Wall St. and Business Wednesdays: Interpreting A $500 Price Of Gold
On Monday morning I received an e-mail from one of my Brothers, Obiozor – a brilliant IT Professional and Entrepreneur who follows capital markets closely. He sent me, and some others, an article that appeared in Bloomberg, "Newmont Forecasts Gold to Rise Above $1,000 on Asian Demand". The lead paragraph stated, "Newmont Mining Corp., the world's largest producer of gold, says the price of the precious metal may rise to more than $1,000 an ounce in the next five to seven years as demand growth driven by Asia outstrips global supply."
That article coincided with a day, in which I conducted business keeping an eye on, and ear open to the financial cable channel CNBC. The possibility of gold breaking the $500 per ounce mark figured prominently in the news coverage. Eventually that mark was reached during trading in Asian markets and gold for February 2006 delivery closed at $503.50 an ounce in New York trading on Tuesday.
One portion of the CNBC programming, I saw included an interview of Mr. John Bridges, the noted gold analyst for JP Morgan. His explanation and analysis included the view that much of the rise in the gold price was demand driven due to purchases made by China and India. He specifically mentioned increases in demand for jewelry in Asia, and a CNBC commentator remarked that this time of the year represented the big wedding season (when rings are purchased.) When asked to give his prediction on where the price of gold was headed, Mr. Bridges said that he was still very positive on gold, saying that its price was still headed higher, because even at the $500 per ounce level its price is low.
Others have pointed not to just the demand for gold but also its supply, stating that South Africa, the world's largest gold producer, has seen its gold output fall by 15 percent this year, the biggest such decline in close to a decade. This decrease in supply, they say, is causing the gold that is available for purchase to be bid up in price. The more scarce a commodity, the more valuable, is the logic.
And then there are those who say the price of gold is determined not by the supply and demand for the actual gold itself, but by the supply of, and demand for money itself - the sea of liquidity of the currency in which the price of gold is denominated, the U.S. dollar.
So, I decided to inquire with my informal ‘Gold Trust’ - a variety of market professionals, analysts, economists and experts whose opinion I respect on the subject of gold, finance and economics - to see what they thought a $500 price of gold was telling us. Monday or yesterday (Tuesday) - either in phone conversation or e-mail - every last one of them kindly and promptly replied with their take.
Here below, are their comments, replies and answers.
Richard Russell, Founder, Dow Theory Letters, Inc.:
$500 is a big number for gold but more in terms of symbolism. It has more of a psychological significance, similar to when the Dow reached 10,000. So this is just the beginning. It is just a matter of time before gold really goes through the roof. All you have to know is that a bull market is in session and you can see where that psychology is going to lead us.
Andrew Gause, Founder, SDL Numismatic Properties, author, "The Secret World Of Money":
You haven’t even seen real pressure on gold yet. At $500 we are only at about three-fourths of the equilibrium price. We still have $125 dollars more to go, upward. It will be interesting to see how monetary policy changes when Ben Bernanke takes over for Alan Greenspan next year. I think that Bernanke is actually going to lower interest rates to re-stimulate the economy. He is going to move away from Greenspan’s idea of ‘asset inflation,’ and he is going to be more concerned about ‘core inflation.’ By lowering interest rates he keeps the housing boom going for a while. They would like to continue to keep the printing press going, increasing the money supply as long as the core rate of inflation does not go above 3%, which has been the formula for years. That is why we have seen the money supply get to its current level of $10 trillion, doubling quickly from $5 trillion. By the way the Federal Reserve announced they are going to discontinue publishing monetary aggregates. I think I turned too many people on to watching those statistics closely to see how much money the Fed is really printing (laughter).
Reuven Brenner, Repap Chair In Economics, School Of Management, McGill University:
Gold is up relative to all paper currencies for the last 5-10 years. It signals alarm about the way they are all being managed - but the US Dollar in particular, since it is THE reserve currency. Announcements about Russian and some South American central banks accumulating gold are not surprising.
Greenspan's departure may have something to do with it too. He leaves in place a vague new strategy for managing the dollar – he called it "risk management." As far as I could see virtually no one had commented on this "risk management" regime, and its lack of clarity. In November, at the Economist Magazine/CATO Institute Monetary conference I offered my perspective on it, essentially presenting the following section (as part of a larger paper):
"The United States has thus been from time to time in the privileged position of being able to buy, invest, loan or donate money in other countries, without its money markets feeling any effects from its balance of payment deficit. It is easy to get accustomed to having a 'deficit without tears,' and it needs much commitment and credibility to see how long this trend can be sustained without having adverse effects on the reserve currency. Mr. Greenspan’s departing speech at Jackson Hole, warned against such an outcome. The scenario outlined in the previous sections may also explain the addition to his vocabulary - namely him saying that as central banker he is in the 'risk management' business. Though Mr. Greenspan never made it clear what he means by this term, the scenario discussed above suggests a clear answer. Note too that in February 2003, when Congressman Ron Paul asked Mr. Greenspan before the Financial Services Committee about gold, he answered: 'I have been quite surprised, and I must say pleased, by the fact that central banks have been able to effectively simulate many of the characteristics of the gold standard by constraining the degree of finance in a manner which effectively brought down the general price levels.'"
So, combine the performance of the last 10 years with Ben Bernanke's uncertain views - and the $500 price is not surprising. In his academic writings, Ben Bernanke seems to support a strict CPI target (a mistake in my view, because of the many problems with this backward looking, strangely computed number). But while he was on the Board of the Fed, he never voted against Greenspan - though obviously Greenspan did not pursue a price index target. Does this mean that Ben Bernanke changed his mind? Does it mean that Mr. Greenspan persuaded him that he was wrong? Or, does it mean, that he just played a "political" game, to become the next Fed Chairman, and he will later adhere to his academic beliefs?
We just do not know. The $500 gold price and the devaluation of all paper currencies suggests that investors expect central banks to manage less well in the foreseeable future. Meanwhile, people and companies are are still borrowing cheaply and bidding up the prices of alternatives.
[Those who would like to obtain a copy of Mr. Brenner's paper, presented at the Economist Magazine/CATO Institute conference are invited to make an e-mail request to him directly. That address is:firstname.lastname@example.org]
Marc Mealy, International Economist Currently Working At The US-ASEAN Business Council (and BEEU Guest Lecturer):
$500 Gold is a very interesting snap shot of the current forces at play in the global economy. My observations include:
1. Note that the "market maker" for this push on the price of gold is Asia. Another example of Asia's economic emergence as the growth engine of the world - where dynamic activities in Asia become catalysts for "global" market changes.
2. Two thinks seem to be at work:
A. Demand for gold in producing things (fueled by demand in Asia) is pushing up against supply.
B. Demand for gold as a financial instrument is increasing for those who have tons of dollars.
3. With gold serving as a classic hedge against currency valuation risks, I believe that the spike in gold prices is another example of a shift in Asia away from the US dollar, in the name of diversifying their potential "over" exposure to a shaky US dollar.
4. With gold at such prices, producers of gold and other commodities in Africa and Asia might see a greater level of interest from investors to expand their production activities.
5. I think the price could also be telling us that participants in global trading markets perceive the disequilibrium in global capital/financial markets in terms of national currencies reflecting their true relative values, as indicators of their national economies, to be on the increase.
6. Note, in the grand scheme of things this price spike will likely not have a "development" impact on Africa and other gold producing economies. We must not forget the historical trend for all commodity prices is still way, way down. In addition, the current nature of the global value chains involving gold is increasingly driven by firms and societies which buy of gold, not the firms and societies which produce of gold. Hence, the greatest share of the distribution of the benefits from the higher gold prices will go mostly to the global companies which "buy" gold and sell brand name goods to consumers.
Paul Hoffmeister, Director Of Global Research, Wanniski.com:
$500 gold indicates about a 3.5-4.0% inflation rate over the next ten years if it stays at this level. But this doesn't necessarily mean interest rates will sky-rocket anytime soon; any upward movement in the long end of the yield curve should be gradual. This is because the dollar-economy today is in what I call an "equilibrium paradigm", where the residual inflation since Nixon closed the gold window in August 1971 has been completely washed out of the system. Because there is very little residual inflation in the economy today, long rates are hovering around levels seen in the mid-1960's and why Greenspan has such a conundrum.
To correct the incipient inflation represented by $500 gold, the Fed should sell Treasury notes (in exchange for currency) to pull gold down to $400.
Dr. Steve Hanke, Professor, Applied Economics, Johns Hopkins University
By itself, gold's current price of almost $500/oz isn't telling us too much. But, the change in the price of gold -- up roughly 10% this year -- is telling us a lot. In short, we can expect more inflationary pressures next year.
John Tamny, Economist and Commentator, National Review Financial Online
Headlines in newspapers continue to note the rising dollar. In truth, the dollar is falling, though less quickly than the euro and yen. And despite the 300 basis points in rate increases over the last 17 months, the price of gold is nearly 25% higher than when the Fed began. Rate hikes haven't worked as advertised this time, just as they didn't in the '70s when the Fed used the rate it sets to rein in dollar liquidity. Since the Fed began raising rates in June 2004, the dollar price of gold has risen nearly 25 percent. While the "unseen" in this case might be what the price of gold would be today absent the 300 basis points in hikes, it also could be said that Fed tightening hasn't worked as advertised. Importantly, there are historical examples that point to the ineffectiveness of rate hikes in reining in dollar liquidity. Despite a 900 basis point rise in the fed funds rate from 1976 to 1980, the dollar price of gold rose over 500 percent in that time, from $140 an ounce to $850. Whatever happens, it seems reasonable to question the present Fed strategy amidst a falling dollar.
Michael T. Darda, Chief Economist, MKM Partners:
We admit to being caught off-guard by the strong gold-price advance, which has vaulted the yellow metal toward $500 to-the-ounce. Since gold is rising in all of the major currencies it could be the result of 1) behind the curve monetary policies in Europe and Japan 2) a Fed that is not yet at equilibrium but closer than the BOJ or ECB, hence the dollar’s advance against the yen and euro; and 3) fiscal policy setbacks in the U.S. (tax cut extensions in doubt) and Europe (Germany’s Merkel set to hike tax rates), which could be loosening the demand for central bank liquidity...If gold (and precious metal prices hold these levels or move higher, it would make us increasingly nervous about core inflation shooting significantly over the top of the Fed’s 2% ceiling...Suring precious metals prices across currency areas are an indication of global excess liquidity and rising monetary velocity. Excess money and rising velocity can raise output and employment in the short run (i.e. boost aggregate demand). However, in the long-run, excess money stimulates inflation not growth. Our model suggests that precious metals prices in current ranges likely will result in core inflation no less than 100 bps above the upper limits of the Fed’s tolerance zone. If we are correct, this almost surely would trigger a 2006-rate hiking response that isn’t even close to being reflected in the relatively subdued Eurodollar futures market. We continue to believe this poses much more of a risk to the bond market, where Treasury yields remain negative after headline inflation and taxes are deducted. This compares to a much more sober reflection of reality in the stock market, where the forward earnings yield on the S & P 500 is well above 6% even assuming conservative, single-digit earnings growth for 2006.
Stephen W. Shipman, CFA
By itself, gold at $500 is not very meaningful. In the short run, the price indicates the Fed or its operating procedures are committing monetary error. By operating procedure, I mean its interest rate targeting regime. In this case, the $500 price of gold indicates a surplus of dollar liquidity relative to the demand needed to implement the total number of commercial transactions in the real economy.
Longer term, a $500 gold price, if it stabilizes at or near this level, would suggest a permanent increase in the rate of inflation, which could dramatically affect the price of financial assets, namely stocks and bonds, and the amount of capital available to fund the real economy. This price might imply a permanent inflation rate as high as 3+% per year that is currently not discounted in prices of both stocks and bonds. Thus far, the 30 year bond rate suggests that such inflation is not anticipated; the various indices of gold mining stocks are mixed, but not as positive as the bond market.
In closing, one should be able to see from the above comments of my informal 'Gold Trust' that there are many ways to interpret the dollar price of gold and examine it - from both a supply and demand perspective. For centuries gold (followed by silver) has been the most monetary of commodities because of its unique attributes, including such factors as its limited supply, unique usage, intrinsic value, and international and intercivilizational appeal.
In the coming months and years, we expect gold to play an increasingly important role in personal financial strategies, international capital markets, economic development, and the rapidly changing geopolitical terrain.
Those interested in the above and in learning more about the precious metal and its cultural, political, and economic implications should enroll at Black Electorate Economics University (BEEU) where we will explore all of this in great depth.
Wednesday, November 30, 2005