Gold Facts and Fundamentals
After the gold price reached a high of $850 oz. in 1980, its price began a long decline that lasted over twenty years. But the decline was not just characterized by its lower price, which eventually bottomed around $250 oz.
More noteworthy was the lack of interest in the yellow metal, which continued for almost twenty-five years. This disinterest was accompanied by a dearth of available and pertinent commentary and news. Gold was simply not a subject of discussion for mainstream media. Journalists and analysts had plenty else to talk about with new all-time highs in the stock market, technology craze and collapse, terrorism attacks, real estate prices, etc.
Over the years that has changed. Gold’s price hit a new all-time high of just under $1900 oz. in August 2011. Then, quite painfully, it dropped to as low as $1040 oz. in Jan 2016. After peaking last August at $2060 oz., the gold price has fallen back to as low as $1675 oz. and is currently about $1770 oz.
This time around, though, there is no lack of interest in or shortage of commentary about gold. A plethora of experts have unleashed a barrage of information to help investors and others grow their knowledge about gold.
No doubt, this has been spurred on and enhanced by this century’s growth in digital communication. Investors in all markets have benefitted.
There are other factors, though. As the price of gold increased and the reality of severe cracks in the financial system became more apparent, there was a treasure trove of new information on the subject of gold. Also, extreme volatility in the stock market has investors looking for alternatives.
Unfortunately, there is a goodly amount of misinformation about gold available and some clarification is in order.
The following three facts are critical to a fundamental and accurate understanding of gold:
- Gold is real money.
- Paper currencies are substitutes are for real money.
- Inflation is caused by the government.
GOLD IS REAL MONEY
Money has three specific characteristics: medium of exchange, measure of value, store of value.
A medium of exchange needs to be portable, which gold certainly is. And gold is and has been easily incorporated into recognizable forms and amounts for use within various standards of weight and measure. But what sets gold apart from every other item that has been used as money is its evidence as a store of value.
Nowhere is this more apparent than in a simple comparison between gold and the US dollar.
The Federal Reserve Bank of the United States was established in 1913. At that time the US dollar was fully convertible into gold at a rate of twenty ($20.67) dollars per ounce. You could exchange paper currency of twenty US dollars for one ounce (.9675) of gold in coin form. The coins were minted by the US government.
The key issue here is convertibility. Twenty US paper dollars was equal to and exchangeable for twenty dollars in gold.
During the past one hundred years, the United States government has suspended convertibility; banned the ownership of gold by US citizens; and then reinstated that legal right several decades later. Meanwhile, the US dollar – without any official backing by gold – has lost ninety-nine percent of its purchasing power. It takes one hundred dollars to buy today what one dollar would buy a hundred years ago. Whereas one ounce of gold will still buy today what it would comparably buy a hundred years ago.
PAPER CURRENCIES ARE SUBSTITUTES FOR REAL MONEY
The first gold coins appeared around 560 B.C. Over time it became a practice to store larger amounts of gold in warehouses. Paper receipts were issued certifying that the gold was on deposit. These receipts were negotiable instruments of trade and commerce which could be signed over to others. They were not actual currency but are a presumed forerunner to our modern checking system. (see History Of Gold As Money)
Gold is real – and original – money. Anything else is not.
INFLATION IS CAUSED BY GOVERNMENT
Inflation is the debasement of money by the government. The term government also includes central banks, especially the US Federal Reserve Bank.
Government causes inflation by expanding the supply of money and credit. That expansion of the money supply cheapens the value of all the money. Which is precisely why, over time, the US dollar continues to lose purchasing power. It takes more dollars today to purchase what could have been purchased ten years ago, twenty years ago, etc. And it has been going on for over one hundred years.
What most people refer to as inflation or its causes are neither. They are the effects of inflation. The increase in the general level of prices for goods and services is the result of the inflation that was already created.
GOLD IS NOT AN INVESTMENT
It is very important, too, to be clear about what gold is not. Gold is not an investment; nor, is it a hedge against inflation or deteriorating world conditions. It is also not insurance, or a barbarous relic.
When gold is analyzed as an investment, it gets compared to all kinds of other investments. Then technicians start looking for correlations. Some say that an ‘investment’ in gold is correlated inversely to stocks. But there have been periods of time when both stocks and gold went up or down simultaneously. (see Gold and stocks)
Quote: “Since gold doesn’t pay interest or dividends, it struggles to compete with other investments that do.”
The statement and any variation of it that implies a correlation between gold and interest rates is false. There is no correlation (inversely or otherwise) between gold and interest rates.
We know that if interest rates are rising, then bond prices are declining. So another way of saying that gold will suffer as interest rates rise is that as bond prices decline, so will gold. In other words, gold and bond prices are positively correlated; gold and interest rates are inversely correlated.
Yet, during the 1970s, the price of gold rose from $40 oz. to $850 oz. as interest rates on US Treasury bonds went from very modest levels to anywhere from 15-18 percent!
Why such apparent conflictions? Any explanation which emphasizes a correlation between gold and interest rates is unhelpful and incorrect.
It has become nearly universally accepted that gold will ‘benefit’ from the threat of war and conditions resulting therefrom. This was evident in the initial price action of gold as the controversy with North Korea reached the front pages several years ago. It is a very scary situation but it did not have any lasting impact on gold prices.
There is an initial ‘shock’ factor that seems to encourage traders to buy gold when an international event of consequence takes place. These could be terrorist actions, political elections, assassinations, even natural calamities; but the effect on the gold market is short-lived.
This is because any consequential and lasting impact on the price of gold is determined by what is happening to the US dollar, not the event itself.
The US dollar is the single, common denominator in all of the situations cited above.
The US dollar is a substitute for gold (i.e. real money). The price of gold is an inverse reflection of the changing value of the US dollar. The ongoing, never-ending deterioration of the dollar’s value means ever rising gold prices over time.
On the other hand, a stable or stronger dollar will be reflected in a gold price that remains stable or declines as the dollar strengthens temporarily. This is evidenced by the scenario we witnessed after gold’s price peak in August 2011 at close to $1900 oz and also during the twenty years following its price peak in January 1980.
Gold’s price is not an indication of its value. Its price is a reflection of the value of the US dollar. As the dollar continues to lose purchasing power, gold will continue to rise in price.
The case for gold is not about price. It is about value. Gold is real money and a store of value. The US dollar is a paper substitute for real money and a complete failure as a store of value.
Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED!