A reader writes in asking about the price of gold and why it keeps falling despite surging US government debt. The thinking here is that gold prices will hedge against a collapse in the US Dollar when the government defaults or “prints money” to the point where it causes hyperinflation or high inflation. This was a very popular bet in 2008/9 and you can be certain that it was an important driver in the price of gold during the big run-up.
In my new book, I refer to gold’s price as having a “faith put” underneath it. Gold isn’t just a commodity, but it’s also viewed as a form of safe money. You could argue that gold is the only universal form of money and has been for quite some time (though I think that is waning to some degree). Because of this its users embed a premium in its price when it is seen as protecting against fiat money and its potential inflationary problems.
But a weird thing has happened in recent years. Despite continuing QE and huge government deficits the price of gold has fallen 35% since its peak in 2011 and is down over 10% from its highs this year. Is there a logical explanation for this? I can’t be certain and I could be totally wrong, but if I had to guess I would argue that some of this “faith put” is coming out of the price over time because the inflation bet has been obviously wrong.
The story goes like this:
- In 2008 & 2009 investors see the Fed printing money and the government debt exploding. They naturally assume that this will lead to inflation because the econ textbooks all teach us that the government “prints money”.
- Instead of buying US Dollar denominated assets you logically buy real assets to protect yourself from the coming high inflation.
- As the years wear on you become convinced that the inflation is still going to come eventually even if it hasn’t come yet.
- But as we near years 3, 4 & 5 the inflation story starts to look a little shaky. What if that high inflation isn’t going to come?
- Then, as year 5 comes and goes the high inflation still hasn’t hit and you begin to totally question the foundational reasons for having ever bought into this theory in the first place.
- Demand continues to slow as the theory looks increasingly shaky….You get the point.
Said differently, gold investors embedded a huge premium in the price of gold betting on a disastrous inflation in 2008 & 2009. And as it’s become more and more obvious that that high inflation isn’t coming the premium has been sucked right back out. That’s my theory anyhow. Who knows if it’s right, but it would seem to make a good deal of sense to me….
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.