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This issue we team up
with the charting research services, Macrotrends.net and Thechartstore.com,
to bring you a grouping of highly illuminating charts on the gold and silver
markets. Though we are a full five years from the genesis of the 2008-2009
financial crisis, its aftershocks still influence (in fact, dominate)
economic policy as well as activity in the financial markets, including gold.
Every once in a awhile, it pays to revisit the fundamental drivers of gold
demand -- particularly investment demand -- in order to determine whether or
not the secular bull market is still on course. If nothing else, it helps to
clear the synapses of excessive media wash and re-establish why gold remains
vitally important to the contemporary investment portfolio. For some, these
charts will serve as an affirmation; for others a revelation -- a golden gut
check of sorts. As you are about to see, the price of gold may have changed
over the past year, but the fundamental monetary forces driving it have not.
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Before proceeding to the
charts, I would like to briefly address the rebirth of silver as a monetary
metal. Gold has always been a monetary metal first and a commodity second. On
the other hand, silver up until the 2008-2009 crisis
was generally considered a commodity first and a monetary metal second --
something that might perform well in inflationary times but not so well in
deflationary times. Since then, the public -- not market analysts and pundits
-- has determined that silver has regained its status as a monetary metal. In
fact, since 2008 the metal has performed very well under what could only be
described as disinflationary circumstances -- a close cousin to deflation. At
USAGOLD over the past few years, we have witnessed this phenomenon first hand
by processing a large number of silver orders, primarily in coin form, placed
with long-term asset-preservation investors. As a result of this reclaimed
status, the first chart we offer in this analysis includes silver.
Gold and silver adjusted
for inflation
The first two charts show
the inflation-adjusted price of gold and silver respectively from 1970 to
present. In 1971 the United States officially severed the link between the
dollar and gold and allowed it to float against other currencies. Many consider
that delinking as the beginning of the modern era in economics and finance.
It has been my view since the early 1970s that as long as that separation
exists, gold will trend higher due to the government's propensity to run
deficits and the central bank's acquiesence in
printing money (when necessary) to cover them. The inflationary process has
accelerated significantly since the 2008 financial crisis and the
introduction of quantitative easing. The ramifications of these policies
which are still in the process of translating to the general economy. Now,
with both metals falling into the same monetary metal category, they should
be analyzed accordingly -- a change that reintroduces the traditional
gold-silver ratio as an important piece of the overall precious metals market
analysis.
(Please see Gold-silver ratio signals trading opportunity within
IRAs by George R. Cooper, September, 2013)
As you can see, there is
considerable headroom between gold and silver's end of June, 2013 lows
($1192/oz and $18.50/oz
respectively) and the inflation-adjusted highs of $2552/oz
for gold and $105/oz for silver*. Another
feature worth noting on the gold chart is the similarity between the
double peak structure and correction of the past two years when compared to
the 1973-76 chart period. Also please note, gold's
inflation adjusted low in the area of $420 in 1976. From there, gold went up
six times to its inflation adjusted highs in 1980 of $2552/oz.
Keep in mind, too, that
this chart is based on the current Bureau of Labor Statistics rendition of
the Consumer Price Index -- a statistical interpretation many experts
consider to be understated. Milton Friedman, the famed monetarist, quantified
a roughly five-year lag between monetary inflation (the expansion of
credit and money printing) and price inflation as represented in
various retail and wholesale indices. If that is the case, we should be
seeing the initial results of the Fed's money printing, which began in 2009,
right about now. The rebounds in housing and auto sales might be the first
signs that the monetary inflation has taken root in the general economy.
* These inflation
adjusted highs coincide with a nominal cycle highs in 1979-1980 of $845/oz for gold and $49/oz nominal
for silver.
What bubble?
It has been said, mostly
by those who have taken up the profession of central banking, that financial
bubbles can be identified only in retrospect. One can only assume that a
corollary to this presumption would be that the absence of a
financial bubble can be ascertained only after the fact. The chart
immediately below undermines once and for all the argument that gold has been
in a bubble over the past several years. In the previous segment, we
mentioned that the new economic era began in the early 1970s when the United
States broke the link between the dollar and gold. From that point forward,
the U.S. and world economies and financial markets simply began to behave
differently. "The world financial system," says Macrotrends,
"moved from the relative discipline of the gold-dollar, fixed-currency
standard to a system of free-floating currencies in 1973. This move unleashed
a series of asset pricing bubbles over the subsequent decades."
With all the confusion
when it comes to identifying bubbles, there is a certain amount of science
that can and should be applied to the problem. This comparative life cycle
chart of various bubbles by Macrotrends is a
significant step in that direction. The "v" shaped vertical spikes
represent real bubbles. The rounded-off, subdued gold chart for the current
gold market does not match up well with the true bubble markets, which
featured strong rocket trajectory climbs and then equally stunning collapses.
"This chart," says Macrotrends, "tracks the performance of gold since July of 2002
against the three largest bubbles of the last 40 years. Past bubbles have
shown strong but steady growth for the first 7-8 years before moving into a
hyper-growth phase for the last 18-24 months. Each series is adjusted for
inflation and is smoothed with a 3-month moving average."
Macrotrends states that gold would have had to spike to $3000
for it to have reached true bubble status in the period 2009 through 2013.
When compared with the NASDAQ and oil bubbles, the current gold market looks
tame -- it has developed more like a traditional, secular bull market
experiencing a healthy correction than a bubble suffering a rapid deflation.
In keeping with the previous chart on the inflation-adjusted price of gold,
we may not see that spike, or hyper-growth phase, until we experience another
inflation wallop similar to what occurred in the late 1970s.
(
Please see "Gold a
Bubble? NOT-EVEN-CLOSE" by Jonathan Kosares, October, 2010)
Traveling partners - the
monetary base and gold
Those of you who follow
the analysis on these pages regularly will recognize the chart reproduced
immediately above. Federal Reserve assets essentially make-up quantitative
easing, i.e. the $85 billion per month shelled out by the Federal Reserve. QE
comes down to the purchase of two kinds of securities -- U.S. Treasury paper
(bonds, notes and bills) and mortgage-backed securities. The Federal Reserve
buys the Treasury paper from the federal government and the mortgage-backed
securities from commercial banks. The first is a direct form of monetization
(money printing); the second is an indirect form since a
good portion of those funds are in turn also used by the banks to
purchase Treasury paper. At present the asset side of the Fed's balance sheet
stands at just over $3.6 trillion -- up about $2.8 trillion since the
beginning of the financial crisis in late 2008. While the market pundits and
Wall Street analysts talk incessantly about "tapering", the Fed has
quietly accelerated purchases, as you can see, like at no time since 2008.
As I wrote in this newsletter back in June, heed what the Fed does, not what
it says.
At first glance, it looks
like the growth in Federal Reserve assets and the gold price are correlated,
but what is really going on with this tandem is that they are both being
pushed by the same force -- a bad economy. It causes the Fed to print money
and investors to buy gold. Over the long run, the monetary base has led gold
higher but, as you can see, over the past twelve months the gold price has
crossed decisively under the reserve bank credit trend line. The two
developments together have made for an interesting chart divergence —
the sort of thing that catches the attention of technicians and value investors
alike.
Our last chart,
immediately above, is the coup de grace in our review of the
monetary fundamentals and gold. It shows the ratio of gold to the monetary
base, and another way of presenting the relationship shown in the previous
chart. "This chart," says Macrotrends, "shows the ratio of the gold price to the St. Louis
Adjusted Monetary Base back to 1918. The monetary base roughly matches the
size of the Federal Reserve balance sheet, which indicates the level of new
money creation required to prevent debt deflation. Previous gold bull markets
ended when this ratio crossed over the 4.8 level." In other words, with
the multiple currently under 0.5x, we have a long
way to go before this ratio returns to its all-time highs. Too, the greater
the divergence between the two, as shown in the overlay chart, the more
geared that latent potential becomes. At a 5x multiple, as achieved in the
1930s and early 1980s, gold would need to be priced at over $6000 per ounce.
Though we are not prepared at this juncture to suggest gold is headed for
such a plateau, we can suggest at $1300 to $1400 per ounce, it appears
undervalued, if not radically undervalued.
Afterword
The fact that we live in
the internet age of instant conmmunication when the
common man on the street has access to the same information available to Wall
Street's top bankers and brokers, it is incomprehensible the relationships
that we have shown in these charts remain generally overlooked -- in fact
hiding in plain site. Don't be distracted by the
anti-gold chatter in the mass media meant to lead you away from the real
reasons for gold ownership -- as a safe haven against monetary exceeses and policy blunders touched upon in this issue
of our newsletter.
Michael J. Kosares is the
founder of USAGOLD and the author of "The ABCs of Gold Investing - How
To Protect and Build Your Wealth With Gold." He has over forty years experience in the gold business.
USAGOLD Review & Outlook is the contemporary,
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Disclaimer - Opinions expressed do
not constitute an offer to buy or sell, or the solicitation of an offer to
buy or sell any precious metals product, nor should they be viewed in any way
as investment advice or advice to buy, sell or hold. USAGOLD, Inc. recommends
the purchase of physical precious metals for asset preservation purposes, not
speculation. Utilization of these opinions for speculative purposes is
neither suggested nor advised. Commentary is strictly for educational
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