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All that glistens

The story the gold price tells us.

Last week, the gold price breached the $1 000 per ounce level, a height it last reached at the peak of the global financial crisis in 2008, before falling back down to the upper $900s range.

Generally, when the gold price rises and tips past crucial levels, it tells us several things. First, it tells us that people are worried about inflation. Gold is generally seen as a safe haven asset, which means that when people are worried that governments are printing too much paper money, they tend to buy gold as a way to “store value”.

Inflation, in the words of legendary free market economist Milton Friedman, is “always and everywhere a monetary phenomenon”. What he meant was that inflation is the result not of rising prices, but of governments printing too much cash. There is logic to this. Let’s imagine that on day one a slice of pizza costs you R1, but on day ten, it costs you R1.50. That means that the value of your R1 has decreased, and you need 50% more rands for a set amount of pizza.

Why would that happen? Some may suggest that possibly a pizza shortage was to blame; this is the argument you hear when people talk about the inflationary effects of rising oil prices – they are saying that as oil becomes scarcer, prices automatically rise, money is diverted from other uses and the net result is a boost to inflation.

However, for Friedman and his acolytes (known variously as the Chicago School, or “freshwater” economists) the correct explanation is that there were more rands circulating and available to convert into pizza, so you need more to claim a fixed amount of pizza.

Thus, the printing of paper currencies, which has no real upper limit, tends to push up the price of gold, which is finite – it’s the old story of more money chasing a limited amount of goods. Thus, one of the things that a rising gold price suggests is that inflation is a worry.

And today, this is a pretty sensible worry given the events of the last 18 months, during which governments around the world have aggressive spending programmes in a bid to rescue the world economy. Many of these spending plans have essentially been funded by printing new cash, which means that there is a heck of lot more paper money in circulation today, hence the spectre of inflation.

A second thing that a rising gold price tells us is that people are afraid of high-risk investments like equities.

Hilton Davies the founding director of SA Bullion, explained this to Moneyweb Radio as follows: “I think the story really is that gold is a currency. In bad times gold is a currency; in good times gold is a commodity. And we’re into the bad times. I think it’s a generational story, and I think in these bad times we will probably see cash delivering pretty poor returns. And the expectation by gold investors is that the gold return will outperform the cash return.”

In other words, people are hesitant to put their savings into things like money markets, because of the inflation problem we’ve touched on and the possibility of associated meagre returns, and so they are looking to gold not just as a safe haven, but also as something that will enable them to grow their wealth despite problems with “fiat” currencies, which are paper currencies that are not backed up by gold reserves.

On this front, one of the most interesting developments in gold markets over the last decade has been the worldwide emergence of gold exchange traded funds which are backed by purchases of physical gold – ETFs are investment instruments like unit trusts, but they can be backed by indices or commodities. Thus, gold ETFs are a way for investors to buy a share in a pile of physical gold without having to take possession of the metal, and, given ETF’s liquidity, without having to worry about being unable to sell their holdings.

These funds have proven extremely popular in countries worldwide. In fact, in China, the government has actively been encouraging its people to purchase gold ETFs, probably in a bid to reduce China’s vulnerability to devaluation in the US dollar. China is the world’s biggest holder of US debt, so if the dollar depreciates in value, China will lose a lot of money on its debt investment holdings.

Gold markets and the gold price are therefore interesting to watch not simply because they give you an idea of the value of your jewellery collection, but also because they tell you a lot about the fears and hopes of people around the world. And whatever your ideological position, high gold prices are a definite sign of rocky and uncertain times.

Write to Felicity Duncan: felicity@moneyweb.co.za or follow her on Twitter at http://twitter.com/FelicityDuncan

*This article first appeared in Discovery Invest

COMMENTS   33

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That was the old thinking, it is a reserve currency. End of story.

If government prints money AND spends it onpet socia engineering, then government out buys the ratiional market starving it of buying power. Undoing the distortion occurs ina recession. However, if government puts too much money into circulation IN THE HANDS OF THE RATIONAL MARKET, then the distortions are minimal and equities will rise with the inflation. Cash savings are the casualty as anyone who has lived in RSA is very familiar with.

RSA is luckily blessed with a government that lacks the skill to spend on anything much except personal enrichment. The reslt is some distortion like the NATS of old created a boat industry that shrank irapidly from 1994.

Nice article. Thanks. To Hedge Fund Manager: You’re not really helping the credibility of your profession (if in fact you do manage a hedge fund). If it is a reserve currency, does that not amount to the same thing? Need more dollars to meet the same requirements (global view) -> need more reserves -> gold is reserve currency -> need more gold -> increase gold demand -> up goes price of gold! Or you can trade on what charts tell you, line charts, not tarot and crash a hedge fund. Just a thought. Paulson & Co. That’s a hedge fund manager/company worth watching.

Hahaha.

@HFM – Gold is much more than just a commodity, that is the “trick” about gold. Even if it is based on assumptions; simply because those assumptions become reality via our actions. Therefore – Gold has a semi-direct relationship with inflation as well as our perception about the future.

hahahahah

Phil McAvity. Is that you. Or is it phil? As in short for Syphilis? Is that your toxic sludge discharge I see glistening in the sunshine? Or is that glistering? Retard.

Sorry I called you a clown Bob. And I’ll go to the clinic as soon as I can.

Interesting article – thanks Felicity, and Bob your first posting was beneficial for me – thanks. Pity the comments between you and Phil(l) descended into the toilet. And yes, it is ‘glisters’, Phil

We, and the world, have deflation presently, not inflation. The Argus food basket for the year is negative. In 2 months time it looks like it will be minus 10%. I believe CPI will be negative next year.

I don’t think THIS is the big gold move. That’s further down the line in 3 or 4 years when inflation returns with a vengeance.

Bob, Phil(l) or anyone really.

What is the Argus food basket?

Quite a statement to make, that we presently have deflation. The PPI might support this, but CPI does not. I suppose I can also make up a basket of goods for my own lies, lies and damn statistics. How about cell phone costs? (for the same spec phone… started @ R1500 pay in, now free to anyone who wants them… whoaa 100% deflation.)

Wait for the US treasury bubble to burst.

..from shakespeare and not “glistens”.

Oh boy, best we let the economists know as they are looking at a 6% CPI at best. They must be working on something other than the Argus food basket. 🙂

Oh and the other thing that goes up with inflation is the hard asset (unfortunately NOT easily portable like gold) property. Though again (unlike gold) it DOES bring you an income while protecting against inflation……..but in return for this you do have to paint it occasionaly.

Remember C.J. unlike cash property does NOT lose its intrinsic value and gives an inflation linked capital and rental return!

gotta love that B&W pic…

If government prints more money and uses it to build dams and irrigation works (invests in production) more food can be grown, more fish farmend and prices will be stable or drop.

If government prints more money and uses it for consumption, to buy bling, beemers & bloat, the parasititc non-producers will bid up prices and import caviar.

It’s the old “give someone a fish or teach them to fish” syndrome. Of course, in SA we have the “if some of the fish get stolen or their rivers poisoned there will be scarcity” factor.

The major flaw in the Chicago School is that it takes no account of the velocity of money (if people are nervous and save rather than spend, the traditional Asian pattern and now becoming prevalent in the West) then increasing money supply becomes “pushing on a string”. In SA, with its large non-cash and no-discretionary-income component, the theory also breaks down.

I read somewhere, ” Traditionally, gold prices weaken the most in June and July. They tend to spike in late September as demand for jewellery picks up ahead of the October-November festival and wedding season in India”. If this is so, then golds performance is right on course, and can be seen as the result of the common supply/demand principle. How else would one explain the total collapse in diamond equities?

Gotta agree. She’s good stuff.

I think they must be smoking the Argus Food Basket!!

Roger that one good budy, she is looking fine!

he he, yeah – they will smoke just about anything in the Cape!

and oh, bob and phil(l)?…

play nicely will you?

thanks

…good article
…glistens also works
…silly comments from the reserve bench
…beautiful and brainy

Published every week by the Sat Argus – it’s a typical shopping basket of goods an average person would buy at a supermarket – the same goods are priced at a cross section of the main supermarkets every week and the price tracked.

Its a pretty good instantaneous way of tracking grocery bill inflation if you ask me. Presently it is negative year on year. The trend is presently downwards and the trend this time last year was up, so in a few months time we should hit negative 10% – that’s 10% DEflation.

Take a look at the CPI inflation graph whilst you are at it – it is in a downward channel, moving between the high and low trend line – the next low around this time next year shows it will be about negative 3%.

Now factor in that wholesale prices year on year are already negative so this has to be passed on to retail prices. Commodity imports and exports are also well into negative territory.

Furthermore our man Cees reckons the rand will strengthen further making imports even cheaper.

Finally all the other major countries are also presently experiencing deflation.

So all in all I reckon the evidence is pretty strong that deflation it is for a few years.

you must be dreaming! The practical impact of the global stimulus with “funny money” will definitely not be deflation. This is further aggravated by the attempted kick start of the global retail sector. The theme is stimulate spending…spending = demand = money chasing goods = inflation. Eco 101.

The only way that SA could be sheltered from inflation would be the strengthening of the rand and consumption of local products- which in itself has its own set of problems.

The floor is Felicity’s

The “funny money” is just trying to fill a huge hole – it is not presently causing inflation. It probably eventually will, but that will be several years down the line. But for now, we seem to have deflation. That is what the stats I mentioned are showing.

As Schiff says..

The price of gold is rising, the increase in gold is a leading indicator of inflation, deflationists are looking at the lagging indicators i.e. CPI when they should be looking be looking at the price of gold which is much more sensitive to inflation. Other prices will rise eventually but the price of gold is rising now.

So CJ, this hole that the FED is filling with Paper money, why do it ? why dont they let deflation just happen? After all deflation IS the solution yet the FED and Bernanke has said on record that he wants to avoid deflation. Whats difficult to understand about that? Bernanke said so… in his own words, he wants to create inflation get consumers spending,
and jump start things.

I am afraid people holding cash will get wiped out. watch this space I

I’m afraid CJ is correct on deflation. Places like Ireland and Spain are already in a deflationary cycle and I fully expect a lot of the rest of the world to follow suit in the near future.

As for gold, I also think it might be on a premature run thanks to investment demand because of inflationary expectations. Here I should make the point that gold is behaving as a neutral currency and should the expected massive inflation kick in around the world, we will gradually find ourselves back on an informal “gold standard” where gold will be the only universally trusted currency in the world. I have my doubts about CJ’s time frame though – I’m leaning more to the 10 year mark.

Brennan, gold is not a leading indicator of inflation, it’s an indicator of the inflationary expectations of the herd of sheep known as economists, investment professionals, brokers and financial advisors. To these guys deflation is the great evil and they believe fully in the power of the Fed to avoid it (and it may do so)… but this is the same Fed that was supposed to be able to manage the US economy away from serious crashes and recessions… I am long gold not because I think inflation is imminent, but because the investor herd think inflation is imminent.

Exactly a year ago when the crash happened the herd rushed into US bonds and cash due to fears of deflation. The Dollar was seen as the only safe haven whilst equities and commodities crashed. At the time I was saying the last place you want to be is in cash or bonds especially US ones. I called inflation as a worry at the time, actually hyperinflation…!

People like you and CJ, freemarketman etc shouted deflation, yet where is this deflation? Its not happening. Yet gold keeps on breaking new highs.

People like you who are questioning golds rise thinking that this is some type of anomaly, unprecedented situation saying “I dont understand it.. even though there is no inflation but gold is going up anyway… ! ” or blaming it on the the market and the herd mentaility, trust me the herd has not woken up yet when it does expect gold to go past $2500.

This is crazy actually there is inflation, thats why gold is going up, money is losing value because gov are creating inflation. Not just USA but around the world.

thats my post.. filled in the wrong box.. oops

currently at $1021.76

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