Why Gold?
Once upon a time money was backed by gold, but after 1971 the gold standard was abandoned for the fiat currencies we know today. Nowadays that shinny metallic yellow stone has uses in jewelry, electronics, medicine and is also part of most if not all central banks reserves.
Money Mischief: Episodes in Monetary History
But why should I buy gold today? As a hedge against inflation? reserve of value? price speculation? Zombie apocalypse? Here a quick analysis of why or when it seems gold is prefered.
- Against inflation:
There where times in which gold price (blue line) went down, like the period from 1980 to 2000, while Consumer Price Index (CPI) continued rising. That 20 year span is too much time to say that gold is bought exclusively to hedge inflation. Imagine that in 1980 an ounce of gold allowed you to buy 12 apples, even if apples remained at a fixed price, that same ounce allowed you to buy 3.5 apples in the year 2000.
Below the same graph but with the percentage change from a year ago.
During the '70s inflation was rising faster which coincides with rising gold prices. But during the '80s gold lost purchasing power, so it may be a dangerous speculative hedge against inflation and we can't explain gold price during 1980-2000 solely with inflation.
- Against yields:
The two reasons for not holding money are its usefulness and its cost. The U.S. Treasury Bonds are the safest asset in the world to reduce the cost of holding mone.
Here gold (in blue again) is shown deflated, with inflation taken out, in other words you see the purchasing power of gold and not its nominal price. Also shown in the graph above in red are the real rates of a 10 year treasury (The treasury rate minus the year ago percentage change of inflation/CPI).
The all time high of gold occurs when real rates where at an all time low. When inflation was stabilized using higher rates gold started a downtrend that lasted till the start of the new millennium.
Not even near a rigorous testing, some simple conclusions by just looking: Real rates around 2% are the turning point for gold and as inflation data lags one month gold is a good predictor for the combination of rates and inflation/deflation.
But we can't draw any conclusion without looking at the core rate variable, the Federal Funds Rate.
It was during the Federal Reserve's response to the dot-com bubble burst that gold price started to go up again. But when real rates and federal funds rate were again higher around 2005, real gold price continued the trend that began in the year 2000 (for a later post, some believe this rate hike due to rising oil prices was the main cause of the subprime crisis in 2008).
In the first yield graph it appears that rates are chasing gold and in the last one gold is chasing rates. Gold price is inversely proportional to real rates, but I still think that something is missing between 2005-2008 or 2012-2015 to justify gold prices. Obviously if gold price is mainly driven by expected real rates it could be that nobody was thinking that higher or lower rates will last (and no, I don't think that the Great Recession was expected by most).
- Against the market:
See the real value of gold against the real value of the total US stock market. Interesting how the incredible 2000 bubble is related to lower gold prices.
Above are the annual rates of return of the US stock market as a whole. Higher returns with very low yields (bond graphs above) during 2012 and 2018 makes gold prices drop. I think that nobody want's to hold a 0% dividend yield piece of rock when you can own shares of a big and trusted currently profitable company (The last S&P500 dividend yield peak was during 2010). Gold price also moves inversely to risk appetite.
- Against rising debt and money stock:
I could not end this humble analysis without showing this two graphs. But as excess federal debt and money can fuel anything, like excess credit and a new asset bubble, and its consequences are not imminent, final results are on average something like two years away, it is not appropriate for an immediate cause-effect analysis.
Expected inflation is shown on the graph as an extreme correlation of gold price and money quantity during the pandemic, but I guess that this expectation will fade away on an instant-results-driven-world. Stay tuned in a year, year and a half, for when inflation really heats up if this excess of money is not timely controlled (Because as seen above, if inflation finally starts but treasuries or equities are better bets why would gold rise?).
- And now?
Gold is actually 20% below its 1980 deflated all time high.
Real yields are not as low as during the '70s to justify that extra 20% and an economic recovery that drives higher inflation looks at least a year away (unless oil prices increase rapidly). Au contraire, central banks are still talking of more QE and debt monetization because they are afraid of deflation. Obviously this are my expectations and if the market is still expecting too much inflation I could be wrong, but higher bond prices are a good indicator that big players are not expecting a quick complete recovery and inflation short term as Milton Friedman predicts.
Using technical analysis (I use NeoWave theory) I assign a 50% probability for gold to go first to $ 2,355.2 and 50% to go as low as $ 1,213.6.
My final possible scenario for higher gold is a collapse of equity prices, that includes a plummet of the value sector that brings avoidance of risk. But with markets starting to price a recovery, rotation from growth to value, with many of those value companies having high dividend yields, why pay for gold near the high it had during a very conflicted world when parts of the equity market are lowering it's risk-reward ratio with positive news of a Covid19 vaccine? (Great Reset conspiracy theories aside).
Let's zoom in
Now I can buy expecting to go from $ 1,800 to $ 2,300 (green arrow) or do nothing because it's going below $ 1,650 (red arrows). Either way from a technical analysis perspective I expect gold to make a downward correction before its next bull cycle. I hope this correction happens and allows me to buy somewhere between $ 1150 and $ 1650 and be prepared for the consequences of uncontrolled excess money in a year or two!
Do your own math, buy now hoping that a new high is coming or wait a little more to see what happens.
To see this and many more related graphs:
- My FRED Gold dashboard: https://research.stlouisfed.org/dashboard/59899
- My TradingView Idea: https://www.tradingview.com/chart/GC2!/B0MStwTB-Why-Gold-see-link-to-blog/
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