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Sorry, gold bugs, but the facts just don't add up
It seems a shame to trash the party just when it's finally becoming fun to be a gold bug.
Bullion is flirting with $1,000 (U.S.) an ounce and hoarding the metal is no longer just a pursuit for Eric Sprott and assorted conspiracy theorists with caches of canned food. Even the guy behind the bar at dinner the other night was long gold and happy to expound on why.
It's all about inflation they say, and gold as a store of value. Except for one thing: The facts don't back it. (Unless you're an American buying bullion because you're worried about the inexorable decline of your dollar. In that case, you should be worried.)
Almost every real measure of actual inflation pressure - as opposed to the inflation paranoia inherent in the gold price - shows little in the pipeline. One of the best long-term indicators of inflation expectations for the next decade, the price premium built into inflation-protected U.S. Treasury bonds, is indicating that prices will rise 1.75 per cent a year.
Yet the bullion pushers forge ahead. After 20 years of being wrong when gold was stuck around $350 an ounce through the 1980s and 1990s, they are nothing if not persistent.
The key to their argument is the man they call "Helicopter" Ben Bernanke, the head of the U.S. Federal Reserve, and all the cash he and his peers at central banks around the world are creating to revive growth in the world economy. At some point, that money will sluice out of the banks into the economy, inflation will be upon us like a tsunami, and gold will be treasured as a store of value.
The proof, as gold bugs see it, is in the price of gold. It rises when inflation is a risk, so inflation must be a risk. Get it?
The problem is one of simple math: Those helicopter-loads of cash, even if they were making it into the real economy, are not nearly big enough to fill the Sudbury-size crater in the global economy created by the crash in the world's housing and stock markets.
The Fed balance sheet, a focal point of inflation hawks, has expanded by about $1.3-trillion as Mr. Bernanke pumped cash into the lending system. Added to that, the Obama administration has come up with close to $1-trillion in stimulus, the biggest of a global group of packages totalling about $5-trillion.
However, the decline in assets is much bigger. The value of global stocks has fallen by more $17-trillion since the markets peaked in 2007 and U.S. housing is down more than $4-trillion since topping out in 2006.
On top of that, the financial institutions that are supposed to push that cash into the economy aren't doing it.
U.S. bank lending, by some estimates, is contracting at the fastest rate since the Depression. Bank credit in August in the U.S. shrank at an "epic" pace equal to 9 per cent a year, according to David Rosenberg, chief strategist at Gluskin Sheff.
The result is a real money supply that's actually shrinking at the same time as the jobless rate is at a cyclical high and factories are idle.
Not surprisingly, executives scoff at the idea of raising prices any time soon, with one telling The Globe and Mail not so long ago that it would be "very cavalier" to even try. That utter lack of pricing power is clearly reflected in Friday's numbers showing that underlying inflation is still slowing on both sides of the border.
To that, many gold bulls retort that central banks are going to miss the transition to hyperinflation when it comes, or be unwilling to fight it with higher interest rates because of political pressure from indebted governments.
That seems far-fetched. Central banks have become very good at keeping inflation anchored. In the 18 years since the Bank of Canada adopted the goal of keeping inflation centred between 1 and 3 per cent in Canada, consumer price increases have averaged a 2.1-per-cent pace. Not bad.
There will likely be plenty of warning before inflation takes hold, as capacity use creeps up and unemployment ebbs.
Those real facts go a long way to explaining why even though gold is at $1,000, inflation fears have yet to become mainstream, and discussion of exit strategies to pare back government stimulus programs before prices take off - talk that dominated the last big G20 meeting in April - has largely, and mercifully, fallen by the wayside.
Mercifully, because if the gold bulls and their view on inflation really held sway, the exit would already be on. Interest rates would already be rising and the world would be well on its way back into recession. The bugs should be careful what they wish for.
It seems a shame to trash the party just when it's finally becoming fun to be a gold bug.
Bullion is flirting with $1,000 (U.S.) an ounce and hoarding the metal is no longer just a pursuit for Eric Sprott and assorted conspiracy theorists with caches of canned food. Even the guy behind the bar at dinner the other night was long gold and happy to expound on why.
It's all about inflation they say, and gold as a store of value. Except for one thing: The facts don't back it. (Unless you're an American buying bullion because you're worried about the inexorable decline of your dollar. In that case, you should be worried.)
Almost every real measure of actual inflation pressure - as opposed to the inflation paranoia inherent in the gold price - shows little in the pipeline. One of the best long-term indicators of inflation expectations for the next decade, the price premium built into inflation-protected U.S. Treasury bonds, is indicating that prices will rise 1.75 per cent a year.
Yet the bullion pushers forge ahead. After 20 years of being wrong when gold was stuck around $350 an ounce through the 1980s and 1990s, they are nothing if not persistent.
The key to their argument is the man they call "Helicopter" Ben Bernanke, the head of the U.S. Federal Reserve, and all the cash he and his peers at central banks around the world are creating to revive growth in the world economy. At some point, that money will sluice out of the banks into the economy, inflation will be upon us like a tsunami, and gold will be treasured as a store of value.
The proof, as gold bugs see it, is in the price of gold. It rises when inflation is a risk, so inflation must be a risk. Get it?
The problem is one of simple math: Those helicopter-loads of cash, even if they were making it into the real economy, are not nearly big enough to fill the Sudbury-size crater in the global economy created by the crash in the world's housing and stock markets.
The Fed balance sheet, a focal point of inflation hawks, has expanded by about $1.3-trillion as Mr. Bernanke pumped cash into the lending system. Added to that, the Obama administration has come up with close to $1-trillion in stimulus, the biggest of a global group of packages totalling about $5-trillion.
However, the decline in assets is much bigger. The value of global stocks has fallen by more $17-trillion since the markets peaked in 2007 and U.S. housing is down more than $4-trillion since topping out in 2006.
On top of that, the financial institutions that are supposed to push that cash into the economy aren't doing it.
U.S. bank lending, by some estimates, is contracting at the fastest rate since the Depression. Bank credit in August in the U.S. shrank at an "epic" pace equal to 9 per cent a year, according to David Rosenberg, chief strategist at Gluskin Sheff.
The result is a real money supply that's actually shrinking at the same time as the jobless rate is at a cyclical high and factories are idle.
Not surprisingly, executives scoff at the idea of raising prices any time soon, with one telling The Globe and Mail not so long ago that it would be "very cavalier" to even try. That utter lack of pricing power is clearly reflected in Friday's numbers showing that underlying inflation is still slowing on both sides of the border.
To that, many gold bulls retort that central banks are going to miss the transition to hyperinflation when it comes, or be unwilling to fight it with higher interest rates because of political pressure from indebted governments.
That seems far-fetched. Central banks have become very good at keeping inflation anchored. In the 18 years since the Bank of Canada adopted the goal of keeping inflation centred between 1 and 3 per cent in Canada, consumer price increases have averaged a 2.1-per-cent pace. Not bad.
There will likely be plenty of warning before inflation takes hold, as capacity use creeps up and unemployment ebbs.
Those real facts go a long way to explaining why even though gold is at $1,000, inflation fears have yet to become mainstream, and discussion of exit strategies to pare back government stimulus programs before prices take off - talk that dominated the last big G20 meeting in April - has largely, and mercifully, fallen by the wayside.
Mercifully, because if the gold bulls and their view on inflation really held sway, the exit would already be on. Interest rates would already be rising and the world would be well on its way back into recession. The bugs should be careful what they wish for.
I always ask gold bugs what their exit strategy is and it always seems to be shades of that the world as we know it will end and gold will be the currency of our Mad Max universe.
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