Is “Golden” Still a Positive Adjective?

I am not a gold-bug and have said so before. In February 2013, I published, How Much Should Gold Sell For and estimated that even with significant inflation, gold should sell for $750 per ounce. Gold was then $1,650 or so and headed to the moon. Frankly my argument about the price of gold was supposed to develop a discussion because it was well off the normal playing field for gold pricing into the future. It developed none.

Again in April. One armed economists. With gold at around $1,500 when written.

Now on the morning of 26 June gold sells for something in the $1,225 range. What is happening? What could happen?

Try stepping back from the rhetoric. Take the big overview.

There is still a big speculative / insurance value in the gold price when compared to commodity prices. Please read the earlier piece. That excess will be validated if there is an economic collapse and high inflation. It will disappear under some forms of future activity by the government.

Yes, I know gold is more than a commodity but it is closer than it once was. In a world where value can move in milliseconds, gold may turn out to be, while still valuable as money, somewhat quaint.

When will the extra value be validated?

Depends on what you mean by when? Short run, intermediate run or long run.

I think in the long run, gold price will reflect commodity prices. Once government activity and speculator variables are removed it will be worth 90 gallons of gas, or 10 cases of beer, or 6 steak dinners a suit of clothes or whatever you want to compare to. You should use your own values here. They will be different depending on where you are. In the long run, the extra monetary value will go away so I will ignore it because the result in numbers, depends on what happens in the short term or a bit longer.

In the short run, governments have two choices. Inflate the currency with a view to stability in the intermediate term or do not.

To be stable, some inflation is necessary soon and there must be material reduction in the government economic footprint. Reduce the size of government and reduce entitlements. Hopefully reverse the entitlement mind set. The idea is that the government can reach affordable debt because of the growth that results from reducing the footprint of the government and reducing the debt share of GDP.

Likely 10 years plus to pull it off and there is a fine balancing act.

  • With inflation, interest rates go up and so too the cost of paying interest on government debt. Expenditures rise even if cuts are made.
  • Higher rates may slow business growth. Businesses may not need a lot of money but consumers might. They have not cleaned up their balance sheets completely either.
  • How high can inflation be to have the mix of variables work out?

In my earlier ramble, American price level had to double to make gold worth $750 per ounce. Double in 10 years says inflation average of 7%. Long term rates at 9%+ but if possible the federal debt, assuming no new borrowing would be around 50% of GDP.

I don’t like the chances of that. Reduce government spending by one third, run 7% inflation and grow GDP by double or more. I suppose anything is possible. Maybe it would be so tentative that the speculative/ insurance element would remain in the price. If so, then this scenario would be moderately attractive for gold prices.

The “do not stabilize” version has two possibilities.

Short term hyperinflation, which would be good for gold prices and bad for almost everything else, is not impossible. I would prefer to think that some element of sanity would prevail. We are talking about political decisions here so that is a preference not a guarantee.

The other extreme is to continue spending on entitlements, grow or sustain large government, continue intrusive regulation and class envy. Tax the rich for a little while. They could finance this by having the Fed print less money and force the banks to hold more government bonds in their reserves. Essentially suck out some of the extra cash that exists now, return to a normal level of velocity and move on.

  • Growth would be lower
  • The debt would rise
  • The ratio of debt to GDP would rise
  • But, inflation would be relatively low.

Like Japan post 1990. A little stable. but with problems. The “force banks to hold higher reserves” model is adverse for gold price. Watch for it.

Then we have the faith in government problem.

  • Can they shrink their size and reduce entitlements to go for the growth with inflation model? My cynic side says, “Yeah, right!” Governments tend to be irresponsible and this is the responsible choice given the mess that they have largely created.
  • Can there be hyperinflation? Possible but even I still think governments are not that stupid. Call it 5 to 1 against because there could be an accidental outcome.
  • Choose the Japanese model and accept 20 years or more of stagnation as the price. The problem does not go away but the politicians and others will be retired by the time someone has to deal with it. This too is stupid but it is politically expedient. Look for it in the short term.

And then there are the external variables. Europe and the Euro, China, Indian jewelry purchases and who knows what else.

In respect to India, I think they will soon figure out that productive assets are better assets than is metal. If they do, there is about 18,000 metric tonnes to come on the market to finance the investment. You can start a lot of small businesses in India with $5,000 each of capital. Price adverse for gold.

Head hurts, but I still think gold is not yet a worthy investment. Maybe a tiny slice for the hyperinflation blunder possibility.

But remember the “crazy market” rule. Just because the price is crazy does not mean it cannot get crazier.

Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario. | Twitter @DonShaughnessy | Follow by email at moneyFYI

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