Monday, April 09, 2012

The Future for Gold

In an article I wrote recently for Seeking Alpha, I tried to give a casual analysis of the future of the gold "price." This is not easy. Crystal balls have a way of clouding up just when you think you've seen something.

crystal ball
[Thanks to for the image. Go ahead, click on the link to the left and ask it something. So far, I've gotten over five conflicting answers to the question, "Will gold go over $2,000?"]

Before we get underway, I really should clarify a detail: The "price" of anything is really just the exchange value of that item in terms of something else. Most often the "something else" is a unit of currency familiar to the concerned parties, buyer and seller. Determining the "price" is a mutually agreed evaluation.

We could say that buyers and sellers intuitively evaluate three variables contained in the transaction:

- The buyer or seller's personal reasons for wanting to exchange the item in the first place;
- The availability, scarcity, or superior utility of the item being bought; and
- The availability, scarcity, or superior utility of the "something else" being exchanged for it.

If a buyer is offering money for something, he or she will tend to forget that money itself can also be a variable. We tend to assume that a dollar is a measuring unit of value, and that it will buy tomorrow what it bought today. We do this even though we've all heard of the CPI. (See the American Institute for Economic Research's EPI Index for an interesting new take on the CPI.) We know prices tend to rise over time. However, even in countries where inflation is rampant, people tend to forget that money isn't always a good measuring stick.

Let me illustrate:

I recently read an anecdote about a person who sat in a café in 1923 Germany. Prices were doubling about every two days. He ordered a cup of expresso priced at, let's say 100,000 German Marks. He lingered a few hours, ordered another, and then asked to pay his bill. The waiter gave him a tab for 300,000 Marks. When he complained that the tab should have been 200,000, the waiter said, "You should have ordered them both at once and paid up front."

Today, with the CPI seemingly under control, we can let ourselves get a little sloppy when it comes to a cup of coffee. But investors, unlike our café-goer, must never lose sight of the variability in the purchasing power of money, even when the inflation rate is apparently tame. The reason is because the rate itself, multiplied by any uncertainty about the future rate, affects every move investors make and complicates their task--especially in times like these.

It turns out that gold itself has a remarkably stable value in terms of other goods over the long term. Ironically, because of its good reputation, it has become the object of much speculation in recent years. When gold speculators think about the "price" of gold, many are concerned principally about the value of the currency they might buy it with, e.g., the U.S. dollar.

Its current "price" represents not just its relatively stable exchange value with other things, but it also includes an amount representing its greater strength relative to the dollar, plus a margin for possible future changes in the dollar and/or in general prices.

All this to get to my point.

Now let's try to analyze informally the future of the dollar in terms of gold. As you can see from the Seeking Alpha article, I can conceive of two fronts in the battle between the dollar and those who could destroy it (central bankers and politicians; see a few of my previous posts). The first front is Europe.

When all will have been said and done after the current crisis plays itself out, the euro with either stand or retreat. The European version of our Federal Reserve, the European Central Bank (ECB), will either put out, i.e. issue euros (probably requiring more help from our Fed), or stand firm. Whether it does either, it will be assisted by international organisms like the IMF, which are heavily funded by the U.S. I gamble that the ECB will put out, thereby exacerbating a dilution of both the euro and the dollar. Politicians hate to admit they were wrong.

The second is the USA. In November 2012 will America give Congress a mandate to deal with our treacherous debt no matter who wins the White House? Or will we split the houses and watch our government dither and spend us dangerously close to oblivion and collapse? My crystal ball says, with strikingly unhelpful certainty, that we have a 50/50 chance of one or the other.

I'm hopeful that in the longer run we will do what is right and deal with the debt. But will we be able to do this without any further crises? No one can say. For the moment we have bailed everyone out. The banks and mortgage companies have learned a lesson, but have the important players (including the Fed) really righted their precarious methodology and their balance sheets? Many banks are still too big to fail. Even certain Fed governors see the systemic dangers of this.

Other geopolitical events could also have an impact: Obstinacy from Iran; a revival of terrorism; the potential collapse of Greece, Portugal, or even Spain; major social unrest in Europe, or right here, never mind Egypt, Syria, Afghanistan, and the rest of the Muslim world. Any one of these might be benign, or any one might be a catalyst for catastrophe.

In conclusion, if I had a pocketful of gold scraps, I think I'd wait a bit before offering it to the local jewelry shop. When you hear confirmed rumors that Europe is going to survive without a revolution and that Congress is finally going to act sensibly, maybe then you could bring some of it out (if you must).