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An Analysis of Price of Gold vs Money SupplyDoctor Dinero's Discussions As I mentioned in my previous article, I like to use an overly simple definition of Inflation as the increase in money supply. (The Keep it Simple Principle.) For the United States, that would be the total Federal Reserve Notes in Circulation. Below is the graph of the yearly average price of gold versus the yearly average Federal Reserve Notes in circulation divided by the official gold reserves of the United States (that is a long winded way of saying "actual gold price versus the theoretical price of gold if the US backed the dollar 100% with gold"). This graph shows us that gold was overpriced in 1980 and a $400 per ounce was a reasonable price (as long as the Fed stopped printing, which they did not). In the 1980's, gold stayed in the trading range of 400 dollars an ounce. Makes sense, it was reasonably valued at the start of the trading range, so steady as she goes.
We are now on a multi year trajectory that should overshoot the FRN per Reserve oz, like what happened in 1980. With the fed increasing the FRNs at about 9% a year, this number will be a moving target. Today (Early January 2004) the theoretical value of gold is $2566 per ounce; this of course assumes that we still have all of our National Gold Reserve according to the US treasury. (I wonder why they will not audit Fort Knox? Maybe if they do it would cause a panic?). Gold will have to revert back to its trend eventually. In its process of correcting up, many gold short sellers, leasers of physical, etc will be heavily squeezed. I would expect at some point that the gold market becomes irrational, (i.e. exploding upwards). Should this event happen, imagine what pressure will be placed on the Bullion Banks, (which are too big to fail, according to general public). To prevent interlocking bank failures, I also expect the Federal Reserve to increase the rate of its printing of FRNs to bail out the Big Banks. As you can see in the next graph the rate of change in FRNs has become unstable. The instability arises from the Federal Reserves bail outs and their own knowledge that the increase in FRNs causes inflation. During the 1970's FRN creation was 8 to 9%, like today's average, but we are going from 12% to 2%, which is highly unstable.
The next graph compares M3 in billions of Federal Reserve Notes with M3 converted to billion ounces of gold (keep in mind that this is more gold than all gold mined since man left the cave). It would appear that the gold M3 has been a pretty good predictor of economic distress. With the dollar M3 declining the past few months and gold rising, this does not portray a growing economy, and solidifies my feeling that we are still at the start of a major economic disaster.
From this data we can also do a simple calculation, should the Gold M3 reach its previous low in 1980, then the price of gold would be around $2868 per ounce, which supports the theoretical FRN price per ounce. I have read some articles promoting a partially back gold standard. Lets hypothetically say the dollar is 25% backed by gold, then our theoretical maximum price would be $840 per ounce. Well, if I was a foreign bank, I would want gold, not dollars and converting the fiat into gold would either cause the dollar to devalue, or reduce our domestic money supply causing a recession. So I strongly believe, that the dollar has to be 100% backed by gold, if we are ever to go back to honest money. Now this following chart is interesting. It graphs the stated US Treasury Reserves of gold going back to 1947. It also displays the current FRN normalized gold price (the gold price in that period times today's FRN supply divided by the period's FRNs). The normalization is only valid when the gold reserves are stable so ignore the data prior to 1971. From this graph we see that the price of gold has reached $3750 in today's FRNs. We have a long way to go in this gold bull.
So what am I doing to protect my family's assets? Buying gold and silver bullion, gold and silver companies, the occasional gold calls, and staying employed. I believe we are still at the beginning of a major gold bull. I am taking a fundamental viewpoint of this market and I am buying and holding until we over correct on the gold priced in FRN, like 1980. I like Technical Analysis, but I do not have the time to devote to implementing it in practice. So I buy when I can and hold and watch as gold continues to make new highs. As I said before, what do I know about economics? I am just a simple chemical engineer trying to figure out where to safely protect my family's assets from the upcoming recession, depression, deflation, hyperinflation, seizures etc. You the reader must decide if any information within this article is worthwhile. I do not guarantee that I am right. I have been wrong before; just ask my wife, she thinks I am crazy (although less so today). I just hope sharing this information with fellow Gold and Silver Bugs gets the word out to more people so they can protect themselves. Cheers, Doctor Dinero 321gold Inc |
