Understanding Gold

Gold and silver are complicated assets to price, because prices depend on the valuation of other assets and on differences between U.S data and the rest of the world. Stocks and currencies depend on fundamental data, but for gold and silver it is more complicated. The gold and silver prices express the strength of the global economy vs the expectations of real interest rates in the U.S.

Understanding the gold and silver prices is the key to unlocking the mystery of fiat money. Do you remember the collapse in Russia in 1999, South East Asia in 1997, and Brazilian and other South American currency crises from 1992 to 1994? Many lost all their savings, because of the collapse of their governments currencies.

Gold cannot suffer such a collapse in value because gold cannot be created by any government at will. That`s why the governments would like to convince the populace that it should disregard gold as a monetary asset and embrace its fiat currencies.

All previous experiments with fiat currencies ended in disaster. Our history books are littered with examples of empires that were built on hard work and destroyed by a devaluation of their currency. But this time is different. Central banks are doing the same thing at the same time; printing money. So, you have to look at the dollar compared to other currencies.

Understanding the gold and silver prices is the key to unlocking the mystery of fiat money. Compared to the prices in the past, the gold price should be $2,500, $4,000, $7,000 or even $14,000, but it isn`t. It is declining.

Fed successor Janet Yellen said (November 2013); «I don`t think anybody has a very good model of what makes gold prices go up and down.» Fed Chairman Ben Bernanke told (July 2013) Congress he doesn`t pretend to understand gold prices. Nobody does.

Gold and Silver are correlated to copper, oil price, Chinese investments and to global money supply and inflation. Higher supply of U.S oil and slower growth weakened the oil price and also the gold and silver price. Copper and oil got under pressure by the slowing Chinese real estate investments.

Chinese law to disallows to buy a second home, helped to calm these investments along with high interest rates.

The main driver for high gold prices in the «gold bubble» during the end of 1970`s was driven by U.S inflation, but what now as the emerging markets achieve half of global GDP? It will be difficult to view the gold price related to U.S inflation now. Falling food and energy prices in Europe are an indicator of weak EM.

Central banks in EM reduced their dollar share and bought gold between 2010 and 2012. India holds 10% of reserves in gold, while China holds 1,7% and Brazil only 0,5%. Countries with current account deficit (India: 10% Central bank gold holdings), Belarus (30%) and Egypt (25%), prefer gold to stabilize their currency.

Western central banks still stick with the former IMF rule not to buy gold any more.

The gold share is very high for many European countries, while it is still low in EM central banks. Central banks of Germany, Italy and France are all three with 70% gold holdings, and they could all build up their reserves during the Bretton Woods era.

All other countries fixed their N currencies against 1 currency, the U.S dollar, in the Bretton Woods system. The Fed was obliged to exchange on ounce of gold into $35 U.S dollar. (N:1 currency system). President Nixon closed this cheap gold at $35 window in 1971.

Gold lost its status with flexible exchange rates, and the IMF demonization of gold policy even urged central banks to sell their gold. Central banks in Switzerland and the UK followed these calls, and the Fed is still the leasing central bank in an implicit N:1 system of central banks (Bretton Woods II).

Quantitative easing makes the gold rise and the dollar to weakens, because private investors and some central banks move out of the dollar and into gold. If the U.S employment falls, then the dollar appreciates which is about to happened now. EM will be more expensive and with lower oil prices the U.S trade deficits diminishes.

U.S funds will find treasuries more attractive relative to gold and silver and normally when the real interest rates is high, the gold price is weak and vice verse. When the U.S economy improves the gold price falls, and the chances of a Fed Funds rate hike increase, but that`s far in the future.

The gold price moved upward together with oil prices and wages during the 1970`s inflation expectations. Wages is playing a role as an underlying factor for interest rates and the gold price. At that time, Fed Chairman Volcker hiked interest rates so that unions stopped higher wage demands, new supply (North-sea oil) suppressed the oil price and the incomes of EM, while the global growth was sluggish.

Fed Chairman Volcker destroyed the gold price by keeping inflation (and company margins) under control and the stock price rose again. Now wages is declining (wage share of GDP) and the company margins are increasing. The gold price have dropped sharply in a few days and are trading below its 1,200 support level. It can go down to 1,000 and below.

A report published by the World Gold Council «China`s gold market: progress and prospects» suggests that the demand for gold will increase by 20%, from 1,132 tonnes per year to at least 1,350 tonnes by 2017. It was a record level of Chinese demand for gold in 2013, and 2014 is suggested to see consolidation, the succeeding years are likely to see sustained growth.

The market began liberalising in the late 1990s, and China is the number one producer and consumer of gold. It is expected to see the market to continue to expand, irrespective of short-term blips in the economy.

Mr. Greenspan said gold is a good place to put money these days given its value as a currency outside of the policies conducted by government. Gold is down 1/3 since it’s all time high of $1,921,50 in September 6, 2011. On October 29, he told the Council of Foreign Relations that the Fed`s $4 trillion balance sheet is a «pile of tinder, but hasn`t been lit.» Once the central banks stop «sitting on» their reserves, said tinder will ignite «inflation will eventually have to rise,» and in turn, «gold will move higher, measurably so.» (Fxsteet.com).

Gold is a hedge against inflation, and not against times of crises. Right now, the problem is not inflation, but the opposite; something worse called; deflation. Gold can go down while inflation increases, as they did from 1980 to 2000. It`s difficult to understand the setting of the gold price, so I will continue to look at the technical analysis. Gold is still  in a bearish market.

 

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