Even those in the non-financial media have noticed the skyrocketing price of gold this year. Some partially identify, but don’t quite understand, some of the many (and more measurable) intermediary effects in the chain of causation such as a “weakened US dollar” and “low bond yields”. Those in the financial press add to these factors ones like “central bank reserves” management along with “mining” “production” and “jewelry and industrial demand”. One mainstream headline surprisingly ‘hits closest to the mark’ regarding the few (and less measurable) underlying causes ie “Fear and cheap money send gold price soaring”.
As will be seen in this article, the chief cause for this and all major rises in gold prices is not “fear and” but “fear of” “cheap money”. To set the stage, the first three charts (immediately following this article, which I created from data published by Measuring Worth) set out the annual gold price and the fourth chart the annual quantity accumulated, all four over very long periods of time. (The more recent gold price trend can be found at Trading Economics.)
- Chart 1 shows the US$ gold price of $59 per ounce from 1972 to the high on 6 August 2020 of $2,065. In between, there were peaks of $613 in 1980 and $1,700 in 2012 as well as troughs of $272 in 2001 and $1,163 in 2015. The current take-off started from $1,390 last year. For the US, 1972 was the first year off any sort of gold standard.
- Chart 2 shows the US$ gold price largely being between $19 and $21 from 1791 to 1932. There were a two minor peaks of $22 during this period in 1815 and 1837 and a more significant peak of $42 in 1864. It then rose again to $35 in 1934 and stayed at that price until 1966. It finished on $41 in the last year of the US gold standard ie 1971.
- Chart 3 puts Chart 1 and Chart 2 together to provide the entire context of the US$ gold price from 1791 to 2020. The less frequent and arithmetic size price rises of the gold standard era largely disappear in the face of the more frequent and geometric size price rises in the fiat money
- Chart 4 shows cumulative gold mining from 1835 to 2016 for a total estimate of 177,000 tonnes, with central banks claiming 33,000 or 18.6% of that. The 2019 total is estimated at 197,576 tonnes (or 6,352,215,905 ounces) with jewellery accounting for 47.0%, private investment 21.6%, central banks 17.2% and other 14.2%.
Robert Blumen is a gold price expert and commentator, as well as follower of the Austrian School of economics, who has written multiple articles for multiple publications over multiple years. This published transcript, entitled What is Key for the price formation of Gold?, of a lengthy 2013 interview of him makes the following seven key points of greatest relevance, not only for then, but for today and for the foreseeable (fiat money) future:
“There might be a statistical correlation between, for example, a net inflow into one sector and higher (or lower) prices. If someone has a statistical model that works, that is great. But it’s not causal. But it seems to me that even if someone has discovered correlations like that, they will be coincident with the price, rather than predictive. In order to forecast the price, you need an indicator that moves in advance of the price.”
There is a “vast amount of brainpower that goes into quantifying gold flows into market segments, such as industry, jewelry, coins, and funds. These quantities may be interesting for some purposes, but they’re not really that relevant if what you’re trying to do is understand the gold price, because there is not a connection between quantities and price in the way that most people think there is.”
“The gold market is not segregated into one market for the gold that was mined this year and another market for gold that was mined in past years. The buyer doesn’t care whether he’s buying a newly mined ounce of gold or buying from somebody who had purchased gold that was mined 100 years ago. All of the buyers are competing to buy and all of the sellers are competing to sell.”
“Gold is primarily an asset. It is true that a small amount of gold is produced and a very small amount of gold is destroyed in industrial uses. But the stock to annual production ratio is in the 50 to 100:1 range. Nearly all the gold in the world that has ever been produced since the beginning of time is held in some form.”
“In an asset market, consumption and production do not constrain the price. The bidding process is about who has the greatest economic motivation to hold each unit of the good. The pricing process is primarily an auction over the existing stocks of the asset. Whoever values the asset the most will end up owning it, and those who value it less will own something else instead. And that, in in my view, is the way to understand gold price formation.”
“Most of the market research about gold deals with exchange demand, which has the advantage that you can measure it. But reservation demand is far more relevant to the price. The profile of reservation demand among people who own gold is the main determinant of the gold price from the supply side. … Reservation demand is where you demand something by holding onto it rather than selling it. … I have reservation demand at the moment for an auto, a dining room table, a couch, a mobile phone, and so forth.”
Thus: “The gold price is set by investor preferences, which cannot be measured directly. But I think that we understand the main factors in the world that influence investor preferences in relation to gold. These factors are the growth rate of money supply, the volume and quality of debt, political uncertainty, confiscation risk, and the attractiveness (or lack thereof) of other possible assets.”
The 2015 book entitled Austrian School for Investors: Austrian Investing between Inflation and Deflation serves as an important complement to Blumen’s work on gold price formation. The four authors are, not just Austrians in an economic sense, but are actual Austrians from the country of the same name. This is rare indeed, at least since the pre-Anschluss days of old when Mises and Hayek were residents there. What follows next is seven key points from the Precious Metals section of chapter 9 on Austrian Investment Practice:
“The marginal utility of gold declines at a slower rate than that of other goods. It is owing to this superior characteristic that gold and silver enjoy their monetary status, and not their supposed scarcity. Their high marketability represents also their decisive advantage over other stores of value. … For this reason, central banks hold gold as a currency reserve, and not real estate, artworks or commodities.”
“Most analysts assert that gold has the characteristics of an inflation hedge. There are, however, also critical voices. They opine that there is no statistical correlation between gold prices and price inflation rates, and conclude that the inflation hedge notion is thus a myth. We examined this question and drew the following conclusion: gold does not correlate with the rate of inflation as such, but with the rate of change of the inflation In order to buttress this hypothesis, we calculated the regression depicted in [Chart 5].”
“If gold is already weakening in a period of disinflation, it must be even weaker in a period of deflation. This is however a fallacy. The trend of gold in a deflationary environment has barely been analyzed, not least because there exist only very few examples of deflationary periods. … In a period of pronounced deflation, [not only do] government budgets become overstretched [but] trust in the financial system and paper currencies declines, while gold gains in importance due its top-notch credit quality.”
As per Chart 6: “Akin to an hourglass, liquidity in the financial system gradually flows downward as the willingness to take risks declines. At the very bottom is gold. Due to general skepticism, the circulation of gold declines as it is increasingly hoarded. The degree of hoarding is always proportional to the confidence in government and its currency.”
“Gold exhibits a very low correlation with most other asset classes, especially stocks and bonds. Gold as a non-correlated asset class therefore represents a means of portfolio diversification. [Chart 7] shows quite impressively why gold is also often referred to as an event hedge.”
“The probably most important characteristic that distinguishes gold from its peers and explains its monetary significance is its high stock-to-flow ratio [eg 65:1 in 2012]. … The worldwide stock of gold grows only by about 1.5% per year…approximately equivalent to the growth rate of the global population. … The high stock-to-flow ratio provides a natural inflation hedge. In the extremely unlikely event of a 50% increase in mine production, the total stock of gold would only rise by 2.3% per year.”
Thus: “There exists no instruction manual for the current financial era. … In the current environment, gold plays the role of a monetary insurance policy. Antony Sutton describes the counter-cyclical character of an investment in gold as ‘there are always the few who observe, reason, and take precautions, and thus escape the flood’.”
In conclusion, the answer to the question, “Why is gold skyrocketing?” is follow the money printing. As can readily be seen in Chart 8, US M0 money supply has been subject to a number of Quantitative Easings (QEs) since 2008. As one regression study has shown: “When the Federal Reserve increases money supply by 1%, gold prices increase by 0.94%.” Such money chaos encourages not only price chaos (for both assets and consumers) but government chaos.
Therefore, as I said upfront, the chief cause for this and all major rises in gold prices is “fear of cheap money”. Such fear increases in times of economic turmoil. Such turmoil is almost always caused, and made worse, by government. In 2020 that includes, not just more QE, but also the chaotic government responses to the coronavirus and civil unrest. I will end with a quote from an article by the great economics educator Bob Murphy of the even greater Mises Institute:
“There’s an old joke that the price of gold is understood by exactly two people in the entire world. They both work for the Bank of England and they disagree.”
But hopefully there is a now a third person who understands the price of gold, namely you!
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Darren Brady Nelson is an Austrian school economist who has mainly worked in Australia & the USA for TV shows, newspapers, think tanks, regulators, politicians, governments & NGOs. This recently includes an Australian Senator & American President. He is the chief economist at LibertyWorks, associate scholar with the Center for Freedom and Prosperity and policy advisor to the Heartland Institute. He blogs and posts at LinkedIn where he has built up a following of 26k in the last year.