Don’t panic on gold

Just a sudden thinking during a few minutes before London opens, I think people spent too much time talking on gold. Just looking at the gold prices, it’s terrific: all of the fears floating around, safe hard assets accumulating, influx into the US money market in the short-term and not-known-place-yet in the longer-term, double dip forecasting, US and EU possible failure in leading the world economy, inflation worldwide, and whatever you and I can think of.

This is the quick chart on 5-yr gold I grabbed on MarketWatch:

Source: Marketwatch


Thank to the Dodd-Frank Act took effect on July last year, I can’t make a nice chart with technical analysis by my forex platform, U.S.’s traders are banned from leveraged precious metals trading (non leverage and minimum of 10 oz per trade acceptable) and oil markets. This canvas is absolutely not worth a thousand words, but whatever.

Look at the prices, from 1500 to now near 2000. This steep angle reminds me a lot of other charts: Tulips, dot-com, 1929, … I know gold are being predicted to get higher and higher and higher, but this chart just washes me off.

However, I find some reasons just forget this nightmare that people use “Inception” to dream a dream into a dream of a dream.

Think about the market characteristics of gold. If you remember the last 3 weeks from the S&P downgraded US credit, there was, I still remember the numbers, $48 billion withdrawn from the global stock markets pumped into the US money market and a relatively $1.6 billion or so put into the gold market. For the $48 billion – US Treasury Yield got to among the lowest levels in history, around 2% – a figure made us remember the Japanese government bond in 1997 followed by a crashed economy. Then the $1.6 billion – gold prices peaked to 1917.9/oz. Stress: only $1.6 billion helped making a big run on gold market. This tells me how illiquid and narrowed gold market is.

So this raises me a question: how large is the gold market? – The calculation is interesting. Recently I’ve just read a new report on biggest gold reserves at the end of August, I show the 3 largest here:

  1. US: 8,965.6 tons – US$ 522.6 billion market capitalization
  2. Germany: 3,747.9 tons – US$ 218,28 billion
  3. IMF: 3,101 tons – US$ 180.6 billion

US is the largest gold owner and holds ONLY $552 billion worth of the asset. $552 billion is not a big number if you think about the current debt of US: somewhere near $14 trillion. The global stock markets value around $58 trillion, the number is $82 trillion for global debt market. So how large is the global gold market?

15 largest countries and financial institutions store around 16.7% of the world’s gold which is 30,700 tons. So this number for the world is: 186,061 tons. A ton converted to 32,000 oz – then there is around 5.95 billion oz of gold out there. Let’s take $1900/oz of gold for easy calculation, we have $11.3 trillion value of total world’s gold. This is 5 times less than the world’s stock market capitalization and 7 times less than the global debt market. Plus, most of gold are not in trading.

This simple figure tells me one thing: the abandon of gold out of the world’s financial market in 1972 was a right decision. The whole world economy can’t base on gold as the blood (i.e. money) of the system because the fast growing boy (economic speaking, the world just started to grow since late 16th century) can’t be limited by the amount of blood for him just to grow.

Here is the gold production since 1850:

The gold production peaked around 2000 (price: $300/oz), and decreased steadily. Gold production will continue to move backward (don’t take it literally, take it as “gold is a limited resource”) and the world will continue to move forward.

So gold prices will move higher. That’s undeniable. Inflation, fears, total output declining are telling the same story. However, bringing the world back to gold-standard system as pre-1972? No, definitely.

Comments

6 Comments:

  1. It is a good comment on the issue of gold price. However, historically, Gold always keep the role of a powerful tool to keep one’s property preventing the difficulties caused by crisis. Can you tell anything more about this?
    In addition, can you make a formula for forecasting of gold price’s trend considering your factors? It is very helpful for many peoples.

    • Hi bac Thanh – it’s great to hear your comment! I’m very glad to discuss with you about these issues.

      For the first issue of Gold’s role as a powerful tool to hedge against difficulties – this is right, however not exhaustive. Not exhaustive because gold’s not only used as a hedge again difficult time, but also used as money.

      So for 6,000 years, gold has been treasured as a value stored asset. However this function is not the shining part of gold. Silver and other things like antiques and other precious metals do exactly the same job. What makes gold stand out is its money using value of gold.

      Everything changed when banking industry appeared. This is the complex part. Because banking operates by taking deposit and loan that money out as a fraction of deposit, effectively banks create money. Here’s how:

      Mr. A has $100 comes to BANK 1 to deposit. Then,
      BANK 1 lends that money out to Mr. B $90, and keeps reserve $10
      Mr. B has $90 as new money – now Mr. A still has $100, and Mr. B now has $90 – total $190
      Mr. B takes that money and buy a car $90. The car dealer put his new $90 to his bank, called BANK 2.
      BANK 2 lends out that money to Mr. C’s business, $81 (9:1). So now Mr. A has $100, the car dealer has $90 and Mr. C has $81. Total $271

      That cycle continues until BANK X can’t loan out any money from that fraction of the initial $100. Notice that this money creating cycle doesn’t involve central bank yet nor printed any new “material” money for circulating.

      Because gold are used as money, or in the past, backed for money – the total amount of money can be created has two tiers. The first tier are the gold backed in the vault – then central bank used that gold to backed its printed money. The 2nd tier are the money then multiplies by commercial banks.

      The above system worked until gold was kicked out of the financial system. So gold is not money anymore, gold is now a good, an asset class – which is prices are defined by supply and demand.

      Why gold was kicked out? because gold limited the amount of money that banks can print out. You can see more from my note here: Feeling the world close, everyday

      So money has been printed enormously after Bretton Wood system collapsed in 1972.

      ——————————————————————–

      The gold prices didn’t perform much after a peak in 1980. From 1980 to 2000 gold prices got lower and lower. People almost forget gold. Since 2000, people suddenly remembered gold and turned into gold as their value reserve. The idea was: people started to lose trust on the financial system – so it’s safe to back to something real. Not fiat value. Gold stands as the number one choice.

      As you can see from the story – this, from my point of view, value of gold are what people give it. Not supply (by production) and demands (by industrial and jewelry usage) – it’s totally psychological issue. So we can make a function of gold price this way:

      Good economy => gold price decreases
      Bad economy => gold price increases

      This approach is very fundamental – however from my point of view, people will finally fade away from this gold rush for some reasons:

      – The banks will never turn back to gold-standard
      – People come to gold because of psychological factor, therefore people will get out of gold because of price psychological factor. When gold prices get high enough to fear people, they will have to find another asset class with less volatile.
      – Besides of psychological factor – there is not much strong reason for gold price to stay high (like scarcity)

      ———————————————————————

      “can you make a formula for forecasting of gold price’s trend considering your factors?”

      I can develop a linear function or regression model to forecast gold price based on some fixed (and can be added more) criteria, theoretically – the idea how valid it is :). I think this idea was tried by numerous of financiers, mathematicians, physicians (now more PhD in Physic work in Finance to compare with Physic itself), and theorists (like game theory practitioners). Basically there is some strong obstacles for anyone to create such function:

      – People can use number to quantify the qualitative data. The idea is how good that is.
      – Data problem – availability, accessibility, and creditability of data.
      – How to gauge the psychological factors.

      So I can just simply pick out some macro information and try quantifying them and make a regression. But I highly doubt on the system myself for it usefulness 🙂 – I think the best way to make money by this is to coding out a scalping trading strategy based on past behaviors of prices and volumes and other technical indicators. If anyone has just made out this, they also would never share – they will open a fund and start their own wealth management business.

  2. great job dude.

  3. Thank Du Hoang – it’s is the emotion and self-confirmation bias that always know the way to get in the financial markets. We’d better stay alert.

  4. Love this article. It is healthy to to be skeptical when the market is heating up. I agree with you on major points. Great job.

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