“The modern mind dislikes gold because it blurts out unpleasant truths.”- Joseph Schumpeter
Since hitting a high of just over US$1,260 in June, the gold price has declined, recently trading around US$1,160. While the correction has occurred in stages over the past few weeks, the biggest impact was felt during US trading on 27 July, where the gold price fell US$25.
This rather hefty fall had the Ill-informed gold bears salivating, calling an end to the decade long bull market and apparently, the ‘gold bubble’. If last month’s high represented the gold market peak, it’s the most unassuming bubble I’ve ever seen. No hysteria, no scrambling for gold coins, gold stocks well of their highs…is this how bull market’s end? I don’t think so.
Gold is simply experiencing a correction. None of the fundamentals that have driven gold’s price higher over the years have changed. In fact they are getting stronger.
To understand gold and why it is likely to continue to rise, you must first understand that gold is money. It has been for thousands of years and will be for thousands more. Despite the best efforts of governments and central bankers to discredit gold (a practice that has become more prevalent since paper money has come into use) gold’s place in the international monetary system is as strong as ever.
Let’s look at a few (relatively) recent examples of gold v government.
1. The term ‘greenbacks’ first made an appearance in the American Civil War. Treasury Secretary Salmon P. Chase (Tim Geithner’s equivalent) printed up a whole bunch of them to finance the war effort. Not surprisingly, they immediately fell in value against gold.
Demonstrating the hubris of officialdom, Chase thought gold was the problem (rather than his trying to finance a war with paper) so he tried to outlaw the gold market. This caused havoc. He soon recanted and had to live with a depreciated currency.
2. In the depths of the Great Depression, the US dollar was tied to gold at $20.67 an ounce. Influenced by Keynes, US President Roosevelt thought the precious metal was holding the economy back. So he confiscated the public’s gold and soon after revalued it to US$35 an ounce. It was an attempt to create inflation amidst the falling price environment of the Depression. The policy has some success…paid for by the public who exchanged their real money for (soon to be depreciated) US dollars.
3. Following WWII, the Bretton Woods system of international finance came into existence. The US dollar was tied to gold at US$35 an ounce, with the other major currencies tied to the US dollar. This worked ok for a while but rising US deficits (to finance the Vietnam War) put upward pressure on the gold price, as US creditors swapped their excess dollars for gold.
A group of central banks tried to maintain the US dollar gold price at $35 an ounce through what was known as the London Gold Pool, but it broke down in 1968 when the French bailed out. (De Gaulle wasn’t a fan of the US’ spending habits).
From there, an artificial, two-tier market was established to control the price of gold and mask the debasement and mismanagement of paper money. Needless to say it didn’t work. US President Nixon abandoned gold in 1971 and throughout the decade, gold went from US$35 to $850 an ounce.
Since 1971 gold has played no ‘official’ role in the global economy, and total debt in most developed economies has exploded. In the absence of gold, there has been no balancing or stabilising influence in the international economy. This is why debt was allowed to get to the extraordinary high levels that eventually caused the credit crisis.
Unfortunately, that debt is still with us, and governments around the world are creating more of it to try and ‘fix’ the problem. This is the wrong course of action but if history is any guide, it will be pursued until the even the village idiot – whoever that is – notices.
In other words, the monetary mismanagement that the rising gold price has been signalling for years will likely continue for a few more yet. Betting that the gold bull market is over is akin to betting on the wisdom of governments. I’ve happily taken the other side of that bet and following the recent sell-off, have just advised my subscribers to buy up a number of attractively priced gold companies. Investors with a little patience should do very well.
for The Daily Reckoning Australia