Say like Coca Cola re-launches New Coke, but people actually like it. Would that mean the laws of physics had been repealed? Or would you need to change what you think…?

“Gold and bonds do not usually go up or down together. But try telling that to the markets over the last two months,” writes Mark Hulbert at MarketWatch.

“Since early August, in fact, gold bullion has risen by around 10% and the Treasury’s 10-year yield, which moves inversely with Treasury prices, has fallen by nearly 15%.

“These moves are substantial, in other words, and more than just day-to-day noise in the data. What’s going on?”

Put another way, “If the gold price is so high, why are 10-year Treasury yields so low?” asks a columnist at EuroWeek, the capital markets newspaper.

To repeat: Rising gold says people fear inflation. Or so both Hulbert and EuroWeek reckon, along with pretty much the rest of the planet. But inflation fears would mean rising interest rates and falling Treasury bonds…and that’s the very opposite of what’s actually happening to government debt.

“Either way you look at it then, recent trends are unsustainable,” says Hulbert. “Something’s got to give” apparently. And it won’t be his assumption that gold and bonds shouldn’t rise together.

“If central banks take the punch bowl away at the wrong time,” says EuroWeek, “those who have bought Treasuries will have been on the right track and we will face deflation. Whereas if they let the party go on for too long the gold hoarders will have been right…and we’ll be wheeling our cash for bread around in wheelbarrows.”

The key assumption that makes these two things impossible, of course, is that gold only goes higher on strong inflation…a demonstrably idiot claim given a quick glance at the 1930s. Or this decade’s four-fold gains. Or the 50% surge of fall/winter 2008.

Back to gold in a moment, however. Because while bonds say deflation, “Equities say reflation” as the Pragmatic Capitalist notes, together with David Rosenberg at Gluskin Sheff and pretty much everyone else. “The stock market is telling a very different story from the bond market,” TPC explains, and “unfortunately for equity investors, they have a poor record of forecasting the future when compared to bond investors.”

Yet again, these two things “don’t typically rise alongside” each other. Yet stocks have risen more than 11% since mid-June, while the 10-year Treasury yield (which moves inversely to bond prices, remember) has dropped nearly 0.7%.

“There have been 4 famous cases of such bond and stock divergences in the last 20 years. The most famous is the summer of 1987. We all know what occurred then.  The other three cases were fall ‘94, summer ‘98 and winter 2000. All three preceded declines in the market. Of all 4 instances, three of them preceded 15% declines in the S&P 500.”

Now throw in rising gold prices, and we’ve got rising stocks…rising bonds…AND rising gold. Hell, since Wednesday this week they’ve even pulled back together, too!

Is the moon made of cheese or what?

The curve-ball in all this – or so we guess here at BullionVault tonight – is not gold, nor stocks, nor even bonds. It’s the underlying guess-work, intuition, assumptions.

That gold only rises when the cost of living soars…or bonds only rise when stocks go down…or that a flood of money, created at zero per cent rates, can’t drive all things higher together, even the promise of cash redeemed in the future…lapped up by a pensions and finance industry faced with $11 trillion in Treasury-debt supplied, but a central bank vowing to step in if buying fails and cap any rise in rates.

Because right alongside, hedge funds are buying futures and options with virtually free finance. What’s not to love in this über-Reflation Rally redux…?

Regards,
Adrian Ash
BullionVault

October 21, 2009

Inflation, Deflation and Reflation at Once was originally featured on Whiskey and Gunpowder

A short series of secret memos, published and dissected at ZeroHedge, provide the “smoking gun” of gold-market manipulation. Apparently.

And given this little slew of dusty archive-digging – throwing up three documents from 1968 to 1975, each one declassified within thirty years – then “If over 40 years ago the Fed and the members of the gold ‘Pool’ were openly intervening in the gold market, one can only imagine what the situation is now…”

Go on, just imagine. Because imagination is what you’ll need if you’re going to nail type-written notes from before the Moon Landings as primary, original-source evidence that the United States’ official gold reserves – variously sold, lent, swapped or simply given away since the early 1990s – have been mobilized to suppress prices, pushing gold down from $250 an ounce a decade ago to, ummm, more than $1000 today.

These memos fret about shrinking gold reserves and the world’s gold-driven money supply…Britain’s failed deflation policy of the late ’60s…whether South Africa will sell its new mine supply on the open market…German border taxes…and the “gold-like” qualities of the proposed Special Drawing Right (SDR). Such prehistory matters, yes. But it’s a world away from demonstrating what newcomers to gold today may mistake for good cause to steer clear.

The little history these scattered notes sketch does echo today, however faintly. Are central banks buying gold at market prices – then France, now Beijing through via its domestic gold output? How to replace the abiding monetary standard – then gold, now the Dollar? And like the Fed memos reviewed on blogs elsewhere this year, the notes republished by ZeroHedge certainly prove one thing, at least:

Just how awkward gold became long before the collapse of the Bretton Woods monetary system. Bluntly put, it was a pain in the arse – and not only for Washington.

“Gold was causing such a rumpus that most authorities wished it would go away and stop bothering them,” as the late Peter Bernstein wrote in his 2000 history, The Power of Gold. But with so much of the world’s gold stacked up in their vaults, slipping away was impossible, and the world’s monetary system instead “lurched from crisis to crisis” says Francis J.Gavin, University of Texas at Austin’s professor of international affairs, in his 2004 monograph, Gold, Dollars and Power.

“There was not one year between 1958 and 1971,” Gavin finds, “when the Dollar and gold problem was not the most pressing issue of American foreign economic policy.” Or as President Kennedy put it in August 1962, “My God, this is the time…

“If everybody wants gold, we’re all going to be ruined.”

Luckily for JFK and the Dollar, not everyone wanted gold. Like Washington, the British government would have quite happily seen its former “badge of honor” turned to dust and swept away, too. Their private citizens were barred from owning gold, with strict controls applied across most of the rest of the developed (and communist) world. Yet with so many new US Dollars flooding the world…and with the Dollar-exchange clause of the 1944 Bretton Woods treaty still in force…less pliant friends increasingly asked for, and got, gold over dollars.

One nation actively sought to bring on the crisis. “There can be no other criterion, no other standard, than gold,” announced French president Charles de Gaulle at a press conference on February 4, 1965 – “gold that never changes, that can be shaped into ingots, bars, coins…that has no nationality and that is eternally and universally accepted as the ultimate fiduciary value par excellence.”

De Gaulle spoke in French, naturellement, in the gilded Salle des Fêtes of the Elysées Palace. But the White House’s least Francophone staffers could get the message loud and clear when, six days later, de Gaulle’s finance minister – future French president Giscard d’Estaing – announced in a lecture at the University of Paris that, from now on, France would swap every new Dollar it accumulated for gold bullion from the Federal Reserve.

The major powers, he said, should “make a solemn and unequivocal declaration” to likewise settle all their international payments in gold. Which was an easy thing for France to declare, given its large balance-of-trade surplus.

To drive the point home, France then made headlines around the world by announcing it would not only swap all new Dollars for gold…but immediately ship that new gold straight to France, too.

What could the United States do? As we’ve noted time and again, the final collapse of the Gold-Exchange Standard – put out of its misery in Aug. 1971, when Richard Nixon canceled America’s gold-for-dollars obligation – came because the US government wanted to keep hold of its gold. The legerdemain of then “demonetizing” it through occasional sales and amendments to the IMF treaty only hid this plain fact; it didn’t deny it.

The international promise signed after the Second World War made defending that hoard impossible given America’s domestic Dollar-inflation. Producing more dollars than the rest-of-the-world needed to finance its trade, the United States also invited a drop in the Dollar. That in turn invited withdrawals of gold from its vaults, effectively sparking a “run on the United States” as one advisor called it in the mid-60s’ phase of the crisis.

“The kind of transcending value attributed to the Dollar,” Charles de Gaulle had said at that 1965 press conference “has lost its initial foundation, which was possession by America of the greater part of the world’s gold.” Never mind that de Gaulle himself knocked out that support. What mattered was the abiding idea – gold equals power. Thus US dominance was clearly ebbing away.

“The French this year have been cashing in dollars for gold at a $54 million-a-month rate,” reported Time magazine in mid-1966. “Last week the Bank of France reported that as of Aug. 1, France had hoarded $5.13 billion in gold. Gold now constitutes 86% of all French reserves, compared with 73% at the end of 1964.

“Moreover, the [French] government is squirreling away the precious metal at such a rate as to account for the entire net US gold drain so far this year.” Hence de Gaulle’s jibe at the Dollar’s fall became self-compounding. By demanding gold over dollars, he proved the value of metal, not paper. But only on the old tattered Gold Standard logic. Losing its dominance as the gold-hoarder par excellence, the United States still retained the supreme currency. The “exorbitant privilege” of which de Gaulle’s advisor, Jacques Rueff, had complained, would now take America’s economic power as its foundation. Depriving the US of its bullion backing, the promise to redeem Dollars for gold was replaced with the promise to redeem Dollars with interest.

Fast forward to the fall of 2009, and the United States remains the world No.1 holder of physical gold (the potential for secret sales, swaps, loans and outright gifts to Wall Street notwithstanding), but while France and the rest of Europe turned seller, Russia and emerging Asia began re-stocking this decade. Moreover, “The United States would be mistaken to take for granted the Dollar’s place as the world’s predominant reserve currency,” as World Bank president Robert Zoellick told an audience at Johns Hopkins University in Washington this week.

“Looking forward, there will increasingly be other options to the Dollar…The future for the United States will depend on whether and how it will address large deficits, recover without inflation that could undermine its credit and currency, and overhaul its financial system.”

Zoellick naturally mentioned the Chinese Yuan, noting that “Over 10 to 20 years [it] will evolve into a force in financial markets.” He just happened to speak on the very same day, as Reuters observes, that Beijing issued its first Yuan-denominated bond open to foreign investors. Yet all the World Bank chief did, however, was confirm today’s abiding idea – that monetary power builds on an economy’s strength.

Maybe a new or even old idea will emerge in the next two decades or so. “The manner in which [this crisis] is resolved may well determine the shape of the world’s monetary arrangements, and therefore our economic and political interests over the next generation,” as then-Fed chief Arthur Burns memo’ed President Ford in June 1975, but the problem of excess Dollars was never quite fixed.

Still, we guess it’s more than coincidence Beijing is now buying gold – as well as frantically powering its non-stop economy – as the world’s monetary standard slides into crisis mode.

Regards,
Adrian Ash
BullionVault

October 2, 2009

Gold, the Dollar and Smoking Guns was originally featured on Whiskey and Gunpowder

GOLD’S CURRENT price-tag of $1,000 an ounce suggests big doubts over the US Dollar, its domestic economy, and its status as the world’s No.1 reserve currency.

Or so we guess after 10 years of watching it quadruple from two-decade lows. But gold investors (old, new and everywhere) should note that this decade’s bull market in bullion is about much more than the greenback.

Here are three ways of judging what you might call the “real price of gold” instead.

#1. The Global Gold Index

Gold has risen against all world currencies since the start of 2001, very nearly tripling on average and hitting record highs against everything bar the Japanese Yen. (Tokyo gold buyers are still waiting for a near-double to the peak of Jan. 1980…)

Introduced in July 2008, Bullion Vault’s Global Gold Index is a stab at mapping this trend. It monitors “real gold” by plotting the daily price in terms of the world’s ten most important currencies, averaging their moves by size of the issuing economy.

Thus the Global Gold Index currently starts with the US Dollar gold price, and then takes in the gold price for Eurozone buyers, Japan, China, the UK, Russia, Brazil, Canada, Mexico and Australia – as per the latest World Bank and IMF data. (It’s rebased each year to accommodate changes in that league table of gross domestic product; India, the world’s hungriest physical gold market until the start of this year, flips in and out.)

Not quite the price of gold for everyone worldwide, this “real” value does at least cover 2.5 billion people who account for over two-thirds of world economic activity. It starts at 100 on New Year’s Day 2000, hitting a record peak for this decade in May 2006, and then all-time record peaks in March 2008 and then Feb. 2009.

Currently, the Global Gold Index is trading some 5% off that top, rising strongly into Sept. ‘09 so far.

#2. Gold vs. the Cost of Living

What about inflation; has the ultimate “inflation hedge” (as most commentators and analysts still mistake it) out-done the cost of living?

Given how suspect inflation data can be (wherever you live), let’s roll our third “real” gold price into this picture too, comparing gold against the cost of raw, productive materials as bought and paid for in the market-place…

This chart shows the Dollar gold-price adjusted for official inflation in US consumer prices (the gold line). Jan. 2000 marks the start of our indexation. You’re looking at gold priced in Y2K dollars, left-hand scale.

The chart also maps the “real” price of gold in terms of raw materials prices (dark red, right scale), indexing it against the CRB’s Continuous Commodity Index of the most-heavily traded 19 natural resources – crude oil, corn, soy beans and the rest. (Again, Jan. 2000 is our starting point for the maths, indexing the real price of gold in commodities at 100.)

But is gold cheap or dear right now? Three observations:

• Gold built a strong base against commodities during the 1980s and ’90s, holding onto far more of its 1970s’ gains than did natural resources;
• Gold has never been more expensive in terms of the raw materials it could buy than in Feb. ‘09, almost doubling in purchasing power from crude oil’s record peak of summer last year;
• Real gold prices stand at only 50% of their 1980 inflation-adjusted peak, but they’ve trebled so far this decade;
• Consumer-price inflation has thus been stronger since Y2K than you might guess…adding 27% to the cost of living and lopping a whole multiple off gold’s nominal gains since the start of this decade.

Still, the Noughties come fifth out of the last eleven decades both for “price stability” and “low inflation”. And gold’s performance in the face of rising consumer prices is varied to say the least…

Most significant perhaps for the fate of Dollars, gold and inflation, is the fact that real commodity prices have in fact halved over the last fifty years. Adjusted for US inflation, they were never cheaper than at the start of this decade.

The decline in real commodity prices between June 2008 and Feb. ‘09 was comparable only with their doubling in 1972-73. Dropping 40% inside eight months, real commodities fell faster than any time on the CRB’s five-decade record.

If this decade’s bull market in gold were only about inflation and commodity-price fears –whether priced in US Dollars or anything else – gold would not be trading four times higher above $1,000 today.

Regards,
Adrian Ash
BullionVault

September 22, 2009

The Real Price of Gold was originally featured on Whiskey and Gunpowder

So speculative betting on gold going higher now equals a record-busting 752-tonne position in Comex futures and options, yet this is not a bubble according to Michael Pento of Deltaga.

Let’s say otherwise. Let’s say that gold prices, surging by almost $100-per-ounce in barely a month, are very much in a bubble…blown up by near-zero interest rates worldwide and a sharply negative cost of borrowing after inflation. Were that the case, the question before potential and existing investors would be simple:

Is this “irrational exuberance” or a “permanently high plateau”?

Alan Greenspan applied the former to US price/earnings in Dec. 1996; Irving Fisher said the latter of US equities in Oct. 1929. Both were looking at what history would decide were clearly bubbles in hindsight. But Greenspan was three years and 105% early.

Fisher spoke less than 72 hours before the Great Crash began…

Buying gold always looks “irrational” to most financial advisors and commentators, because it doesn’t pay an income or yield.

No matter that gold has beaten all other asset classes bar none since the start of the decade. People looking to buy gold (the blue line of Google searches above) have been underwhelmed with content and analysis online, despite outstripping the volume of “buy stocks” searches (in red) for nearly five years.

Gold buyers have also averaged 20% gains year-on-year since this point in 2004. That compares with -0.6% on average from shares, but so what? Check the spike in “buy stocks” stories highlighted by Google Trends’ lower chart during October last year. Just when gold turned sharply higher – and stocks still had another 40% to fall – the news-flow focused on bottom-fishing in equities.

Gold’s productive value is also judged to be nil next to foodstuffs, energy or base metals – materials that vanish in use and thus display a clear supply/demand dynamic. Whereas all the gold mined in history—being indestructible—is still with us today…some 165,000 or so tonnes. That makes a fundamental case for gold built on tight supply, rising demand absurd. Nor can TV or newspaper journalists get used to applying “exuberance” to gold, the ultimate in gloom-and-doom insurance outside your local gun-store.

But while permanent plateaus are harder to find in finance than geology, gold’s peg-legged clambering of the last nine years most certainly puts it higher than it started.

What’s powering the Stannah Stair-Lift today? In a word, leverage.

Liquidity (meaning “leverage”, as 2008 proved) has flooded back into the big investment houses, thanks to tax-funded injections, quantitative easing, and central-bank asset guarantees.

Near-zero interest rates sure help as well. And that, in turn, has enabled what we used to call investment banks to revive their prime broking services, offering to deal whatever leverage-hungry clients want most, and financing the trade with that ultra-cheap money.

The most leverage-hungry clients, outside of the banks’ own proprietary trading desks, remain hedge funds – hedge funds which doubled in number from 2003 to end-2007 (Hedge Fund Review), growing their assets under management from $600bn (Goldman Sachs’ estimate) to $2.9 trillion (HedgeFund.net) before hitting the credit crunch precisely as Bear Stearns blew up.

Just as the long-run bull market in gold threatened to keel over on this sudden withdrawal of derivatives leverage, however, the physical appeal of owning gold – or a near proxy, at least – came into its own.

Physical gold investment surged in the back-half of 2008 and early 2009, rising 150% from July-to-Dec. 2007 before adding two-thirds of that fresh record between Jan-and-March this year alone. (Data courtesy of the World Gold Council.) And now that deflation seems to be tipping ever-so-smartly into inflation – and the surge in ETF, coin and bar demand has eased off – leverage is back just in time for gold’s typical autumn move higher, a pattern seen 20 years in the last 40 and delivering some 15% gains on average this decade between Sept. and Feb. even for cautious investors buying on cash, rather than margin.

Inflation, deflation, who cares? Whether it’s exuberant hedgies or panicked private investors with something to lose, this “bubble” in gold – if that’s what you choose to call it after a decade of beating everything else, and four years after it broke sharply higher versus all currencies, not just the Dollar – just keeps expanding.

Sub-zero real rates of interest sure help. Media hype, to date, is missing. When those two factors reverse, buying gold may well become irrational – and whatever plateau it’s reached might well give way.

Regards,
Adrian Ash
BullionVault

September 21, 2009

Gold: A Permanently Exuberant Plateau was originally featured on Whiskey and Gunpowder

Just like poor Pip Dickens’ Great Expectations, central banks keep inheriting unwelcome bequests.

Today’s “legacy assets” are toxic derivatives; a decade ago it was gold reserves. Both are proving hard to shrug off, but for very different reasons. Both legacies also come thanks to previous central-bank history; the fossils remain only too livid today.

And 10 years from now, if not sooner, just how welcome will the current central bank must-have become – freshly printed government debt, bought with money that doesn’t exist until the central bank wills it?

Seeking first to defend against inflation and war, the West’s central banks built up huge reserves of the ultimate hard money –gold bullion– during the early-to-mid 20th century. Long before the turn of the millennium, however, these hoards grew to look quaint and expensive. Unyielding and relatively useless to industry, gold simply sat there, down in the vaults, costing money to store but returning no interest.

Who needed crisis-proof gold when Western Europe (if not the Balkans or Mid-East) was enjoying its first generation of peace-time in history? And who needed fine gold when the Nasdaq index of tech stocks was priced for 20% annual earnings growth over the next decade and more?

In short, who needed gold when we’d got Alan Greenspan, as the New York Times asked in May 1999. “The argument against retaining gold is that its day is past,” wrote Floyd Norris with uncanny timing, just two days before Gordon Brown’s Treasury announced its ham-fisted sale of half the UK’s gold bullion hoard.

“Once it was useful as a hedge against inflation that would hold its value when paper currencies did not. Now financial markets have their own sophisticated ways, using exotic derivative securities, to hedge against inflation.”

You could butter your toast with the irony. But it wouldn’t taste sweet or provide much nutrition. Whereas a further glance back at history might.

“With huge gold stocks available for sale, [governments] may discourage excessive price increases but naturally do nothing to prevent sharp decreases,” reported an investment piece for Medical Economics published in October 1977. (Our thanks to the author for finding and faxing it to BullionVault this week.)

“The government specter [over the gold market] can’t be expected to disappear quickly,” F.D.Williams continued, some 32 years ago. “Gold will continue to be part of many national reserves for a long time. The stocks are so large, they can’t all be dumped at once.”

Compare and contrast with today’s unwanted bequest – those toxic derivatives the US Treasury chooses to call “legacy assets” as if it played no role at all in producing them. Unlike state-hoarded gold, it only encouraged their creation; it didn’t want to look after the damn things. And quite unlike the market for state-hoarded gold, a ready stock of willing mortgage-bond buyers also looks unlikely to gather.

“The PPIP, which was beset by multiple delays as regulators tried to figure out the best means of removing many of the troubled assets from banks’ books,” as CNN reports, “is still not up and fully running yet.” It’s not been for lack of incentives. The $2 trillion Public-Private Investment Partnership, announced to much fanfare in March, offers huge leverage – entirely at tax-payer expense – plus some or other hold-to-maturity value to risk-cushioned investors, albeit as yet unknown. Private investment groups can use up to $1 of non-recourse loans, plus another dollar of Treasury finance, for every $1 they spend on taking toxic housing derivatives off the banks’ busted balance-sheets. Yet as a report published this week by the Congressional Oversight Panel put it:

“Whether the PPIP will jump start the market for troubled securities remains to be seen. It is also unclear whether the change in accounting rules that permit banks to carry assets at higher valuations will inhibit banks’ willingness to sell. Similarly, it is unclear whether wariness of political risks will inhibit the willingness of potential buyers to purchase these assets.”

Funnily enough, as the US authorities struggle to sell toxic debt, Western Europe’s Central Bank Gold Agreement has also stalled in 2009. This comes, however, despite prices and private-investor demand both holding near record levels. First signed ten years ago this September, back when no one at the New York Times, Economist, Financial Times or big central banks could see a use for the metal (simply owning this secure, liquid store of value is use enough, by the way), the CBGA capped annual gold sales and made them plain in advance for the coming five years. It aimed to avoid a repeat of May 1999, when the UK Treasury’s announcement drove prices down to what then proved their floor. In contrast to Washington’s PPIP, however, central-bank gold sales weren’t arranged in the hope of achieving maximum price, but merely curbing a rush for the exits instead. And as it is, they needn’t have bothered.

Gold prices have since risen three-fold and more against all major currencies, even while the 16 signatories to date sold almost one-fifth of their hoard in aggregate. Thus gold’s weighting in their reserves portfolio has doubled regardless, rising as gold outperformed all other assets from the start of this decade.

Hence the dramatic slowdown in central bank gold sales since the financial crisis began in August ‘07. Because it’s tough selling gold when its use becomes so clear, so present. Here in the fifth and last year of 2004’s renewed CBGA, “Net central banks sales likely to be in the order of 140 tonnes this year, down from 246 tonnes in 2008,” reckons London market-maker Scotia Mocatta. Yet the annual ceiling for CBGA sales currently stands at 500 tonnes!

The new agreement – just signed and due to commence on Sept. 27th – tips its hat to the facts, reducing that limit by one fifth. But who’s left to sell any way? Just as in the gold mining sector worldwide, the “easy metal” has already gone from West Europe’s vaults, pretty much emptying Spain, the UK and those excess Swiss holdings which maintained the Franc’s 100% gold-backing until the turn of this century. The two largest holders, Germany and Italy, continue to face down political calls for “mobilization”, refusing to yield one ounce so far despite signing all three agreements. France, the third largest owner, has pretty much sold the 600 tonnes from its hoard announced when it joined the central-bankers’ Cash4Gold party in 2005. That leaves only the International Monetary Fund’s 400-tonne sale, hardly enough by itself to meet the next half-decade’s 2,000-tonne limit.

Back at the Federal Reserve, meantime, tomorrow’s central-bank legacy – of freshly printed Treasury bonds bought with magic money from nowhere – continues to swell. Yes, the Fed’s stockpile of T-bonds may be smaller today than it was back in August ‘07 before the Great Inevitable broke, thanks to record Wall Street demand for the safety of Washington’s debt. And yes, the Fed isn’t quite collecting new bonds from the Treasury door directly, waiting instead a few days or so before picking them up (as Brian Benton, Chris Martenson and others have found) from those primary dealers who do bid at auction, rather than out-and-out monetizing the debt for all to see with its newly created cash.

And sure, private-sector demand for Treasuries continues to look so strong right now – what with overnight rates at 0%, plus the ongoing collapse of house prices, world trade and jobs creation – that the Fed says it will stop financing Uncle Sam’s spending in, umm, October rather than in September as previously stated.

But hoarding gold looked rather more sensible amidst the violence and misery of the mid-20th century, and no one at the Fed or Treasury guessed two years ago that they’d be offering leverage incentives to try and revive the market in mortgage-backed derivatives. When the global economy gets off the floor…or risk assets become more attractive to private investment…or China and Japan find they really don’t have any space left for US debt in their central-bank vaults, the market into which the Fed will want to sell its Treasury hoard will look very different to the market from which it’s currently buying.

Whether a decade from now, in 2010, or perhaps this fall – when the $300 billion of quantitative easing ear-marked for Treasuries is spent – trying to quit the Fed’s newest “legacy asset” could prove tougher even than finding ready buyers for today’s toxic junk. And given the soaring interest rates and potential US bankruptcy that in turn might trigger, spurred by whatever’s added to the Treasury’s $11.7 trillion of debt between now and then, perhaps buying gold will look a smart move to the Western world’s central bankers once more.

Regards,
Adrian Ash
BullionVault

August 18, 2009

Gold Will No Longer Be a Toxic Derivative to Central Banks was originally featured on Whiskey and Gunpowder

Here’s a thought—that tiny handful of investors and analysts warning how Fed policy risks hyper-inflation are in fact doing the central bank’s work.

The Fed wants you to believe hyperinflation is looming. Or at least, it should want that, if doubling its balance-sheet – purchasing and lending against investment junk – is going to work the wonders that modern central-bank theory says it can. And the Fed certainly wants you to believe it will stop at nothing to avoid deflation (”whatever means necessary” as the chairman put it back in 2002).

So anyone touting the hyperinflation risk in public is playing the shill, a decoy – seemingly unconnected – proclaiming the miracle powers of Dr.Ben Bernanke’s snake oil to CNBC anchors at every chance.

In fact, they’re doing the Fed’s work better than the Federal Reserve itself. Really.

“The major danger with a zero lower bound for the interest rate,” said Swedish policy-wonk Lars Svensson (also a Princeton colleague of the Fed chief and his credit-bubble associate Paul Krugman) in a speech earlier this year, “is that inflation expectations will be too low and even negative, and that the real interest rate will thus become too high.”

With it so far? Slashing interest rates to the very minimum of 0% suggests inflation has vanished, at least in the central bank’s eyes. But that, in turn, reduces the rate of inflation expected by consumers, investors and business. Central banks are credible forecasters, you see. At least in central-bank eyes. So in Svensson’s philosophy, the zero-rate solution to falling inflation proves self-fulfilling as people hoard cash and sit tight in bonds.

“It is thus necessary to…to counteract expectations of falling inflation, and preferably to create expectations of higher inflation,” Svensson went on. But “as Paul Krugman put it” says the Riksbank’s deputy governor, “How will the central bank ‘credibly promise to be irresponsible’…?

Heaven knows the Fed’s trying. (So’s Krugman, to no one’s surprise.) But while it’s embraced credible recklessness, the Fed’s stop short of French kissing it.

Why so coy…?

“We have a very serious recession, we have a 9.4% unemployment rate,” said San Fran Fed governor Janet Yellen in a speech in California on Tuesday. “If we were not at zero, we would be lowering the funds rate…We should want to do more.”

Just how much further would the Fed go – all the way to hyperinflation perhaps? Racing to first base, “The vigorous policy actions of the Fed and other central banks, combined with sizable fiscal stimulus here and abroad, have sent a clear message that deflation won’t be tolerated,” Yellen said.

“Based on measures of inflation expectations,” she went on, an apparently reading straight from Svensson, “the public appears confident that the Fed will adopt policies that will maintain a low, positive rate of inflation. Evidently, the credibility that the Fed and other central banks have built over the past few decades in bringing inflation down has spilled over into a belief that we won’t allow inflation to get too low either.”

Steady on, cheeky! Second base next, and “A glance at history shows that many countries with massive structural deficits and without an independent central bank turned to the printing press to pay off their debts,” Yellen continued.

Straight to third then, and “That’s a recipe for high inflation and, in some cases, hyperinflation.”

Gulp, almost home! But then, somewhere between third and fourth base, the Fed’s gone shy and rebuttoned its blouse. Because “I don’t believe the United States faces that threat,” Yellen said, showing the come-on to be just one big tease.

“Looking back in history, runaway fiscal deficits have often been accompanied by high inflation,” she explained in Tuesday’s speech in the bankrupt state of California. “But, since World War II, such a relationship has only held in developing countries. In countries with advanced financial systems and histories of low inflation, no such connection is found.”

Oh man, what a let down! Who’s gonna put out hyperinflation if not the Fed…?

“In order to make up for the collapse of credit, we are effectively creating money,” said George Soros, the legendary if only occasionally accurate hedge funder, at a Washington forum in March. “If and when credit is restarted, you would then have an incredibly swollen monetary base, which, if it were leveraged, you would have an explosion of inflation.”

The trouble comes, as Lars Svensson guessed back in January, with that “if and when”. Because it opens the door to the idea that a central bank might opt instead to withdraw all this new money after the deflation panic has ended. And that in itself is enough to make creating it useless. Pointing to Japan’s five-year experiment with ‘Quantitative Easing’ between March 2001 and March 2006, said Svensson, boosting the monetary base by some 70% failed to “noticeably affect expectations of inflation and the future price level.

“For example, the Yen did not depreciate as it should otherwise have done. Firms and households clearly believed that the expansion of the monetary base was temporary and not permanent, which subsequently proved to be true. The monetary base fell back to normal levels when the interest rate was later raised to above zero.”

Sure, the Bank of Japan’s trillions did triple Japanese Gold Prices. But even with gold refusing to drop back against the Dollar right now, eagle-eyed readers will note that, quite apart from the urgent debate in Europe, the US authorities are at pains to deny they need an ‘exit plan’ any time soon. White House advisor Christina Romer made that much plain in last week’s Economist magazine, blaming the double-dip depression of 1937 on “an unfortunate, and largely inadvertent, switch to contractionary fiscal and monetary policy.” Yellen said it again Tuesday.

So Team Bernanke have got the right idea – at least on Planet Svensson – if not the right level of irresponsibility just yet. Slip a little vodka into their juice though, and they might start talking up inflation like Alan Greenspan, Bernanke’s predecessor and the Maestro himself, writing last week in the Financial Times. He tried to spook everyone out of cash and into the stores by warning of a decade of inflation ahead!

“A pending avalanche of government debt is about to be unloaded on world financial markets,” Sir Alan of Greenspan warned sagely, almost visibly winking from behind those enormous spectacles. “The need to finance very large fiscal deficits during the coming years could lead to political pressure on central banks to print money to buy much of the newly issued debt.”

Or given enough sauce to get really loose, the Fed might even get crazy like Asia-based doomster Dr.Marc Faber. (He’s been known to enjoy the odd cocktail or two.) Stop warning on hyperinflation. Just come out and say it instead.

“I am 100% sure that the US will go into hyperinflation,” as Faber told Bloomberg in late May, and again on June 29th. “The US central bank has structured and introduced policies without considering exponential credit growth and its consequences,” added the Gloom, Boom & Doom author in an interview with the Korea Times on Wednesday.

See what I mean about being a shill? It’s like he’s on the payroll…

“The United States will not raise interest rates for many years to come because it needs to pay off its huge debts,” he went on, recommending inflation-friendly assets such as equities and Gold Bullion. “In turn, too much money in the economy will raise costs of everything, including healthcare and education, giving rise to hyperinflation.”

There, now that’s the way to do it! Greenspan and Faber on song, while the Bernanke Fed tip-toes around stating its aim:

Spark inflation and leave it to burn. Because putting it out worsened both the Great Depression and Japan’s “lost decade” – the one that started two decades ago and hasn’t yet ended. Everyone who’s anyone in monetary theory knows that.

And if they claim otherwise, maybe they’re the ones kidding.

Regards,
Adrian Ash
BullionVault

July 6, 2009

Faber and Greenspan: Shills for Fed Snake Oil was originally featured on Whiskey and Gunpowder

-Jude Wanniski, former Reagan advisor, April 1982

So does the price of gold rise or fall in a deflation?

Hint: It’s a trick question, already tripping up plenty of would-be advisors. Because gold must fall during deflation, since it rose during the ’70s inflation. Right?

“Gold prices, in real inflation-adjusted terms, unsurprisingly tended to increase during inflationary times,” nods one commentator, writing in London but posted at the Business Times in Singapore. “Its purchasing power tended to sag during depressions and deflation.”

The source for this claim? Besides syllogism (”The ’70s gave us inflation and a gold bull market; ergo, the opposite must be bad for gold…”) it was apparently Roy Jastram’s The Golden Constant, that dusty study of gold’s enduring stability across the very, very long run by the end of which we will all be deader than Austrian disco hits.

First published by Wiley in 1977, The Golden Constant has just been updated by Jill Leyland, former chief economist at the World Gold Council, for Edward Elgar Publishing. I’ve not seen the re-issue yet (not at £72 a pop! Some $120). But unless Jill’s scrapped Jastram’s research entirely and written a wholly new monograph, the conclusions should in fact be precisely the opposite.

Gold, like silver, gained in purchasing power during deflation but lost out to inflation. The only things to rise during commodity-price inflations were commodity prices and social unrest.

Three centuries of data are hard to ignore, but it seems they can be misread – not least when skim-reading for a quick book review. (If you care for the big picture, Jastram’s charts are available free at the Golden Sextant.) Those three centuries of data can also prove a real bore to analysts without a library pass, as Jastram apparently makes for “a very dense read” says a recent Seeking Alpha post. And all those numbers can also mislead the unwary if the key point’s neglected:

Gold, like silver, rose in value during deflations when it was still used as money. It lost out to inflation back when that role applied, too. But since the end of WWII, we’ve not suffered the first and only endured the second…and gold has risen sharply in purchasing power as the supply of what we’ve come to call “money” has swelled by an order of magnitude or twenty.

Meantime – and not coincidentally – gold ceased being money beyond offering a store of value (and free from default risk, as well). Little wonder that inflation really took off after the limits to money-supply growth set by the post-war Bretton Woods deal were cut by the Nixon White House at the start of the ’70s.

And we all know where that little trick got us…

“What the press and policymakers are calling ‘disinflation’ is simply deflation, the deterioration of the monetary standard characterized by falling prices,” wrote Jude Wanniski, former Wall Street Journal editor and advisor to Ronald Reagan, in 1982 – slap bang in the middle of what he’d come to call the “Volcker Deflation” in honor of the tall, cigar-wielding inflation-fighting Fed chairman.

Volcker took US rates to double-digits and left them there, wringing inflation out of the system and squashing the gold price—then (as now) a key marker for the stable value (or not) of money.

“There is a confusion because commodity prices [in 1982] are falling even as the cost of living continues to rise. [But] the price of gold, the ‘commodity money par excellence’ is the surest proxy for all prices, goods and bonds…[and] the recession that threatens to become depression could also swiftly turn into a major bull market if the Fed arrests the gold-price decline at $300, signaling an end to continued deflation and the monetarist policies that have guided the open-market desk.”

Fast forward the best part of three decades, and here we are again, trying to heat-treat the mutant spawn of a new “monetarist experiment” that’s also broken out of the lab and started to munch bystanders on the corner of Wall Street and Main.

Wanniski’s point back then was that, to prevent the end of the world, the gold price should be forced higher, making dollar devaluation explicit and pumping cash into the economy that could then be lent and spent to unwind that “deterioration of the monetary standard characterized by falling prices.” And only an idiot would pick a fight with Wanniski’s terms of reference.

So please – if you’ll glance at that chart of gold both sinking and rising as deflation failed to hit during the ’80s. Then hold my jacket a second…

Gold is no longer money, not as a means of exchange. Anyone who tells you it should be forgets that the Pound, Dollar, Yen and Euro have yet to expire. Whereas gold has signally failed in that role, not being used to make payment anywhere in the world today. The gold-money survival rate is zero, and so are the chances of a near-term return to any kind of gold-backed currency. (What do you think politicians and central-bank chiefs read for fun if not Brad DeLong and Barry Eichengreen?)

Absent the money-supply limits which the gold standard imposed on the world, people rightly guess that double-digit inflation would prove rocket-fuel for the bull market in gold. Yet the purchasing power of gold nearly doubled during the Great Depression, and it’s risen four-fold during this decade’s low consumer-price inflation as well.

Why? Because both those periods of low price-inflation saw the money-issuing authorities devalue the currency, first with explicit reference to gold but now without daring to name it. Roosevelt in the mid-30s slashed the dollar’s gold content by 40%; the Greenspan/Bernanke Fed devalued the Dollar again to sidestep a DotCom Depression, keeping real interest rates at less than zero, between 2002-2005.

The maestro’s apprentice applied the same trick in the back-half of 2008, but so far to no avail. And now even the European Central Bank is pumping out money – a near half-trillion euros today alone – in a bid to revive bank lending, swamp the currency markets, and pull Germany out of its first flirt with deflation since the 1930s.

Just such a devaluation – and again, absent any stated reference to gold – was attempted by the Bank of Japan a little less than a decade ago.

Indeed, Japan is the only developed nation since the end of the gold standard to have suffered an extended deflation in prices. So far, at least. Germany and Switzerland look set to try for a re-wind, and unless the dollar can outpace the euro’s descent, we might yet see truly sub-zero inflation in the United States, too.

But whatever that should mean for gold prices, all other things being equal, just doesn’t matter. Because the gold price will not get a chance. All other things are not equal, and the policy solution – rank devaluation – can only make gold more appealing to investors and savers, whether the “monetarist experiment” of TARP, quantitative easing or a half-trillion euros proves successful or not.

Japan’s slump into deflation coincided with the Bank of Japan’s “zero interest rate policy” (ZIRP) at the start of this decade. It also saw the gold price worldwide hit rock-bottom and turn higher, a move that analysts (including us) have typically linked to US monetary moves and investment cash looking for safety as the Dotcom Bubble exploded.

But zero-rate money from the world’s second-largest economy shouldn’t be ignored. And today, zero-rate money is all the developed world has to offer – a trick that might not beat deflation, but might just spur a whole new rush into gold.

Regards,
Adrian Ash
BullionVault

June 29, 2009

Gold and Deflation: A Trick Question was originally featured on Whiskey and Gunpowder

TIME WAS that central banks targeted and fretted about keeping their currency stable against the Dollar.

But as the Dollar-led inflation of 1950-1980 destroyed the value of bonds and savings worldwide – and then destroyed equities, as well as any sober hope of business and hiring plans – policy-makers tried to target instead the volume of cash flowing around their domestic economy.

Monetarism in turn fell apart as first the mid-80s “super Dollar” and then globalized deregulation of finance pulled the various “M” aggregates down, up and finally out of the window. “We didn’t abandon the aggregates,” says one practitioner in Steven Solomon’s 1995 book The Confidence Game; “they abandoned us.”

Central banks already had a new hope at hand, however. But now that theory – inflation targeting – is falling apart after almost 20 years of apparent success. And so the monetarists are back, in practice if not in policy statements.

What else do you think “quantitative easing” aims to achieve if not easier quantities of cash flowing from banks to business and households? And how can inflation targeting – whether explicit as in the UK, or generally guessed to be the chief aim, as in the United States – possibly survive this crisis given the failure of policy-makers to either hit target or reduce volatility?

It’s not simply the impact of monetary policy on consumer inflation which has gone “off message” in 2009.

Extending their remit – and now hoping also to control longer-term interest rates as well as overnight money rates in the “open” market – central banks are signally failing to cap either the yield or volatility of long-term government bonds. The 10-year US Treasury bond, formerly the financial world’s modern “Gold Standard” equivalent – has never offered such wide-swinging returns.

Most disastrous for policy wonks pulling this lever and pushing that button, you have to go back to the Great Depression – when central banks still nailed exchange rates and the volume of money to a tightly supplied quantum of Gold Bullion bars – to find uncertainty about quite where the cost of living will stand running this great, this fast. The month-on-month rate of change in US consumer prices has been three times as vicious since December as the CPI’s previous six-decade average. Here in the UK, consumer-price inflation has now overshot the official 2.0% target for 20 months running, even as the previous measure of living expenses – the Retail Price Index – has sunk below zero.

“We didn’t abandon the inflation target,” the Bank of England will no doubt declare. “It abandoned us…”

Thing is – and as with any social experiment, such as the London Gold Pool’s attempt to cap the price of gold in Dollars at $35 an ounce, finally abandoned in March 1968 – trying to observe as well as influence the “out-turn” of inflation means neither task is done very well, if at all.

Promising to buy and sell gold in the “open” market at a fixed price lower than private traders would bid, the Gold Pool only invited fresh pressure on their fast-shrinking stockpiles. Defending that $35 price – itself arbitrarily set by President Roosevelt at a series of jovial breakfast meetings three decades before – showed the absurdity of any particular fixed value for gold in a world awash with money.

Now in 2009, and slashing rates towards zero to try and force savers out of cash and boost new mortgage debt, the Bank of England has itself caused those sub-zero readings on the Retail Price data – the very opposite of what it set out to do. Because those numbers include mortgage-interest payments each month. Whereas the Bank’s mandated target of 2.0% is pegged against the mortgage-less Consumer Price index. And on the logic of that measure alone, not least with oil prices about to start pushing higher on the year-on-year figure as the spike of July ‘08 fades from the series, interest rates should in fact now stand higher, rather than encouraging yet further hikes in the cost of living.

What to do? At this pace, we’ll all join the Swiss in quietly setting targets for foreign exchange rates and ranges, hoping to side-step deflation at the expense of our neighbors’ overseas exports. Already in March this year, the Bank of England’s Spencer Dale cheered the fact that “the marked depreciation in Sterling should support demand, both at home and abroad, for domestically produced output.” But that exchange-rate gain was swiftly undone as the Pound then raced back towards $1.65 to the Dollar, knocking 18% off the Gold Price in Sterling and widening the UK’s trade deficit to £7.0bn in April from March’s eight-year low of £6.5bn.

How to escape this policy nightmare? Besides yet more volatility, we guess here at BullionVault that only one thing is certain. Central bankers scrabbling around for a new “Hey! This might work” policy to square the circle of full employment with low, stable inflation are guaranteed not to apply a fixed limit on the absolute volume of cash, as set by some implicit if not official Gold Standard.

Sure, if policy-makers, politicians and the rest of us would only abandon the hope of costless inflation, then yes – a Gold Standard might well appeal. But the promise of above-average wealth for everyone makes yawning debt a necessity, and that makes a commodity-linked supply of money untenable. And anyone who tells you otherwise needs to review not only the one policy lesson taken away by every economic advisor who’s studied the Great Depression, but also how unstable the “stability” of precious-metal standards proved in practice beforehand.

Digging deep in the archives three decades ago, Professor Roy W.Jastram of the University of California at Berkeley found that – while relatively constant across broad sweeps of history – holding gold even amid a Gold Standard didn’t do much to smooth short-term volatility in prices.

As the table above shows, taken from Jastram’s analysis of “the English experience” across 366 years, neither silver or gold overcame shorter-term shocks to the cost of living, typically driven upwards by war. Indeed, the post-Gold Standard inflation of the 20th century proved the only exception. Precious metals rose ahead of the cost of living, gaining real value as the value of money diminished and commodities leapt. Whereas until the end of first the Silver, then bi-metallic and finally Gold Standard in the mid-1930s, it was deflation which boosted the real purchasing power of precious metals – then, unlike now, hard cash you could take to the shops and exchange at the bank.

Quite what this means for central bankers now seeking the next number to chase in their monthly meetings, we neither know nor care. But for private investors seeking a little stability in their own savings and wealth, the one certainty remains vicious, violent changes in value, no matter what digit on what metric is chosen.

Regards,
Adrian Ash
BullionVault

June 19, 2009

Inflation and Random Numbers, Part II: Return of the Monetarists was originally featured on Whiskey and Gunpowder

– James Warburg of the banking dynasty, resigning as President Roosevelt’s monetary advisor, 1933

Want to know where the price of gold, oil, the S&P, Euro or overseas stock markets are heading?

Pick a number, any number. Go on, choose whatever number you like! Because that’s how policy-makers and their advisors would like to set the common denominator of asset prices: the value of money.

“When I calibrate my favorite version of the Taylor rule using the most recent data,” says Greg Mankiw, professor of economics at Harvard and chairman of Dubya Bush’s “I get a target for the nominal federal funds rate of about negative 1%.”

Actually, “as long as expected inflation is still positive…that means an even more negative target for the real interest rate. And given the forecasts of inflation and unemployment, we are likely to get further into the negative region in the months to come.”

Yes, you read right. As Dr.Marc Faber of the Gloom, Boom & Doom Report has been howling since Mankiw published his “Economic View: Time to Go Negative” in the NY Times back in April, the professor “seems to have great sympathy for the outright expropriation of savers.”  Negative real rates of interest – returns paid to cash depositors that lag the rate of consumer-price inflation, thereby devaluing bank savings in terms of purchasing power – are currently best maintained in Zimbabwe, notes Faber. And Mankiw is such a man of the future, sent back in time to guide us with the wisdom of ages yet to pass, that pension savers in the United States might hope their retirement runs out before the Fed acts on his hindsight and drags us all into Robert Mugabe’s brave new world.

Ignoring the fact that the real Fed Funds rate was negative for 34 of the 38 months between Aug. 2002 and Oct. ‘05 – a feat topped only by the 40 months of negative real rates between Sept. 1974 and Jan. ‘78 – “The idea of negative interest rates may strike some people as absurd,” writes Mankiw.

“But remember this: Early mathematicians thought that the idea of negative numbers was absurd. Today, these numbers are commonplace…”

Early mathematicians also gave the world geometry, algebra, Pi, elevation surveying and pneumatics. But those old, dead people with their fear of surds…They know nothing! NOTHING! as class monitor Jim Cramer would no doubt scream if invited to comment. And closer still, even within living memory, “When you look at the [Fed's] mistakes of the 1920s and 1930s, they were clearly amateurish,” as Mankiw told the WSJ in Feb. 2000.

“It’s hard to imagine that happening again – we understand the business cycle better.”

“[In May 2001] I wrote a paper on monetary policy in the 1990s,” the über-enlightened Mankiw blogs on. “I estimated the following simple formula for setting the federal funds rate:

“Federal funds rate = 8.5 + (1.4 x (Core inflation – Unemployment))

“The parameters in this formula were chosen to offer the best fit for data from the 1990s,” explained Mankiw after solving his equation 8 years ago. Yes again, you read that right. His “favorite” monetary-policy rate for any given pair of inflation and jobless data is spat out by taking the one from the other, multiplying the result by 1.4 and then adding that result to eight-point-five.

Not because those figures of 1.4 and 8.5 represent some immutable law of the universe. They’re now stuck in the mold of, say, the ratio of a circle’s circumference to its diameter always equaling 22/7…or the weight of fine gold (its specific gravity) being 19.3 that of an equal volume of water. No, Mankiw instead built his theorem upon the achievements of “miracle worker” Alan Greenspan (to quote the professor), head of the Fed when inflation – as well as unemployment – trended down towards 40-year lows.

Inflation is always and everywhere a monetary phenomenon; so any change in the rate of inflation must come due to changes in monetary policy. Unemployment is also influenced “over a period of at least two or three years by central-bank actions,” Mankiw asserts. Hence the numbers – not quite any numbers – squeezed out of Mankiw’s solution to the Maestro’s 40-year records in US macros-stability and growth.

One-point-four, eight-point-five. Keep them in mind. They might mean something important. Not least a whole new surge in commodity and especially gold prices as savers flee the warm, welcoming  arms of US commercial banks – now being recapitalized by lending cash at pre-crisis prices but giving depositors next-to-nothing in return.

“I’m advocating 6% inflation for at least a couple of years,” says Mankiw’s Harvard colleague – and former IMF chief economist – Kenneth Rogoff. At current interest rates, “It would ameliorate the debt bomb” by taking real rates to their very lowest in history and leaving them there. Or rather, it would make the debt bomb sound like a fire-cracker against the exploding oil refinery of re-shrunken savings rates, impossible investment decisions, and collapsing Treasury bonds.

“There’s trillions of dollars of debt, in mortgage debt, consumer debt, government debt,” Rogoff notes sagely. Yet somehow, he thinks, soaking the lenders will mean avoiding “a long period of slow growth.”

Remember: This tomfoolery might sound absurd right now, but in Harvard’s bright smiley future, it could indeed become commonplace – and US cash savers lived with precisely this outcome between 2002 and 2005.

Now this “thinking” represents the blue-sky academic and professional chin-stroking amidst which the Federal Reserve claims it will start raising rates and withdrawing “excess liquidity” just as soon as Consumer Price inflation ticks higher.

Like Jim Cramer says, they really do know nothing.

Regards,
Adrian Ash

June 18, 2009

Inflation and Random Numbers, Part I was originally featured on Whiskey and Gunpowder

“FEAR, Mr. Bond, takes gold out of circulation and hoards it against the evil day,” as 007 learns from a Bank of England officer in Ian Fleming’s Goldfinger (1959).

So “in a period of history when every tomorrow may be the evil day, it is fair to say that a fat proportion of the gold dug out of one corner of the earth is at once buried again in another corner.”

Evil-day gold buying really motored since the credit collapse began in August 2007. Soaking up investment dollars worldwide, in fact, new allocations to the metal – whether trust fund or owned outright – swelled by 38% during the first quarter of 2009 compared with total demand between Jan. and March 2008, according to marketing-group the World Gold Council (WGC).

Within that figure, what the GFMS consultancy (who supply the WGC with its data) calls “identifiable investment” leapt 248% compared to Q1 ‘08. And gold ETFs made the headlines once more, sucking in “another quarterly record” as new inflows required 465 tonnes of metal to back them, thus dwarfing the previous record of 149 tonnes set in the third quarter of last year.

That doesn’t mean the world’s investors are now all in, however. According to the World Gold Council’s Marcus Grubb last month (using we-don’t-know-which data), current gold investment allocation stands at less than 0.6% of total global wealth.

It makes a nice pie chart, and it offers a useful snapshot of different asset classes vs. each other. But we also think the idea’s worth refining. Because this estimate both over-states liquid assets in toto and under-estimates the stock of gold available to investment flows – whether retail or wholesale.

First, note the scope for double-counting between pension, mutual and insurance funds. I’m not saying the WGC’s data trips up on that error, but you can see how likely it seems given the end-allocation categories applied. For instance, “hedge funds” are stripped out separately (as are REITs and private-equity), even though institutional allocations via funds-of-funds will be counted elsewhere under the broader “funds” title.

Similarly, but more pertinent, the outstanding quantity of “gold – investment stocks” underplays the true volume of metal held as a store of wealth. Simply counting the “investment” volume excludes fully 84% of the above-ground supply, as another chart from the WGC’s presentation shows.

Why not also include “official sector” gold hoards? Sovereign wealth funds and FX reserves were included on the other side of the ledger, after all.

More crucially still, why not include jewelry? Trying to split out the volume of trinkets held for aesthetics alone might feel easy enough to a Western analyst just back from window-shopping at Mappin & Webb. But across south-east Asia, and most particularly in India – typically the world’s No.1 destination for physical gold each year – large, chunky necklaces and bracelets make for “investment jewelry”, acting as a store of wealth in the absence of any formal banking network.

Still, the point is well made, we believe. Gold remains but a slither of investable wealth – albeit a fast-growing slither as the value of other assets has dropped.

“Gold [has] been deprecated and reduced as a financial asset,” as Jeffrey Christian of the CPM consultancy put it earlier this year. “In 1968 gold may have represented 4.5% to 5.0% of the world’s wealth…By the 1990s it was down to 0.2% of the world’s wealth. Not that gold was falling in value so much as the other wealth – stocks, bonds, paper assets, government bonds, corporate bonds, bank deposits – were exploding once the tie to gold was severed.

“In 2006 gold represented 0.2% of world wealth. At the end of 2007, it was about 0.4%. Depending on what you think about wealth destruction in 2008, it may have been 0.6%.”

That figure just about matches the WGC’s estimate of 0.7% (perhaps they used the same inputs and excluded the same volumes of central-bank and jewelry gold?). It also contrasts with our own Estimate of Gold as a Proportion of Investable Wealth at nearer 2.7% by the close of 2008.

Either way, gold is fast-attracting attention – both from nay-sayers, retail investors and new die-hard bulls amongst the professional institutions. Regulatory filings show legendary hedge-fund manager John Paulson took his position in the SPDR Gold ETF to 30% of his portfolio during the first quarter of 2009. Paulson & Co. now owns 8.7% of that paper – as well as significant chunks of the Gold Miners ETF (GDX), Kinross Gold (KGC), Gold Fields (GFI) and AngloGold Ashanti (AU) – if not any actual bullion itself.

Does that in itself make gold a buy? Of course not. But compared to the evil days of 1930s depression – or the fearful inflationary panic of the late 1970s – the world’s wealth remains very under-invested in metal right now.

Regards,
Adrian Ash
BullionVault

May 21, 2009

The World Gold Council Wrong About Gold was originally featured on Whiskey and Gunpowder