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Time-preference and gold


 -- Published: Friday, 3 January 2014 | Print  | Disqus 

By Alasdair Macleod

The future price of gold cannot be discussed without considering its implied discount rate expressed through time-preference. This is the relative desire to own goods at an earlier date rather than later. There are several reasons gold is almost certainly more valuable sooner rather than later, including the fact that when someone wants something he naturally wants it now, and there is always the risk that a promise for future delivery will not be kept.

Bear in mind that time-preference for one good is not necessarily the same for another, reflecting factors peculiar to any good such as supply and demand. The other side of the coin, a lower preference for money, is compensated for by payment of interest on currency that reflects a balance between current and future demand for all goods generally.

This is the starting-point for understanding the true relationship between paper currency and gold, now that gold is no longer circulating as money. Currency pays interest and gold we are often reminded does not. If this were the end of the matter time-preference for gold would coincide more or less with the norm for all other goods.

However, individuals have widely differing ideas of gold’s time-preference. If you think there is systemic and currency risk your time-preference for gold will be high, or put another way it will take a significant discount to tempt you to buy it for forward settlement compared with paying for immediate delivery. If you think that the banking system is completely safe and there is no risk in holding currency, you will accept a far lower discount for forward settlement of gold, reflecting approximately current currency interest rates.

Near-zero interest rates for the four major currencies and time-preference rates for gold as indicated by lease rates suggest either there is minimal systemic and currency risk or gold’s forward discount rate is badly mispriced. Given the rapid expansion of central bank balance sheets, logically the latter must be the case.

Back in 1980 interest rates were raised to choke off price inflation: this is the same as saying time-preferences for goods were discouraged from rising further and began to fall. Gold also became less desired as an inflation hedge, so its time-preference reduced as well. Later that decade the London bullion market began to lease central bank gold in large quantities and gold’s time-preference continued to fall, suppressed well below the return available on dollars in the interbank market. In other words the London bullion market developed by treating gold as an asset whose lease rate was to be permanently below LIBOR.

Therefore gold’s time-preference discount is radically different from what it would otherwise be in an unfettered market. Instead, gold’s time-preference should reflect that of other goods, adjusted by gold’s own specific characteristics, including its soundness relative to fiat currencies. And therefore the gold forward rate (GOFO) in a free market should normally be negative, given that expansionary monetary policies for currencies are the norm, because GOFO is defined as LIBOR less the gold lease rate. Instead it has been nearly always positive.

Sooner or later a more realistic time-preference for gold is bound to return as leasing by central banks dries up. This explains why GOFO tried to go negative on several occasions in 2013. All that’s happening is time-preference is beginning to be rightfully re-instated.

 

Ends

NOTES TO EDITOR

For more information, and to arrange interviews, please call Gwyn Garfield-Bennett on 01534 715411, or email gwyn@directinput.je

GoldMoney is one of the world’s leading providers of physical gold, silver, platinum and palladium for retail and corporate customers. Customers can trade and store precious metal online easily and securely, 24 hours a day.

Historically gold has been an excellent way to preserve purchasing power over long periods of time. For example, today it takes almost the same amount of gold to buy a barrel of crude oil as it did 60 years ago which is in stark contrast to the price of oil in terms of national currencies such as the US dollar.

GoldMoney is regulated by the Jersey Financial Services Commission and complies with Jersey's anti-money laundering laws and regulations. GoldMoney has established industry-leading governance policies and procedures to protect customers' assets with independent audit reporting every 3 months by two leading audit firms.

GoldMoney has its headquarters in Jersey and also has offices in London and Hong Kong.  It offers its customers storage facilities in Canada, Hong Kong, Singapore, Switzerland and the UK provided by the leading non-bank vault operators Brink's, Via Mat, Malca-Amit, G4S and Rhenus Logistics.

 Visit www.goldmoney.com.


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 -- Published: Friday, 3 January 2014 | E-Mail  | Print  | Source: GoldSeek.com

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