Although it is not possible to determine an objective value for gold (the value of everything is subjective), by looking at how the metal has performed relative to other things throughout history it is possible to arrive at some reasonable conclusions as to whether gold is currently expensive, cheap, or ‘in the right ballpark’. In particular, gold’s market price can be measured relative to the prices of other commodities, the stock market, the price of an average house, the earnings of an average worker, and the real (purchasing-power-adjusted) money supply. In a recent TSI commentary I looked at the last of these, that is, I looked at gold’s price relative to the real money supply, and arrived at the conclusion that gold’s current price was about 20% above ‘fair value’. I’ll now take a look at gold relative to other commodities.

As illustrated below, over the past 20 years — with the exception of a short-lived spike in 2011 — major swings in the gold/silver ratio have bottomed at around 45 and peaked at around 80. The ratio is currently near the top of its 20-year range, which means that gold is expensive relative to silver.

As a consequence, to argue that there has been a successful long-term price suppression scheme in the gold market you must also argue that there has been a successful long-term price suppression scheme in the silver market. Such arguments have, of course, been put forward, with one analyst claiming that JP Morgan has managed to do the impossible by amassing a large long position in physical silver while simultaneously suppressing the price of silver by selling futures contracts.

The next chart shows that gold is also near a 20-year high relative to platinum, the implication being that gold is expensive relative to platinum.

Consequently, to argue that there has been a successful long-term price suppression scheme in the gold market you must also argue that there has been a successful long-term price suppression scheme in the platinum market. Again, such arguments have been put forward. For example, one analyst has suggested that the daily platinum ‘fix’ in the London market was used to manipulate the price downward over the long-term, even though there was an overall upward bias in the price over the period under analysis. For another example, an analyst has argued that the platinum price has been persistently reduced by the short-selling of platinum futures, an outcome that would only be plausible if every sale of a futures contract didn’t subsequently have to be closed-out via the purchase of a contract and if automotive companies had figured out a way to replace the physical platinum used in catalytic converters with paper contracts.

The final chart shows that gold is presently near an all-time high relative to the CRB Index (an index representing a basket of 17 commodities). This chart therefore shows that gold is expensive relative to commodities in general.

As far as I know, nobody has yet tried to argue that the prices of most commodities are being suppressed as part of a grand plan to conceal the long-term suppression of the gold price. Instead, gold’s expensiveness relative to commodities in general is studiously ignored.

To summarise the above: gold is currently expensive relative to many other commodities.

Almost regardless of what gold is measured against, it does not look cheap at this time. However, given what is happening to money and economies around the world, there is logic to the fact that gold is relatively expensive right now. Also, it is logical to expect that gold is going to get a lot more expensive within the next few years.

As I’ve explained in the past, gold is not now and has never been a play on “CPI inflation”. Of course, on a very long-term (multi-generational) basis the gold price will tend to rise by enough to offset the decline in the purchasing power of money, but so will the prices of many other assets. What makes gold special is that it is the premier long-term hedge against bad monetary and fiscal policies.

Gold isn’t cheap right now, but in a world that is rife with bad monetary and fiscal policies it is destined to become a lot more expensive.

Due to the confiscation of gold by the Roosevelt Administration in 1933, there remains an undercurrent of concern among gold owners that the US government or another major government will confiscate gold in the future. However, the risk of this happening is presently so low as to not be worth taking into account. Of far greater risk are capital controls and the confiscation of cash.

Gold confiscation is not a realistic threat under the current monetary system, because under the current system gold isn’t money. To further explain, the reason that gold was confiscated in the US in 1933 was that gold, at that time and place, was money, with the dollar essentially being a receipt for gold. Consequently, the amount of gold in the banking system placed a limitation on the quantity of dollars. By making gold ownership illegal the US government not only prevented the public from removing gold from the banking system, thus eliminating one of the superficial deflationary forces, it also pushed additional gold into the banking system and paved the way for greater monetary inflation.

Today, gold imposes no limitations on the abilities of the government and its agents to spend, borrow and inflate, so there is no reason for the government to confiscate it or even to care about it.

As an aside, in the 1930s the US government confiscated silver shortly after it confiscated gold, even though silver wasn’t official money at the time. However, the primary reason for the silver confiscation was the same as the reason for the gold confiscation — to pave the way for greater monetary inflation. As part of an effort to increase the money supply, the confiscated silver was put directly into the monetary base by turning it into legal tender in the form of coins or silver certificates. The 1934 silver nationalisation order actually brought silver back into the monetary system, where it remained until the early-1960s.

What the government wants to control is the official money, which in 1933 was gold and today is the dollar or some other fiat currency. The government is therefore focused on monitoring/controlling the flow of today’s currency units, which means that you are at far greater risk of having your cash confiscated or restricted in some way than having your gold confiscated.

Moreover, capital controls aren’t just a potential future problem, they exist in almost every country today. In almost every country there are already restrictions on a) the transfer of money across national borders, b) the transfer of money between different account-holders, and c) the amount of deposit currency that can be converted to physical cash. If these aren’t capital controls by another name, what are they?

Capital controls are likely to become more draconian over time. People with significant financial assets should therefore already be managing the capital-controls risk by diversifying their assets internationally*. Also, everyone (especially US citizens), including those who don’t yet have significant financial assets to protect, should have a second passport as a guard against future restrictions on freedom.

*If you are concerned about gold confiscation then you could also manage this risk by distributing your gold across vaults in different countries. This is easy to do via Bullionvault.com or the new BitGold service.

According to the fellow in the video shown below, the Chinese are invading Australia. It isn’t a military invasion, it’s an economic invasion that involves the buying-up of Australian real estate and has caused young Australian families to be priced out of the property market. The solution, apparently, is for the Australian federal government to stop turning a blind eye to this flood of foreign investment and, instead, to put a stop to it, thus resuscitating the “Australian dream”. Unfortunately, the star of the video is both ethically and economically wrong. He is ethically wrong because he is advocating the widespread violation of property rights (he wants the government to dictate who Australian property owners can sell to, with the particular aim of preventing the sale of property to buyers who live in China), but it’s the economic error I’m going to deal with in this post.

Our ‘the-government-oughta-do-something-to-stop-the-Chinese-real-estate-invasion’ protest organiser and You-Tuber is unaware of two important economic realities, the first and lesser important of which is that Australia runs a large current-account deficit. This deficit, which comprises dividend payments, interest payments on foreign debt and a surplus of imports over exports, is running at around A$40B per year. This means that about $40B per year is ‘flowing’ out of the country on the current account, which means that about $40B/year of new investment MUST flow into the country (since nobody has any use for Australian dollars outside Australia). In other words, the current account deficit necessitates $40B per year of net foreign investment, approximately a quarter of which goes into real estate.

The more important economic reality of which our irrepressible video presenter is unaware is Australia’s rapid rate of monetary inflation. Thanks to the activities of the Reserve Bank of Australia (RBA) and the commercial banks, the supply of Australian dollars has risen by 13% over the past 12 months and 44% over the past 4 years. With this rate of money-supply growth and low interest rates it is no wonder that houses have become very expensive. With this monetary backdrop, houses would almost certainly have become very expensive even if China didn’t exist. Furthermore, a rapid rate of monetary inflation tends to increase the current account deficit and weaken the currency on the foreign exchange market, thus putting more of the currency in the hands of foreign investors and simultaneously making domestic property prices look cheaper to foreign investors.

So, if the guy in above video had a better understanding of economics he’d be organising a protest outside the RBA headquarters instead of the Chinese consulate.

The title of this post refers to the debate between Jeff Clark and Harry Dent about gold’s prospects over the next 2 years, with Harry Dent arguing for a collapse in the gold price to less than $700/oz and Jeff Clark arguing in favour of a bullish outcome. I put inverted commas around the word great, because neither participant in this debate made a good argument. However, while the Clark side of the debate could have been a lot better, the Dent side was a stream of complete nonsense. In this post I’ll deal with a couple of the flaws in Dent’s analysis and also briefly address the extremely persistent deflation fantasy that lies at the core of Dent’s latest big prediction*.

An important point to understand is that gold is not now, and has never been, a play on “CPI inflation”. As I stated in an earlier post: “Gold is a play on the economic weakness caused by bad policy and on declining confidence in the banking establishment (led by the Fed in the US). That’s why cyclical gold bull markets are invariably born of banking/financial crisis and/or recession, and why a cyclical gold bull market is more likely to begin amidst rising deflation fear than rising inflation fear.” Jeff Clark barely touches on this key point, while Harry Dent believes that the point is invalidated by the fact that the gold price fell by 33% during part of the 2008 financial crisis.

Harry Dent keeps returning to gold’s performance during 2008 and provides no other historical examples of gold performing poorly in times of financial crisis. He therefore either has very little knowledge of gold’s historical record or he believes that hundreds of years of history were negated by what happened during 2008. Either way, he is misinformed, because gold outperformed the US$ over the course of 2008. The 33% decline is from the best level of the year to the worst level of the year, but even this sizeable peak-to-trough loss was fully eradicated by the first quarter of 2009. Moreover, if we consider the entire Global Financial Crisis (GFC), with the 10th October 2007 closing high for the S&P500 marking its beginning and the 10th March 2009 closing low for the S&P500 marking its end, we find that gold gained 24% in US$ terms and 34% in euro terms over the course of the crisis.

Information that must always be taken into account when assessing gold’s performance in reaction to events is the gold-price starting point. The reason that gold was initially hit hard in US$ terms during the general market crash of 2008-2009 is largely due to the US$ gold price being ‘overbought’ and at a multi-decade high just prior to the crash, which is obviously not the case today. Furthermore, as I mentioned above it quickly recouped its losses.

And information that must be taken into account when assessing the performances of all the financial markets during the GFC of 2007-2009 is that the Fed did not begin to pump-up the US money supply (properly measured via TMS) until September of 2008. From September of 2007 through to August of 2008 the Fed cut interest rates, but the monetary inflation rate remained at a low level. Since there is no longer any scope to cut interest rates, it’s a virtual certainty that the Fed’s initial response to a deflation scare in the not-too-distant future would involve ramping-up the money pumps.

In addition to presenting gold’s GFC performance in a misleading way, there are numerous problems with Dent’s argument. Due to time constraints I’m only going to deal with one of them. Here’s the relevant excerpt:

“The gold bug camp is constantly telling us that governments are debasing our currency, especially the almighty US dollar and destroying the value so that the dollar is not a good store of value. I 100% disagree.

Here’s an analogy to explain: Since its invention in 1971, the microchip has been multiplied by the trillions, creating a revolution in human communications. Its evolution is a crystal-clear sign of progress and of a higher standard of living. Translating that back to the dollar argument, if the exponential multiplication of the microchip was (is) a good thing, why would the multiplication of dollars not also be a sign of progress that similarly fosters a revolution in urbanization, more complex and rich specialization of skills, and an improved standard of living? Increasing urbanization leads to rising affluence and the need for greater dollars for transactions in a more complex urban society!”

This may be the stupidest economics-related comment I’ve ever read from a trained economist, which is saying something considering the competition. It implies that he doesn’t know the difference between a rise in the quantity of the medium of exchange and a rise in the quantity of real wealth. It implies that he sees no difference between the private sector increasing the supply of labour-saving or life-sustaining or life-enhancing products and central banks creating new money out of nothing. Also, he apparently perceives the factual decline in the US dollar’s purchasing power as a goldbug delusion.

Harry Dent should not be taken seriously, but the view that deflation is coming should not be dismissed out of hand. Also, it is possible to make a legitimate gold-bearish argument, it’s just that Harry Dent hasn’t done it.

Under the current monetary system and the theories that dominate central banking, true deflation — such as occurred in the US during 1930-1932 — has a near-zero probability of happening. In the future there could (almost certainly will) be changes to the monetary system and/or the political environment that pave the way for true deflation, but that’s not something that has a realistic chance of happening over the next two years. In the meantime, there will probably be another deflation scare.

While it’s in progress a deflation scare will look and feel like 1930s-style deflation to most people. The difference is that you don’t get the economic ‘reset’ that would be caused by true deflation. Instead, policy-makers react to the scare by 1) aggressively injecting new money into the economy, 2) ensuring that the total volume of credit continues to grow, and 3) generally doing whatever it takes to prop-up prices. In doing so they add new imbalances to the existing imbalances.

Deflation scares are very bullish for gold. That’s why the deflation scare of 2001-2002 set in motion a large multi-year advance in the gold price and why the deflation scare of 2007-2009 set in motion a large multi-year advance in the gold price. If another deflation scare gets underway this year then so, in all likelihood, will another large multi-year advance in the gold price.

Looking out over the coming 1-2 years, the risk for gold isn’t that there will be true deflation, because that’s a virtual impossibility under the current monetary set-up. Nor is the realistic possibility of a deflation scare a risk for gold, since such a development would create a very gold-bullish fundamental backdrop. Rather, the risk for gold is a continuation of the monetary-inflation-fueled boom of the past few years.

In effect, the main risk for gold is an economic outcome that is almost the OPPOSITE of what Harry Dent is predicting.

*Harry Dent’s modus operandi is to come out with a new ‘big prediction’ almost every year. This creates a media buzz that facilitates the sale of books. If a big prediction doesn’t pan out, no problem — just make another one. Eventually, one will hit the mark. In the early-1990s he got lucky and correctly predicted the ensuing boom (it was blind luck because his reasoning was wrong). If he gets lucky again, he’ll have a track record to shout from the hilltops.