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The TRUE inflation-adjusted price of gold

-- Posted Monday, 21 June 2010 | | Source:

By: Michael Kosares

There is good reason to think that gold’s best days might still lie ahead. These charts show the degree to which it is undervalued based on the historic rate of inflation. The first shows the inflation-adjusted price using the current Bureau of Labor Standard’s (BLS) consumer price index. The second shows the inflation adjusted price using the same statistical model the BLS did in 1980 -- data still tracked by Shadow Government Statistics (SGS) without the current CPI’s hedonic adjustments. This chart could very well reflect the true inflation-adjusted price of gold. Even I was surprised at the over $7500 per ounce result. The World Gold Council’s Jill Leyland in her update of Ray Jastram’s study, The Golden Constant, concluded that “gold and consumer prices have broadly kept pace with one another in the USA from 1800 to the present.” If that is the case, gold looks like it has plenty of gas left in the tank. (Many thanks to old friend, Nick Laird at, for use of the charts.)

CPI Graph


Bernanke says he doesn’t “fully understand” gold

The remarkable aspect of gold’s performance during this recessionary period has been how well it has held up while the commodities’ complex was essentially tanking. Gold’s performance under these circumstances is unprecedented and impressive. During the 1975-78 recession, for example, gold halved in value, and indications are that this recession is considerably worse than the one then. The Commodity Research Board’s index is down 40% since 2007 -- the sort of correction one might expect during a recession. By comparison gold is up nearly 40% over the same period. Its counterintuitive performance argues against those who like to label gold as just another commodity.

Judging from recent testimony before Congress, it appears that Federal Reserve chairman Ben Bernanke is among those struggling to understand gold’s performance in disinflationary times. As you can see, his lack of understanding stems from viewing gold as simply a commodity:

"Gold is out there doing something different from the rest of the commodity group, I don't fully understand the movements in the gold price, but I do think that there's a great deal of uncertainty and anxiety in financial markets right now. Some people believe that holding gold will be a hedge against the fact that they view many other investments as being risky and hard to predict at this point."

Contrast that statement about gold to this one from Alan Greenspan during his tenure as Fed chairman. He understood gold as a stable form of money:

“I do think there is a considerable amount of information about the nature of a domestic currency from observing its price in terms of gold. It is a longer-term issue. It is an issue which I think is relevant, and if you don't believe that, you always have to ask the question why it is that central banks hold so much gold which earns no interest and which costs them money to store. The answer is obvious: they consider it of significant value, and, indeed, they consider it the ultimate means of payment, one that does not require any form of endorsement. There is something out there that is terribly important that the gold price is telling us. I think that disregarding it is to fail to recognize certain crucial aspects of the value of currencies.”

And finally, here is what CNBC’s Larry Kudlow had to say about Bernanke’s statement:

“Gold is looking at wildly profligate spending and borrowing in Europe and the U.S. as a leading indicator of massive money creation that ultimately will lead to significantly higher inflation. In other words, a loss of confidence in paper money, due in no small part to a loss of confidence in governmental fiscal policies. If central bankers like Bernanke won’t get tough on the budget, gold prices are going to continue to rally higher and higher.”

When does it make sense to sell your gold?

“The environment we’re moving into will steal money from the conservative, the prudent, the cautious investor — through currency debasement...[Investors] have to understand that they have to work to protect themselves because I see a time coming that’s going to be very painful. I hope it doesn’t come, but I think it will.” - Rob McEwen, CEO, US GoldCorp

Along these lines, I have been asked on many occasions if there might be a set of circumstances when selling one’s gold holdings in toto might make sense. Since I view gold more as a form of savings than as an investment for gain, selling it simply to make a gain doesn’t make a great deal of sense to me. If your intent was to purchase gold as a hedge starting out, why would you sell it simply because the price reached some arbitrary plateau? Like dollar-based savings, you should tap your gold reserves based on need.

In Germany, those who converted paper marks to gold coins in 1918, a few years before the inflationary debacle began, learned in 1923 that they had become multi-millionaires, even billionaires, as a result of the depreciation of the currency. A gold coin denominated in 20 marks -- an item owned by a good portion of our clientele -- was worth about 22 million marks at the height of the inflation in 1923. An ounce of gold worth roughly 87 marks in 1918, was worth over 95 million marks in 1923. The nominal gains no doubt appeared attractive and the temptation to sell at various points along the way must have been overwhelming. For those who did sell, however, it didn’t take long for them to realize the consequences of their actions. As the currency continued to depreciate so did the purchasing power of the illusory profits accrued from the sale. In the end this saver was not much better off than the one who neglected to own gold from the beginning.

Though the German experience was extreme, an important lesson can be drawn from it. Under threatening monetary circumstances, gold should not be viewed as a means to profit, but as a means to asset preservation. The task of the investor is not to calculate the level of profit and act accordingly, but to keep from losing one’s wealth to the crisis. Ultimately success during the German nightmare inflation became synonymous with financial survival, and financial survival equated to holding onto one’s gold no matter the temptations presented along the way. Like any other form of savings though, it could have been converted back to the currency on a pro rata basis as need or opportunity presented itself. After all, preserving purchasing power with the ultimate aim of putting it to use is the primary reason for owning gold in the first place.

Michael Kosares

USAGOLD - Centennial Precious Metals, Denver
-- Posted Monday, 21 June 2010 | Digg This Article | Source:


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