Gold - Continuous Contract (EOD) - 9 yr: "
via StockCharts.com
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She's a beauty ain't she?
I get a same question nearly every time I speak about gold. Namely, isn't gold in a bubble? That is usually followed by the person explaining he has heard gold should really be 800, or 600, or some other number and gold is way too expensive at these levels. This is a natural question that comes to mind because our friends in the government and the Fed have conditioned us to believe that bubbles are natural and inevitable. This in itself is funny, because our politicians and the Fed seemingly can never recognize a bubble they are creating, and after the fact when it has popped and they finally acknowledge its existance, they deny any participation in its creation. I wrote seemingly because in reality they know exactly what they are doing and to what purpose it serves. At any rate, the common man rightly understands the bubble phenomenon because he has eyes, ears, and a brain (well, most of them do) that can process information.
The 600 and 800 figure is not surprising when you look at the chart. Western thought is very linear, because our society prefers the finite and quantifiable. Eastern thought is quite a bit different and they see the world in a cyclic nature, non-linear, and they are quite comfortable with the undefinable and infinite. The chart shows trend lines that have increasing slope. When viewed in its entirity and smoothed to fit the trend lines, a parabolic structure emerges. A parabola is non-linear. The people that insist gold must come back to 600 or 800 an ounce are thinking gold must follow a linear trajectory. Yet it has exhibited non-linear behavior throughout the entire trend. Have debt levels followed a linear trajectory? Has the monetary supply followed a linear trajectory? Why in the world would gold, that must be purchased in dollars, follow a linear trajectory when the supply of dollars is growing exponentially? Silliness.
To discern a bubble from a fundamental secular trend, you must examine the subject from all sides and answer a number of questions. What is the driver for the potential bubble? What has the driver looked like in the past as compared to know? How sustainable have past trends been? How sustainable is the current trend? What are the ramifications of a bubble? Take the housing bubble for example. What was the driver for ever-escalating home prices? Answer: ever-escalating liquidity, provided via the US Treasury and the Fed. The supply of dollars available to the economy far outpaced real growth in the economy and needed a place to go. Those dollars found a place. What did liquidity to the housing market look like in the past? Historically through the 19th century, home and land values, along with everything else remained essentially flat or unchanged. This is reflective of slow economic expansion coupled with slow monetary expansion. This should be no surprise because monetary expansion was largely an honest endeavor tied to savings and gold standard. Today monetary expansion is a debt transaction. Real economic expansion was generated by doing real work and producing things, not by producing debt.
In the 20th century, home prices climbed at a slow and predictable rate. Depending on the timeframe, prices climbed between 1-3% per year. This is indicative of the overall inflation rate the country experienced after the Fed was established in the early 1900s. Our monetary system changed from a constitutional monetary system to a debt based system with the inception of the Fed. After 1970, Nixon completely floated the dollar free of the gold standard and backing. Inflation ticked up dramatically from that point ot the present day, as there was no limit to monetary creation. Afterall, inflation is the expansion of the monetary base, not rising prices as is often quoted. With the accelerated expansion of the money supply, the housing market experienced rapid growth to facilitate the flow of newly created dollars. As with any bubble, the bubble starts as a trend that gets carried away and enters a phase of unsustainabilty. As more liquidity flowed to the housing market, prices started rising. Rapid growth brought supply that tempered higher prices to some degree. But this trend depended on more and more supply that needed to enter the market to keep prices reasonable. The ugly side of this deal is that supply must have demand. Demand is provided by the consumer and his ability to take on debt.
That was not a problem for the Fed however. All they had to do was to make debt easier to come by and easier to service through lower interest rates. They created more demand for debt. Which is another way of saying more demand for money. That was not a problem either, the Fed can make an infinite amount of money out of thin air. Of course for a price. Ultimately, housing supply could not keep up with the artificial housing demand generated by massive liquidity injections through the latter decades and prices increased more rapidly. This all came to a head at the peak of the housing bubble when the cumulative effect of all the previous liquidity injections were then piled onto by the post 911 liquidity flood unleashed by the Bush administration and Alan Greenspan's Fed. House prices went ballistic, experiencing double digit percentage increases year to year.
How sustainable is double digit increases in home price? Well, that's an easy one to answer. How sustainable is double digit increases in debt? Told you it was an easy question to answer. The bubble burst when the consumer either exhausted access to credit or chose not to take on any more debt. In other words demand collapsed and builders were slow to recognize an inevitable change in paradigm. The rest is history that we are still watching unfold. What is the ramification of a bubble in housing prices? If the trend had not been interupted, house prices would have continued their ballistic trajectory and would have required consumers to take on even higher amounts of debt. This is an impossible situation. So, a rational human being could look at the trend and answer some questions, and in quick order come to the conclusion that housing was experiencing a bubble.
Lets ask some questions about gold. What is the driver for higher gold prices? The answer is largely twofold. Higher prices reflect demand outstripping supply. Think of demand as the number of dollars around that can go into gold, and supply is the gold above ground available for acquisition. Supply is limited and is relatively fixed in its ability to expand. That is one of the qualities that has made gold a currency for thousands of years. On the other side of the equation, demand is directly proportional to the monetary supply, which is infinite via our friends in Washington and the Fed. So, as the Fed continues to conjure dollars from nowhere the supply/demand equation is tilted to the demand side. Another way to say this is that there are far more dollars chasing a relatively fixed amount of gold. Therefore the purchasing power of each individual dollar is diluted, requiring more of them to acquire an ounce of gold.
The second factor to consider is the confidence issue. Paper money, fiat currency, has value only when it has the confidence of its users that the symbol for money (piece of paper) actually is one in the same as the value it represents. When that confidence is gone, the user of a fiat currency sees the symbol for what it physically is, a piece of paper. So as confidence in paper money wanes, the demand for hard currency increases, again stimulative to higher prices. People often say gold is a scam because you can't eat it. My response is always to ask if they have ever tried to eat dollar bills? In this way gold and fiat currency are the same. They are both a symbol that represents value. The difference is in the supply and the origin. Gold must be mined or acquired from existing stock above ground. It takes considerable resources, monetary, human, and in time to produce an ounce of gold. But, a fiat dollar can be conjured from nothing, in no time whatsoever. It is an electronic digit on a computer. It takes no sweat, labor, or investment in time and infrastructure. Therefore, supply is theoretically infinite. Which symbol would you choose to store you wealth in?
So a flood of fiat currency coupled with the resulting loss in confidence is powering gold higher. What has this driver looked like in the past? This is an easy one to answer, again by asking another question. How many fiat currencies have survived the ages, let say the last 3000 years? The answer is zero. That's right, every currency based on fiat has failed. Gold has been a currency the entire time, a symbol that is a storage of value. It all comes down to the issue of source and supply. The source of fiat currency always sees it in their best interest to inflate supply. The end is always the same, supply is inflated to the point the symbol loses all of its value. Another way of saying it is that confidence is always eroded in paper until it reaches zero. Then it joins the trash heap of the other failed fiat currencies throughout history. Gold's issuer is the earth, and the men that mine its depths to find it. Supply is always limited and very difficult to come by. So, will the issuers of fiat currency reverse and restore value to their paper? Will the earth somehow pump out more gold to reverse its trend of scarcity? Will the Fed quit printing and allow systemic global default on trillions in debt? Will gold bubble up out of the earth or fall from the sky?
We know the answers to those questions. What about sustainability? How sustainable is the escalating price of gold? There is a distinction that must be made here, one of price versus and value. Gold is a symbol of value. Does it matter what the symbol says on it, what ink is printed on the paper in the case of fiat currency? The answer is obviously no, what matters is what that symbol will buy in the market and how many of these symbols you can acquire. So it begs the question, the price of gold is rising, but is the value of gold also rising? The answer is largely no, the value of gold remains stable minus artifacts introduced by manipulation from the Fed. An ounce of gold has the same purchasing power over centuries and millenia. This idea is most often quoted by comparing a Roman citizen's purchase of a fine Toga, belt, and sandles for 1 ounce of gold to a fine men's suit, belt, and shoes today for 1 ounce of gold or about 1200 dollars. The symbols have different numbers associated with them, but the value remains the same. So how sustainable is value? Since it is the same as it ever was, the answer is it is very sustainable. How sustainable is the escalating price, or the escalating number on a symbol used to purchase gold? It is ink on paper, so it is infinitely sustainable.
So as you can see the questions regarding whether gold is in a bubble have quite different answers than those regarding a proven bubble like housing. Gold will remain a storehouse of value. The fiat paper required to purchase gold will continue to lose value, and therefore more and more will be required to represent the value of an ounce of gold. Gold is not in a bubble.
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