One of the challenges with investing in precious metals is that there is so much distortion in the market that figuring out a true fair value is not always the easiest thing to do. Yet there are clues investors can look at that indicate that when the price starts to move, it won’t be by a small amount.
Back in 2011 I was still working as an equity options trader on the New York Stock Exchange, and was about two years into my studies of the precious metals market. Following the collapse of the subprime housing bubble, I was stunned by how despite having a decade of experience on Wall Street and an MBA from Wharton, I hadn’t seen any of it coming.
However I found it interesting how many of the Austrian economists had seen the situation clear as day in advance, and as soon as I started to understand their perspective the underlying case for precious metals always made a lot of sense.
So in 2011 following Ben Bernanke’s second quantitative easing program, a widely publicized debt ceiling debacle, and the downgrade of the U.S. credit rating by Standard & Poors, it seemed like there was every reason to believe the dollar was on the ropes. Which as the years have gone by and put things in perspective, I personally believe was actually the case.
Yet that all changed in the early morning hours of September 6, 2011.
First, there was an announcement that the Swiss Franc, which at the time was being viewed as the last remaining safe haven currency, was being pegged to the euro. Seemingly clearing the path for gold and silver. Yet within the next couple of hours, rather than seeing gold move from the $1900 range to near or above $2000 per ounce, the price was hammered in the early morning hours in New York time.
Which always struck me as extremely odd.
Perhaps it was because after years of training as a trader, there was just so much about the situation that didn’t feel right. The fact that it seemed rather counter-intuitive to see gold drop at the exact same time one would have naturally expected it to rise.
Also odd was the manner in which the order was executed. Put in other words, if the owner of my trading firm found out that I placed a massive block sell order at the time when the liquidity was the thinnest, I likely would’ve been escorted out the door that same day. As many others have reported on since then, it just isn’t the way anyone looking for best price would execute the trade.
Fast-forward back to today, and the investing environment is much different. However the underlying fundamentals are not. The debt is significantly larger than ever. And while we have been told that the Fed’s balance sheet has not increased significantly since then, it’s become more evident that nobody really knows for sure how much money these guys are printing. And even according to the Fed’s own numbers, the amount of money in existence has in the very least not decreased since then.
So if the premise that the main force dictating the precious metals pricing is indeed the manipulation, as GATA, Ted Butler, and others have so thoroughly documented the evidence of, it would seem as if $1900 per ounce would be the floor. With the true value being somewhere north of that.
How far north?
Since so much of the data released by the government, the Fed, and other gold agencies comes with a degree of skepticism, no one really knows for sure. Yet I often find myself thinking back to the calculations Jim Rickards laid out in his book Currency Wars, that showed based on the M2 money supply and a 40% gold backing, the number would be over $12,000 per ounce. Use a 100% backing and the price is even greater.
Of course the M2 data is produced by the Fed, and one can only wonder how accurately that actually reflects the true money growth. After all, if the government has $21 trillion of undocumented adjustments, it at least raises serious debate as to how much money actually exists.
Even leaving aside how much money will be created going forward from today, I find it hard to see how the current $1300 price isn’t miles away from gold’s true value. Especially in the current environment where the largest U.S. creditors like China continue to give every indication that they’re simply walking away from the system while simultaneously loading up on gold.
Which perhaps might not leave you with a clear picture of exactly what gold is worth, but at least explains why so many in the precious metals community continue to advocate holding gold. Even despite the distortions in the market.
One could make the argument that if nothing changed in the world, but simply the free market was able to determine the gold price, that it would be well north of $1900 per ounce. Now factor in what is going on in the world, just how fragile the dollar-based economic system is at this point, and the likelihood of more quantitative easing, and owning a gold makes more sense than ever.
After rising together through 2012, the past five years have seen a massive divergence between the total amount of accumulated U.S. government debt and the price of COMEX gold. When, if ever, will we see this correlation reappear?
After falling together through the late 1990s, the price of COMEX god and the total accumulated U.S. debt began to rise together since 2002. With the help of Nick Laird at GoldChartsRUs, we’ve been able to plot this relationship on the chart below:
As you’ll recall, and as you can see in the chart above, massive U.S. military efforts and the economic collapse during The Great Financial Crisis led to a surge in the total US debt from $6T to $15T in the ten years between 2003-2012. And what happened to the price of COMEX gold over the same time period? It moved up from $400 to $1,800 per ounce.
However, a (not so) funny thing happened in late 2012. The price of COMEX gold began to consistently fall, this despite the over $1T QE3 program that The Fed ran from late 2012 to early 2014 AND a continuing surge in total U.S. debt from $15T to $20T.
Of course, we can debate WHY and HOW this occurred, but that’s a topic for another day. For now, let’s just take another good, long look at that chart of total debt and gold.
It could be said that, beginning with The Great Financial Crisis, gold got ahead of itself. Price had consistently risen with the accumulated debt through 2009 but, by 2011, it was considerably above the established trend. In the correction that followed and ended in 2015, you might note that price fell to roughly the same distance below the established trend. Perhaps this visual aid will help?
Simply put, it now appears that the price pendulum had swung just as far downward in 2015 as it had swung upward in 2011. Thus it could also be said that if gold was overvalued in 2011, it was equally undervalued in 2015.
So, now the question becomes: where does price go from here? In the months ahead, will price at least move back to the apparent median line of the accumulated U.S. debt? If so, that would imply something back around $1,800 or $1,900. Could it move to another bullish extreme, as in 2010-2011? Another financial crisis could cause such a run, and that would imply something closer to $2,500.
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