Why is Gold Going Up?

[raja]

Re: Why is Gold Going Up?

raja, you need to explain why those other factors would lead to a higher gold price in the absence of a fear of devaluation. it is not self-evident that "breakup of the Eurozone, bank failures, Chinese out-of-control inflation, demand collapse, GDP stagnation" would make people want to buy gold, except for the fear of currency devaluation. please elucidate.

A reasoned reply, thank you.

I believe the iTulip theory postulates that it is not just the fear of devaluation, but actual devaluation, that causes the price of gold to rise. So I would like to answer your question slightly restated as, "you need to explain why those other factors would lead to a higher gold price in the absence of . . . devaluation."

Here are some examples of individual motivations that could occur in large numbers of people, which could lead to the price of gold rising in the absence of devaluation. Please note -- you may not agree that any of these outcomes are possible . . . but lots of people may, and that belief may be sufficient to cause a rise in the price of gold:

1) You live in Greece, Spain, Portugal, Italy, or other countries that are experiencing solvency problems. You fear that any day there could be a solvency crisis leading to bank runs, and you will not be able to get your money out. So you buy gold because it is an asset that you control; it is not dependent on the wisdom and integrity, or lack thereof, of others.

2) You live anywhere on the planet, and you fear there might be a global banking collapse that cannot be contained. You're not certain, but you give it a 25% chance. You buy gold for the same reasons cited in 1. above.

3) You believe that demand cannot be created by government actions, as we have seen of late. You fear this will continue and eventually set off a downward spiral of unemployment, GDP decline, disinflation or even (gasp!) deflation. Stock values plummet, bonds are paying nothing, home prices and down 30% and could go futher . . . so where do you put your money. Keep some in cash, of course, but move out of stocks and bonds into gold to diversify.

4) If you buy into 4. above, then you may also fear future government reflation attempts, futile as they may be, resulting in future big inflation. Actual devaluation hasn't yet occured, but you still invest in gold betting that inflation think will come.

5) You have some knowledge of history, and you know that human greed, stupidity and insanity have no limits. You also know that extreme situations have a lower probability, but you watch more and more bloggers, commentators, news analysts and economists become increasingly pessimistic. You start to have a vague sense that anything can happen -- it certainly has in the past -- so even though you can't entirely justify it, you buy gold to achieve a sense of security in the face of growing global uncertainty.

6) You run a national central bank. You know that all the other central bankers and big bankers in general are greedy scumbags just like you, and you don't trust them one bit. So, you buy as much gold as you can get away with without setting off a run to insure yourself and the Financial Elite that you serve against the rampant immorality with which you are personally familiar.

7) You watch Glenn Beck and Cramer, and they say buy gold, so you do. Heck, they're on TV, so they must be smart, right?

I might be able to come up with more . . . but is that a suffient response?

[jiimbergin]

Re: Why is Gold Going Up?

Raja,

I may not understand, but it seems that each of your 7 reasons (except number 6) all involve the devaluation. If you can not get your money, it is not worth very much. At least not as much as when you could get it. To me that is devaluation.

[jk]

Re: Why is Gold Going Up?

1) You live in Greece, Spain, Portugal, Italy, or other countries that are experiencing solvency problems. You fear that any day there could be a solvency crisis leading to bank runs, and you will not be able to get your money out. So you buy gold because it is an asset that you control; it is not dependent on the wisdom and integrity, or lack thereof, of others.

why not just hold banknotes?

2) You live anywhere on the planet, and you fear there might be a global banking collapse that cannot be contained. You're not certain, but you give it a 25% chance. You buy gold for the same reasons cited in 1. above.

why not just hold banknotes?

3) You believe that demand cannot be created by government actions, as we have seen of late. You fear this will continue and eventually set off a downward spiral of unemployment, GDP decline, disinflation or even (gasp!) deflation. Stock values plummet, bonds are paying nothing, home prices and down 30% and could go futher . . . so where do you put your money. Keep some in cash, of course, but move out of stocks and bonds into gold to diversify.

in deflation, cash is king. not gold.

4) If you buy into 4. above, then you may also fear future government reflation attempts, futile as they may be, resulting in future big inflation. Actual devaluation hasn't yet occured, but you still invest in gold betting that inflation think will come.

as i said above, i think it is the anticipation of devaluation, on top of ongoing devaluation, that drives the gold price. in this example, you agree.

5) You have some knowledge of history, and you know that human greed, stupidity and insanity have no limits. You also know that extreme situations have a lower probability, but you watch more and more bloggers, commentators, news analysts and economists become increasingly pessimistic. You start to have a vague sense that anything can happen -- it certainly has in the past -- so even though you can't entirely justify it, you buy gold to achieve a sense of security in the face of growing global uncertainty.

this is saying that you buy gold irrationally, because it gives you a sense of security for which you have no thought-out basis of belief. sure- i agree. it's possible people will buy gold just for the hell of it.

6) You run a national central bank. You know that all the other central bankers and big bankers in general are greedy scumbags just like you, and you don't trust them one bit. So, you buy as much gold as you can get away with without setting off a run to insure yourself and the Financial Elite that you serve against the rampant immorality with which you are personally familiar.

by saying that all the other central bankers are greedy scumbags, are you meaning to imply that you don't trust the value of their money? sounds like a fear of future if not present devaluation.

7) You watch Glenn Beck and Cramer, and they say buy gold, so you do. Heck, they're on TV, so they must be smart, right?

this goes back to the irrational motive.

summary- your examples boil down to present or fear of future devaluation, or buying gold on an irrational impulse. sounds right to me.

[c1ue]

Re: Why is Gold Going Up?

Krugman offered an interesting analysis on the price of Gold today. (Queue up the anti-Krugman ranters ...)

Krugman is simply too easy to pick on, but I'll indulge in it once again just because you've brought him up.

So what determines the price of gold at any given point in time? Hotelling models say that people are willing to hold onto an exhaustible resources because they are rewarded with a rising price. Abstracting from storage costs, this says that the real price must rise at a rate equal to the real rate of interest, so you get a price path that looks like this:



Obviously there are many such paths. Which one is correct? Given rational expectations (I know, I know) the answer is, the path under which cumulative flow demand on that path, up to the point at which you hit the choke price, is just equal to the initial stock of gold.

Now ask the question, what has changed recently that should affect this equilibrium path? And the answer is obvious: there has been a dramatic plunge in real interest rates, as investors have come to perceive that the Lesser Depression will depress returns on investment for a long time to come:

Boiled down, Krugman is trying to say that low interest rates mean people will buy gold because they're giving up less interest income.

Except one little problem: gold is far and away the best performing metal. This performance has been very consistent - which differentiates it from silver.

Why doesn't Krugman talk about platinum, rhodium or palladium? None of these metals have performed anything like gold even though some are strategic, some are precious, some are both.

If the only reason gold is going up, is because the opportunity cost in terms of interest income is lower, then all commodities should be increasing in a similar matter.

This is not the case.

But of course the Great Krugman is attacking gold and doesn't want to be inconvenienced by facts.

Note: I am absolutely not a gold bug. It isn't money. It isn't the solution to all our problems.

For this is essentially a “real” story about gold, in which the price has risen because expected returns on other investments have fallen; it is not, repeat not, a story about inflation expectations. Not only are surging gold prices not a sign of severe inflation just around the corner, they’re actually the result of a persistently depressed economy stuck in a liquidity trap — an economy that basically faces the threat of Japanese-style deflation, not Weimar-style inflation. So people who bought gold because they believed that inflation was around the corner were right for the wrong reasons.

Here he attempts to say buyers of gold are right, even though they're wrong, because the Great Krugman says deflation, and ultimately deflation is what is causing the price of gold to increase.

Yet his specific Japan-style deflation had ZERO impact in the price of gold.

The Japanese deflation started in the 1990s. Is there any correlation whatsoever between the demand for gold in Japan, the price of gold in yen, or any other Japanese relationship to the yellow metal?

Note also his complete failure to address any aspect or possibility of dollar devaluation - something which has clearly been going on for a significant period of time.

[*T*]

Re: Why is Gold Going Up?

8) negative real interest rates remove the opportunity cost of holding gold
9) trend following

Raja I would like to remind you that debt deflation is part of the iTulip central thesis. However, because they realise economies are not closed, this can result in price inflation. See my piece on Iceland for a case in point.

A reasoned reply, thank you.

I believe the iTulip theory postulates that it is not just the fear of devaluation, but actual devaluation, that causes the price of gold to rise. So I would like to answer your question slightly restated as, "you need to explain why those other factors would lead to a higher gold price in the absence of . . . devaluation."

Here are some examples of individual motivations that could occur in large numbers of people, which could lead to the price of gold rising in the absence of devaluation. Please note -- you may not agree that any of these outcomes are possible . . . but lots of people may, and that belief may be sufficient to cause a rise in the price of gold:

1) You live in Greece, Spain, Portugal, Italy, or other countries that are experiencing solvency problems. You fear that any day there could be a solvency crisis leading to bank runs, and you will not be able to get your money out. So you buy gold because it is an asset that you control; it is not dependent on the wisdom and integrity, or lack thereof, of others.

2) You live anywhere on the planet, and you fear there might be a global banking collapse that cannot be contained. You're not certain, but you give it a 25% chance. You buy gold for the same reasons cited in 1. above.

3) You believe that demand cannot be created by government actions, as we have seen of late. You fear this will continue and eventually set off a downward spiral of unemployment, GDP decline, disinflation or even (gasp!) deflation. Stock values plummet, bonds are paying nothing, home prices and down 30% and could go futher . . . so where do you put your money. Keep some in cash, of course, but move out of stocks and bonds into gold to diversify.

4) If you buy into 4. above, then you may also fear future government reflation attempts, futile as they may be, resulting in future big inflation. Actual devaluation hasn't yet occured, but you still invest in gold betting that inflation think will come.

5) You have some knowledge of history, and you know that human greed, stupidity and insanity have no limits. You also know that extreme situations have a lower probability, but you watch more and more bloggers, commentators, news analysts and economists become increasingly pessimistic. You start to have a vague sense that anything can happen -- it certainly has in the past -- so even though you can't entirely justify it, you buy gold to achieve a sense of security in the face of growing global uncertainty.

6) You run a national central bank. You know that all the other central bankers and big bankers in general are greedy scumbags just like you, and you don't trust them one bit. So, you buy as much gold as you can get away with without setting off a run to insure yourself and the Financial Elite that you serve against the rampant immorality with which you are personally familiar.

7) You watch Glenn Beck and Cramer, and they say buy gold, so you do. Heck, they're on TV, so they must be smart, right?

I might be able to come up with more . . . but is that a suffient response?

[Alvaro Spain]

Re: Why is Gold Going Up?

1) You live in Greece, Spain, Portugal, Italy, or other countries that are experiencing solvency problems. You fear that any day there could be a solvency crisis leading to bank runs, and you will not be able to get your money out. So you buy gold because it is an asset that you control; it is not dependent on the wisdom and integrity, or lack thereof, of others.

Raja, I live in Spain and I can tell you that when the euro gets devalued against the dollar the gold does not rise (much to my chagrin, because I used to think like you).

Let me add some data:

In December,1 2009 EURUSD = 1.49 / Gold in US dollars = 1,200 (more or less)

Then we had the PIIGS issue and euro got devalued.

In June, 1, 2010 EURUSD = 1.19 / Gold in US dollars = 1,200 (more or less)

I myself was greatly surprised at this development, but I must conclude that devaluation of euro does not lead to gold appreciation in US dollars.

What happens is not always what should happen.

[raja]

Re: Why is Gold Going Up?

Raja,

I may not understand, but it seems that each of your 7 reasons (except number 6) all involve the devaluation. If you can not get your money, it is not worth very much. At least not as much as when you could get it. To me that is devaluation.

A progressive devaluation, as iTulip predicts, is different than a default.

[jiimbergin]

Re: Why is Gold Going Up?

A progressive devaluation, as iTulip predicts, is different than a default.

KA-POOM is anything but a progressive devaluation.

[raja]

Re: Why is Gold Going Up?

why not just hold banknotes?
in deflation, cash is king. not gold.
as i said above, i think it is the anticipation of devaluation, on top of ongoing devaluation, that drives the gold price. in this example, you agree.
this is saying that you buy gold irrationally, because it gives you a sense of security for which you have no thought-out basis of belief. sure- i agree. it's possible people will buy gold just for the hell of it.
by saying that all the other central bankers are greedy scumbags, are you meaning to imply that you don't trust the value of their money? sounds like a fear of future if not present devaluation.
this goes back to the irrational motive.
summary- your examples boil down to present or fear of future devaluation, or buying gold on an irrational impulse. sounds right to me.

Please keep in mind that I'm not claiming that dollar devaluation is irrelevant in the price of gold. What I am saying is that it is not the only factor, and at times, perhaps not the most important factor.

Let's look at it from another angle . . . .

In 2001 gold was around $270; it's now around $1900. That's a 7x price rise. Has the dollar devalued 7x? I know I'm not paying 7x higher for any items that I normally use.

IMO, this establishes that the price of gold can rise significantly without commensurate dollar depreciation.

Now, to the question of whether gold rises on fear of devaluation. I say yes, but it is not the only factor, and at times, not the most important factor. For example, another motivation is that gold may bring a higher return than other investments. This may not be due to fear of devaluation, but simply that other investments are less attractive.

1. Right now, some people are looking at the stock market, they are looking at gold, and they are understanding that gold will probably make them more money.

2. Commodities are looking like a bad investment, since it appears that that we are heading for a global economic slowdown. Again, gold seems like a preferable choice.

3. Housing is down and many think it will go lower. Why invest in a losing proposition when gold has been steadily going up.

I agree that gold is money, and on one level there is no reason to own gold unless you think that the money will lose value in comparision to gold. But money is not the only way to store wealth, and prudent investors diversify. So, I will add diversification as a reason to buy gold . . . and diversification is especially desired in uncertain times such as we are undergoing now.

And finally there is the fear factor.

You discount this by saying, "this is saying that you buy gold irrationally, because it gives you a sense of security for which you have no thought-out basis of belief. sure- i agree. it's possible people will buy gold just for the hell of it."

There is a difference in buying gold "just for the hell of it", and buying gold because you see the economic world collapsing around you.

[raja]

Re: Why is Gold Going Up?

KA-POOM is anything but a progressive devaluation.

Not so.

EJ has described the POOM course of inflation over 5 years as 5%, 10%, 20%, 10%, 5%.
That's far different than a currency going to zero in a default.

[raja]

Re: Why is Gold Going Up?

Raja, I live in Spain and I can tell you that when the euro gets devalued against the dollar the gold does not rise (much to my chagrin, because I used to think like you).

Let me add some data:

In December,1 2009 EURUSD = 1.49 / Gold in US dollars = 1,200 (more or less)

Then we had the PIIGS issue and euro got devalued.

In June, 1, 2010 EURUSD = 1.19 / Gold in US dollars = 1,200 (more or less)

I myself was greatly surprised at this development, but I must conclude that devaluation of euro does not lead to gold appreciation in US dollars.

What happens is not always what should happen.

The interest payment on Greek bonds is now nearing 100%.
Don't you think that's a bit different situation than existed in 2010?

[Alvaro Spain]

Re: Why is Gold Going Up?

The interest payment on Greek bonds is now nearing 100%.
Don't you think that's a bit different situation than existed in 2010?

What do I know. In my opinion, in 2010 the majority of investors knew that Greece was going to default.

In any case, what I fail to see is people in Europe buying gold (because of our own european crisis) even with greek bond yields at 100%

I'd like that the things were different, since 42% of my net liquid worth is invested in gold.

[jpatter666]

Re: Why is Gold Going Up?

What do I know. In my opinion, in 2010 the majority of investors knew that Greece was going to default.

In any case, what I fail to see is people in Europe buying gold (because of our own european crisis) even with greek bond yields at 100%

I'd like that the things were different, since 42% of my net liquid worth is invested in gold.

Heads in the sand is a powerful force. People dislike change, and they play boiling frog until the bitter end.

[raja]

Re: Why is Gold Going Up?

Here (Krugman) attempts to say buyers of gold are right, even though they're wrong, because the Great Krugman says deflation, and ultimately deflation is what is causing the price of gold to increase.

Yet his specific Japan-style deflation had ZERO impact in the price of gold.

The Japanese deflation started in the 1990s. Is there any correlation whatsoever between the demand for gold in Japan, the price of gold in yen, or any other Japanese relationship to the yellow metal?

Note also his complete failure to address any aspect or possibility of dollar devaluation - something which has clearly been going on for a significant period of time.

I don't want to put words in Krugman's mouth, but I think what he is suggesting is not that deflation per se causes gold to go up, but rather that when deflation comes with most other investments going down, gold becomes more attractive.

In the past during Japan's deflation, there were other places in the world to invest, and other things to invest in. Now, when we are in a global economic contraction, stocks, bonds, housing and commodities all suck . . . so gold looks very good.

[raja]

Re: Why is Gold Going Up?

What do I know. In my opinion, in 2010 the majority of investors knew that Greece was going to default.

In any case, what I fail to see is people in Europe buying gold (because of our own european crisis) even with greek bond yields at 100%

I'd like that the things were different, since 42% of my net liquid worth is invested in gold.

How do you know people in Europe are not buying gold?
I have no evidence one way or the other, but I would be surprised if that is the case . . . .