As we enter ‘Fed day’ (the day on which the US monetary politburo is scheduled to provide a new set of clues on how it intends to manipulate the price of credit in the future), the gold-mining sector is poised for a breakout. Unfortunately, the HUI chart (see below) doesn’t clearly indicate the most likely direction of the breakout. This is normal. It’s always the case that price charts say a lot more about the past than the future.

Sentiment indicators and the HUI’s price chart suggest two different near-term outcomes. The first is that the HUI made a short-term top (a top that holds for at least a couple of months) 10 trading days ago and will confirm this top by breaking downward from its 2-week range in the aftermath of the Fed news. The second is that there will be an upside breakout in reaction to the Fed news followed by a quick move to a short-term top over the ensuing several days.

I think the second outcome is the more likely, but I’m not buying in anticipation. Instead, I will continue to do what I’ve been doing over the past 2.5 weeks, which is look for opportunities to raise cash.

In my two “Gold Is Not Money” posts (HERE  and HERE) I explained why it is not correct to think of gold as money these days, and in a subsequent post I explained why it was not correct to view gold as an economic constant (there is no such thing as an “economic constant”). It is clearly also not correct to think of gold as “just a commodity”, because if it were just a commodity then its price would have collapsed relative to the prices of other commodities due to the massive size of its aboveground supply relative to its annual usage in commercial/industrial applications. Instead, the price of gold is near an all-time high relative to the CRB Index. So, if gold isn’t money and it isn’t an economic constant and it isn’t just a commodity, then what is it?

Is gold a speculation? That’s a matter of opinion. Some of the commentators who claim that gold is money tell us that gold is not a speculation, but they are only expressing a personal view. For example, if I buy gold with the aim of selling it in a few months at a higher price, then gold is a speculation to me.

Is gold insurance? It can be, but many of the people who own gold do not hold it for insurance purposes. Gold is certainly not inherently a form of financial/monetary insurance, but it can be held for such a purpose. Furthermore, of the people who believe that gold can be used as financial/monetary insurance, one group thinks that it should be used for this purpose all the time while another group thinks that it should only be used for this purpose when the risk of monetary collapse is high. For example, I own gold and recognise its ability to be a form of insurance against financial catastrophe, but none of my gold is currently held for insurance purposes. In my opinion there isn’t a good reason to hold gold for insurance purposes right now, because there will always be warning signs well in advance of a monetary collapse and those signs are currently not present (at least with regard to the US$). That’s my opinion. Other people think differently.

Is gold a good store of purchasing power? It depends on the starting point and the time frame. Gold has lost a lot of purchasing power (PP) since its September-2011 peak and lost more than 90% of its PP from its January-1980 peak to its April-2001 trough. Furthermore, despite the huge gold rally of 2001-2011, someone who bought gold at its January-1980 peak (almost 36 years ago) and held to the present day is still down by more than 50% in PP terms. However, someone who accumulated a long-term gold position during 1998-2002 and held to the present day would still have a substantial gain in PP terms, despite the large decline of the past four years. In this respect gold is similar to investments in companies or real estate. Regardless of the quality of an investment, if the purchase price is high enough it will probably generate a large PP loss.

As an aside, the importance of timing will be obscured by extremely long-term studies. Of particular relevance, studies that assess gold’s performance over centuries will suggest PP stability and will mask the fact that if you bought near one of the speculative peaks you would have sustained a permanent loss.

Is gold a financial asset? The answer is yes. Moreover, it is considered to be one of the world’s most liquid financial assets, which is why some of the world’s most important clearing houses accept gold — along with other liquid financial assets such as T-Bills — as collateral. However, physical gold is not someone’s liability, which means that gold can’t suddenly become worthless as the result of a default. In this respect gold is a safer financial asset than a T-Bill or any other security.

In summary, gold is primarily a liquid financial asset that can be held for speculative, insurance, store-of-purchasing-power or collateral purposes.

It is always possible to find evidence to support any market opinion. If you want to find evidence to support a bearish view, you will be able to find it. If you want to find evidence to support a bullish view, you will be able to find it. If it’s evidence of an impending economic collapse or financial crisis you desire, if you look hard enough you will be able to find it. At the same time you will be able to find evidence that the financial/economic future is bright, if that’s what you really want.

For example, someone wanting to paint a bearish picture of the US economy and stock market could choose to single-out the performance of Wal-Mart (WMT).

Whereas someone wanting to paint a bullish picture of the US economy and stock market could choose to focus on General Electric (GE).

This year’s performances of WMT and GE largely reflect company-specific issues, but they can still be used to support opposing overall-market views.

The point is that there are always two sides to any market. Regardless of your current view, you can be sure that there are many people who are just as smart or smarter than you who have the opposite view. You should therefore always entertain the possibility that your current outlook is wrong and be wary of commentators who only present one side of the story.

Also, it is important to recognise and account for your own biases. One way to do this is to go out of your way to read the analyses of people whose views contradict your own. For example, if, like me, you tend to be too bearish on the US stock market, then you should spend at least as much time reading bullish stock-market commentary as you spend reading bearish stock-market commentary.

In general, there’s nothing to be gained by fixating on market analysis that confirms what you already think you know.

My two “Gold Is Not Money” articles (HERE and HERE) provoked numerous disagreeing responses, the majority of which were polite and well-meaning. Despite presenting various arguments, these responses had one thing in common: they did not offer a practical definition of money that gold currently meets. As I mentioned previously, a practical definition of money cannot avoid the primary economic role of money, which is to facilitate indirect exchange*. If something is not generally used to facilitate indirect exchange, then regardless of what other attributes it has it cannot be money; at least not in the way that money is commonly understood today and has been commonly understood through the ages. When people willingly perform logical contortions in an effort to show that something is money even though it doesn’t fulfill the primary role of money, all they are actually showing is the lengths to which they are prepared to go to ignore a reality that is not to their liking. Would gold perform the monetary role far better than the US$ and any of the other monies in common use in the developed world today? Yes. Would I rather that gold was money today? Yes. Is gold money today? Unfortunately, no. However, the main purpose of this post isn’t to rehash the reasons that gold can no longer be correctly viewed as money in any developed economy. It’s to consider the claim, which was made by more than a few of the respondents to my “Gold Is Not Money” posts, that gold is an economic constant.

Such a claim ignores good economic theory. Gold, like all of the elements, is a physical constant, but there is no such thing as an economic constant or yardstick. The reason is that value is always subjective. Every individual will have his/her own opinion on what gold is worth and these opinions will change based on circumstances.

Currently, most people in the Western world own no gold and have no intention of buying gold. This will change, but the reality is that gold is presently very low on the ‘utility scale’ of the average person. At the same time, there are plenty of people who place a high value on gold, which is why gold’s price is what it is.

The market price at any time reflects the collection of all the differing opinions about value, but the market price is constantly changing. The market price, therefore, does not measure value in the way that the mass of a physical quantity can be measured.

The claim that gold is an economic constant also ignores the historical record. For example, there has been a large decline in gold’s purchasing-power (PP) over the past 4 years. Prior to that, there was a huge gain in gold’s PP during 2001-2011, a huge decline in gold’s PP from January-1980 through to early-2001, and a spectacular rise in gold’s PP during 1971-1980. Over the same period the dollar’s PP has been vastly more stable, although certainly far from constant.

It could be argued that the large swings in gold’s PP over the past 45 years are due to changes in the perception of the official monetary system. This is true — the perceived value of gold as an investment or a speculation or a vehicle for saving has undergone large oscillations over the past 45 years due to changing perceptions of the US$ (money in the US). These oscillations are secondary evidence that gold is no longer money in the world’s largest economy, the primary evidence being that it isn’t generally used as a medium of exchange.

It should also be understood that gold was not an economic constant even when it was money. In general terms, even the best money imaginable would not be an economic constant, because even if its supply were kept constant its demand would be continually changing. Again, we stress that there is no such thing as an economic constant (an UNCHANGING quantity against which everything else can be measured).

When gold was money neither its supply nor its demand were ever constant over what most people would consider to be a normal investment timeframe or holding period, although it still performed admirably in the monetary role. It would have performed even better — and its reputation would not have been unfairly tarnished — if fractional-reserve banking had not been permitted. Fractional-reserve banking was to blame for the financial crises that occasionally erupted during the Gold Standard era.

Over extremely long periods the swings in gold’s PP have evened-out in the past, but something that starts at a certain level and can be relied on to return to that level at some unknown point in the distant future cannot be legitimately called a “constant”. Moreover, to be useful as money it isn’t necessary that something maintain relatively stable purchasing power over centuries; it is necessary that it maintain relatively stable purchasing-power from one year to the next.

Something won’t survive as money if it tends to experience wild swings in its purchasing-power over periods of a few years or less, but it can survive as money if its PP can be relied on to change by no more than a few percent in either direction from one year to the next. There is no need for money to have constant PP to remain useful as money, which is just as well because economic constancy is an impossible dream.

*Here’s what I mean by “indirect exchange”. In an economy without money a tomato farmer who wanted bread would have to find a baker who wanted tomatoes. A direct exchange of ‘wants’ could then take place. However, in an economy with money a tomato farmer who wanted bread could sell his tomatoes to anyone in exchange for money and then use the money to buy bread. This is an indirect exchange of ‘wants’, with money providing the link.