Gold: a better and simpler explanation
The emotional inflexibility that dominates most gold analysis contributes to confusion and misunderstandings. For example, “The backdrop for gold today is as rosy as it has been in a long time”; o “The precious metals sector is on an important buying signal.” These and other similar claims are often backed by heaps of technical analysis, the best money can buy.
And this adds to the general misstatements of fact. It would appear that there is practically no justification for lower gold prices, except when caused by manipulation associated with conspiratorial forces.
Otherwise global stress, terrorism, natural calamities, social unrest, economic weakness, interest rates, inflation, trade deficits, demand for Indian jewelry, etc. etc. all put a “floor” under the price of gold. At least this is what we are told.
And the moment. Oh my word; Timing! “It’s now or never).” “Gold has finally overcome its upper resistance.” “$ 2,000 / oz by end of 2017.”
Does understanding gold require a degree in cyclical theory or financial mathematics? Or is it related to climate change?
There is a better and simpler explanation for gold. It just requires a bit of historical observation.
1) First, and most important, is the simple fact that gold is real money.
Its value (purchasing power) is constant and stable. And its role as money came about through trial and error. Gold has stood the test of time.
2) Second, paper money replaces real money.
Gold is also original money. It was stored in warehouses and receipts were issued to owners reflecting the ownership and title of the deposited gold. The receipts were negotiable bearer titles for trade and exchange.
3) Third, inflation is caused by the government.
One thing that should be clear from history is that governments destroy money. That may sound harsh, but it’s true. And when we say “destroy” we mean that. Inflation is intentionally practiced by governments and central banks. Its effects are severe and unpredictable. The Federal Reserve Bank of the United States has managed to smash the US dollar to pieces over the past century. The result is a dollar that is worth 98 percent less than in 1913, when the Fed began its great experiment.
The relationship between gold and the US dollar is similar to that between bonds and interest rates. Bonds and interest rates move in reverse. The same goes for gold and the US dollar.
If you own bonds, then you know that if interest rates go up, the value of your bonds is going down. And conversely, if interest rates are decreasing, the value of your bonds increases. One does not ’cause’ the other. Either result is the real inverse of the other.
A stable or stronger US dollar means lower gold prices. A falling US dollar means higher gold prices.
In other words, higher gold prices are a direct reflection of the weakening of the US dollar.
And don’t confuse the US dollar with the US dollar index. The US dollar indices tell us nothing about the price of gold. A dollar index reflects changes in the exchange rate of the US dollar against other currencies.
Real changes in the value of the US dollar are reflected in the constantly increasing general level of prices of all goods and services, over time.
The threat of a world war is ominously present today. Countries and municipalities go bankrupt. And acts of terrorism happen almost daily. This is in addition to an economy that cannot seem to improve enough or maintain an acceptable growth rate.
So let’s buy gold, right? Maybe, maybe not. You see, gold doesn’t care about those things. It doesn’t matter if someone fires a rocket armed with a nuclear warhead or if the state of Illinois files for bankruptcy. And he doesn’t react to comments from Janet Yellen or Donald Trump. The demand for Indian jewelry is not on their radar. Nor does the construction of houses begin.
Gold responds to one thing. Changes in the US dollar. Nothing more.
A continuously weaker dollar over time means higher gold prices.
Periods of dollar strength are reflected in a fall in the price of gold.
Let’s talk for a moment about North Korea and the threat of war. It is a very scary situation. But even if things get worse, it won’t have an impact on gold prices. This is why:
In the late 1990s, there was much speculation about the potential effects on gold of the impending Gulf War. There were some sudden spikes in price and anxiety increased as the target date for the “action” approached. Almost simultaneously with the start of the bombardment by US forces, gold retreated sharply, giving up its previously accumulated price gains and actually moving lower.
Most observers describe this turnaround as surprising. They attribute it to the swift and decisive action of our forces and the results obtained. That is a convenient but not necessarily accurate explanation.
What mattered most for gold was the impact of the war on the value of the US dollar. Even a prolonged participation would not necessarily have undermined the relative strength of the US dollar.
All of which brings us back to a better and simpler explanation:
When it comes to gold, it is the US dollar.