resumed their seats behind the wheel. The effect of a weak dollar on US exports may be pronounced. Shipments may increase enough to substantially reduce the trade deficit, but the US is not an export driven economy nor is its work force widely engaged in manufacturing. Exports may grow appreciably without it having any noticeable effect on American unemployment. Exports might look excellent to economists and free traders without US workers feeling any better or increasing their spending.

Of the three gold buying groups, the monetarists and the traders are most susceptible to Fed policy changes. But the traders are likely to act first. For them the earliest indication of a genuine change in Fed policy will be enough to abandon their long gold positions for profit. Monetarists are likely to wait until they are sure the Fed will act and then wait again until there is proof that the Fed has acted in time to prevent inflation.

And here we have the pernicious effect on the dollar. Until the Federal Reserve reestablishes the link between economic growth and interest rates the logic of the gold buyers is inescapable. Gold is not predicting a decline in the dollar or the inevitable advent of inflation but it is promising that without a vigilant Fed the first will continue and the second creep ever closer.

Comments

[squozzer:]

Your logic makes sense. What I'm trying to figure out is how historical examples of hyperinflation such as pre-WW2 Germany, Brazil, Mexico and Argentina fit into your evidence. Or forget history, what about Zimbabwe? And didn't the Fed recently stop publishing some of its' money supply metrics?

Oct 16 05:23 PM

[doubleguns:]

You forgot hoarders, true gold bugs. We buy because we dont like fiat and we dont trust govt, we generally dont like or trust anyone for that matter. We encompass all of these 3 groups. We believe the west is failing, the dollar is failing and its a great investment although we rarely sell ;-{

Oct 17 12:58 AM

[fleeing omega:]

"Irrespective of what the US economy is doing the world’s markets can export inflation to the US."

That's a great point that has troubled me a lot recently.

While I perceive the US to be in a deflationary mode, even though the Fed is going ape with the printing presses, I agree with the author that the most likely proximal source of inflation would come from East Asia and that this is basically out of the Fed's control. If and when this happens, the US could get booted out of the great recession and into the inflationary depression.

Obviously, I am not one who believes we are in the upswing of a V shaped recovery and although China is showing some stimulus-related bounce I am not convinced they are out of the woods yet either. Right now inflation seems to be on a tear in China and it is pretty amazing that that hasn't come back to bite us, or not quite yet.

What puts me in with the Spenglerians, as you call them, is that I think the never ending can-kicking policy decisions mean that additional, severe financial dislocations are basically guaranteed at this point.

Oct 17 01:42 AM

[Albertarocks:]

This is a well thought out and very well written article but I don't agree with it completely.

>With prices stationary or in decline in many industrial economies and unemployment at a new and much higher normal, it is hard to see how firms can extract higher prices from consumers when cheaper international goods are so readily available. Whatever the theoretical prospect for inflation, the current empirical evidence points the other way, toward deflation.<

First of all, we have to review and understand exactly what inflation is. Theoretically, the amount of goods on the planet is a fixed quantity (think of commodities just to make it simple), being chased by a variable number which of course is the increasing amount of printed fiat currency. Whether we are seeing the "effects" of inflation today or not is more or less irrelevant because the "effects" (rising prices starting with commodities) is inevitable. We WILL see it. True enough, there may be a brief and violent period of deflation first. I think we'll see that when the stock markets resume their secular bear trend to the March lows and beyond. That means we'll almost assuredly see a brief and violent reaction in the form of a surging dollar. It'll likely last no longer than a couple of years. That will probably revolve around the issue of scrambling for dollars to pay off debt in the short but furious bout of deflation.

But thereafter...

Even if foreign goods are held at as low a price as possible or better yet at a constant, when those goods hit the shores of the country that has printed the most fiat (USA), that country receiving the goods (USA) has no choice but to pay with a dollar that is worth less than it was last week. There you have it... the effects of inflation. If the currency is falling in value (and the charts pretty much show that the American dollar has gone over a cliff...for now), then the foreign supplier needs to be paid more American dollars than he charged last week, because the American dollars he's receiving are now worth less than they were last week. The supplier of goods "has to charge more" or he goes broke... or else he won't sell.

>it is hard to see how firms can extract higher prices from consumers when cheaper international goods are so readily available.<

It's not a matter of extracting higher prices. It's a matter of having no choice but to charge more. The fact that the consumers may no longer be able to afford the goods (IOW higher prices indeed cannot be extracted from him) is a sad consequence. Nonetheless, the sad truth that the consumer needs more worthless dollars in order to buy that loaf of bread... is beside the point. The baker had to pay more for his raw materials. So he has to charge more... he has no alternative.

The result therefore is an inflationary nightmare where the masses can not afford to purchase... yet the inflation will continue in spite of fewer sales. As long as the cost of raw materials increases due to a currency that is decreasing in value, costs are going to go higher, whether goods are sold or not. Therefore a lot of the goods won't be sold, or worse yet, they won't even be manufactured. It becomes a vicious circle where inflation rages, sales decrease, employment decreases, in spite of the fact that the foreigners may have actually held their prices steady in terms of their own currency. In other words, the foreign supplier isn't gouging... it's the other way around. WE are offering them paper that is more worthless than it was last week. How is that the foreigner's fault?

The foreigners have not exported inflation to the USA. The inflation that's going to be felt in the USA is a good old "made in the USA" product engineered by the FED. The FED has created inflation out of thin air. It's called the printing press. Too few American dollars chasing whatever goods the American people need is not the fault of foreign countries who are not responsible the the FED's actions. The idea of blaming foreigners for "exporting inflation" is a case of failing to look in the mirror and admit the facts... "Houston, we've got a problem... and it's called the FED".

Oct 17 02:02 AM

[Anthropus:]

Perhaps if we look into the 20's crisis which, for many, was triggered by the FED (USA), we may find a possible life savers for the consumer if not an attenuating impact tool.

Oct 17 06:56 AM

[Anthropus:]

Perhaps looking into the 20's crisis, which for many it was caused by the FED (USA), we may be able to find a possible attenuating tool to help by the loaf of bread. Or not?

Oct 17 07:06 AM

[The Dark Years:]

What is in your pocket, safety deposit box, or under the bed? Is it plastic, electronic trading certificates, world currency, a deed, mortgage papers, or a few old silver coins, and maybe a few of gold?
Given the very real prospect of continued world wide economic disruption it seems reasonable to have some backup that has the prospect of being an acceptable currency substitute. Having a fist full of of one ounce gold coins seems a good idea.

Very few of the Seeking Alpha articles, or the commentary that follows have mentioned the reality of Peak Oil and it's Affordability, Peak Potable Water Availability and the impact that those forces would have on Peak World Food Production. Meanwhile the world population increases and with it demand for all three of the above. If those concepts seem wrong in the short term, they cannot be denied in the longer term, nor can we or governments do much about them. Since virtually everything in the world economy depends on inexpensive oil and there is less available forecast for the future at a rate of about 5% decline annually it is reasonable to predict economic turmoil, and perhaps resource wars over commodities. Would you rather have some gold as a holding in your pocket, or a piece of paper backed by the government that promised it had value? In the short term I personally will continue to trade gold and silver ETFs, and when I have spare cash acquire a few gold coins. If I am wrong over the longer term at least my children will have some nice trinkets to show their friends.

Oct 17 10:53 AM

[sorgmot:]

In the USA now (Oct 17, 2009) $ prices of goods, services, capital goods, and securities are going two ways at the same tine.

Up when supply is limited by nature (gold,silver,copper) or monopolies or cartels (oil, breakfast cereals, and things made by strong unions) or the common stocks of companies which are monopolies or cartel members and down when prices are competitively set in a free market as for example houses and buildings.

Your house 's market value goes down while bank stocks go up.

Your paycheck goes down while food and gasoline prices go up.

Retails, sell fewer items but at higher prices and layoff help and cut pay rates. Towns raise real estate taxes and the US Government raises income taxes.

Oct 17 11:16 AM

[Albertarocks:]

Here's an example I should have included in my post above:

Canada is a friend of the USA. Canada fits into the category of foreigner nonetheless, so let's use it as a proxy for "foreigners" since Americans understand Canada far more than they understand China (just for example). And Canada is getting crushed (well, not crushed, but it's manufacturing sector that exports mainly to the USA is hurting real bad) due to the fact that it's dollar is surging in value.

From the American perspective, it could be argued that Americans think Canada is "gouging" or "exporting inflation to the USA". Nothing could be further from the truth. Canada DOES NOT WANT to have to charge more for its goods, but it has no choice because the dollars that are flowing into Canada for their goods are worth less today than they were last month. It's not Canada's fault!

In this matter, Americans are kind of strange in that they don't yell and scream at their buddy up north because they understand the problem. But when the discussion turns to China or Japan, they tend to get a little bit angry and blame those "foreigners". The problem is "home grown" and if Americans would only direct their well founded anger in the right direction, the problem would have been solved long, long ago.

Oct 17 01:18 PM

[Chancer:]

My opinion is that Fed is going to have twin problems of permanently higher unemployment (than we have had in past) and permanently slower growth (than we have had in past). This does not bode well for their "tool" of increasing rates.

I heard a stat today- don't know if absolutely correct. We have a $14 trillion economy and $108 trillion of debt, including obligations of Social Security and Medicare.

It is hard to envision how the government can generate tax revenue to pay down the debt.

I believe the Democrats will push for value added tax in Obama's second term to pay off the debt. But that VAT will have to be sizeable to even make a dent in the debt. This is a huge problem. The math to accomplish this does not work out.

Oct 17 02:45 PM

[yellowhoard:]

If you were forced to buy $10,000 of one asset to hold onto for 30 years, that would pass onto your children, what would that be?

30 year government bonds?
Corporate bonds?
General Electric stock?
Microsoft stock?
Land?
Gold?

All of these, except one, have counterparty risk.

Even land is a hostage to appetite of government taxation. Given the outlook for real estate, I'm not sure that I would take for free a piece of ground that I had to hold for 30 years.

Oct 17 03:55 PM

[Albertarocks:]

On Oct 17 03:55 PM yellowhoard wrote:

> If you were forced to buy $10,000 of one asset to hold onto for 30
> years, that would pass onto your children, what would that be?<br/>
>
> 30 year government bonds?
> Corporate bonds?
> General Electric stock?
> Microsoft stock?
> Land?
> Gold?
>
> All of these, except one, have counterparty risk.<

And if I'm not mistaken, that same one is the only instrument that can accumulate value tax free in your vault.

Oct 17 05:10 PM

[TheFounder:]

The extreme scenatios almost never come true. All the guys with the canned food, ammo, cabbin in the woods and gold coins under the pillow are grossly overreating.

If i need to choose between the gold bugs reality judgment and the fed's, i put my $$ on the fed.

But the more gold bugs are out there, they just add to the general demand. And most people believe inflation is innevitable, which will ad yet more demans for gold.

That makes it a pretty reasonable trade. I guess that means I am a momentum trader.

Oct 17 05:21 PM

[Albertarocks:]

On Oct 17 05:21 PM TheFounder wrote:

> The extreme scenatios almost never come true. All the guys with the
> canned food, ammo, cabbin in the woods and gold coins under the pillow
> are grossly overreating.<

I sure hope you're right, but when you consider that the exposure the banks have to dangerous derivatives is said to be $600 trillion, the stage is set for a potential scenario that's so bleak you and I can't even imagine it yet. They're not only playing with fire, they're playing with a massive, massive bomb.

Just to show you how serious this is, at today's rate of production from every gold mine on the planet, it would take mankind 7400 years to mine an equivalent amount of gold. That's not a guess, it's a fact. There isn't that much gold on the planet. In fact, I'd think that after only 1000 years of gold mining, it might be getting a little hard to find, no?

> If i need to choose between the gold bugs reality judgment and the
> fed's, i put my $$ on the fed.<

I wouldn't.

Oct 17 05:28 PM

[optionsgirl:]

How about if that land is in Australia, Canada, New Zealand, or some other commodity rich country with a democratic stable government? Would your opinion of land change then?


On Oct 17 03:55 PM yellowhoard wrote:

> If you were forced to buy $10,000 of one asset to hold onto for 30
> years, that would pass onto your children, what would that be?<br/>
>
> 30 year government bonds?
> Corporate bonds?
> General Electric stock?
> Microsoft stock?
> Land?
> Gold?
>
> All of these, except one, have counterparty risk.
>
> Even land is a hostage to appetite of government taxation. Given
> the outlook for real estate, I'm not sure that I would take for free
> a piece of ground that I had to hold for 30 years.

Oct 17 06:39 PM

[yellowhoard:]

Or Chile perhaps?

Oct 17 06:49 PM

[optionsgirl:]

Let's take this to TBP private message re Chile.I'll contact you tomorrow. My husband is going to kick the chair out from under me if I don't step away from the computer!


On Oct 17 06:49 PM yellowhoard wrote:

> Or Chile perhaps?

Oct 17 06:55 PM

[TinyTim:]

Yellowhoard-
No concern for govt rounding up gold stashes?
Don't forget, it happened once.

Oct 17 07:27 PM

[doubleguns:]

I find it unconscionable that you would consider that BO would have a second term. Since you do, I believe anything that you spout is suspect. Sorry but we are talking about realistic situations here.


On Oct 17 02:45 PM Chancer wrote:

> My opinion is that Fed is going to have twin problems of permanently
> higher unemployment (than we have had in past) and permanently slower
> growth (than we have had in past). This does not bode well for their
> "tool" of increasing rates.
>
> I heard a stat today- don't know if absolutely correct. We have a
> $14 trillion economy and $108 trillion of debt, including obligations
> of Social Security and Medicare.
>
> It is hard to envision how the government can generate tax revenue
> to pay down the debt.
>
> I believe the Democrats will push for value added tax in Obama's
> second term to pay off the debt. But that VAT will have to be sizeable
> to even make a dent in the debt. This is a huge problem. The math
> to accomplish this does not work out.

Oct 17 09:43 PM

[doubleguns:]

It passes on to our children. That means the govt gets none. Even if I have to bury it in the septic tank.

Ya wanna look in there do ya? I doubt the govt stooge will either!!!


On Oct 17 07:27 PM TinyTim wrote:

> Yellowhoard-
> No concern for govt rounding up gold stashes?
> Don't forget, it happened once.

Oct 17 09:47 PM

[The Geoffster:]

70% of world wide debt is denominated in dollars. U.S. monetary and fiscal policy is debauching the dollar at the expense of creditors. U.S. policy makers are hoping for a controlled descent but, market forces will eventually prevail. As these credits spiral downward, the dominoes start falling and it's a race to the exits. At that point, the only viable currency is gold.

Oct 17 10:21 PM

[Albertarocks:]

On Oct 17 09:47 PM doubleguns wrote:

> It passes on to our children. That means the govt gets none. Even
> if I have to bury it in the septic tank.
>
> Ya wanna look in there do ya? I doubt the govt stooge will either!!!<

LOL! Dude... if you're gonna stash some gold for your kids, bury it in the garden or something. Even the kids won't take a swan dive into the septic tank... gold or no gold.

Oct 18 12:37 AM

[Diegojames:]

Reasons for Gold
1. Federal Reserve has screwed us all from dementia Greenspan, B.Frank, Fannie and Freddie and AIG and CDO's to present day
2. War with Iran
3. Middle East countries adopting a basket of currencies in place of the US dollar
4. you like to handle it
(but at a high price?)
5.Bernanke who wants a job is whipped by Nancy Pelosi, Harry Reid , Barney Frank, Dodd, Summers, et al. and does idiotic things
6. California, the liberal capital of the world , power companies ...plus 20 other bankrupt idiotic states need a bail out....
7. China buys Africa and Australia or the USA

Hopefully your septic tank can produce bio fuels ....but I own integrated oils such as Occidental Oil -OXY- because it is mainly in the USA and produces the next fuel -CNG-
Also XTO, BP, Nokia, XOM,CNX,CVX,CCJ,BMY,and a little cvs.
These will rally as oil spirals higher forcing CONGress to shut up and deal the right cards.

Just Make Federal Clinics and healthy food centers for those who are broke and stream line insurance companies who exist for paper profits and do nothing and cap their salaries, drop the idea that costs go up every year...just freeze them...and shake out the badly run companies until they modernize....tax large chain pharmacies for building so many drugstores that are not efficient....claw back ALL WALL STREET BONUS MONEY and use it to start up FEDERAL CLINICS similar to fannie or freddie.

Oct 18 08:53 PM

[optionsgirl:]

The VAT is frightening. It adds additional tax burdens to every level in the process, from purchase of raw goods through manufacturing and then the final sale. Therefore, it has the potential to add many layers of taxes to our already overburdened load. I don't know how to get the message out to enough people to recognize the dangers of a VAT and how crippling that will be.


On Oct 17 02:45 PM Chancer wrote:

> My opinion is that Fed is going to have twin problems of permanently
> higher unemployment (than we have had in past) and permanently slower
> growth (than we have had in past). This does not bode well for their
> "tool" of increasing rates.
>
> I heard a stat today- don't know if absolutely correct. We have a
> $14 trillion economy and $108 trillion of debt, including obligations
> of Social Security and Medicare.
>
> It is hard to envision how the government can generate tax revenue
> to pay down the debt.
>
> I believe the Democrats will push for value added tax in Obama's
> second term to pay off the debt. But that VAT will have to be sizeable
> to even make a dent in the debt. This is a huge problem. The math
> to accomplish this does not work out.

Oct 19 12:28 AM

[fleeing omega:]

I agree that VAT is a hideous disease. I lived in UK for a while and did work in Denmark. VAT drives up the price of everything and will really put a damp blanket on any economy.

Oct 19 02:04 AM

[doubleguns:]

Fair tax not vat.

Oct 19 08:48 AM

[yellowhoard:]

My wife is a pack rat.

I've been on her for years to have a garage sale.

A VAT would make all of her treasure worth more. As new products go up in price through the VAT, all of our nuggets of crap in the basement will go up in price.

Only now does her lifelong diabolical plan start to make sense to me.

Oct 19 09:14 AM

[doubleguns:]

YH, it won't matter it will never get sold for you to realize the gains!!!!LOL

Oct 19 09:42 AM

[Graham and ...:]

My mother said that some years ago about ME.


On Oct 19 09:14 AM yellowhoard wrote:

> My wife is a pack rat.
>
> I've been on her for years to have a garage sale.
>
> A VAT would make all of her treasure worth more. As new products
> go up in price through the VAT, all of our nuggets of crap in the
> basement will go up in price.
>
> Only now does her lifelong diabolical plan start to make sense to
> me.

Oct 21 12:39 PM