The Superbubble and the Wisdom in Owning Gold

Gold Prices Since '08--An 18-Month Stagnation Mirrors the 1983-2001 Era

Money Supply M1:  Obama Meant Change

Monetary Base--Can Be Expanded Tenfold  from Here

I have been subscribing to Przemyslaw Radomski's Sunshine Profits newsletter for four or five months. One of his Kitco articles is here.  He is a capable technical analyst who is predicting a gold-price turnaround. His short-term predictions may be correct, although there’s reason  not to be surprised if there are a few years of a hiatus in gold’s movement upward (the current hiatus has lasted 1.5 years, as the top chart indicates). Even if Radomski is right and gold rallies this year, there could be a several year stale period before another epic-scale rally occurs. That's not to say to sell gold because the Federal Reserve Bank and the federal government have led America to an unstable, casino economy.  Because the US monetary system is unstable, gold is a hedge.

If fundamental political and monetary patterns don’t change, then gold can see a much larger long-term upswing than the six-fold-or-so increase that has occurred over the past 10 years.   From 1981 to 2001 there were fundamental bullish reasons to buy gold, but the Reagan, Bush I, and early Clinton years' monetary expansion caused lower commodity prices. Gold’s price fell to a low of about $250. This occurred because Federal Reserve money printing increased competition among miners as well as manufacturers.  Mining competition increased supply just as the supply of consumer goods increased, resulting in intermediate-term price depression. Also, the Chinese absorbed American inflation by demanding dollars to buy treasury bonds.   

The Chinese policy continues, and now we see a new monetary expansion under Obama that dwarfs the Reagan-Clinton-Bush expansion (see the second and third charts above).  If the Chinese policy changes, or the initial depressing effect on commodity prices from the Obama monetary expansion ends quickly, a larger bull market can occur in gold in the intermediate term than occurred from 2001 to 2011.  

The 1980s and 1990s economy was something like the 1920s, with monetary expansion funneled into stock-and-real-estate bubbles rather than price inflation.  Because the prior, 30-year monetary expansion mutes the effects of the three QEs, and the Fed added the QEs to the 30-year expansion with no reallocation or liquidation of the (distorted) real economy, in the coming years we can expect larger bubbles or larger inflation than we’ve seen in the past.  Either may augur well for gold once a shakeout in the mining sector occurs.

Let’s say natural gas fracking and shale oil cause energy price declines. The result can be a more expansive economy.  Let’s say the Fed is reluctant to withdraw the bank credit and monetary base that it has created. (The money supply –M1—has gone from $800 billion in ’08 to over 2.4 trillion now, while the monetary base has gone from a little over $800 billion in ’08 to over $2.8 trillion now, as per the two above charts.)  In that case, the monetary base can be expanded so that the money supply is up to 10 times the monetary base. That will occur in an inflationary period. In other words, the $2.8 trillion in monetary base can become $28 trillion in money supply, leading to a more than tenfold increase in the supply of money.  

That’s not all because, first, the US federal debt is currently $16 trillion, $5 trillion of which is held by foreign holders. Let's say the US economy continues to stagnate. At some point there may be a panic in US debt.  If so, there will be sales of dollars in exchange for other currencies and assets, resulting in a large inflow of dollars into the US.  Also, according to this Fedral Reserve Bank report:  “Estimates by the Federal Reserve suggest that as much as 60 percent of the $760 billion in U.S. currency outstanding at the end of 2005, or roughly $450 billion, was held outside the United States.” In the event of a run on the dollar, large dollar holdings can be repatriated through demand for exchange at banks and purchases of US assets. The result will be a dollar collapse. 

Hence, holding gold along with  other non-dollar assets such as stock has a diversification rationale.  The Fed's hyper-expansion is having the same effect on the stock market that the 1983-2000 expansion had, but the economy is much worse off in terms of misallocation of resources.  In the past, monetary bubbles and their concomitant asset bubbles and inflation were followed by contractions, but that has not occurred;  Obama and Bernanke have invented the superbubble.

Investors are no better off than they were in 2003 and 2007, and the stock market is at similar levels.  Interest rates are near zero.  Although the Fed has caused valuations of future earnings to increase to nearly infinite levels, causing the stock market to escalate, stock market prices are constrained by the availability of money to invest.  Will banks continue to pump up the stock market in a kind of Ponzi scheme whereby the Fed prints money, uses it to buy treasury bonds, and the banks then use the printed money to pump up the stock  market?  Alternatively, can foreign investors carry the US stock market to ever higher levels?   It is not at all clear that the current stock market valuation is more than one more peak in a secular bear market that began in 2000.

Another problem with the stock market is that during periods of uncertainty, there can be sharp falls in valuations.  If, for example, there is a currency collapse, the stock market might fall because of the risk.  Hence, we see the wisdom in owning gold.