Gold Bubble?

[Guest JackRiver]

Eric

 

Thanks for the useful information.

 

I think my gold assumption was merely because I assumed that gold was coming off unusually low lows.  I'm just thinking about this stuff off the top of my head which might explain the inconsistency in my views (gold bubble versus housing bubble).  Lastly, I'm not trying to make the case that gold is not approaching a bubble, I'm more trying to figure out what the evidence of that might be other than Parsad's citing of an article.

 

Let me ask you this.  If I said to you that the 1970s inflation (stagflation) was caused by the Fed secretly practicing quantitative easing (buying treasuries through open market operations) and not their actions on the discount rate or fed funds rate, would you agree?  Furthermore, if you agree, would we not be experiencing a similar policy action today?  Gold spiked up in the former period and if I recollect correctly did not die down until after Volcker reversed those policies.  Do you think this is relevant thinking as it pertains to today?  Please point out any assumptions I'm making that are wrong.  

 

So is life.

 

Yours

 

Jack River

[ERICOPOLY]

Eric

 

Thanks for the useful information.

 

I think my gold assumption was merely because I assumed that gold was coming off unusually low lows.  I'm just thinking about this stuff off the top of my head which might explain the inconsistency in my views (gold bubble versus housing bubble).  Lastly, I'm not trying to make the case that gold is not approaching a bubble, I'm more trying to figure out what the evidence of that might be other than Parsad's citing of an article.

 

Let me ask you this.  If I said to you that the 1970s inflation (stagflation) was caused by the Fed secretly practicing quantitative easing (buying treasuries through open market operations) and not their actions on the discount rate or fed funds rate, would you agree?  Furthermore, if you agree, would we not be experiencing a similar policy action today?  Gold spiked up in the former period and if I recollect correctly did not die down until after Volcker reversed those policies.  Do you think this is relevant thinking as it pertains to today?  Please point out any assumptions I'm making that are wrong.  

 

So is life.

 

Yours

 

Jack River

 

 

Well, I would say that if we are going to get into the business of discussing quantitative easing I think we also need to discuss a decline in the velocity of money.  This famous citation of Milton Friedman goes something like this "Inflation is always and everywhere a monetary phenomenon".  But I saw (forget where) a criticism of Friedman that said in essence that Friedman based his reasearch on a 30 yr period of time where velocity of money was relatively stable.  So perhaps his finding just isn't relevant to a falling velocity environment where quantitative easing may merely offset a fall of velocity (or perhaps fail to fully offset it!).

 

I'm not a knowledgable economist so I am of limited value in that kind of discussion.

 

I think that if we are talking about real stores of value we ought to simply plot where gold is today vs where real prices are today and leave the forecasting of where inflation is headed to somebody else.  Paying a real dollar premium for anticipated inflation doesn't seem wise if you want to recover 100% of your purchasing power.

 

[Guest JackRiver]

No, I'm not trying to make the case for store of value.  I got into this discussion based on the suggestion of a bubble.  I was curious what the more data driven evidence of that was.  That's all.

 

As you say, you are not a knowledgeable economist nor am I, and I have a limited understanding of the velocity of money, but that QE money has got to go somewhere.  It's got to bubble up somewhere, no?  And once it shows up, there's no way to easily control how it continues to turn over.  Anyway, no bother, I don't even know where I'm going with this.  A much bigger topic than my brain or knowledge can handle.  Thanks for the replies though.

 

Time to focus on an individual company.  Do you have any company that you would suggest I look into other than those that normally get discussed here and turnarounds.  I have a bit of change to invest still and have plum run out of ideas and motivation.  If you have one and are willing to offer it up, you need not waste your valuable time explaining anything to me.  You can just give me a name and ticker symbol if that much.  I would be willing to freely offer my thoughts on it if I have anything intelligent to add. 

 

Yours

 

Jack River

[uncommonprofits]

There are some nice charts here on the historical price of gold:

http://www.finfacts.ie/Private/curency/goldmarketprice.htm

 

You would have paid roughly $19 for gold in 1800 and might have sold it for:

a gain of 57% in 1970  (170 year holding period)

a gain of 4,300% in 1980 (180 year holding period)

a gain of 1,400% in 2001 (201 year holding period)

a gain of 4,900% in 2009 (208 year holding period).

 

Something to keep in mind is that pre-great depression the sum of inflation + deflation was roughly zero.  Spikes of inflation were offset by spikes of deflation.  If you look at the historical chart below, the post-great depression era represents the longest predominantly inflated period in the last 200+ years (hit the link to view whole chart).  This present inflated era is going on 75+ years and it's likely to continue.

 

True enough that over the course of Gold's history it has served as a proxy for inflation -- and when allowed to trade freely it reacts similarly to common stocks as short term voting machine, long term weighing machine.  However, the proxy for common stocks has an added kicker in that (over the long term) they are a proxy for not only inflation but also economic growth.  Of course one should also be looking at valuation.  I have no clue whether Gold is in a bubble or not -- bottom line is there still remains some very undervalued select common stock opportunities.  I would even venture to say that the S&P index itself will outperform gold over the long haul. 

 

UCP/DD

 

http://www.visualizingeconomics.com/wp-content/uploads/inflation-history.jpg

 

http://www.visualizingeconomics.com/wp-content/uploads/inflation-history.jpg

 

[uncommonprofits]

Over the span of 100 years, the DOW, neglecting dividends, increased an average of 5.5% CAGR.  Including dividends, i'm guessing the returns would have been somewhere around 6%.  2% compounded over 100 years is a good sized difference.  

 

When you look at an index quote for today it will have factored in today's ex-dividends.  So actually dividends are factored into the indexes.  You can do an experiment and take an index quote from one year end to the next and it will match the year's return for the index with dividends included.

 

UCP / DD

[Guest kawikaho]

Ah, very interesting to know.

[Guest JackRiver]

Ah, very interesting to know.

 

Yeah, make sure to distinguish the index.  ie. total return index etc.

 

Yours

 

Jack River

[ERICOPOLY]

As you say, you are not a knowledgeable economist nor am I, and I have a limited understanding of the velocity of money, but that QE money has got to go somewhere.   It's got to bubble up somewhere, no?  

 

Read this article from John Mauldin that will explain velocity to you.  The last paragraph that I've quoted suggests that an increase in the money supply is needed to prevent deflation when the velocity of money is slowing.

 

http://www.investorsinsight.com/blogs/thoughts_from_the_frontline/archive/2008/12/05/the-velocity-factor.aspx

 

 

Now, let's introduce the concept of the velocity of money. Basically, this is the average frequency with which a unit of money is spent. Let's assume a very small economy of just you and me, which has a money supply of $100. I have the $100 and spend it to buy $100 worth of flowers from you. You in turn spend the $100 to buy books from me. We have created $200 of our "gross domestic product" from a money supply of just $100. If we do that transaction every month, in a year we would have $2400 of "GDP" from our $100 monetary base.

 

So, what that means is that gross domestic product is a function not just of the money supply but how fast the money supply moves through the economy. Stated as an equation, it is Y=MV, where Y is the nominal gross domestic product (not inflation-adjusted here), M is the money supply, and V is the velocity of money. You can solve for V by dividing Y by M. (In last April's discussion of the velocity of money I used "P" instead of "Y". Lacy Hunt tells me the more correct statement of the equation is Y=MV, and I defer to the expert. Sorry for any confusion.)

 

Now, let's complicate our illustration just a bit, but not too much at first. This is very basic, and for those of you who will complain that I am being too simple, wait a few pages, please. Let's assume an island economy with 10 businesses and a money supply of $1,000,000. If each business does approximately $100,000 of business a quarter, then the gross domestic product for the island would be $4,000,000 (4 times the $1,000,000 quarterly production). The velocity of money in that economy is 4.

 

But what if our businesses got more productive? We introduce all sorts of interesting financial instruments, banking, new production capacity, computers, etc.; and now everyone is doing $100,000 per month. Now our GDP is $12,000,000 and the velocity of money is 12. But we have not increased the money supply. Again, we assume that all businesses are static. They buy and sell the same amount every month. There are no winners and losers as of yet.

 

Now let's complicate matters. Two of the kids of the owners of the businesses decide to go into business for themselves. Having learned from their parents, they immediately become successful and start doing $100,000 a month themselves. GDP potentially goes to $14,000,000. But, in order for everyone to stay at the same level of gross income, the velocity of money must increase to 14.

 

Now, this is important. If the velocity of money does NOT increase, that means (in our simple island world) that on average each business is now going to buy and sell less each month. Remember, nominal GDP is money supply times velocity. If velocity does not increase and money supply stays the same, GDP must stay the same, and the average business (there are now 12) goes from doing $1,200,000 a year down to $1,000,000.

 

Each business now is doing around $80,000 per month. Overall production on our island is the same, but is divided up among more businesses. For each of the businesses, it feels like a recession. They have fewer dollars, so they buy less and prices fall. They fall into actual deflation (very simplistically speaking). So, in that world, the local central bank recognizes that the money supply needs to grow at some rate in order to make the demand for money "neutral."

[ERICOPOLY]

As you say, you are not a knowledgeable economist nor am I, and I have a limited understanding of the velocity of money, but that QE money has got to go somewhere.  It's got to bubble up somewhere, no?  And once it shows up, there's no way to easily control how it continues to turn over.  Anyway, no bother, I don't even know where I'm going with this.  A much bigger topic than my brain or knowledge can handle.  Thanks for the replies though.

 

 

 

And in that same John Mauldin article this quote is important:

 

Also, Lacy pointed out, in a conversation which helped me immensely in writing this letter, that the velocity of money is mean reverting over long periods of time. That means one would expect the velocity of money to fall over time back to the mean or average. Some would make the argument that we should use the mean from more modern times since World War II, but even then mean reversion would mean a slowing of the velocity of money (V), and mean reversion implies that V would go below (overcorrect) the mean. However you look at it, the clear implication is that V is going to drop.

 

 

You asked how this compares to the 1970s situation -- in the 1970s there wasn't this threat of correction due to mean reversion in velocity.

 

I think this could throw a wrench in the plans of the goldbugs.

[Guest JackRiver]

Ericopoly

 

I lied when I suggested I don't know much about the velocity of money.

 

I wont elaborate, but that version of the equation is less useful for thinking about the stuff we are thinking about.

 

The equation before:

 

Y = M X V  (Y being GDP)

 

The more useful version:

 

M X V = unit X Price

 

That is all the different individual units of product and services multiplied by their prices.

 

Think kids and cell phones.

 

Yours

 

Jack River

 

PS  Eric, I'm moving on (onward always onward), but if you weren't aware of this altered version before, I trust a smart guy like yourself will find it immensely useful in your thinking.  Feel free to email me from time to time jacksriver@comcast.net

 

 

 

[Guest Broxburnboy]

Boardmembers may be interested in a historic inflation/gold price calculation by a respected precious metals analyst, Paul Van Eden, which directly addresses the subject of this thread:

 

http://www.paulvaneeden.com/Gold

 

The issue in my mind is not whether there is a "bubble" in gold prices (if so it is the longest running bubble in history, predating the very existence of the US dollar), but whether the recent price run up reflects the rate of inflation of the USD or includes a "safe haven demand" premium for the worst case scenario for the US economy/buck.

 

 

 

 

[ERICOPOLY]

Boardmembers may be interested in a historic inflation/gold price calculation by a respected precious metals analyst, Paul Van Eden, which directly addresses the subject of this thread:

 

http://www.paulvaneeden.com/Gold

 

The issue in my mind is not whether there is a "bubble" in gold prices (if so it is the longest running bubble in history, predating the very existence of the US dollar), but whether the recent price run up reflects the rate of inflation of the USD or includes a "safe haven demand" premium for the worst case scenario for the US economy/buck.

 

 

 

He is linking monetary inflation to gold prices.  However, in theory we can have continual annual monetary inflation for the rest of eternity without actually pushing up prices of consumer goods (if monetary inflation does not exceed increases in productivity for example).

 

That is something I find very strange.  I would expect gold to behave like a real asset (maintain it's real purchasing power) -- but this guy doesn't see it that way.  He simply says all that matters is the money supply -- so in theory if an ounce of gold buys a few square feet of house today, it could buy a billion square feet of house at some point far out in the future.  Now that doesn't make sense.

 

Monetary inflation does not necessarily lead to price inflation -- except this guy seems to be suggesting it should always push up the price of gold (leading to real price increases of gold as measured by the quantity of goods an ounce of gold can purchase).

 

The argument may be that more dollars chasing a fixed supply of gold, however if there are productivity gains to precisely offset the increase in dollars then it should not be pushing on the price of gold.

[Guest Broxburnboy]

 

quoting Ericopoly:

 

"He is linking monetary inflation to gold prices."

 

Quoting from the aforementioned article (http://www.paulvaneeden.com/Understanding.the.gold.price written in 1998), this is what van Eeden's research supports and  says about the gold price:

 

"As I have shown, the most important influence on the gold price is simply the US dollar exchange rate. If the dollar gets stronger, the gold price declines. If the dollar declines, the gold price increases. While central bank sales and other forms of disinvestment do have an influence on the gold price, it is the dollar exchange rate that plays the most important role and it is the dollar exchange rate which up until now has been overlooked by most investors and analysts."

 

The most recent confirmation of this which was on March 18 2009, the day the Fed announced 300Billion$ worth of "quantitave easing" ... creating new dollars out of thin air. The price of gold jumped 60.00$ USD almost instantly.

 

http://66.38.218.33/scripts/hist_charts/daily_graphs.cgi

 

Going forward, quantitative easing will be the only way the US government can finance the announced trillion dollar(plus) deficits as the now rising cost of borrowing (higher interest rates) would defeat the stimulus spending. The gold price (in US dollars) then, extrapolating Van Eeden's logic, must rise. The bubble is in US dollars.

 

[Guest Broxburnboy]

 

The attached link to the gold chart doesn't work so I have attached the chart as a .gif file:

A thousand apologies.

 

 

 

 

 

 

[Zorrofan]

Boardmembers may be interested in a historic inflation/gold price calculation by a respected precious metals analyst, Paul Van Eden, which directly addresses the subject of this thread:

 

http://www.paulvaneeden.com/Gold

 

The issue in my mind is not whether there is a "bubble" in gold prices (if so it is the longest running bubble in history, predating the very existence of the US dollar), but whether the recent price run up reflects the rate of inflation of the USD or includes a "safe haven demand" premium for the worst case scenario for the US economy/buck.

 

 

 

 

 

 

Bill Gross, always an interesting read, mentions not only the current deficit problems but the looming social security & medicare/medicaid ones as well. Potentially $40 TRILLION....might be a bit of pressure on the dollar!

 

http://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2009/IO+June+2009+Staying+Rich+in+the+New+Normal+Gross.htm

 

cheers

Zorro

[ERICOPOLY]

 

quoting Ericopoly:

 

"He is linking monetary inflation to gold prices."

 

Quoting from the aforementioned article (http://www.paulvaneeden.com/Understanding.the.gold.price written in 1998), this is what van Eeden's research supports and  says about the gold price:

 

"As I have shown, the most important influence on the gold price is simply the US dollar exchange rate. If the dollar gets stronger, the gold price declines. If the dollar declines, the gold price increases. While central bank sales and other forms of disinvestment do have an influence on the gold price, it is the dollar exchange rate that plays the most important role and it is the dollar exchange rate which up until now has been overlooked by most investors and analysts."

 

The most recent confirmation of this which was on March 18 2009, the day the Fed announced 300Billion$ worth of "quantitave easing" ... creating new dollars out of thin air. The price of gold jumped 60.00$ USD almost instantly.

 

http://66.38.218.33/scripts/hist_charts/daily_graphs.cgi

 

Going forward, quantitative easing will be the only way the US government can finance the announced trillion dollar(plus) deficits as the now rising cost of borrowing (higher interest rates) would defeat the stimulus spending. The gold price (in US dollars) then, extrapolating Van Eeden's logic, must rise. The bubble is in US dollars.

 

 

 

I should have stated explicitly, but I was referring to the chart where he simply plots gold price against his theoretical gold model.

 

He says the following:  "It is based solely on historical money supply (US dollars) and gold supply data."

 

 

 

[Mark Jr.]

Speaking of the usurers of the world (pawn shops/buy here pay here lots/payday lenders/rent to own sellers), has anyone looked at any for investment?

 

Totally anecdotal: back around '02 - '03 I used to hit the pawn shops to clean them out of junk silver and gold maple leafs and here in Toronto, they seemed to be for a large part dying on a vine. When I got to talking to the owners they were telling me they were getting killed by eBay.

 

I wouldn't know how the larger chains fared as a result of this: Cash Converters, etc. But the mom-and-pops were hanging on by a thread.

[valuecfa]

I don't know.

 

Jim Grant (one of the few economists I actually listen too) has been bullish on Gold recently.

 

Interesting video today on CNBC as well where he is interviewed:

 

http://www.stockbox.tv/jim-grant-fed-would-be-shut-down-if-it-were-audited/