The Fed is sending gold higher

November 18, 2009

Is gold going to $6,300? Dylan Grice, an analyst with Societe Generale, says it’s possible, given the decline in central bank credibility. But investors need to keep one thing in mind: Gold is merely a vehicle to protect the purchasing power of money.

Gold is surging because investors see that the Federal Reserve — more concerned with deflation and unemployment than sound money — may be trapped in a never-ending cycle of monetary accommodation.

Ben Bernanke says he won’t monetize debt, but he already has. His Fed has bought $300 billion of Treasuries and is on pace to buy $1.45 trillion of government-backed mortgage debt all of which is being salted away indefinitely on the Fed’s balance sheet.

Why indefinitely? Because the Fed has no intention of unwinding its balance sheet so long as the economy is stressed. Witness comments this week from Bernanke, Fed Vice Chairman Don Kohn and San Francisco Fed President Janet Yellen all suggesting that the Fed’s “extended period” of low interest rates can be measured in years, not months. Today St. Louis Fed President James Bullard said rates aren’t going up till 2012.

So long as deficit spending continues, if the Fed wants to avoid deflation, it will be forced to monetize more debt.

[Elsewhere, capital controls are being erected in emerging economies like Brazil, Taiwan, and possibly Indonesia in order to keep speculative waters at bay. As Hong Kong’s chief executive remarked last week, a dollar carry trade spawned by low rates threatens to inflate dangerous asset bubbles in emerging markets the same way low Japanese rates did in the ’90s.]

Exploding debt throughout the developed world means other central banks face similar pressure.

(Click chart to enlarge in new window, reprinted with permission)

insolvent

So confidence in paper currencies is waning.

Some people say it is absurd to buy gold; the metal has no intrinsic value. That may be. But is it any less absurd to hold paper? The best that can be said for paper is that if you lend or invest it, tomorrow someone will give you more paper in return. This is fine so long as its purchasing power is maintained. But it isn’t. A 2009 dollar is worth a 1914 nickel.

Eventually the value of all the paper you’ve accumulated goes to zero. The trick is to turn that paper into tangible assets with tangible value.

Gold may be volatile, but at least it maintains its real value:

(click chart to enlarge in new window, reprinted with permission)

golds-real-value1

Grice contends that the price of gold could reach $6,300 an ounce. He explains: “The U.S. owns nearly 263 million troy ounces of gold (the world’s biggest holder) while the Fed’s monetary base is $1.7 trillion. So the price of gold at which the U.S. dollar would be fully gold-backed is currently around $6,300. Gold is very cheap — at current prices, the USD is only 15 percent gold-backed.”

Absurd you say? It happened 30 years ago. President Nixon ended the Bretton Woods global monetary system and his compliant Fed Chairman Arthur Burns let inflation run wild. So by 1980 gold spiked to a level at which the dollar was “overbacked” according to Grice.

Did gold overshoot in 1980? Sure, but only because Paul Volcker was willing to hammer the economy to re-establish the Fed’s credibility. Today’s Fed has been very clear that it isn’t willing to put up with a recession of any kind in the service of sound money.

All of that said, investors should be careful. Grice’s chart shows that, over the long run, gold is likely to do no better than protect your purchasing power. An ounce of gold today buys a good men’s suit; in 100 years, it is likely to buy the same.

So gold won’t make you rich. But it may protect you from becoming poor.

38 comments

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Executive Order 6102, anyone?

Posted by no-friends | Report as abusive

If you’re just worried about inflation, there are all sorts of things to put your money in besides gold (TIPS, plain old equities, agricultural commodities, etc.). The prices of these things will rise with inflation, so you get some protection. If you’re worried about defaults you can buy CDS… my point is that there are lots of instruments that you can buy that let you hedge different types of risk, so why is gold spiking?The only answer I can think of is that, unlike the assets mentioned above, gold is totally free of counterparty risk. If gold is mainly pricing in counterparty risk fears, then isn’t that kind of scary? In other words, gold could be a sort of CDS on the entire system, but without the worry that your counterparty on that contract won’t be able to deliver.If this is the case, then the question is: what level of systemic risk is it pricing in? Does $1,150/oz still correspond to just a basis point or two of traditional credit risk, or is it a few hundred basis points?

Posted by ZeroShrubbery | Report as abusive

ZeroShrubbery…..I think you have it exactly right. Lots of gold investors aren’t worried about conventional inflation. They’re buying crisis insurance. They literally want to be out of the system….

Posted by Rolfe Winkler | Report as abusive

Gold transactions are easier to make without being taxed, for one.

Posted by Andrew | Report as abusive

Gold is a huge bubble and is worthless as a store of value. As noted in a comment I recently read, a shotgun will be a better store of value than any amount of gold if the dollar goes to zero.

Posted by Denis | Report as abusive

Gold is a barbaric relic because it recalls those times men could not trust other men. As folks kept their word, folks started believing in promises, and accepted currency (promise money). In time, financial sociopaths started playing on this confidence, lyin’ and stealin’ by making promises they knew they could not keep. Folks converted those promises to gold as they could. Therefore, the barbaric relic becomes popular when men cannot trust other men. Instead of currency (promise money) we’re forced back to barter. Gold and silver are highly-trade-able assets, but it’s still barter. When financial sociopaths are removed and the lyin’ and stealin’ is stopped, physical gold and silver will start being converted back into promises.

Posted by Edward Ulysses Cate | Report as abusive

So a rush to gold is, then, a rush to the exits. It’s not a conventional investment vehicle–it’s more like a non-investment vehicle, a decision to cash in your chips and get entirely out of the game. No wonder the investing community hates it. Every other asset class is enmeshed in a web of contract and hence has value in the system and to the system. Even real-estate, which has no counterparty risk but which exists in the system as a bundle of rights (mineral, water, development,e tc.), obligations (taxes, upkeep, etc.), and cash-flow (from rent or cultivation), derives most of its investment value and fungibility from this web of contract. Not so gold; once value is converted to gold, it’s essentially private, singular, invisible. It’s like the dark matter (antimatter?) of the market. Barbarous indeed.

Posted by ZeroShrubbery | Report as abusive

If agree with me, Rolfe, then your headline needs to be nuanced. What the Fed is doing with debt monetization is sending /the stock market/ higher (with stock prices and PEs reflecting inflation fears). If the Fed is sending gold higher, it’s because large investors with deep pockets are nervous about the impact of the Fed’s actions on the entire (credit-based) system.So it’s not as simple as:1) Fed prints money2) Gold goes higher on fear of inflation.It’s more like:1) Fed prints money2) Stocks and other assets go higher on fear of inflation3) Gold goes higher on fears that the asset bubble that the fed is blowing will burst and take down the entire system with it, and no counterparty will be left standing to deliver on any of the contracts that were written as insurance against the mother of all bubbles bursting.If the market were pricing in a normal crisis, step #3 would look like:3) Rates go higher on instruments meant to insure against a bubble burst.Am I wrong?

Posted by ZeroShrubbery | Report as abusive

The gold in FED’s balance sheet is not audited since 1950’s.Plus the gold stored in fort Knox is not pure, it was collected from the american people during great depression and it was in coins, so it was not 99% pure gold, so its value is less than it is estimated.

Posted by john | Report as abusive

John,I believe that your observation is particulary germane here. The Elephant in the room is that a primary source of Gold since the world went off the goldstandard is likely going away. That is central bank supply. If gold mining and scrap were the only source of supply we would have genuine shortage. For those not familiar with the work of the Gold Anti Trust Action Committe (GATA) there seems to me to be evidence that the Fed and other central banks may have been involved in Gold Swaps and possibly leases and that the reported physical gold in the central bank vaults may be significantly less than is in the vaults. Even if GATA’s conclusions were completely wrong, something I very much doubt, the fact remains that demand is increasing even as mining supply is decreasing as are the long term hords of gold that have at one time comprised the national treasure of many nations and their central banks and which for years have made up the supply deficit.

Posted by Duffminster | Report as abusive

[…] Full Blog Post Here […]

Posted by Dylan Grice: Gold to $6,300? | The Daily Gold | Report as abusive

If the object is to buy a tangible asset that will rise with inflation I still think housing, for example rental, is a better choice than gold. For one thing the price is temporarily depressed while gold is sky high. Apossibility exists that you can make money and still have long term appreciation.The price of gold for the nest twenty years is anyone’s guess, based on the past twenty years of history. Does anyone seriously think that in ten years real estate won’t be back on track? After all, unlike gold, housing actually serves a purpose.

Posted by al coholic | Report as abusive

The graphics are poorly scaled and annotated. Maybe we should request a ‘Conspiracies and Speculations’ blog space from the Editors.

Posted by Casper | Report as abusive

al….You make a great point. Owning tangible assets that have utility for consumers is preferable to owning gold.The problem, as I see it, is that houses are still overinflated by too-easy credit. To buy one, most people have to go into debt. Those that don’t have to overpay because they’re competing with buyers who are willing to go into debt.But gold is only good for a portion of your portfolio. The highest allocation I’ve heard of from folks who really think we’re headed for a system crash at some point, is 20%.And I’m not sure it makes sense to own gold unless you have significant liquid assets and want to have an insurance policy.

Posted by Rolfe Winkler | Report as abusive

Stare at it. We have been here before with gold. It is worth somewhere between two and three hundred dollars, period. It has risen to heights before, always to crash later. Its gravity. Buy a pre-CBS Fender Strat, you can stare at it. You can also play it. Buy land. You can stare at it. You can also grow something on it, build something on it, store something on it, lease it. There are numerous items that will retain their value and over the long haul appreciate. If you have held gold for a long while, you should be selling it now. You can buy it back after the next gold crash. There will be another crash, as sure as the sun will rise.

Posted by paul | Report as abusive

It’s not clear what’s being measured in the chart of the Real Gold Price over the centuries. We need a better explanation of the what the units on the y-axis represent. Incidentally, I completely agree with Rolfe’s blog – gold, because it can’t be printed up, is a wealth protector. But, it’s not an investment.

Posted by Peter | Report as abusive

One is a fool today to not turn fiat into GOLD and even that much more SILVER!!! SILVER THE -THE INVESTMENT OF A LIFETIME AND TRUE CURRENCY SINCE 1000’s of years ago…Same with GOLD..but more SILVER…Only a fool would do anything in mind to keep thye’re minds from understanding GOLD/SILVER…..THat makes more for those in the know..Look at this way for the simpleminded…BIg BAnks /Central Banks,Hedge funds and Brkerages are buying Silver and GOld ….THINK…WHile they tell you to buy paper assets and make a commission f your ignorance,,AWAKEN !!!!

Posted by SILVGOLD | Report as abusive

You might want to label the Y-axis of your “seven-and-a-half centuries” graph. Have no idea what it is charting.

Posted by gp | Report as abusive

paul, to play Devil’s Advocate… you can look at it from the opposite direction, and say that gold keeps dipping… but always rises back up.For that matter, you can turn gold into jewelry or employ it in various industrial purposes. It may be that both of these uses, combined, don’t really justify current prices. But to say that it’s useless is completely inaccurate.Gold has at least as much utility as the pre-CBS Fender Strat, I submit.

Posted by Matt K | Report as abusive

[…] The Fed is Sending Gold Higher   (Rolfe Winkler) […]

Posted by THURSDAY NEWS MIX-UP Market Nut | Report as abusive

i am and have been laughing all the way to the bank since 2003 at you people that spout this Government propagated nonsense about Gold. Keep it up you all are very entertaining!

Posted by james | Report as abusive

I think the point is this…Gold is money. We’re not talking about inflation/deflation, equities, credit crisis. Gold is, and always has been, the money choice of free people. It can’t be manipulated and stolen (via inflation) like fiat money. The world is now losing faith in the fiat-money experiment of the last 30 years and hence we need to hold real money.Ironic how the US Treasury has never let go of it’s hoard of gold. Is that just stupidity? why hold a barbaric relic? hmmmmmm? Possibly it’s because when the world hits the reset button on the fiat-experiment guess whose New Currency is going to be the strongest? The Central bank who owns the most gold – the US. FEEEWWWWW

Posted by George | Report as abusive

What will happen if the lights go out? If there were to be a disruption in the electricity grid, it would take no more than a few days for the major cities to look like New Orleans after hurricane Katrina.Food, water, fuel, communications, et al, would be gone.It is the people that have prepared with their own supplies, that can defend them with precious weapons, and that have gold for barter that will survive.Paper promises are fine but try bartering for food with a brokerage statement.

Posted by Mike Constitution | Report as abusive

Gold, as with pointless art and useless antiques, will meet it’s fate. It will, however, take many hundreds of years, possibly thousands, requireing a higher state of intelligence by man to realise it’s relative uselessness. Gold should, and will be, relagated to it’s only real use – in industrial processes.

Posted by Darwin | Report as abusive

Gold mania will hit soon, despite the government’s efforts to suppress the price of gold. That will cause a gold balloon by people panicking away from Dollar denominated paper. The government will panic and make gold ownership illegal, herding honest people away from it.But gold is still an international currency. It will cross the border and be redeemed for whatever passes for money at that point.

Posted by Timuchin | Report as abusive

It’s just a pretty and heavy metal. Has some industrial application. Otherwise, it is useless.This is just ANOTHER sukers market.

Posted by kthomas | Report as abusive

I like the way the American media repeats stupid statements as if they were a fact. Then again you ARE the nation that invaded the wrong country ..so no surprise there. If you people were any good with facts you wouldn’t be dead-broke both morally & financially I guess.The fact is an ounce of gold actually buys 5 or 6 good suits nowadays,unless of course one decided to foolishly buy only ONE top-priced Armani instead, in which case that same ounce wouldn’t probably even be enough.Please stop making stupid comparisons. I have enough IDIOCY to put-up with coming from your African president and his moronic 3rd World administration.

Posted by ProTaliban | Report as abusive

Gold finger once said, regarding the the metal gate in front of Fort Knox, “It will be dynamited”. This is proof that gold is going to go up, because everybody who saw the movie Gold finger must realize that there will be a nuclear bomb that will go off somewhere in the world and gold will go sky high, just like what Goldfinger wanted to do. ….. Gold finger…he has the Midas touch

Posted by GuitarLots | Report as abusive

The FED is only seeing the deflation in home/property prices, but blind to the inflation in commodities that affect the price of food and energy(oil import) prices. Of course Ben does not worry about food and energy since he dines at invitational lunches/banquets, and travels in a government-supplied car and air transportation. The CPI conveniently excludes food and energy prices, so there is no inflation as far as the government is concerned. This policy saves on COLA for those who need it most…the retired.The present FED policies definitely create inflation, a largely monetary phenomenon. Couple this with a stagnant economy with no jobs being created, plus fiscal policies with new taxes in energy users — aka the CAP & TRADE, new costs from a Health care bill, the second V of the W recovery, and we have STAGFLATION.

Posted by Eu Jen Ek | Report as abusive

[…] as important. Dylan Grice, an analyst at Soc Gen, says gold could potentially be worth $6300/ounce (via Reuters): Grice contends that the price of gold could reach $6,300 an ounce. He explains: “The U.S. owns […]

Posted by Soc Gen Worst Case Scenario | Contrarian Musings | Report as abusive

Yves Smith at nakedcapitalism posted an interesting article on gold earlier this week (written by Wm. Buiter, IIRC).The article posits that gold is a fiat commodity. Since it has no intrinsic value or modern use (except as ornamentation) its value is determined solely at the whim of those parties exchanging it.

Posted by StevenKs | Report as abusive

GOLD RULES !!

Posted by goldformoney | Report as abusive

Aaaah, gold! I posit that gold is a tangible asset only so long as it has real utility (and to lesser extent cosmetic, which is not long-term supportable) usefulness. If it has real utility use, then the second consideration would be a supply-demand one. How much demand against alternative and cheaper substitutable metals. Any demand based on the monetive value must be dismissed as illusory and a fiction propped up only by custom, tradition and legend.Lastly, I submit that the value of an ounce of gold in 100 years will be little different than an ounce of any other common metal. Why? Modern day alchemy already knows how to turn lead into gold. They just don’t know yet how to do it for a cost less than it’s final value. Once they’ve figured that out it’s all over for gold as a unit of money.The same goes for fiat paper. Computers and electronics have already replaced much of it. Once the money wizards figure out how to completely systematize those electronic digits (and that’s coming fast in this digital age) and fully and transparently account for each and everyone, paper money will be another relic of the past.

Posted by Michael Kelly | Report as abusive

I dont agree that gold has no value.you should read the Q3 2009 report from www.gold.orgthe main sorce is mining, and some scrap , there is a cost of mining gold, production is decreasing, its getting harder to go deeper depths, today its purified by chemicals from soil, and this process has a cost about $400/ounce today, few years later it will go up more becuase production will become more costly..

Posted by john | Report as abusive

I’m a young investor so I’m looking for long term growth. Gold might be a short term play but I seriously doubt there’s any way gold would outperform stocks in a time horizon in the decades.

Posted by Randolph Miller | Report as abusive

[…] Rolfe Winkler » Blog Archive » The Fed is sending gold higher … […]

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[…] prices, the USD is only 15 percent gold-backed.

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[…] Rolfe Winkler » Blog Archive » The Fed is sending gold higher … […]

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The fundamental function of money is as a record of the release of REAL, hard won product by a producer into a non barter market. A benign god would have a platoon of accountant angels recording who produced what in an incorruptible ledger to ensure just entitlement to the producer.Gold bugs see hard money as the only system that can approach that ideal. The gaming of fiat currencies aid mostly those who have closest access to the newly created money, whilst diluting the claims of the producers less enfranchised, to the economic pool.BTW The fed would love to see a huge increase in th price of gold since it is sitting on so much of the stuff. All its policies seem to be tailored to this end, the reinstatement of gold backed currencies. Greenspan (gold bug extraordinaire) and the Bushistas long play?

Posted by whitman | Report as abusive

Adding to the above. I have a hypothesis on the current financial crisis backed only by circumstantial evidence.The fall of the Berlin wall saw the West facing the Chinese oligarchy as the last hurdle facing the western capitalist system.Under the guise of free trade, a poker (or mahjong) game started with the ultimate aim of enriching and then enticing a new Chinese elite into joining the global economic system,thus diffusing the possibility of an isolationist and antagonistic superpower carving Asia from the Global (ie Western) system.Capital goods, acess to technology and of course lashings of debt was exchanged for economic goods which were given incredibly generous, (almost suicidal) access to western markets in the full knowwldge that those debts could be defaulted on if the strategy didn’t work (ie the Chinese oligarchy withstood the temptation). Heck, the fact that the Chinese pegged their currency means that they have no moral right anyway.Greenspan, the Libertarian idealogue, supposedly not only changed his spots, but grew wings and a trunk, and oversaw the inverse of his previous beliefs, ie the total debauching of the US currency. Yea right.These guys are playing a very high stakes game. Its a pity they think the average person is too stupid to be let in on it. Maybe they are right.

Posted by whitman | Report as abusive

I went to Measuringworth.org I could not find a graph of the gold price since 1265 that looks even remotely like the one printed in the article. Can you clarify what data you used and what manipulations you used if any?

Posted by Martin Poolasic | Report as abusive

Martin…..I don’t see that data on Measuringworth.org either. I will follow up with the Dylan Grice, the author of the SocGen report cited in the article, to find out where on the site he got that data…. (believe he’s on vacation so might not be soon!)I have read elsewhere about gold holding its real value. The suit anecdote I’m actually borrowing from the author of Creature from Jekyll Island, who notes that an ounce of gold bought a good toga about 2,000 years ago.

Posted by Rolfe Winkler | Report as abusive

Some of you are dead wrong about gold. It is absolutely a store of value and has never been properly adjusted for inflation. What makes gold unique is that there is only so much of it and it is universally recognized as a store of value; therefore, when our fiat currency loses its value, gold will hold its value among the alternatives. There’s no question about it.

Posted by Kevin | Report as abusive

People in here talking gold down. Look at a ten year chart, and then do the same for stocks, bonds, housing, the dollar, and oil. Gold shines. If you must hate it for being what it is, that’s your emotions talking. The numbers tell a different story.

The dude who said, “. . . gold is worth $300, tops,” (or something similar), is especially emotional about it. Gold has been worth more than $300/oz. for a long, long time, despite your valuation.

Posted by Mortimer | Report as abusive

[…] quick napkin calculations. According to Dylan Grice of Societe General, a great adjustment would be required if a Gold Standard is imposed. The monetary base would have […]

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