Gold Arithmetic: Why the Gold Price Has No Ceiling
October 7th, 2009By David Goldman
What’s the price of the last ticket on last train out of Paris on the night the Germans march in? Whoever is carrying the most cash will get it, and that will be the price. Robert Merton, the great finance theorist, showed that in a multi-time-period model, investors hedge against the prospective change in the investment opportunity set. If sufficient hedges are not available the price of such hedges can be arbitrarily high. As I have tried to show in several recent articles, most recently this Sept. 15 essay at Asia Times, gold is a hedge against the collapse of America’s central role in world affairs.
What is the correct price? Central banks alone own about 4.8 million tons of gold. The world produces about 2,200 tons. Suppose that central banks wished to increase their gold holdings by 1 percent. That’s 48,000 tons or so, or more than 20 times annual mining production. What’s the price elasicity on that sort of thing? How badly do you need that ticket out of Paris?
I’ve been recommending gold since June, for the last $100 or so of the runup, and I continue to hold my own cocktail of gold mining stocks and gold futures.
October 7th, 2009 at 8:45 am
The arc of instability circles the globe. From the Spengler essay of Jan 26, 2002: Is the U.S. still “long vol”? I think now more so than ever before.
October 7th, 2009 at 10:08 am
Wow! Isn’t the biggest indication of the peak of a bubble when people start saying “It can only go higher?” This sounds too much like Faber, and Rogers.
Reading and listening to Mr. Goldman for a couple of years now, I could NEVER have guessed he would be added to the list of “gold bugs.” Do my eyes deceive?
Not that I disagree, I’ve been in a weak dollar position for a while now (though unfortunately not completely consistently)- it’s just odd to see this drift in that direction on this blog. I recall several Bloomberg podcasts in the distant past, at the onset of the financial crisis where Mr. Goldman was clearly worried real deflation.
October 7th, 2009 at 10:20 am
I don’t think the US is long vol any more, not with foreigners buying $500-$600 billion of a $1.7 trillion Treasury offer. And I have not given up the idea of deflation: you can have a falling CPI AND a rising gold price. See my Sept. 14 post:
“Gold, moreover, can keep rising even while the dollar stabilizes against other currencies, or the price level falls. In a service-based economy, most of the measured price level depends on the price of labor. Americans are likely to work more cheaply than ever before. To begin with, the cost of living has fallen dramatically for American workers because the cost of owning a home has fallen. In many parts of the country, the combination of lower home prices and lower mortgage rates has reduced the single-largest item in the household budget by more than half.
“To have actual inflation, someone has to take cash and buy goods rather than (for example) securities. If everyone hypothetically wanted to buy securities rather than goods, prices of goods would crash. China will be exchanging securities for goods to the extent it can, but Americans will eschew goods in favor of securities.
“An aging population increases its purchases of securities and decreases its purchases of goods as it saves for retirement. Americans have saved nothing for the past 10 years, and the capital gains that they considered savings-substitutes have vanished. That means that an enormous savings deficit accumulated over more than a decade has been exposed, and that Americans must attempt to correct it quickly and under the worst of circumstances. Americans will work more, spend less, and save more. America may have the worst of both worlds: currency devaluation and price deflation, as in the 1930s.”
Most of my portfolio is in very high-quality munis, which have done extremely well this year. At the moment I am making money both on the hedge (gold and other dollar-sensitive equities) as well as the underlying.
October 7th, 2009 at 11:31 am
With FED printing trillions of dollars and federal government producing ever larger deficits, every deflationist would become inflationist. That´s no brainer.
October 7th, 2009 at 11:53 am
Mr. Goldman,
Thanks for the response. Though it’s probably because I’m too much of a 1-D thinker when it comes to markets, there are some things I don’t understand in the above. If you’re in fix-income and hedged with gold - what are you hedged against, if not a weaker dollar?
For a country like the US that imports everything, how can a weak dollar not mean inflation - eventually even in the CPI?
As a matter of fact I thought your article on how 80% of the rally in equities was due to dollar weakness was right on point.
Thanks
Jim
October 7th, 2009 at 1:58 pm
Mr. Goldman,
I admit to being on the cutting edge of survivalist paranoia but when I was thinking about the US being long volatility I was doing my amateur armchair general impression of the next few years. How quickly could things fall apart from the current version of normal? Any number of armed conflicts, especially if India or China is involved, could send people running back to the US, Canada, UK or Switzerland for the very reason that there is no international space station with a safety deposit vault…yet. Not likely I know. And if Gold ends up being the most valuable thing in my portfolio then all bets are off.
*I do own tiny nuggets of the GLD etf and have for a while due to secret sympathies for the Austrian school and occasionally colliding with a Mogambo column.
I heard George Friedman of Stratfor on the Dennis Prager radio show on Monday and he seems now to be thinking that a military strike on Iran is much much more likely. I listen to the podcast again this weekend to make sure I wasn’t drinking any of my high quality yet favorably priced German white wines. http://www.rieslingreport.com
October 8th, 2009 at 4:29 am
Anytime US economy gets into troubles, americans wish for a war. Ahem …
October 8th, 2009 at 7:51 am
“Wish for a war?”
Not me but we live in very interesting times.
1) The only crafty politician on the world stage appears to be Spengler’s choice for President. And he seems to get what he wants by default.
2) When the shoeshine boy starts giving you tips on gold watch out.
3) When in doubt. Victory Garden!
4) Essay’s on sacred music get ones mind of the day to day boredom of internet news portals.
October 8th, 2009 at 8:17 am
One more point to add to my last question. I did read your previous post as well as the excerpt above so I wouldn’t be surprised if you thought you’d answered me there. A few key phrases:
“In a service-based economy, most of the measured price level depends on the price of labor.”
“To have actual inflation, someone has to take cash and buy goods rather than (for example) securities.”
“America may have the worst of both worlds: currency devaluation and price deflation, as in the 1930s.”
In the 1930’s we made “stuff.” Today we import almost all of our “stuff” while labor is largely service based. Today then, how is it possible that “stuff” doesn’t get more expensive as the dollar weakens. Even the stuff we export (like food) that’s traded on a world market (since there are much more efficient world markets today) would mean we will pay more for it as the currency weakens.
So I will be able to pay less for someone to cut my lawn (which, at least until recently, was effectively imported also) but I will have to pay more to build or repair my house, fill my car, and feed my kids. I heard an analyst on Bloomberg call this “skewflation” (the price of certain assets falls while others (presumably those goods whose price is largely driven by the price of commodities traded on world markets) rise). First 1/2 of this podcast: first 1/2 of this podcast:
http://media.bloomberg.com/bb/avfile/Markets/Analyst_Calls/vjq3MJR7.dvo.mp3.
October 8th, 2009 at 12:01 pm
“Not me, but…”.
OK, I got it. Thanks. Now, may I ask you to enlighten me about what´s going to happen in the next few years? Thank you.
October 12th, 2009 at 1:12 pm
開店さん I can’t tell the future. I just think the geopolitical order is getting more unstable and by extension dangerous.
October 15th, 2009 at 6:57 am
The time´s volatile, of course. Power shift of this extent is not happening every day. On the other hand, the power´s only restoring to its default status. - back to the EuroAsian continent. And others will be … well where they belong to - at the periphery.