The gold price tells us nothing about inflation

By Felix Salmon
April 5, 2012

Matthew Bishop and I have a fundamental disagreement when it comes to gold. There’s a “canary in a gold mine,” says Matthew: when the price of gold goes up, “it tells you we should worry about why it’s going up, and what it tells you about the value of paper currency.”

Whereas I think it tells you no such thing.

Essentially, we’re looking at two different things. Here’s a chart of the gold price, in green, versus the 30-year bond yield, in orange, over the past five years.

chart.tiff

The long bond currently yields just 3.36%, which is the clearest way that the market knows of saying that there’s not going to be any nasty inflation in the future. If you want, you can even get an exact number, by subtracting the 30-year TIPS yield of 0.94%: the market is saying that over the next 30 years, inflation is going to work out at just 2.42%, on average. Which is not anything to get worried about.

Now TIPS are not a foolproof guide to future inflation, but gold certainly isn’t. Indeed, the bond market does more than undermine the gold price as a guide to future inflation: it actually provides a much more credible explanation for the gold price than an inchoate fear of future price increases. After all, if you want to protect yourself against inflation, you buy assets which throw off income which goes up when prices go up, like TIPS, or companies, in the form of stocks. Gold, on the other hand, throws off no income at all, and its price is just as crazy and volatile in real terms as it is in nominal terms.

And if you think that prices in the Treasury market represent an idiosyncratic flight to quality rather than a reliable guide to future inflation, then you can look at an even broader market indicator. As Peter Rudegeair notes, if you look at the $1.246 trillion in the 100 largest US corporate pension funds, more of it is invested in bonds than in stocks. And retail investors, too, are moving their money out of stock funds and into bond funds. Essentially, everywhere you look, the market is showing that it trusts the dollar and that it has no fear of inflation.

Of course, the market might be wrong. But Bishop isn’t telling us to mistrust the market, he’s telling us to trust the market — albeit just one tiny slice of it, in the form of the gold market. That’s silly. If you’re going to trust market signals, you should trust the big market signals which are sending a clear message, rather than the noisy and volatile ones which mean whatever you want them to mean.

Why is the price of gold going up? Simple: when interest rates are this low, bonds are increasingly unattractive as a source of yield, so you might as well just buy stuff — call it SWAG — instead. SWAG doesn’t have any yield, but then again, neither does cash, really. And when there aren’t attractive investments out there, then it becomes more attractive to spend money rather than to invest it. As a result, people spend their money on SWAG, and some of them even kid themselves while doing so that by buying their SWAG they’re making some kind of investment. They’re not. And they’re certainly not producing a reliable guide to the future status of the US dollar.

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Comments
16 comments so far

matthew bishop is clearly the smarter of the pair

Posted by domainslayer | Report as abusive

Gosh, Mr. S – you really rounded-off a lot of corners and skipped over more than a few of the moving parts in the equation of gold prices and Treasury yields.

“Why is the price of gold going up? Simple: (but incomplete answer appears in text)” (F.S.)

The really simple answer is that gold prices have risen because more money has flowed into that asset than has been removed from it; same is true of Treasuries – and oil – in varying degrees. Why?

Too complex to discuss in detail in a post, but in sum – in the interplay between fear and greed SWAG is perceived as a way to cover them both, by means of that single asset class. You seem to think the “fear” part of it is just phantoms and shadows and should be discounted all the way to 0 – others disagree. Others also disagree that the CPI is always the sole indicator of the extent of inflation, as the TIPS formula presumes it to be.

IDK who’s right; IMO nobody else does either – we’re all just guessing. Mr. Bishop seems to acknowledge that. Kinda hope you have it right, though – I’m 80% cash/20% realestate.

Posted by MrRFox | Report as abusive

Everything is about price Felix. What the dollar buys each year declines, this is one reason we expect a rate of interest when forgoing consumption and lending it out via savings. When the rate of interest is high, the loss of purchasing power is made up in part by the increased amount of dollars we get back and in such an environment gold may not be so attractive, but when that rate is lower or zero, then the only difference is the carrying cost or storage costs of gold. Gold is a store of value, that it does not pay interest in an environment of dollar deposits paying a negative real rate of return turns out to be a difference without a distinction. At the end of my time horizon I just want to know my purchasing power is maintained.

Posted by Sechel | Report as abusive

Hasn’t the Fed had something to do with buying long term Treasuries with a goal of suppressing the yield?

Posted by tqft | Report as abusive

My question is why the gold futures curve doesn’t reflect the hyperinflation concerns that surround the asset.

A quick glance shows that there aren’t any concerns of a dollar collapse in the market.

Posted by djiddish98 | Report as abusive

Long term interest rates in 1950 were about the same as they are today, but if you had purchased a 30 year government bond due in 1980, the paper dollars you got back in 1980 had a fraction of the purchasing power they had when you “invested” them in 1950.
Not a good deal.

From 1792 to 1933 ten US dollars would buy about 1/2 ounce of gold, and you could exchange a $10 bill for a $10 gold piece at any bank. Today, ten US dollars will buy about 1/5th of a gram of gold, which is about the size of a finger nail clipping from your little finger. If you were holding 1/5th of a gram of gold in the palm of your hand and sneezed, it would probably be gone forever.

Posted by unclepie | Report as abusive

Gold isn’t a store of value. It’s a shiny metal.

They are as much a store of value as tulips were during that mania.

Posted by petertemplar | Report as abusive

Felix, why are you comparing the PRICE of gold with the YIELD of bonds? Shouldn’t you compare price and price (assuming reinvestment of interest)? Or yield and yield?

Of course that latter would be pretty boring, since the yield on gold is zero (or negative)…

Real interest rates are very low (negative) right now, so those low bond yields may imply significant expected inflation.

Posted by TFF | Report as abusive

“Gold isn’t a store of value. It’s a shiny metal.
They are as much a store of value as tulips were during that mania.” (Posted by petertemplar)

Yes, gold’s worth is based purely on psychology, not utility in any economic sense; there’s inherent risk in that – and has been for the 3000+ years that gold has overcome that risk. Chances are it will continue to do so for at least another hundred years – who cares what happens after that?

Sometimes the obvious answer is the right one: the Treasury/gold anomaly isn’t really that at all – people and governments have fled to Treasuries out of, respectively, fear and lack of an alternative, and simultaneously to gold because of fear and greed. Fear influences investing like never before in my lifetime – and I’m not young.

Posted by MrRFox | Report as abusive

If one graduated from a university in the last 40 years, you may want to read “Crisis in Competence” published by the National Association of Scholars.

The “dollar value” of gold is how many piece of paper some figure they’d trade for an ounce. The “value” of holding gold is that there are no counter-party promise being relied upon, and that’s highly important during times when many high-level folks aren’t keeping their promises.

“I am more concerned with the return of my money than the return on my money.” Will Rogers, quoted in Will Rogers Performer, p. 292. Also attributed to Mark Twain.

Posted by EdwardCate | Report as abusive

And, it could be that the sovereign debt loads in the western world concern many the folk who are invested in sovereign debt are simply wrong, like the people, pensions, hedge funds and other financial institutions who invested in mortgages were. If that’s the case, then gold may be priced very much on the low side at present.

My point here is that I think people, all over the world, are increasing their exposure to gold as a hedge against the debt profligacy of the sovereigns. If it works out the way they think it might, they will be wrong right up until they aren’t, sort of like the folk who were shorting mortgage backed securities a few years ago were.

Posted by sewells1951 | Report as abusive

“Gold prices have risen because more money has flowed into that asset than has been removed from it.”

EXACTLY as much money has flowed out of gold as has flowed into it. Always. Full stop. Let’s get the accounting identities right as a first step, yeah?

Posted by ckbryant | Report as abusive

djiddish98 – think it through. If the gold futures price was double the spot price, you could easily sell gold forward, buy spot gold, store it in a vault at a cost of less than 0.5% pa, and wait until the delivery date and make a riskless profit. So the spot price is, essentially, the futures price.

Posted by mjturner | Report as abusive

@ckbryant, on one level what you say is obviously correct. But on another level, people are investing a greater percentage of their assets in gold than before. Do you have a better way to describe this?

@Mjturner, that “riskless profit” is only a profit if a dollar tomorrow is worth the same as a dollar today.

But I agree that there is no evidence that the markets are anticipating rapid inflation — at least not as measured by the Treasury/TIPS spread.

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