Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 13

An historical (not hysterical) look at gold

Around the world in the last two weeks, people have rushed retail stores to buy physical gold. Perth Mint has reported sales are at their highest level in five years, and they traded over the weekend to cope with demand. People are queuing across Asian cities in panic-like conditions, while the US mint has been forced to cancel sales of its gold coins. Buyers are responding to the rapid price fall to USD1,322 per ounce in mid-April, the lowest level for two years.

What is most extraordinary is that retail investors usually react to rapid market falls in the opposite way. When equity prices drop, investors usually panic from fear it will fall further. Inflows to managed funds are always at their strongest when the market is at its peak, and outflows at their highest when markets bottom. But something else is happening with gold.


Source: Compiled by Grant Williams of Mauldin Economics from various public sources.

A brief look at gold price history

Most of the time over history, one ounce of gold has been able to buy items worth the equivalent of around USD500 in today’s dollars adjusted for inflation. It has done so for much of the past 2,500 years through many societies. Occasionally the gold price (when measured in paper currencies) surges when paper currencies devalue, but it then falls back again in real terms. If bought below its long run level, gold can provide a hedge against the devaluation of paper, but if bought above the level it is speculation, not ‘investing’. It is not a matter of whether gold represents a store of value or some other safe haven characteristic. For an investor, it is only worth buying when it is cheap.

The gold price reached USD1,900 per ounce on 5 September 2011 in the midst of the US debt ceiling and credit downgrade crises. Since then it has fallen by more than 20%, including a 10% fall on 15 April 2013, triggered by fears that Cyprus and the PIIGS may have to sell their gold reserves to repay debts.

Gold may shoot up to USD4,000 or USD5,000 in one of two scenarios: (a) an extreme left wing outcome resulting in run-away US inflation leading to a breakdown of society; or (b) an extreme right wing scenario with a Tea Party-led Republican government bringing back the gold standard. These scenarios look remote. People who bought gold in the last bubble in 1979-80 are still waiting to get their money back in real terms after inflation 33 years later.

Investors cannot consider gold without also thinking about currencies and inflation, as the three are inextricably linked. Long term holding of gold makes sense as an inflation hedge or as a store of value if bought at or below the long term price around which it has oscillated for thousands of years. However, if paper currencies collapse, the nominal value of gold expressed in paper money terms can rise dramatically. So gold has most appeal if the investor’s home currency is about to experience massive hyper-inflation which destroys the value of paper money, which is unlikely in Australia in the near future. Or since the price of gold is expressed in USD terms, any expected rapid destruction in the value of a home currency may merit purchases of gold.

Of course, profits from short term trading are always possible as a more speculative bet, but long term portfolios are designed to look after long term needs, such as producing income and protecting wealth.

A copy of our comprehensive 2012 study of gold can be found here.

 

Ashley Owen is Joint CEO of Philo Capital Advisers and a Director of Third Link Investment Managers.

 

1 Comments
scottb
May 03, 2013

"Investors cannot consider gold without also thinking about currencies and inflation."

Indeed. But in considering inflation, Mr Owen has forgotten that governments purposely and systematically understate the amount of actual inflation so as to make it possible for debtors everywhere – and governments are the greatest of all debtors – to repay obligations in a devalued currency, thereby enabling the ongoing operations of a debt and liquidity-based economy. The U.S government reports inflation at about 2.5% (the basis of Mr Owens analysis), but in fact it's most likely significantly higher...close to 10%. Check out Shadowstats.com.

Adjusted for true inflation, gold peaked in 1980 at about $5,000 which would suggest there's some room to the upside today.

And one can't ignore the size of the monetary base today. A look at the the ratio of the St. Louis Adjusted Monetary Base to the price of gold shows it above 2.0 ...almost record levels. All previous gold 'booms' have only stopped when the ratio falls below 0.22. And we are a very long way from that.

And consider this. In January 1980 when gold peaked at $875, the average price for gold for the month was $669. The monetary base in January 1980 was $132 billion, which means it took only 198 million ounces of gold to cover the monetary base. In January 2012 when gold averaged roughly $1,600, the monetary base was $2,750 billion. Thus it would take 1.7 billion ounces to cover the monetary base. To get the same coverage as in 1980, gold would have to be trading at almost $14,000.

Or maybe you can look at it like this. If the US actually has the 8,133 metric tonnes of gold they claim they have in their reserves (World Gold Council - World Official Gold Holdings) and the US used that gold to back the US monetary base, gold would have to rise $9,745 per ounce. Even backing 40% of the monetary base would see gold at $3,900 an ounce.

 

Leave a Comment:

RELATED ARTICLES

What do fund managers mean by Quality Investing?

1979 US Government defaults: what happened next?

Nassim Taleb on managing investments for rare events.

banner

Most viewed in recent weeks

Raising the GST to 15%

Treasurer Jim Chalmers aims to tackle tax reform but faces challenges. Previous reviews struggled due to political sensitivities, highlighting the need for comprehensive and politically feasible change.

7 examples of how the new super tax will be calculated

You've no doubt heard about Division 296. These case studies show what people at various levels above the $3 million threshold might need to pay the ATO, with examples ranging from under $500 to more than $35,000.

The revolt against Baby Boomer wealth

The $3m super tax could be put down to the Government needing money and the wealthy being easy targets. It’s deeper than that though and this looks at the factors behind the policy and why more taxes on the wealthy are coming.

Meg on SMSFs: Withdrawing assets ahead of the $3m super tax

The super tax has caused an almighty scuffle, but for SMSFs impacted by the proposed tax, a big question remains: what should they do now? Here are ideas for those wanting to withdraw money from their SMSF.

Are franking credits hurting Australia’s economy?

Business investment and per capita GDP have languished over the past decade and the Labor Government is conducting inquiries to find out why. Franking credits should be part of the debate about our stalling economy.

Here's what should replace the $3 million super tax

With Div. 296 looming, is there a smarter way to tax superannuation? This proposes a fairer, income-linked alternative that respects compounding, ensures predictability, and avoids taxing unrealised capital gains. 

Latest Updates

Investment strategies

9 winning investment strategies

There are many ways to invest in stocks, but some strategies are more effective than others. Here are nine tried and tested investment approaches - choosing one of these can improve your chances of reaching your financial goals.

Planning

Super, death and taxes – time to rethink your estate plans?

The $3 million super tax has many rethinking their super strategies, especially issues of wealth transfer on death. This reviews the taxes on super benefits and offers investment alternatives.

Taxation

Raising the GST to 15%

Treasurer Jim Chalmers aims to tackle tax reform but faces challenges. Previous reviews struggled due to political sensitivities, highlighting the need for comprehensive and politically feasible change.

Shares

The megatrend you simply cannot ignore

Markets are reassessing the impact of AI, with initial euphoria giving way to growing scepticism. This shift is evident in the performance of ASX-listed AI beneficiaries, creating potential opportunities.

Gold

Is this the real reason for gold's surge past $3,000?

Concerns over the US fiscal position seem to have overtaken geopolitics and interest rates as the biggest tailwind for gold prices. Even if a debt crisis doesn't seem likely, there could be more support on the way.

Exchange traded products

Is now the time to invest in small caps?

With further RBA rate cuts forecast this year, small caps may be key beneficiaries. There are quality small cap LICs and LITs trading at discounts to net assets, offering opportunities for astute investors.

Strategy

Welcome to the grey war

Forget speculation about a future US-China conflict - it's already happening. Through cyberwarfare and propaganda, China is waging a grey war designed to weaken democracies without firing a single shot.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.