…only after further, significant loss of U.S. dollar purchasing power.
We are currently in the midst of the latest round of projections for new highs in the gold price. Those projections are more the result of anxious anticipation and elevated emotions rather than real fundamentals.
Expectations for a reversal in Fed interest rate policy were given a boost last month with indications from Chairman Powell that there will eventually be some cuts in rates. That was all that investors needed to bid up the prices of financial assets.
Two of the biggest beneficiaries were bonds and gold. (I consider gold to be a financial asset since it is real money.)
The logic for bond bulls is reasonably straightforward and fundamentally correct. A decline in rates correlates inversely to higher bond prices; just the opposite of the action we have experienced over the past couple of years as rising interest rates were directly reflected in bond price declines which totaled as much as fifty percent.
As far as gold is concerned, its price action is a typical knee-jerk reaction based on assumptions that the next round of cheap and easy money is already here.
That is certainly not the case. First of all, the Fed spent nearly four full decades engineering interest rates to abnormally low levels of historic proportion. The current attempt to return interest rates to a higher, more reasonably normal level is only 2-3 years old.
Is it reasonable to think that's all there is? Back to business-as-usual now? For most investors and analysts, it is difficult to view things in proper perspective when your entire life has been lived in a make-believe world of endless money creation available at artificially low rates.
Current projections for the gold price to move substantially higher are based on the assumption that gold will respond affirmatively to the expected onslaught of cheap money. That is not the way it works.
WHAT CAUSES A HIGHER GOLD PRICE?
The only reason the price of gold increases is to reflect the actual loss of purchasing power in the U.S. dollar. It reflects this decline only in hindsight - after the fact, and never before.
When the price of gold peaked in 1980, it reflected the effects of inflation that had previously eroded ninety-seven percent of the dollar's purchasing power.
At that time, people were no less fervent in their expectations for a complete collapse in the U.S. dollar. Along with that expected collapse came predictions for the gold price to exceed $1000 oz.
Eventually, it did so; but it took nearly thirty years to happen. Meanwhile, the U.S. dollar did not totally collapse. It did, however, continue to lose purchasing power from the effects of inflation.
The gold price declined from an average closing price of $677 in January 1980 to a low of $250 during the summer of 2000.
Beginning in 2000-01 and continuing until August 2011, the gold price marched upwards to a new high of $1895 oz.
The "new high" for the gold price was a three-fold increase from its 1980 high and reflected at that time a nearly ninety-nine percent loss in U.S. dollar purchasing power. In inflation-adjusted terms, the prices were similar. In other words, the "new highs" of 2011 reflected the same inflation-adjusted value for gold evidenced in 1980.
Similarly, the "new high" for gold at $2048 in August 2020 reflected the additional loss of purchasing power in the U.S. dollar that had occurred after 2011 and also reflected the same inflation-adjusted value for gold referred to previously.
Here is what the price action looks like on a long-term chart...
Gold Prices (inflation-adjusted) 1980 -2023
As you can see on the chart above, the ending gold price of $2062 for the year 2023 is not a "new high" in real dollars. In fact, the current gold price is actually cheaper by almost $300 oz. compared to its previous peak in August 2020.
The price peak of $2048 oz. for gold in August 2020 cannot be exceeded until the gold price in current, inflation-adjusted dollars exceeds $2336 oz.
PERVERTED LOGIC FOR SOME GOLD BULLS
When the Fed announced its plan to orchestrate higher interest rates for the expressed purpose of reducing the effects of inflation to a more acceptable level (supposedly in line with their oft-missed 2% target), their efforts resulted in a stronger dollar and a lower gold price; at least temporarily.
The Fed has now indicated that recent evidence is indicative that progress has been made on that front and that the effects of inflation have been reduced measurably, if not entirely subdued; and that continuing to increase rates may not be necessary.
Question: If the reasoning for a stronger dollar and lower gold price was based on the announced efforts by the Fed two years ago; and, since their recent statements indicate they feel they are approaching their goal, even if they haven't reached it yet; doesn't that mean that the perception of the inflation threat is not what it was and hence, a stronger dollar and lower gold price are justified?
My purpose in asking is that gold bulls seem to tend to view conflicting evidence through rose-colored glasses.
Here is what it sounds like in sequence: 1) Inflation is very bad; the dollar is going to collapse, so buy gold. 2) Inflation isn't as bad as previously thought; the Fed may not need to keep raising interest rates, so buy gold.
CONCLUSION
The gold price is always playing catchup to the previous effects of inflation which are manifested in the continual loss of purchasing power in the U.S. dollar.
The current gold price of $2060 oz is one hundred times higher than its original fixed price of $20.67 oz. and reflects the ninety-nine percent loss of $USD purchasing power that has occurred over the past century.
The potential for a higher gold price is always there because the effects of inflation continue indefinitely however...
The gold price will not move appreciably higher until after there is a further, significant loss of purchasing power in the U.S. dollar.
Since the gold price is currently at or near its inflation-adjusted peaks from 1980, 2011, and 2020, expectations for a much higher gold price at this particular time seem premature.
(Also see What We Know About Gold)
Kelsey Williams
Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN'T, AND WHO'S RESPONSIBLE FOR IT and ALL HAIL THE FED!