Thursday, April 13, 2017

Over the past 220 years the one key factor in higher gold prices is when inflation is higher than interest rates

Many analysts have been citing the Fed and their new interest rate hike policies as the catalyst for rising gold prices, as well as a few who have been pointing to geo-political events such as Brexit and the Trump election as the key driver of gold.  But the reality of this is that most moves following these events have been fleeting, especially with the central bank's ability to manipulate prices through derivatives and the paper markets.

So if there was one intrinsic data point we could point to that would ensure a near certainty for gold to move higher and higher in price, which one has the historic evidence to back this up?

How about when real inflation is higher than central bank set interest rates.

Chart of Consumer Price Index, 1800-2005

As we can see from the above chart, when the nation was on a gold standard from the start of the Republic to 1913, inflation was relatively flat except for the periods of war (1812 and 1860-1865) when monetary expansion was needed to conduct them.  And even during the time of the industrial revolution in the late 19th century, the set price of gold remained the same as it was in 1792 and where inflation barely grew at all.

It was only after the creation of a private central bank in 1913 that mirrored the ones controlling Europe that inflation really began to take off in America.  And it was this inflation, coupled with a devaluing of purchasing power of the dollar, that forced FDR to raise the gold price from $20 per ounce to $35.

Yet even this increase in the price of gold to keep up with the jump in inflation that took place over the 20 years from 1913 to 1933 was enough to sustain the dollar's purchasing power until the 1960's when the U.S. began to increase the currency's monetary base to pay for the extended war in Vietnam.  And this led to nations beginning to reject the dollar and demand redemption in gold which began to dwindle the nation's gold supply.

And with a smaller gold supply to back the ever increasing currency supply, the gold price was once again raised in 1972 to $42.22 per ounce.

One year later however, the dollar was completely removed from a gold backing and instead backed by the petrodollar agreement which as part of the deal with Saudi Arabia and the OPEC nations, allowed for a tripling of the oil price so that the U.S. could then triple their money supply.  And this is once again seen in the above chart around 1973 when inflation was finally let loose upon the public in an unprecedented way.

Of course we know from that point on the gold price was free to move as the market's saw fit, and as inflation turned into stagflation, and then high inflation (13% by 1979), the gold price eventually rose to near $850 per ounce before Paul Volker and the Fed did something drastic...

The raised interest rates from 11.5% to 21% over the next 18 months.

And with interest rates now finally being above Real inflation, the gold price began to fall, almost in tandem to inflation itself.

During the 1980's and into the early 1990's the Fed kept interest rates relatively high, and well above the rise of Real inflation.  And you can see on the chart that during this period inflation rose moderately and was easily masked by the economic boom that took place during the Reagan years.  But following the 1987 stock market crash, Alan Greenspan would soon take over control of the Federal Reserve and began to lower interest rates from 7.5% to eventually 1% following 9/11, and as such the gold price once again rose in tandem to real inflation being greater than set interest rates.


Image result for gold price chart 1992 - 2008

And ever since 2003, interest rates have never been above 4.5%, and have mostly been below 1%.

So what has been the REAL inflation during that time period?



Around 2015 real inflation has begun to rise once again, and the Fed has summarily been forced to embark on a new rate hike policy that started in December of that year.  And even with three rate hikes over the past 18 months, interest rates are not even close to the real rate of inflation, and thus the gold price has remained constant despite the crash in the gold price between 2009 and 2011 when real inflation dropped by more than 50%.

So what does the future hold for gold both now, and in the coming years?  Well the Fed no longer has the ability to raise interest rates above real inflation since U.S. and global debt levels have made it impossible to do so without bankrupting all sovereign nations.  And this means that while the paper manipulators may succeed in holding down the price in the short run, the invisible hand of the markets will always win out, and rising inflation that is greater than central bank interest rates will mean that the gold price cannot help but keep moving up.

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