I’m just trying to think it through with both inductive and deductive processes. I agree that there is something odd that it would be anti-USD in inflation, but substitute USD in deflation. But maybe that means that there is some kind of embedded option in gold that has to do with assumptions about fiat currency management. It’s an incomplete idea, but I think it’s worth exploring a bit more. Gold sometimes acts as money and sometimes acts as a commodity. There is something option-like about that, and it may help explain sources of volatility and strategy.
Gold certainly shifts roles and shifts the way it trades. I’ve never been successful at trying to come up with “change point” trading strategies. I think determining when a change point has happened is really a difficult problem. I’d be interested in hearing ideas though…
I’m the first to admit setting a price target on gold - or a current valuation for that matter - is more of an art than a science. There was another thread a while back where we discussed how to set a price target on gold and I went into more detail there than I will now. Basically, it’s a function of historical inflation adjusted gold prices, supply and demand, and technical analysis. Oh, and global macro/geopolitical considerations. You know simple shit. Or, maybe I just base it off of inflation expectations and forgot how to add. Anyway, I think BChad said something about gold bugs rooting for financial disaster. I don’t know that that’s entirely fair. I think most people buy gold to hedge against it, but would still rather see a positive global ecomonic climate. At least I would. The thing that would actually cripple my position the most is what I wish would happen - European austerity. That path leads to (extreme) short term pain, but favorable long term economic conditions. I firmly believe that would be the correct path to pursue. I have very little faith anyone has the balls to propose it, and withstand the riots that would surely follow. Pretty much all other outcomes are favorable for me. Deflation in the US is also a concern, but that’s the beauty of fiat - deflation is easily countered by printing more money. Given that we (the US) are still in an economic flatline situation, Uncle Ben won’t have a problem rolling out QE3 at the slightest hint of deflation. Or, seen the other way, since inflation isn’t an immediate concern, QE3 is on the table if/when we dip into negative GDP growth territory. Aside from acute liquidity events (which seem to be more and more common these days), I do believe over the last several months inflation expectations have replaced safe haven status as the primary (but not only) driver of gold’s returns. That’s all just a small part of the puzzle. Long term (say 10-15 years) considerations include much more than just inflation (or more accurately, currency devaluation). I’ve outlined my thesis on gold on this forum three or four times now, and it’s a bit more complex than just screaming inflation at the top of my lungs. And, as I’ve said time and time again, while I like gold, silver is where it’s at. If you don’t already own any silver, start a small position around $27 (physcial or PSLV) and be patient. It’s possible it’ll go to $22 at which time you mortgage your house, sell a kidney, whatever, and go all in. Within five years it’ll reach $100. It’s a rollercoaster though.
I still don’t get the argument that Gold is the best investment in an inflationary environment. I did this chart a few months back and I think I posted it somewhere on AF. 1980 was very similar to today. The only difference is inflation was already high then. BUT even if you timed your gold purchase nearly perfectly at the end of 1978, your return was terrible relative to the same investment in the S&P 500. This is the closest historical example I can find for a gold vs. equity argument. Appears to me the S&P 500 was a far superior inflation hedge… http://thecrowdedmarket.blogspot.com/2011/08/fools-gold.html
JDV was the one talking about rooting for disaster, and I don’t think he was advocating it, he was just saying that extreme gold positions require disaster to have a pay ut, but that the very disaster often makes the payout either meaningless or impossible to execute in practice. The reason I’ve trimmed my positions in gold is that pretty much everyone is going the austerity route, which is deflationary. But right now, austerity is more “the plan” than “the reality” (though it is becoming reality in Europe). The question on my mind is whether it will be possible to stick to the austerity route when it comes time to pay the piper and actually live with the consequences of austerity. In Europe, the scene seems to be set to do that. The ECB doesn’t have the legal authority to engage in quantitative easing, the periphery doesn’t have the access to capital to do fiscal expansion, and the Germans are doing very well as it is, thank you very much. It really all hinges on whether Germany finds the idea of an EMU a “cute enough” idea to be worth shelling out money for. It’s worth remembering why the EMU exists at all. There were basically three reasons to do it. 1) To integrate France and Germany to keep them from going at each other again like they did last century, 2) to form a common bloc against a now-dead Soviet Union (an economic counterpart to NATO, basically), and 3) to blend Europe into an economic bloc sufficient to be a counterbalance to the United States in the global economy. Of these reasons, only #3 really carries any real weight today, and this may be the only reason that Germany might step up and bail out Europe. But if the Germans decide that they are content being the #3 sized developed economy (after the US and Japan), then there’s really not that much need for the Euro. The other reason for the Germans to try to save the Euro is that much of their exports go to other parts of Europe. If the EMU dissolves, German exports are going to be more expensive because the other currencies are going to devalue/inflate relative to whatever currency the Germans are using (Euro or a revivied D-mark). That’s going to hurt German exports. But then again, austerity is going to hurt German exports too. As for the US, printing money would seem to be a way to get out of deflation, by forcibly inflating everything… but it didn’t really work very well in Japan. There are arguments (which I tend to believe), that printing yen did stave off a worse outcome, but it’s also clear that it didn’t return Japan to any kind of real prosperity. My suspicion is that printing money works when the source of deflation is rapidly improving productivity (and therefore supply) in excess of monetary expansion, but that it doesn’t work when the source of deflation is collapsed demand due to debt deleveraging. There’s an option-like aspect to money-printing too, which seems to be the reverse of the option-like aspect to gold, and they are probably connected. The switching point seems to have to do with accumulated debt and how debt gets discharged. In the US, the Congress seems to be in the pocket of the very wealthy, which bodes well for austerity supporters, who presumably own enough to be able to sit out an extended downturn while everyone else scrounges for scraps of whatever’s left over. My sense right now is that Obama may actually win the election next year, but that the House and Senate will be in Republican hands, setting the stage for virtually nothing to happen for another 4 years. The automatic cuts negotiated in the last debt agreement will kick in, and we will get an austerity package that was deliberately designed to be so bad that “we’ll have to agree on something different,” but which won’t actually work out that way. This package will be slightly less bad for Republicans than for Democrats, since they have been the ones advocating cuts most actively. On Capitol Hill these days, it’s all about relative gains - who gets to live in first class on the Titanic, instead of how to deploy lifeboats effectively. I’ve rambled a bit here, but I think the points are worth making.
Just to be clear, I’m wildly anti-QE.
“The thing that would actually cripple my position the most is what I wish would happen - European austerity. That path leads to (extreme) short term pain, but favorable long term economic conditions. I firmly believe that would be the correct path to pursue. I have very little faith anyone has the balls to propose it, and withstand the riots that would surely follow.” Uhh… European austerity has been going on for 2 years now. Economic conditions have worsened. There are riots in the streets. Procyclical fiscal policy is a terrible idea and history as well as current conditions bear that out.
Gold acts in an inconsistent manner because it’s a perception asset. People don’t always react the same given the same circumstances, but you can find some patterns. Current inflation is not important as expected inflation - that is why it’s been proven that gold correlates better with next year’s inflation rather than the current year inflation. In the same way, in deflation there could be an argument BELIEVED by people that gold is a ‘safe heaven’ which can lead to increase in prices. The correlations created are conditional and dynamic. The only way to try to figure out where gold is going (and I’m not saying that it’s easy) is to figure out investor behaviour and cash inflows.
I don’t think the amount of money in an economy, expansion of Fed balance sheet, devaluation of USD directly matter to the price of gold. There is no fundamental basis on pricing gold, just perception. Of course, if you see USD devaluing against other currencies, you might think that gold is the way to go and then the perception is self sustaining
If deflation was easily addressed by monetary easing Japan would be in a completely different position then it is now.
So there are 25,000 tons of gold kept around the world by central banks to use as foreign currency reserves. Gold is denominated in dollars worldwide. And somehow devaluation of USD doesn’t directly matter for the price of gold? How could that be?
You are making the argument that because gold supply is limited and monetary supply increased (a lot), gold prices should increase. If the relationship would be that direct, then probably the price of oil, copper, houses, land, etc - basically all hard assets should have increased a lot. The truth is that the inflow of money into certain hard assets is based either on fundamentals (the need to eat, the need to have a house etc) or based on perception (investing in other currencies, gold, art, stocks). Although on a theoretical level, the argument that increased money supply should lead to increased prices holds, I don’t believe that the relationship holds as good as we’d like to think, especially on shorter periods. As bodhisattva said, if things were that simple the yen would be less strong right now, Japan would have higher inflation. But despite the central govt efforts they are still dealing with a strong currency and low inflation. The demand for some hard assets (food, oil, copper) is way more stable than the demand for investable assets which are more perception priced.
For those that avoid ZH like the plague, just wanted to bring a couple links to your attention. The first is an interesting article on the divergence of the miners from the gold price. Basically making the case of how ETFs like GLD have crushed the market for miners’ stocks. Nothing revolutionary, but a good read. The data is from a GS report. http://www.zerohedge.com/news/did-gld-and-other-gold-etfs-kill-gold-stocks The second link is one that slipped pass me last week. It’s about the problem of tracking the ownership of the gold that’s supposed to be backing ETFs (read GLD) but may not be. I think it was this thread where we were discussing this a few months ago. Maybe it was another. Anyway, it’s worth reading if you use GLD. http://www.zerohedge.com/news/gold-rehypotecation-unwind-begins-hsbc-sues-mf-global-over-disputed-ownership-physical-gold
That guy Tyler Durden is crazy and misses the point all the time. This dispute over the HSBC gold is nothing like a “rehypothecation” problem. There is a guy named Fane who was a client of MF Global and (I guess) took delivery of some metals under Comex contracts. That means he bought them and he owns them, right? Well, in almost all cases the answer would be yes, but here the problem is that MF Global stole client money and the remedy for that is the “equitable redistribution” of other client money to the clients whose assets were stolen. That’s why client accounts at MF Global were frozen. Fane tried to do an end run around that by taking his gold and silver from the custodian. The bankruptcy trustee stopped him from doing that. HSBC sued the trustee because they don’t want two people claiming the same metal in their vault. It has nothing to do with all that malarky that Tyler Durden is writing about, that this somehow muddies the water about GLD’s claims on its gold. Edit: I look at zerohedge sometimes, but there is so much misinformation on that site that I wish it didn’t exist. I don’t care at all if charterholders are reading that site, but novice investors go there and become convinced that the only sensible investing strategy is to bury gold eagles in the crawl space under their house.