Economists Say Precious Metals Are in a Bubble, History Says They're Dirt Cheap

by: Danny Furman

Most market analysts learned how to give reports in high school and college. School teaches us to use as many outside sources of information as possible, cite them and make conclusions based on their data. Students are therefore encouraged to amass varieties of data that confirm a prevailing, and generally foregone, conclusion. Simply put: Students are taught to argue, not analyze.

I'm generally amazed, and often disgusted, by analysis of financial markets that directly draws macroeconomic conclusions for the future based on historical charts and data. As cyclical as human behavior and market performance are, circumstances and outcomes sometimes change drastically. Without connecting the dots as they pertain to a specific situation, any outline suggested is merely a facade.

Debating the current value of gold is a hopeless task. Historically, the yellow metal has been a highly regarded medium of exchange. In many societies gold and silver spent at least centuries as the only accepted currencies. Today, however, silver is demanded more highly for industrial than monetary use and gold exists largely as a relic of the past.

The end of the 1970s bull market in gold and silver stifled worldwide mining operations, trading cards killed coin collecting and stock market investing has become the dominant form of saving. Ultimately, no documented period in human history appreciated precious metals less than the mid-1980s through the mid-2000s.

Those arguing gold is today's greatest bubble often use a "laundry list" of apparent similarities between the gold market today and bubbles of the past. While commonalities such as media attention and price increases exist, there are no indications of a gold bubble. Precious metals bears have an endless number of arguments while bulls have endless history on their side.

First of all, over the last year or two the media has certainly bashed gold infinitely more than it has supported it as an investment. Goldline's well documented and highly publicized manipulative sales tactics clearly painted the gold buying process as a risky and dubious one. The only television analyst who consistently recommends buying and holding gold is Marc Faber. I trust his analysis, but sincerely doubt many Americans do. Jim Cramer pushes gold stocks, especially when his CEO guest du jour heads a major producer, but not physical ownership. While many argue gold is in a bubble, ownership is still extremely rare. Faber himself speaks at conferences at which not a single attendee owns gold or silver. If audiences paying to hear Mr. Gloom Boom Doom speak don't own PMs, who does? Most likely those who study history.

Throughout 19th century England, one shilling was five grams of silver. A British pound was 100 grams, which was considered a decent weekly wage until around the turn of the 20th century. At today's silver price of approximately $38/oz, 100 grams of silver is worth about $125. Compared to a century and a half ago, silver today is dirt cheap.

While empirical data on older civilizations is far less abundant, we know that China adopted fiat currencies over 500 years ago and since deteriorated from the world's beacon of prosperity to it's most oppressive dictatorship. Ancient Rome has a similar history. It is widely known that Asian cultures, more deeply rooted in history today than Western ones, save in gold and silver.

Having received credit for winning World War 2 while Europe remained in shambles, American dominance characterized the last half of the 20th century. Corporations flocked here and global demography allowed the USA to focus on growth and innovation rather than survival. Dollar dominance earned cheap access to labor and resources from countries led by those willing to sell their people and land for personal gain. For decades Americans were highly able to save in precious metals while most of the world could not at all. Emerging economies have changed that in recent years and are poised to extend the new trend.

Any study of precious metals prices in U.S. dollars is highly convoluted in that it uses the strongest fiat currency that has ever existed. In 1964, the last year most USA coins were minted as 90% silver, the average annual American wage was $4,576, or 18,304 George Washington quarters. At today's price that's over $130,000 in silver. Gold bears may chose to see such data as supportive of their arguments, but all it shows is extreme temporary strength in the U.S. dollar.

The most stable currency over recent decades has been the Swiss Franc. Representative of conservative economics and monetary policy, it has doubled in value versus the U.S. dollar in the last 10 years and kept pace better than other European and emerging market currencies throughout the 20th century. The unit "franken" and denominations have not changed since 1850. In fact, 1850 and 1967 "1 franken" coins are basically identical and contain four grams of silver. Today the Swiss franc is stronger than the U.S. dollar despite being weaker than a British shilling (a twentieth of a British pound) just a century ago. An 1850 "1 franken" coin is worth less than 5 franken today. It seems highly unlikely that PM bears would find much support in the Swiss Alps.

Beyond the online financial community, I still haven't encountered a single person who has bought physical gold or silver. Those willing to invest in PMs seemingly choose mining stocks and ETFs, which may influence the price of gold and silver but do not change who holds all the shiny stuff. Trading to make dollars is not owning PMs.

Regarding current PM prices being dubbed "bubblicious," the U.S. dollar had far more purchasing power in terms of food and housing when gold reached $1000 and silver $50 in 1980. Gas stations would let customers fill up for silver coins with little face value in fear of what might happen to fiat currency. Today that fear has been systematically eliminated by boom-bust cycles and modern economic theory.

Inflation and deflation arguments based on money supply and circulation ignore a "store of value" component, which money must possess by definition. Nothing more than further deterioration in the image of fiat currency, or incremental appreciation for precious metals as money, is required for an indefinite bull market in gold and silver. For a bubble to exist, people would need to be sitting on PM investments with hopes of selling at a higher price. The environment today is characterized by one group insisting a bubble and another insisting no amount of fiat money abused as badly as most are today is worth an ounce of gold or silver.

When Chevron (NYSE:CVX) starts taking these, we can start talking about a PM bubble.

Disclosure: I own physical silver.

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