Gold, Unhinged

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If you're wondering whether gold will go higher from here, the answer is likely yes. But it may not keep rising for the reasons that gold bulls cite.

In the battle between bulls and skeptics, the bulls are clearly winning. They have the advantage of conviction; a belief that something is right is always more powerful than whether something is actually right. Those who say gold is a bubble often compare it to the dot-com boom. If they're correct, then we need to ask whether today is 1997, or 2000. It could very well be the former. 

But while skeptics may succumb to momentum, they shouldn't accept fuzzy arguments. One such argument gaining traction lately is that the price of gold isn't rising; the dollar is falling. By nearly any reasonable metric, this doesn't add up. Measured against the U.S. Dollar Index, it's false. Measured against a slew of other commodities, it's false. Measured against nominal wages, real estate, or stock prices, it's false. Measured against the Consumer Price Index -- or MIT's Billion Prices Project, if you're more skeptical -- it's false.

One metric it may stand up to is the U.S. monetary base. A Fool colleague used this argument last week to argue that gold prices "steadily tracked the amount of money in circulation over the past decade." Thus, he wrote, "an increase in the monetary base dilutes the dollar; as a result, the price of gold (and everything else) has increased. In other words, speculation has little to do with the recent rise in gold prices."

This is a rational starting point -- although "everything else" is not moving at anywhere near the pace of gold. If you want to value gold, comparing it to money circulating throughout the economy is a smart way to do so.

But the monetary base doesn't reflect the amount of money circulating throughout the economy, particularly right now. Why? For the same reason that two rounds of quantitative easing did little good: The vast majority of money the Federal Reserve has "printed" over the past three years has not entered the economy. It stayed right at the Fed in the form of excess reserves. Since 2008, the monetary base has increased by $1.8 trillion, yet excess reserves held at the Fed increased by $1.6 trillion. Despite the hue and cry, the increase in money actually flowing throughout the economy -- money that can legitimately chase goods and services and push up prices -- hasn't diverged far from historic averages.

A more reasonable metric involves comparing gold to the M2 money stock. This is money that's actually in the economy, flowing through stores, sitting in people's bank accounts, and buried in backyards. Here, the story speaks for itself:

Sources: World Gold Council, Federal Reserve, author's calculations.

In numerical terms, M2 has increased 104% since 2000; gold has climbed 560%. Lest you think this is an abuse of dates, gold has increased 4,900% since the dollar's tie to the yellow metal was severed in 1971. M2 rose 1,400% over that period.

There could be an easy counter here. The monetary base may be the more relevant metric, because excess reserves can eventually snake their way into the economy, sending money supply surging. This isn't just a remote theory; it's quite likely to happen.

But when it does happen, the Fed isn't likely to sit idly by. Former Fed Chairman Paul Volcker's heave of interest rates well into double-digits in the 1980s testifies to that. "The Fed is filled with serious people," investor and commentator John Mauldin said last year. "They'll try to give us inflation. Some inflation, but not hyperinflation. They know what to do with inflation. They've done this before. There's a less than 1% chance of hyperinflation."

Monetary tightening isn't in the cards today or tomorrow. But when it comes, even a sniff of it, I wouldn't want to stand in its way. Many gold bulls counter that they plan on selling before that time comes. But folks, that's everyone's plan. The annoying rules of logic hold that everyone cannot get out before everyone else.

There's nothing wrong with gold. There's a time and a place for it. Companies like Yamana (NYSE: AUY  ) , Barrick Gold (NYSE: ABX  ) , and AngloGold Ashanti (NYSE: AU  ) will make money for their shareholders. But as Peter Tasker recently wrote in the Financial Times, "Gold generates nothing and therefore cannot be valued in its own right, only as a measure of revulsion towards other assets. Rather than being a store of value, it is doomed to obey bubble dynamics." Alas, those dynamics have created far more tears than smiles over time.

The odds that gold will keep rising are good. But the odds that it will eventually end in misery are nearly assured.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (29) | Recommend This Article (21)

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  • Report this Comment On September 15, 2011, at 12:00 PM, dubtex wrote:

    Interesting article, but doen't account for:

    1. Very limited supply that is only increasing by about 2% a year;

    2. It's cultural underpinnings and store of wealth in two of the largest and fastest growing economies in the world--China and India;

    3. It is a world currency and comparisons to where it is in regard to any U. S. metric may not have that much validity.

    Yes, like any asset class, it will fluctuate in value, but collapse it may---history will tell.

  • Report this Comment On September 15, 2011, at 12:25 PM, plange01 wrote:

    both gold and silver are just to high and are slowly collapsing under their own weight....

  • Report this Comment On September 15, 2011, at 1:13 PM, Rustle731 wrote:

    This article also fails to account for:

    4. Global central banks attempting to suppress the price of gold.

    5. The fact that the dot-com bubble lasted three years vs. gold's ten year bull run.

    Is gold due for a correction? Yes,but the exchanges have tried to induce corrections by raising margins on gold, as well as silver, and where is it today? Fed keeping rates low until 2013 gives one a good timeline of at least how long this will continue.

    Unhinged? More like stymied.

  • Report this Comment On September 15, 2011, at 1:21 PM, cmfhousel wrote:

    <<The fact that the dot-com bubble lasted three years vs. gold's ten year bull run.>>

    I'm curious why people think this matters. Real estate rallied for 14 years before peaking in 2006. Did that mean it wasn't a bubble? The length of the rally is insignificant. If anything, the longer something rallies, the better the odds of mispricing because people's perception of history usually only goes back 5-10 years.

  • Report this Comment On September 15, 2011, at 1:28 PM, khrushchv wrote:

    Great article Morgan...I too have done some head scratching about the justification for higher gold prices when so much of the monetary stimulus has landed on the asset side of bank balance sheets (to comply with Basel III or look good for stress tests, for example) while the liability side contracts (due to tighter lending standards, delevering, etc.). And you nailed the measurement with M2!

  • Report this Comment On September 15, 2011, at 1:36 PM, smartmuffin wrote:

    "Gold generates nothing and therefore cannot be valued in its own right"

    And what do paper dollars generate exactly?

  • Report this Comment On September 15, 2011, at 1:37 PM, cmfhousel wrote:

    ^ Interest/dividends/real returns when invested.

  • Report this Comment On September 15, 2011, at 1:37 PM, cmfhousel wrote:

    Further, dollars provide the ability to purchase stuff -- unit of exchange.

  • Report this Comment On September 15, 2011, at 1:41 PM, TMFKopp wrote:

    "The fact that the dot-com bubble lasted three years vs. gold's ten year bull run."

    Wait, wait, wait...! I'm totally confused by this. Why are we saying that the dotcom bubble only lasted three years in the first place? If the article fails to account for that fact, it's because it's not a fact.

    Glancing at Shiller's valuation work, the market was already on the overvalued side in 1991/early-1992. And that covers just the S&P 500. I'm sure the tech-heavy Nasdaq was getting bubbly even earlier.


  • Report this Comment On September 15, 2011, at 1:43 PM, smartmuffin wrote:

    Gold can also be converted into other investments or used as a unit of exchange, it just requires an extra step of converting it to dollars (or euros, or whatever) first.

    In any case, the point is that "interest/dividends/real returns" are... more dollars! Dollars generate more dollars. If the dollar itself becomes worthless, it won't matter whether you have 100 of them or 110 of them. People buying gold are simply placing a bet that the dollar is much more likely to lose its value than gold is. Thus far, they've been right. Now, you can sit here and say "it's going to crash, it's going to crash, it's going to crash" every day until it does. If it does, that won't make you a genius, it'll just make you right one time as opposed to all the other times when you were wrong.

  • Report this Comment On September 15, 2011, at 1:45 PM, whereaminow wrote:

    You guys are what.. about 3 to 5 gold bubble articles a week now?

    "^ Interest/dividends/real returns when invested."

    So does gold. I can take my gold right now and buy things thats get real returns, like a rental property.

    But I'm glad to see you that finally concede the argument I have made for a year, that excess reserves and the interest rate (and public debt held by central banks) are the key factors in uncertainty surrounding future gold prices.

    So I guess, thanks, for coming over to our side. You are welcome to stay here, Morgan. Ben isn't pulling a Volker anytime soon.

    David in Qatar

  • Report this Comment On September 15, 2011, at 1:52 PM, whereaminow wrote:

    See, you can buy office space right now with gold

    When you rent it out, that qualifies as a real return, right?

    David in Qatar

  • Report this Comment On September 15, 2011, at 1:52 PM, wantingtoretire wrote:

    First of all it isn't gold that is unhinged. It is the world economies that are unhinged and this is being reflected in the price of gold (and silver, and Platinum). You need to think about the issues in a different way.

    Why people, like yourself, try to rationalize why gold is doing this in the same way you rationalize what a company stock is going to do is absurd. This is not the game that is being played out with gold. It is a different game entirely and the sooner it is realized it is a totally different game to predicting stock movements the happier you will be.

    The pessimists in the world do not like what they see for the future. They buy gold to feel secure. Others buy gold because they see a way of making some money. Many of the high rollers take advice from people who are actively advocating moving in to gold and have been advocating this for some years now.

    In addition, we have people in India and China, and other countries that are better off than they have been and can purchase more gold and silver than they have in the past. They look at these metals in a totally different way to the American/European cultures.

    So long as the fundamentals for lack of economic growth and large reductions in company earnings are in the cards, it is likely that the stock market will not perform well in the near future and maybe for some time. To preserve capital, investors will move out of the stock market in a big way.

    Gold is going to look like the internet stock bubble of 2000. How high is not know. How quickly it will fall is not known. That depends on how the world economies negotiate away the debt, hopefully. The alternative is not at all palatable.

  • Report this Comment On September 15, 2011, at 1:59 PM, TMFKopp wrote:

    "This is not the game that is being played out with gold. It is a different game entirely and the sooner it is realized it is a totally different game to predicting stock movements the happier you will be."

    This is not the kind of sentiment that usually ends well.


  • Report this Comment On September 15, 2011, at 2:11 PM, TheDumbMoney wrote:

    Well, much love as I feel for you, this doesn't look like a very tight chart to me at all..

    Worse, it starts in 2000. 2000? Really?.

    The problem is that M2 also went up significantly from the 1980 gold high (where M2 was under $2,000 billion, to 1998, (where M2 was just under $5,000 billion).

    See here:

    And during that time, gold did bupkus, to be chartible.

    In fact M2 pretty much always goes up.

    I truly do suggest you look at the real interest rate model, which I have now shilled in my own blog post, on a Barker post, on a Koppenhoffer post, and now here.

    See below:

    That chart goes back to 1951. I think it is inarguable that this is a "more reasonable metric" even than M2 money stock. Or am I missing something?

  • Report this Comment On September 15, 2011, at 2:15 PM, djemonk wrote:

    Gold's true value is to keep highly impressionable FOX viewers focused on something while the rest of us buy undervalued stocks. In that, it has had epic success.

    This also applies to "climate change", "government stimulus", and "Obama."

    John in Midtown Manhattan

  • Report this Comment On September 15, 2011, at 2:17 PM, cmfhousel wrote:

    John in Manhattan for the win!

  • Report this Comment On September 15, 2011, at 3:07 PM, whereaminow wrote:

    "Gold's true value is to keep highly impressionable FOX viewers focused on something while the rest of us buy undervalued stocks. In that, it has had epic success."

    That's amusing. But the gold bull market started in September, 1999.

    Fox didn't change format until mcuh later than that, and Glenn Beck didn't start his show until 2009.

    John in Manhattan for the win.... NOT!

    Just another Krugman copycat.

    And Morgan, you are a gold bull now, looking out for Volker's, uh I mean Bernanke's next rate hike.

    Figure out which team you are on now, buddy.

    David in Qatar

  • Report this Comment On September 15, 2011, at 3:12 PM, ouchtouch wrote:

    Someone did an analysis of the gold price in pounds sterling vs. real interest rates, going back hundreds of years, and the correlation was amazing. Wish I could remember who did it, might have been Rogoff and Reinhart.

    So when the Fed pulls a Volcker and cranks up interest rates, how exactly does the federal government pay the interest on its debts? Hmmm.

  • Report this Comment On September 15, 2011, at 3:42 PM, djemonk wrote:

    << That's amusing. But the gold bull market started in September, 1999. >>

    And I was buying it back then because it was an intelligent investment.

    Now? I don't necessarily agree that gold is a safe buy now. The fundamental difference between where you are coming from and where I (and possibly Morgan) am coming from is that I am trying to make intelligent investment decisions and you seem to want to prove that you are right.

    Guys on FOX and guys who watch a lot of FOX seem to be singing the song of gold, and have been since Obama took office. I don't think it's a coincidence that gold prices are skyrocketing at the same time this is happening, so the businesslike investment strategy is to look elsewhere and stocks are what people are disregarding these days. I don't care if my philosophies are correct, I don't care if people agree with my points, I care if I make money or not. And I will, and some of those profits will come at the expense of people who are not willing to make rational investment decisions.

  • Report this Comment On September 15, 2011, at 4:30 PM, whereaminow wrote:

    "Guys on FOX and guys who watch a lot of FOX seem to be singing the song of gold, and have been since Obama took office."

    Yeah, they're frauds that jump on any idea that makes Democrats look bad (as if that takes any skill). That's a given. They started talking about gold 3 years after mocking Ron Paul and his crazy theories in 2007. Nothing FOX's empty suits and skirts say has any impact on a rational outlook of gold prices or any impact on me. I hope to wake up one day and there is no more FAUX News channel. That would be awesome.

    And you know what else? I have counted up all the friends and family that I know that watch Fox. 1 watches them. The other 20-30 do not. The one that watches Fox hates Ron Paul and therefore will never by an ounce of gold. The ones that don't watch Fox either like Ron or don't care, but know that gold is a solid bet.

    The Krugmanista line that Fox is driving up gold prices is total baloney. Fox is beholden to the bankers. They only tout gold now to point out the price to make Obama look bad. No regular Fox watcher understands why gold is priced so high. If they did, they wouldn't be watching Fox.

    That's enough of that. I'm sick of hearing about that network of idiots. They make no difference and only serve to prop up the warfare/welfare state.

    David in Qatar

  • Report this Comment On September 15, 2011, at 5:11 PM, djemonk wrote:

    This isn't about FOX. I only mentioned them because I've been reading your CAPS blogs for at least a year or two now and have noticed a correlation between what they're agitating about and what you blog about (although your posts are certainly 100 times better thought-out, presented, and backed up by sound thinking than FOX's articles). However, that's not the point. That's your potential blind spot/bias if it's true, not mine. I have my own blind spots and biases, and I have systems in place to manage around the ones that I know about.

    The point is that there are enough signs that point to what Morgan is talking about that it makes sense to step back and ask yourself "do I want to participate in this, or are there easier investment opportunities?" That's why I mentioned that you seem to be trying to prove something. That's not what this is about, and that's not what TMF is (to my understanding) trying to do. What we're trying to do here is make smart investment decisions. My read on Morgan's recent posts about gold is not "you are stupid if you want to buy gold" but "it's possible that buying gold when everyone is talking about buying gold is not going to lead to long-term profit."

    Is buying gold a smart investment decision? Chris Barker seems to think so, and he may be right. He sure as heck knows a lot more about it than me, and there's no question that he's a super-smart guy with keen analytic skills. But it's not a gimme. Buying Berkshire, for example, at just a few percent over book value is. I'll take the easy ones. No politics necessary, no monetary theory necessary, no media-inspired confusion. Just smart, easy investment decisions for the win :)

  • Report this Comment On September 15, 2011, at 5:15 PM, ryanalexanderson wrote:

    Hi Morgan,

    One of the selling points for me on gold is that "Paul Volcker's heave of interest rates well into double-digits" would be damn near impossible today, given the north-of-100% debt-GDP ratio. Aren't we in a bit of a trap of loose money?


    Long gold/silver, hate Fox (except for its contributions to Jon Stewart), and (vis-a-vis previous gold discussion) sadly allergic to milk.

  • Report this Comment On September 15, 2011, at 5:26 PM, blob100000000 wrote:

    Option #1: Overt Default. If the US defaults on its debt, it would be catastrophic for the Treasury market. And not only would bondholders get fleeced, the market for US dollars could easily dry up just about overnight. So anyone holding dollars when it happened would be in severe financial pain.

    The bad news is this is probably the best long-term solution to US debt problem. In fact, it may be inevitable. The good news (for bond holders, at least) is that Washington knows an overt default – simply not paying obligations – is political suicide. So they’ve proven before and they’ll prove again that they’re going to go to great lengths to prevent it.

    Option #2: Austerity plus higher taxes. Another real solution to US debt problem is to own up to it and pay it down. But they have to take it more seriously than they did during the debt ceiling talks. This means slashing (not just cutting) military spending, Social Security, Medicare and Medicaid, and tons of other government entitlements.

    Yet there’s just no way Washington’s going to reduce spending in any way that would really matter. After all, you can’t win elections by killing Social Security. But some cuts plus higher taxes for the “rich” are already coming down the pike... which means if you either rely on government help or have or make any money to speak of, you’re a target.

    Option #3: Rampant inflation. This is both the easiest and hardest way to deal with a debt problem. You see, the US has the advantage that all US debts are denominated in US dollars.

    Of course, there are problems with this. Monetary inflation – printing money – inevitably leads to price inflation. This makes inflation an invisible tax that hurts everybody... especially savers. Every dollar you own is losing purchasing power by the day. It’s the reason a loaf of bread or a gallon of milk costs many multiples of what they used to. The bread and milk aren’t gaining value: your money is losing it. But the printing press is like a drug for Washington. The more they use it, the more they want it. Hence TARP, TALF, QE1, and QE2. All were spun politically as “Saving America” from crisis – but really they’re just a guise for inflating away the debt. Sure, they stimulate the markets while they last, but long term they’re leading the US down a path to destruction.

  • Report this Comment On September 15, 2011, at 5:33 PM, smartmuffin wrote:

    In fairness FOX and some of its personalities, hocking gold isn't BRAND new for them. I was hearing Bill O'Reilly do radio commercials for buying gold (as well as other conservative radio hosts like Savage and Hannity) back in 2005. Well before Obama.

    Now, I won't claim that they haven't increased the volume since then, or that they were doing anything other than reading copy placed in front of them by their sponsors, but this really isn't some brand new thing...

  • Report this Comment On September 16, 2011, at 12:56 AM, TheTrueMoney wrote:

    Haha... some people who argue that Gold is not money just blah blah blah... Relax people... Think for a moment... Why does our US Treasure hold the biggest amount of gold in its reserve compared to any country in this world if they, like you, believe that the value of gold will eventually goes to zero? And, what does it mean when our 'fiat' currency is 'backed by' gold? Gold is a currency, but it is too heavy to carry, so we have other physical paper objects for us to carry around and to trade, which represent certain amount of value each based on their backed values of gold units. If you think that gold is of no eventual value, please write a letter to our US Treasury and ask them to dump all their gold reserve. Thank you. :D

  • Report this Comment On September 16, 2011, at 10:57 AM, decbutt wrote:

    DiQ -

    "See, you can buy office space right now with gold

    When you rent it out, that qualifies as a real return, right?"

    Charlie Munger rule #2

    Love can make us change or distort the facts to match up with the world as we want to see it.

    The article you have linked to cites one specific case where gold was used as a *deposit* on *commercial lease*. It does not show any cases of gold being used to buy property for rental returns.

    That only happened inside your head, not in the real world.

  • Report this Comment On September 16, 2011, at 12:25 PM, DrDoom1929 wrote:

    Fiat Gold and tulips are the same. Just abstracts for fools to chase. Indeed fiat gold is more of a fiat than paper currency.Because it must be converted to a fiat currency for everday utility. Bubbles have nothing to no with logic...never have and never will.

    When you actually turn off the lights (Grid) both fiats have the same store of value. Nothing.So where's the store? A farm is the only store of value you never need to worry about taking to a Bank for value.No lights required?

    Gotta love bubbles..

  • Report this Comment On September 16, 2011, at 3:56 PM, CaptainWidget wrote:

    Just in case anyone was wondering, gold does have some real world uses. If the apocalypse comes tomorrow, people will still hoard gold. Why? It's an extremely easy to work with, beautiful, useful metal.

    That's why people invest in Gold. It's rare and has unique physical properties that will ensure it's use in perpetuity. The value of Gold has remained constant, unfortunately the value of the other thing it's measured against is dropping like a rock.

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