“Fluctuations in the US dollar” is the oft quoted reason for US dollar gold price being up or down on any particular day. Just looking at the daily commentaries one might think that the price of gold has gone nowhere this decade. However, the strength or weakness of the US$ is relative to other currencies and the apparent US dollar strength has for many months been much more the result of the fundamental weakness of all currencies stemming from massive world-wide monetary expansion rather any fundamental strength of the US dollar.
Gold has risen this past decade in all currencies being up 274% in US dollars, 260%, UK pounds 200% in Yen and 179% in Euros. It should continue to rise as long as governments increase money supply at rates faster than the increase in the total supply of refined gold sitting above ground, i.e. at a rate in excess of 1.8% per annum. Certainly over the intermediate term governments would appear to have no choice but to keep the computerized printing presses running as fast as possible. While governments talk about controlling inflation once the recovery gets underway any significant contraction of money supply is highly unlikely.
In the meantime if money supply grows faster than its use, inflation in the prices of goods or assets will probably follow. According to the late Milton Friedman:
“Inflation is always and everywhere a monetary phenomenon”
Money supply is important because it is linked to inflation by the equation of exchange:
MV = PQ
- M is the total dollars in the nation’s money supply
- V is the number of times per year each dollar is spent
- P is the average price of all the goods and services sold during the year
- Q is the quantity of assets, goods and services sold during the year
As neither V nor Q is rising then as M is being inflated P should also be move up, albeit perhaps with a delay.
Despite this, there still remains an obsession about the daily US dollar gold price still not exceeding last year’s peak London pm fix of US$1,011 per ounce. Patience, it is coming. The Federal Reserve continues to pump up the Monetary Base and with it M1. Both have expanded since last summer at unprecedented rates. That gold is rising to new highs in other currencies suggests that money supply elsewhere is rising even faster.
Pump up the supply of any commodity relative to another, or to its demand, and its price will eventually fall. The chart below of USM1 and the US dollar price of gold shows this most clearly.
In latter half of the 1990s there was an unprecedented decline in US M1 as Alan Greenspan acted to try to curb “Irrational Exuberance”. It fell by 7.7% from US$1.15 Trillion in January 1995 to US$1.06 trillion by October 1997. From April 1995 the trade- weighted value of the US dollar rose by 46% from US$0.77 in April 1995 to $1.12 in January 2002. Conversely, the monthly average price of gold fell by 36.8% from a peak of US$405 per ounce in February 1996 to a low of US$256 in July 1999.
Despite the recovery in US M1 between 1998 and the end of 2001 the US dollar price of gold remained low until 2002. It then started to take off following the rapid expansion of US M1 through 2005 and it continued to rise until March 2008. The brief pull-back with the financial crisis in the fall of 2008 was probably the result of a general flight to liquidity more than anything else. Between August of last year and June 2009, US M1 has exploded by 31.8% from US$1.39 Trillion to US$1.65 Trillion. The running four week average for the period ended July 15 is even higher at US$1.66 Trillion. This has to show up in a higher gold price sooner or later.
In the case with economic activity there often is a lag of up 9 to 18 months between action by central banks and the first green shoots of economic recovery. This also appears to be the case with gold measured in US dollars.
Unlike gold, the US dollar is measured against other currencies that are also responding to massive monetary infusions by their respective central banks. The result is that the US dollar can appear to be strong but this is more the result of other currencies falling and not necessarily the US dollar rising.
The race toward the bottom of the currency ladder, a sort of reverse “snakes and ladders’, through competitive devaluation distorts the picture of the US dollar price of gold. What is really happening is that the entire ladder is falling against the “currency” gold. Turning this on its head, the price of gold is rising in all currencies.
Considering money as a commodity then if its supply is increased rapidly and exceeds either demand or a competing commodity then its price will eventually fall. The total amount of gold above ground is some 140,000 tonnes, which is approximately 95% of all of the gold that has ever been mined. Annual mine production is 2,500 tonnes so that the supply of the “currency” gold is rising at only 1.8% per year. This is far below the recent 38% per annum growth in USM1. As the US dollar is holding its own around the $0.80 level, this growth is probably either equal to, or marginally below the rate of inflation of M1 in other countries.
While not yet making new daily highs, the monthly average US dollar price of gold is edging upwards, in June it was US$946 per ounce. Despite the lack of fanfare that was the highest monthly average this year and second only to the record US$968 per ounce monthly average of March 2008. On a daily basis gold is back above US$950 per ounce
Although the pace of the monthly gold price rise may seem glacial, it appears inexorable. Soon, probably in the second half of this year, technicians will be shouting “breakout” and as they do, the pace will probably accelerate as it heads into new record territory on a daily as well as a monthly basis. The only question that will remain is:
“How high is up?”
As a terrifying thought, look at what printing money has done for the value of the Zimbabwe currency. Twenty years ago an ounce of gold sold at Zim$1,400 per ounce. After adjusting for the removal of all the zeros (except Mugabe) an ounce of gold a few weeks ago costs Zim$50,000,000,000,000,000,000 ($50 Quintillion?). It would probably be higher today but for the abandonment of the Zimbabwe dollar. Is this what we are facing?
Perhaps not yet, but starting with the price of gold at US$20 per ounce in the Nineteenth Century and adjusting for the 100 fold inflation since then it is easy to see gold trade north of US$2,000 per ounce. If the Federal Reserve is good to its word and adds another US$1 Trillion to M1 over the next year, by buying all the bad debts out there, we could be looking at another double to US$4,000 per ounce.
Keep faith in gold. It seems a lot safer than any country’s fiat paper currency.
Gold equities respond to gold price movements.
Using the S&P/TSX Capped Gold Index at 310 as a yardstick, both the index, having risen from 153, and the shares of the intermediate and larger producers of gold doubled from their lows of last autumn and are either close to or at their respective twelve month highs. These should continue rise with the price of gold.
The junior producers and the exploration companies have, by and large, lagged far behind as investors remain cautious about their respective funding needs and ability to raise money. Despite this many will become Lazarus companies that spring back to life as the gold-rush fever of the mid 1990s returns to the market with new record high US dollar gold prices. Once that takes hold who knows where a “firestorm of rampant speculation” will take us.
Tony is an all-round investment professional with a broad range of credentials, skills, contacts and work experience in Canada, England, the United States and Australia.