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Relax Everyone, It’s OK

-- Posted Wednesday, 29 September 2010 | | Source:

By: Christopher K. Potter

Although it is nine years old, the bull market in gold remains surprisingly misunderstood.  Fund managers who focus on gold are mislabeled as doomsayers and each new high in the gold price breeds fresh talk of a gold bubble.  Much of this has to do with fear, and embedded in the psyche of Wall Street is the notion that equity investors should fear a rising gold price.  The financial press perpetuates this myth with stories like the lead in today’s Wall Street Journal that screams, “Gold Vaults to New High … Amid Global Economic Worries”.  Television ads, billboards and financial analyst reports proclaim gold to be the ultimate “flight to safety” asset class.  This campaign of misinformation has led most investors, including many in the gold community, to operate under the incorrect assumption that a rising gold price must somehow be indicative of trouble in the stock market.  This is nonsense.  All one has to do is look at the periods (2002 – 2007) and (2009 – now) to see that most of the current bull market in gold occurred concurrent with rising stock prices.

Alarmists’ opinions to the contrary, gold is not signaling anything ominous.  It is simply doing what it is supposed to do, adjusting to changes in global monetary conditions.  All currencies do this.  When a monetary authority increases the supply of money, whether it be Japan performing an unsterilized currency intervention last week or the ECB monetizing bad debt last spring, the price of other currencies, including gold, adjusts upwards.  With most money, the price adjustment is muted because of a corresponding upward supply adjustment in other currencies.  This is why we did not see a doubling of the euro/dollar exchange rate in 2008 with the 100% increase in the US monetary base – the ECB was printing in tandem with the Fed.  On the other hand, gold, whose supply growth rarely exceeds 2% per year, must adjust to monetary expansion almost entirely through price.  Why then are we alarmed to see the gold price up by 60% during a period when the Fed’s balance sheet grew by 140%?  

Unable to reconcile $1300 gold (up 350% since 2001) with a recovering stock market, naysayers and bubble seekers proclaim gold to be expensive.  Can this be?  Has gold crested the proverbial wall of worry, poised now to descend the other side?  To answer in the affirmative one must wonder if copper (up 430% since 2001) and oil (up 300% since 2001) are also in bubbles.  Here the bearish chorus grows dim, replaced by bullish talk of emerging market population mobility and demand for raw materials.  This however is only part of the story.  Along with new homes and automobiles, those same emerging market folk are moving some of their newly earned wealth into gold, even at these “elevated” levels.  Emerging market central bankers, voting with their wallets, have also judged gold to be cheap and paper money to be dear.  Witness the buying of gold by the central banks of India, Bangladesh, Sri Lanka and Thailand in recent months.

Economic stimulation through currency expansion is the unwritten, unspoken policy of today’s monetary leaders.  In response, gold is predictably performing its role as the only supply constrained currency.  Its price is adjusting upwards.  Bears claim the adjustment is overdone and that gold is in a bubble.  Bulls point to an investing public which has only just begun to buy gold.  While this debate is far from over, reasonable people can agree that gold is a lot cheaper today than at its bubbly peak in 1980. Back then, at $850, the above ground gold stock was valued at 141% of the US money supply (M3).  Today, at $1300, above ground gold is valued at only 50% of M3.  You could say that gold is now trading at a significant discount to dollars.  To reach the 1980 peak, the gold price would have to adjust upwards by another $2300.  Will gold be in a bubble at $3,600?  Maybe, but let’s see where the money supply is when/if gold gets there.  Meanwhile, the next time someone rants about the apocalyptic implications of a rising gold price, tell them, “relax, it’s ok.  Gold is not doing anything scary.  It is simply adjusting to the supply of other currencies.”

Christopher K. Potter

Northern Border Investments L.P.

-- Posted Wednesday, 29 September 2010 | Digg This Article | Source:


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