Gold prices. Past. Present. Future.
June 24, 2008
The media company The Motley Fool recently ran an interesting article titled Peru’s New Emperor of Gold.
This article dicsussed Peru’s commercial gold mining operations at Yanacocha, Latin America’s largest gold deposit. In a nutshell, profits are up even while production levels fell to only 1.54 million ounces in 2007. The short article is worth noting and reading if you have time but what I find far more interesting is a trend running through different Fool reports from 2005 to present. And for that matter, the real meat here is in trying to understand why shares in the Yarinacocha holding company rose by over 200% in the last year even amidst labor disputes and deceased production.
To understand why gold jumped from a few hundred an once to now hovering around $1000 an ounce is to begin to dissect the economy at large. This theme — told in the context of gold — has been the staple of a long standing hypothetical Fool debate: Would you rather own shares of Google or Gold?
I am going to present snippets but please try to look at these articles in their entirety. And try to look at all economic news in terms of the roles of inflation (real money purchasing power) and speculation. Gold prices have been driven up precisely for these 2 reasons and these are the same reasons that most analysts predict a continued rise in gold prices.
Google or Gold?
The case for gold can be made on a historical basis. Here was a metal that had its price fixed at $20.65 an ounce through most of the 1800s. It was not until the latter half of the 20th century that trading in gold became a speculative art. Even though gold is trading for less than it fetched when it peaked in 1980, an ounce of gold acquired 34 years ago has appreciated tenfold today.
Stocks vs. Gold: 1968-1981
| Gold | Stocks | |
|---|---|---|
| Real Return 1968-1981 | 8.8% | (0.4%) |
| Value of Portfolio 1968 | $10,000 | $10,000 |
| Value of Portfolio 1981* | $34,400 | $9,416 |
* Value in 1981 reflects real returns adjusted for inflation in 1966 dollars.
Better than a dollar
Today, we find the dollar losing its value relative to foreign currencies, oil prices and other commodities near record highs, our country loaded with debt, and a housing bubble that’s deflating every day. What does this have to do with gold?
First, the falling dollar and high commodity prices are linked. Most commodities trade in dollars, and as the dollar falls, commodity prices increase. In 2002, gold was trading at around $300 an ounce, and the dollar/Euro exchange rate hit a low of $0.95/Euro. Today, the exchange rate is $1.30/Euro. If the price of gold had remained constant in Euro, it would now be $411 an ounce–accounting for roughly one-third of gold’s recent price increase. For the past five years, at least, gold has been far better than the dollar.
Furthermore, with our massive debt and vast trade imbalance denominated in dollars, there are huge incentives for the metaphorical printing presses at the Federal Reserve to run full-time. Furthermore, with the housing market in a tumble, the Fed will have a tough time tightening credit. Beyond current conditions, the presses at the Fed rarely stop. Over the past 50 years, the money supply has steadily increased, constantly draining the dollar’s purchasing power.
Money Supply 1959-2006
| M1 Money Supply | M2 Money Supply | |
|---|---|---|
| 1959 | $139.9 | $286.6 |
| 2006 | $1366 | $7021 |
| Annualized % Increase | 5% | 7 |
Source: U.S. Federal Reserve.
Gold keeps its value over time. One of the reasons we invest is to prevent inflation from devaluing our money, and gold serves that purpose well. A thousand ounces of gold would have purchased a house in California in 1970. It will purchase a similar house today. And I’ll bet that same thousand ounces will buy a house in 10 years.
Furthermore, gold as an inflation hedge is more important now than at any other time in the past 20 years. The dollar has lost 30% of its value compared with the other major foreign currencies during the past three years. Because gold, oil, and other commodities are traded in dollars, a less-valuable dollar has been responsible for a large amount of recent commodity price increases. Rising prices may not be showing up yet in the consumer price index, but I wouldn’t bet on low inflation for the next decade.
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