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This post is a slightly-modified excerpt from a recent TSI commentary.

The Federal Reserve has monetised a few trillion dollars of bonds over the past seven years without creating much in the way of what most people call “inflation” (a rise in the general price level). How could this happen?

One popular explanation is that the Fed’s Quantitative Easing (QE) adds to bank reserves, but not the economy-wide money supply. According to this line of thinking, the ‘money’ created by the Fed to purchase bonds remains trapped in reserve accounts at the Fed. However, this explanation can be immediately eliminated, because as previously explained every dollar of QE adds one dollar to bank reserves at the Fed AND one dollar to demand deposits within the economy. The fact is that the economy-wide money supply is now a few trillion dollars larger thanks to the Fed’s QE.

A second explanation is that QE isn’t “inflationary” because it involves the exchange of one cash-like instrument for another. This explanation can also be immediately eliminated due to the fact that it mistakenly conflates two very different things — money and debt securities. If you don’t understand the difference, try buying something with a T-Bill. You should then understand. Also, more information on this particular issue can be found in my 9th May post at the TSI Blog.

As an aside, QE is not only NOT an exchange of one cash-like instrument for another, it involves increasing the amount of cash in the financial system and simultaneously decreasing the amount of financial assets that can be bought with cash. That is, it results in more cash ‘chasing’ fewer assets.

A third explanation is that the increase in the money supply stemming from the Fed’s QE has been offset, in terms of effect on the general price level, by a decrease in the velocity of money. This is yet another explanation that can be eliminated, because changes in “money velocity” never explain anything. The reason is that money velocity (V) is nothing more than a fudge factor that makes one side of the tautological and practically-useless equation of exchange (MV = PQ) equal to the other side. It exists in academia, but not in the real world. For more information on the irrelevance of money velocity, refer to my 10th June post at the TSI Blog.

Having eliminated three of the fatally-flawed explanations for why the Fed’s gargantuan QE hasn’t yet led to problematical “price inflation”, I’ll now provide two explanations that make some sense.

First, for decades prior to 2008 almost all of the US economy’s new money was created by commercial banks (commercial banks can loan new money into existence and they can also monetise securities). As a result, the first receivers of the new money tended to be within the ‘general public’ (home buyers/sellers, private businesses, etc.). However, since August-2008 almost two-thirds of all new money has been directly created by the Fed. This means that the first receivers of most of the new money were bond speculators, and that the second, third, fourth and fifth receivers of the new money were probably bond speculators or stock speculators. In other words, rather than being trapped in reserve accounts at the Fed as some people have mistakenly asserted, it is likely that a lot of the new money has effectively been trapped within the financial markets. It will eventually leak out into the ‘real’ economy, but due to the way the money was created/injected there has been a much longer-than-usual delay between the money creation and the inevitable effects on everyday prices.

Second, it’s important to understand that even if it were possible to come up with a single number that reliably reflected the actual change in the economy-wide purchasing-power (PP) of money, this number would not tell us the “inflationary” effect of a change in the money supply. The reason is that to know the effect on money PP of a change in the money supply you have to know what would have happened to PP in the absence of the money-supply change.

For example, let’s assume for the sake of argument that there is a consumer price index (CPI) that reliably indicates the change in the general price level. In our hypothetical example, the CPI would have fallen by 10% over a certain period, but due to money-pumping by the central bank the CPI increases by 2%. In this case the “inflationary” effect of the central bank’s money-pumping is not a 2% increase in the CPI, it is a 12% increase in the CPI (the difference between what happened and what would have happened).

Taking into account the high private-sector debt levels that existed in 2008 and have persisted to this day, it is not hard to imagine that in the absence of the Fed’s money creation there would have been a sizable decline in the CPI rather than a moderate increase. The “inflation” caused by the Fed’s QE is the difference between the decline in the general price level that would have happened and the rise in the general price level that did happen.

In conclusion, there are two main contributors to the lacklustre performance of the “general price level” over the past few years. First, unlike in earlier cycles a lot of the money created during the current cycle was injected directly into the financial markets. Second, it’s likely that there would have been significant “price deflation” in the absence of the money-pumping.

One of the interesting aspects of the financial newsletter business is that an incorrect prediction of a market crash will probably drum-up a lot more new business than a correct prediction that there won’t be a crash. Hence, the never-ending popularity of crash-forecasting, despite the fact that such forecasts almost never pan out.

From the perspective of a newsletter writer or any other commentator on the financial markets, the best thing about forecasting a crash is the massively asymmetric reward-risk associated with it. If the market doesn’t crash this year, when it was supposed to according to your original forecast, then you can just say that the event has been delayed and will happen next year instead. You don’t have much to lose because people will soon forget the failed prediction and focus on the next prediction. And if it doesn’t happen next year, then just repeat the process because eventually the market will crash and your amazing prescience will be there for all to see. Furthermore, after you correctly predict a crash there will be thousands of people eager to find out your next big prediction and buy your newsletter/book. In other words, from the forecaster’s perspective the downside of making an incorrect crash forecast is trivial compared to the upside of making a correct crash forecast.

The point is that regardless of how many times you forecast a crash that never happens, you will only have to get lucky once and you will be set for life. From then on you can promote yourself, and be introduced in interviews, as the person who predicted the great crash of XXXX (insert year). From then on a large herd of ‘investors’ will hang on your every word and rush to buy your advice whenever your next big forecast hits the wires.

Having seen how the process works, I’m officially entering the crash forecasting business. My inaugural forecast is for the US stock market to crash during September-October of 2016.

My forecast isn’t a completely random guess, for four reasons. First, stock-market crashes have a habit of occurring in September-October. Second, the two most likely times for the stock market to crash are during the two months following a bull market peak and in the year after a bull market peak (that is, roughly a year into a new bear market). The 1929 and 1987 crashes are examples of the former, while the 1974 and 2008 crashes are examples of the latter. The current situation is that either 1) a bear market began a few months ago, in which case the opportunity to crash during the two months following the bull market peak was missed and the next opportunity will arrive during the second half of 2016, or 2) the bull market is intact, in which case a major peak is likely during the second half of next year. Third, market valuation is high enough to support an unusually-large price decline. Fourth, interest rates are likely to have an upward bias over the next 12 months.

A few months from now a lot of commentators on the financial markets will be forecasting a crash for September-October 2016. If/when the crash happens, remember that you read about it here first and be ready to pay a much higher price (higher than zero, that is) for my next big prediction.

Just once I’d like to read a negative critique of “Austrian” economics from someone who actually understands it, but up until now every piece of criticism I’ve come across has contained basic misunderstandings of what this school of economics is about. The latest example is a 6th November blog post by Martin Armstrong.

According to the beliefs expressed by Mr. Armstrong in the above-linked blog post, Austrian Economics informs us that “fiat” money causes the business cycle and that the business cycle began with the Industrial Revolution. Both of these beliefs are completely wrong. Austrian Economics does not say that the business cycle is caused by fiat money and it does not say that the business cycle began with the Industrial Revolution.

Austrian Economics informs us that the business cycle is caused by large increases in the supply of money that create the impression that there are more real savings in the economy than is actually the case. Over the past few centuries the dominant cause of these large money-supply increases in the most developed economies was “fractional reserve banking”, a practice that effectively began with goldsmiths issuing more receipts for gold than they had actual gold in their vaults. However, “Austrian Business Cycle Theory” does not revolve around the specific method via which the monetary inflation occurs. A king debasing the coinage or issuing large quantities of paper money could potentially have a similar effect to goldsmiths issuing unbacked receipts for gold or an economy being flooded with gold — in the days when gold was money — due to successful foreign conquest (e.g. Spain and the Conquistadors in the 1500s) or commercial banks lending new money into existence or modern central banks implementing QE.

As to the other of Mr. Armstrong’s aforementioned beliefs, anyone who has gone to the trouble of researching Austrian Economics would know that “Austrian” economists have analysed the monetary and economic developments that occurred throughout history. As a good economic theory should, Austrian Economics works in all circumstances. It works regardless of whether we are dealing with a large modern city, a small village, a man alone on an island, a free economy, a command economy, an economy that uses paper money, an economy that uses tangible money, a robust economy, an economy immersed in depression, and so on.

Towards the end of his post Mr. Armstrong makes two assertions that aren’t specifically related to Austrian Economics, but warrant clarification.

First, he writes:

“…tangible money must have a “use” other than money. Gold and silver were prized objects but had no utilitarian “use” value outside of jewelry. Gold was desirable but was not a vital commodity that served a purpose beyond its prized status like art. Therefore, numerous monetary systems have existed that were not gold based since the medium of exchange had to have a “use” value other than as money.”

The fact is that many things have been used as money throughout the ages, but the more advanced economies ended up gravitating towards gold and/or silver. One reason is that for an item to become money in a large and mostly-free economy it must have a use other than money, but the non-monetary demand for the item will ideally be very small — to the point of being trivial — relative to the monetary demand. Otherwise, changes in non-monetary demand could cause large and unpredictable swings in the purchasing-power of money. That’s why if markets were free to choose they would almost certainly not choose platinum as money, even though platinum has similar physical attributes to gold.

Second, he writes:

“Money is not a store of value; it is a medium of exchange. In that case, it is merely an agreed upon medium to supplant barter.”

This is mostly correct. However, if an item isn’t widely perceived to be a good store of value then in a free market it won’t generally be accepted as a medium of exchange and therefore won’t be money.

There are two general reasons for a trader with an intermediate-term or a long-term time horizon to sell a stock during a period of strength. The first encompasses the situations where the stock has reached the trader’s price target, or has become stretched to the upside in valuation terms, or has reached a price level at which the intermediate-term risk/reward is no longer favourable. When a stock is in such a position it offers what I call an “objective selling opportunity”. The second general reason is that even though a stock is not yet fully valued and is still well below the trader’s intermediate-term target, selling makes sense based on personal money-management considerations. I call this a “subjective selling opportunity”.

Many of the stocks I own and also many of the stocks I cover in the TSI newsletter are in the gold-mining sector. For these stocks, objective selling opportunities have been as scarce as hen’s teeth over the past 2.5 years. However, over this period there have, from my perspective, been many subjective selling opportunities. Most recently, the September-October rally created several such selling opportunities.

I can’t identify subjective selling opportunities for my readers as these opportunities are, by definition, determined by each individual’s financial position. However, what I can do is note when TSI stocks are becoming ‘overbought’ or nearing resistance that could limit the short-term upside. I can also (and do also) note when I’m taking some of my own money off the table.

Due to the nature of modern money, it would technically be possible to adjust the way the monetary system works such that governments directly print all the money they need. If this change were made then there would be no requirement for the government to ever again borrow money or collect taxes. This would have an obvious benefit, because it would result in the dismantling of the massive government apparatus that has evolved to not only collect taxes but to monitor almost all financial transactions in an effort to ensure that tax collection is maximised. In other words, it would potentially result in greater freedom without the need to cut back on the ‘nanny-state services’ that so many people have come to rely on. So, why isn’t such a change under serious consideration?

The answer is that it would expose the true nature of modern money for all to see, leading to a collapse in demand for the official money. Taxation, you see, isn’t just a method of forcibly diverting wealth to the government; it is also an indispensable way in which demand for the official money is maintained and modulated.

Think of it this way: If the government were to announce that in the future there would be no taxation and that it would simply print all the money it needed, there might initially be a great celebration; however, it probably wouldn’t take long for the average person to wonder why he/she should work hard to earn something that the government can create in unlimited amounts at no cost. People would become increasingly eager to exchange money for tangible items, causing prices to rise. The faster that prices rose due to the general decline in the desire to hold money, the faster the government would have to print new money to pay its expenses. With no taxation and no government borrowing, there would be no way for the government to stop an inflationary spiral once it was set in motion.

One of the best historical examples of how taxation creates demand for money is the use of “tally sticks” in England from the 1100s through to the 1600s. In this case, essentially worthless pieces of wood were converted into valuable money by the fact that these pieces of wood could be used to pay taxes. Moreover, once taxation had created demand for the sticks, the government was able to fund itself by issuing additional sticks. A summary of the tally stick story can be read HERE.

Money can currently be created out of nothing by commercial banks and central banks, but hardly anyone understands the process. Also, many economists and so-called experts on monetary matters who understand how commercial banks create money are either clueless about the mechanics of central-bank quantitative easing (they wrongly believe that QE adds to bank reserves but doesn’t add to the economy-wide supply of money) or labouring under the false belief that money and debt are the same. The ones who wrongly conflate money and debt tend to wrongly perceive QE as a non-inflationary swap of one “cash-like” asset for another.

The point is that under the current system there is great confusion, even in the minds of people who should know better, regarding how the monetary system works. The combination of taxation and the general lack of knowledge about how money comes into existence helps support the demand for money.

Simplify the process by having the government directly print all the money it needs and the demand for money would collapse. That, in essence, is why taxation must continue.

In a recent article Mike Shedlock (Mish) weighs in on the question of whether or not gold is money. Near the end of the article he concludes: “The only possible debate about whether or not gold is money pertains to the phrase “demanded mainly as a medium of exchange”.” That’s totally correct, which is why it is not correct to say that gold is money. However, earlier in the same article Mish seems to argue that gold has again become money thanks to the advent of BitGold. As discussed below, this makes no sense.

There are two major problems with the argument that the advent of BitGold means that gold is now (once again) money. The first and more important is that the BitGold system comprises only a miniscule fraction of the total gold supply, so in no way does it result in gold being “demanded mainly as a medium of exchange”.

The second problem is that the BitGold debit card does not involve using gold as money. When someone uses such a card to buy something, the merchant doesn’t receive gold in exchange for goods/services. What happens is that some of the gold in the cardholder’s account is sold to obtain “money”, which is then transferred to the merchant. In this respect, paying for something using a BitGold debit card is similar to paying for something by writing a cheque on a Money-Market Fund (MMF). When you pay using a MMF cheque (check, if you are American), the receiver of the cheque doesn’t end up with MMF units. What happens is that the MMF sells some of its assets to obtain the “money” needed to complete the transaction. That’s why MMFs should not be counted in the money supply. They are investments in securities, not money.

Moving on, it’s important to understand that money isn’t just ‘a’ medium of exchange. At any given time in any economy, many things will be occasionally used as media of exchange, that is, as currencies. Take Frequent Flyer Miles as an example. Frequent Flyer Miles are sometimes used as a medium of exchange. In fact, in most developed economies they are used more commonly than gold as a medium of exchange. However, nobody is seriously claiming that Frequent Flyer Miles are money. Cigarettes are another example. Cigarettes are used as mediums of exchange in some prisons, but cigarettes obviously aren’t economy-wide “money” and nobody (as far as we know) is seriously claiming otherwise. Clearly, then, sometimes being used as ‘a’ medium of exchange is not the same as being money.

Money is not simply A medium of exchange (a currency), it is THE medium of exchange used in the vast majority of economic transactions (a very commonly-used currency throughout the economy).

The final word goes to Ludwig von Mises, the greatest economist of the 20th Century. It was Mises who, from beyond the grave via his writings, convinced me many years ago that gold is no longer money*. Here is Mises from his book “The Theory of Money and Credit“:

“The balancing of production and consumption takes place in the market, where the different producers meet to exchange goods and services by bargaining together. The function of money is to facilitate the business of the market by acting as a common medium of exchange.”

And for those people who harp on about “store of value” as if it were the dominant characteristic of money:

“The simple statement, that money is a commodity whose economic function is to facilitate the interchange of goods and services, does not satisfy those writers who are interested rather in the accumulation of material than in the increase of knowledge. Many investigators imagine that insufficient attention is devoted to the remarkable part played by money in economic life if it is merely credited with the function of being a medium of exchange; they do not think that due regard has been paid to the significance of money until they have enumerated half a dozen further ‘functions’ — as if, in an economic order founded on the exchange of goods, there could be a more important function than that of the common medium of exchange.”

And here is Mises from his book “Human Action“:

“The theory of money was and is always the theory of indirect exchange and of the medium of exchange.”

A recent Bloomberg article notes that household leverage in Australia is now almost twice the developed-market average. Specifically, the article states that Australia’s household debt as a proportion of gross domestic product has risen to a record 134 percent, the highest among 36 developed- and emerging-market nations analysed by Barclays. This compares to a developed-market average of about 74 percent.

The article contains the following chart, which suggests that the easy-money policy of the country’s central bank is driving the housing-finance binge.

This is not going to end well.

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.

Early last year I gave banking behemoth Goldman Sachs (GS) credit for looking in the right direction for clues regarding gold’s likely performance, which is something that most gold bulls were not doing. In November I again gave them credit, because, even though I doubted that the US$ gold price would get close to GS’s $1050/oz price target for 2014, their overall analysis had been more right than wrong. It was clear that up to that point the US economy had performed better than I had expected and roughly in line with the GS forecast, which was the main reason that gold had remained under pressure; albeit, not as much pressure as GS had anticipated.

But this year it was a different story. Here’s what I wrote in a TSI commentary in January-2015:

“This year, GS’s gold market analysis begins on the right track by stating that stronger US growth should support higher real US interest rates, which would be bearish for gold. Although we expect that the US economy will ‘tread water’ at best and that real US interest rates will be flat-to-lower over the course of this year, GS’s logic is correct. What we mean is that IF the US economy strengthens and IF real US interest rates trend upward in response, there will be irresistible downward pressure on the US$ gold price.

However, the analysis then goes off the rails. After mentioning something that matters (the real interest rate), the authors of the GS gold-market analysis then try to support their bearish case by listing factors that are either irrelevant or wrong. It actually seems as if they’ve taken the worst arguments routinely put forward by gold bulls and tried to use the same hopelessly flawed logic to support a bearish forecast.

For example, they argue that the demand for gold will fall because “inflation” levels are declining along with oil prices. They are therefore unaware, it seems, that “price inflation” has never been an important driver of the gold market and that the latest two multi-year gold rallies began with both “inflation” and inflation expectations low and in declining trends. They also appear to be unaware that the large decline in the oil price is very bullish for the gold-mining industry.

Their analysis then gets even worse, as they imply that the price weakness of the preceding three years is a reason to expect future weakness, whereas the opposite is closer to the truth. They go on to cite outflows from exchange-traded funds (ETFs) and reduced investment in gold coins as bearish influences, apparently unaware that the volume of gold coins traded in a year is always too small to have a noticeable effect on the price and that the change in ETF inventory is a follower, not a driver, of the gold price.

Finally, just when it seems as if their analysis can’t possibly go further off track, it does by asserting that lower jewellery demand and a greater amount of producer hedging will add to the downward pressure on the gold price. The facts are that jewellery demand has always been irrelevant to gold’s price trend and that gold producers are part of the ‘dumb money’ (meaning: they tend to add hedges at low prices and remove hedges at high prices, that is, they tend to do the opposite of what they should be doing based on gold’s intermediate-term risk/reward).”

I concluded by stating that in 2014 the GS analysts were close to being right for roughly the right reasons, but that in 2015 they could not possibly be right for the right reasons. They would either be right for the wrong reasons, or they would be wrong.

At this stage it looks like they are going to be wrong about 2015, but not dramatically so. My guess is that gold will end this year in the $1100-$1200 range, thus not meeting the expectations of GS and other high-profile bears and at the same time not meeting the expectations of the bulls. However, GS is on record as predicting a US$1000/oz or lower gold price for the end of next year. I think that this forecast will miss by a wide margin, but I’m not going to make a specific price forecast for end-2016. Anyone who thinks they can come up with a high-probability forecast of where gold will be trading 15 months from now is kidding themselves.