It’s the money supply stupid, what some investors still don’t get about gold and silver
Posted on 08 October 2011 with 10 comments from readers
Having just read another article by an able job-smithing hack in The National newspaper purporting to explain the gold and silver market to readers my toes curled up at the lack of understanding about the most crucial factor that investors in these precious metals need to grasp.
It’s the money supply stupid! The focus is always on demand for gold jewelry or the industrial uses of silver. But really the rising price of gold and silvet is all about money and the devaluation of paper money against the one money that nobody has ever succeeded in manufacturing.
Rare metals
The alchemists of old tried very hard but they never succeeded. All the gold we have has been dug out of the ground by man over the past several thousand years, and we do still have most of it but not very much. All the gold in the world would fit into a cube less than the size of a tennis court.
Silver is actually more rare because it does get used up in many industrial processes, particularly these days in electronics and medicine. The estimate is that all the silver in the world is roughly one hundredth of the value of gold or in volume terms roughly half.
Scarcity does not of itself confirm value but it does when you are dealing with the only two monetary metals. Silver and gold have been used as money at least since the pharoahs built the pyramids. The US has its gold and silver reserves stashed in Fort Knox. Indian ladies are reckoned to have a similar amount in their personal possession as jewelery.
Central banks of the world include gold and silver in their reserves and have recently been net buyers of gold. It is the ultimate money with no third party risk.
Now let us consider what global central banks have been doing to the money supply, especially in the past decade. There has been an orgy of money creation.
Last week the Bank of England did it again with $110 billion more in quantitative easing. The upcoming eurozone bailout may well involve a fund that can create $2.7 trillion. And to bail the world out after the 2008 crisis the Federal Reserve created $16 trillion and that is an audited fact.
Increase the money supply and you automatically reduce the value of money. Does that make sense? Basically you have more paper and the same number of goods so they cost more in paper. That is textbook inflation, too much money pursuing too few goods.
Gold supply static
What happens to the supply of gold and silver at the same time? Well, apart from a bit of mining activity the supply is pretty static and nobody can change that. So you have more money pursuing the same amount of gold and silver and the price goes up.
Ah, but let us not forget that as money is created more and more investors seek protection against this devaluation of their savings. So actually you have more and more buyers for gold and silver, and that will push the price up way beyond the actual rate of inflation.
It is true this upward movement in price for precious metals is seldom a straight line. Sometimes the market enthusiasm overreaches itself and prices dip back, like silver in April or gold last month. Would a global asset sell-off like the one in late 2008 pull gold and silver prices down for a while? Yes but not for long as central banks will fear deflation and print even more money.
ArabianMoney has been saying this for over three years and has been right (click here). We also commented when silver fell below $10 in late 2008 and said it was a great buy when everybody else ran scared (click here).
Unless there is a signal that central banks are moving to seriously reduce the money supply then there is only one way for precious metal prices to move over the medium term and that is up and up. It’s the money supply stupid!
10 Comments posted by readers:
Is this the article?
http://www.thenational.ae/lifestyle/personal-finance/silver-is-as-good-as-or-better-than-gold
The description of the author as an “able job-smithing hack” is an oxymoron and invites a splash-back criticism!
It’s not a bad article although he does claim that the long-term gold-silver ratio is 40:1 instead of 16:1. The basic theme is to introduce to the lay public the notion of silver as in investment, for many of whom this will be a novel concept.
Of course this site has been pushing that theme for years, so kudos for that.
I read the same stupid article, I believe, in the Telegraph where gold bugs were derided for wanting things to be bad and to get worse. As if gold bugs have anything to do with central banks printing currency!
I don’t know whether it’s primarily due to an enlarging currency supply or shares crashing out and down with bonds reducing their yields everywhere to ridiculous levels for investment purposes, but there is a report today in the same newspaper saying that a pension pot now produces 30% less pension income than it did just three years ago.
Maybe what PriceWaterhouseCooper left out of the 30% reduction is that the reduced monthly pension cheque buys less goods than it did three years ago, because the currency has devalued in that time. And this is due to the increased currency supply!
Forgive me for mentioning a mechanism for running your own pension fund in gold and silver, but this does avoid the currency supply weakening the currency and the collapsing stock markets. It is run by GoldMoney (hence my apology!) with Standard Life in the UK.
Through the GoldMoney website, you open an account with Standard Life who receive your premiums each month and also apply for income tax which goes into your account with them. This money is then transferred to GoldMoney where you yourself can decide how much is invested in gold or in silver.
From 2000-2010, you could have watched your gold and silver pension increase by 450% and 500% respectively in comparison to shares increasing by 67% and bonds by by 94% over the same period of time. 2010-2020 is looking even better for bullion already.
You can pull all your pension pot out of bullion by simply transferring it back to your Standard Life account, from which you invest elsewhere if that is what you want.
So, there is no need to lose 30% of your pension in three years or, as the Depression comes over us, say, 50% in two years by investing in currency-based stuff, all of which is being ruined by the expanding currency supply.
There’s also the concept of money velocity that might mitigate the impact of the money supply. But I think we can safely disregard this notion as the current economics theory and the economy of the world that was built on top of it is an irredeemable and fragile hodge-podge.
all that paper sitting around like a coiled spring…….it does not dissappear.
sooner or later its inflation or stagflation, which we saw the beginning of last fall….
they will do this to get the price of the houses back up to what is loaned on them…..which was inflated by the same process they are going to solve it with.
According to an article by Nicole (Stoneleigh) Foss in the Automatic Earth 3rd Oct., it is not just the money supply that is important to the monetary price of commodities (including gold and silver) but the Debt/Credit supply (M3 plus total credit market debt). The nice clear chart from Elliot Wave International shows very clearly that it reversed in 2008. Then as we all know Uncle Ben stepped in and printed enough money to keep it stable. “Velocity” of money never turned up, however from its 2008 peak and has remained in a down trend, by most measures – hence no real recovery. This is not surprising since the extra money was designed to be used for the benefit of the banking system and not the real economy.
Yes the BOE and Europe are starting to print some extra dosh (for the banking system) but I personally doubt whether it is enough to match the austerity purge going on in Europe and the debt reduction going on throughout the world, let alone revive “Velocity”.
Of course, at the end of the day, it depend on which currency you price Gold and Silver in. Money printing – supply and demand – gold and silver should increase in value against the the Euro and Sterling but not against the US dollar unless Uncle Ben gets his cheque book out again – then that will only temporarily weaken the USD in terms of commodities unless the trend of “Velocity” of money is reversed.
Thoughts on the Ed.’s commentary:
1. Very straightforward
2. Easy to understand & comprehend
3. Compelling
It’s the ever-increasing paper money supply, stupid! Buy some real money with all that paper you are now holding in the bank!
Got physical gold?
Got physical silver?
Nice job Ed !!
Makes me want to rush out to buy some
We should also realize that all this mucking around with the “money” supply is a smokescreen for what’s really going on, which is the use of devalued fiat currency for purchasing real assets, such as natural resources, crucial infrastructure and possibly political control.
This nonsense the central banks and IMF call “austerity measures” is really a ploy to get at all of our savings and assets, both personal and national. Don’t kid yourselves.
A little food for thought,
Tulip
the amount of gold i have always heard, tho i have no idea how anyone really knows, is it would fit into an OLY sized swimming pool. thanks for the article.
@ Tulip:
Your remarks are “on target.”