LOL Gold

Hyperinflation is coming! No, seriously! Yes, I know that I’ve been saying that since 2008 and that I’ve also said that it would be due to QE and low interest rates and now the Fed has signaled that these might come to a slow soon, but still it’s totally coming! What should you do? Buy gold, of course. Oh, and my website just so happens to sell gold — and tinned food; make sure to buy lots of tinned food.

Seriously though, the gold bugs are getting burned like there is no tomorrow these days. Check out this entertaining clip of an economist who studied the long-run trend of gold prices:

Of course, such studies should be looked upon with some skepticism. The future, after all, is not a perfect mirror of the past. Still, as I divined back in February using some rather unusual, erm, data-points, gold is likely to continue it’s fall in the coming year and I’ve heard crazier estimates than $800 as the price it will revert to. Oh, and for all you folks interested in the underlying dynamics of the gold market I cannot recommend this absolutely fantastic analysis by hedge fund manager Mark Dow enough.

Although I was aware of most of this analysis myself Dow points to something I had missed: the extremely low price elasticity of gold. For all those of you who have not been indoctrinated in the jargon of the dismal science in practical terms that means that when even a small amount of gold is dumped on the market its price must fall substantially before a buyer is found. What this tells us is two things. (1) That gold is less a hot commodity than a hot potato commodity — outside of a select group of cultists no one wants the stuff. (2) Any time an “event” happens in the gold market that signals a sell opportunity — as, for example when Bernanke announced the QE taper — the price effects are going to be substantial.

While I’m not in the business of giving investment advice (right now, anyway…), that makes it a very attractive short for gold bears because in the medium to long-run there is substantially more downside risk than upside risk. In plain English: the chances of the gold price falling substantially is far, far higher than the chances of the gold price rising substantially — the latter of which to me seems almost non-existent outside of some completely unforeseeable event.


About pilkingtonphil

Philip Pilkington is a macroeconomist and investment professional. Writing about all things macro and investment. Views my own.You can follow him on Twitter at @philippilk.
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4 Responses to LOL GOLD!

  1. Lord Keynes says:

    *”Seriously though, the gold bugs are getting burned like there is no tomorrow these days. “*

    And it’s a joy to watch too!

    Any data on whether its fallen to its near its industrial production costs?

    Also, we know that in inflation adjusted terms it never even hit its high of 1980 over the last few years. And then a *20* year bear market followed!

    • The cost of production question is interesting — and informative. The gold bugs are now flailing around wildly trying to justify their bullishness. The latest meme is that gold has fallen to is marginal cost of production. They then claim that this indicates a buy opportunity because the price cannot continue to fall past the cost of production.

      However, the marginal cost of production rose as the price rose. As gold increased in value it became profitable to extract it at higher marginal cost — as you can see in the graph here:

      So, as anyone who actually knows economics — the gold bugs and the Austrians seemingly don’t — the marginal cost of production was dragged upwards as the price went up. The supply-side of the market responded to the demand-side, as it should — not to mention all those “cash for gold” shops that sprang up.

      Lesson? In order for the costs of production argument to be meaningful we would have to look at long-run costs of production. But if we recognise that these respond to price, then we can safely say that all we need to do is look at long-run price!

  2. Lord Keynes says:

    Thanks for this and the link. The graph is informative.

    “They then claim that this indicates a buy opportunity because the price cannot continue to fall past the cost of production.”

    They had an epiphany and converted to the administered price/cost of production theory of price!!

    But, seriously, even that argument they now make doesn’t follow, for in a highly speculative, flexprice commodity market like gold, where so much demand is always speculative, how can you speak of fundamentals? Why shouldn’t the price collapse to below present costs of production, and then drag down the marginal cost of production too, just as the price rises dragged it up.

    • Well that’s the thing. You joke about their understanding of price, but its actually really bizarre. You can explain the gold market prices of production perfectly well from a marginalist perspective. You can claim that Marginal Revenue in the gold production sector is tending toward Marginal Cost. You can then say that as MR rises because the demand for gold rises (due to “rational” inflation expectations) and so MC rises in line with this. That’s how you would interpret that graph using a marginalist analysis and its not far off what I’m saying. I really don’t think these guys do understand even what they supposedly believe in!

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