The gold price fight of 2013

This post is from staff writer William Cowie.

I love a good fight — don’t you? The latest fight I’m enjoying from the sidelines is the gold fight of 2013.

Gold, it seems, has the power to elicit more raw emotion than any other investment. On one hand, it’s been around thousands of years — far longer than any other investment. On the other hand, it doesn’t yield dividends or interest, and it doesn’t grow in its ability to produce income. In fact, it doesn’t produce any income at all, making investor purists scoff that gold “isn’t a real investment.” But it has appreciated (at least some of the time) and anything that appreciates interests investors.

The fight

In one corner of the debate are the so-called gold bugs, who say gold will only rise in value. In the other corner are the gold bashers, saying the bugs delude themselves with “the narrative.”

What’s a narrative? Nothing but a story. So the bashers say the gold bugs hang their investment hats on… a story.

What’s that story? In a nutshell: only gold can withstand unstable governments, inflation and upheaval, social or economic. And, according to the gold bugs, we live in times ever more uncertain, and the dramatic rise in the gold price shows more smart people are getting it.

However, the gold price has dropped more than 25 percent this year, and that has brought both sides out of their corners, swinging.

The Gold Price: 1970 - Present

The Gold Price: 1970 - Present

For the bashers, Barry Ritholtz wrote a scathing article,  The 12 Rules of Goldbuggery, in which he accused the gold bugs of burying their heads in the sand to avoid admitting that the narrative has failed, because they can’t explain why gold lost 25 percent of its value in half a year.

The gold bugs, not surprisingly, responded with a withering rebuttal, anchored by large governments incurring levels of debt unparalleled in the history of man. Sooner or later, they say, that debt will cause upheaval and when that happens, you’ll be glad you have gold.

Time even weighed in on the fight, calling it The Golden Bloodbath of 2013.

Watching a fight like this is not only fun, it’s educational: both sides are pushed to the limit to explain the reasons for their beliefs. Best of all, it forced me to do some research of my own, which uncovered something both sides seem to overlook.

The facts

The first run-up in the gold price happened from 1970 to 1981, a decade of ridiculous inflation. The chart confirms the narrative working as advertised: high inflation = gold price rising.

Then Paul Volcker killed inflation with sky-high interest rates, and America had 20 years of stability, low inflation, and high growth. While the S&P 500 soared from 100 to 1, 500, the gold price languished and actually went down a little. The narrative held, if only in the negative.

Economic cycles are relentless, and the bursting of the dot-com bubble sent America into recession. Again the narrative held as the gold price took off.

The economy recovered after the dot-com bust, as it always does,  but this time the narrative didn’t hold. Instead of the gold price remaining steady or even dropping, it kept climbing. This rise didn’t line up with the narrative as before, but the gold bugs didn’t care. Any rise is a good rise and, for them, requires no further explanation. “See, we were right all along!”

The bashers didn’t have an answer, because how can you dismiss such a dramatic rise when it’s right there?

In the same way, the narrative can’t explain the drop of 2013. This time it’s the bashers crowing, “See, we told you all along!” and the gold bugs are left with not much more than their old standby, “Just you wait.”

The missing factor

What both sides seem to have missed is a new element introduced around 2003: exchange-traded funds.

Before 2003, the only people who could own gold in any significant quantity were governments and super-wealthy individuals. Physically owning gold is cumbersome. It’s heavy and valuable, requiring specialized storage. In days gone by, the wealthy stored their gold in bank vaults, but after Franklin D. Roosevelt literally confiscated all that gold in 1933, and outlawed gold ownership, owning gold became even trickier.

That changed with the introduction of gold ETFs around 2003. Through an ETF, anybody, including you, can own a slice of a gold bar, because the ETF buys physical gold bars for all the dollars invested in it.

While each individual might not own much, together they added an enormous new chunk of gold ownership. GLD, the largest gold ETF, physically owns more gold now than anybody except the four largest governments in the world! And that’s just one of the ETFs.

However, this is ownership of a kind gold has never seen before: empowered fickle individual investors. If you own a few bars of gold, buying and selling is a cumbersome and slow affair, rendering the investment illiquid to a large degree.

No longer. A few clicks of the mouse and voila! Your gold ownership doubles or vanishes in a second or two.

Nobody includes this new development in their debate over future gold prices.

The future

In the final analysis, gold has only one value: what other people think it will be worth in the future. When you invest in gold, you’re saying: “other people will reckon this stuff is worth more than it is now.” Gold never has had any other value.

The narrative, as it stands today, looks similar to the eighties:

  • Inflation fears: despite quantitative easing, there are more signs of deflation than inflation (e.g. copper prices).
  • Weakening dollar: the dollar is at a multi-year high.
  • Recession: gone — we’ve had 25 consecutive months of positive GDP growth since 2009.
  • Social upheaval: we’ve had no major riots for almost 50 years.

The narrative, then, dictates that gold prices should be stable, and possibly even declining.

We know there will be another recession; those come every 7-10 years. The dollar will decline again, it always does. Inflation and social upheaval are wild cards: they may or may not happen. Put together, that means the gold price will go up again… at some point. It may be next year, it may be twenty years from now.

Until then, though, the ETF demand growth seems to be in the throes of stabilizing itself. If that continues, we could therefore continue to see the gold price decline further. If that happens, fickle individuals and hedge funds may abandon the metal and the price of gold will continue its slide until the next disruption.

What do you think? Are you a gold bug or basher?

8 Responses to “The gold price fight of 2013”

  1. Anonymous

    Brilliant take on the gold fight. I canâ??t agree with you more on the ETF argument after listening to this reasoning about the October 11th gold price drop. While there are hardly any 100% verifiable arguments about the dramatic ups and downs of the gold price, Iâ??m inclined to believe the â??narrativeâ??. Ok, I guess you got it by now, Iâ??m a gold bug 🙂

  2. Anonymous

    Right now, cash is more liquid than gold. In the past, cash and gold were one in the same because cash was merely just a receipt for your gold. People started trading the receipts instead of the gold because it was easier to just leave the gold in the bank. Now we have just a bunch of receipts floating around that are not backed by any gold and the only reason people still trade the receipts is because they are under the illusion that they will always be able to pass it off to the next guy and the next guy is going to be stupid enough to accept it. This system pretty much works for now, until it doesn’t. When the dollar collapses, it will be fast, not slow. I say “when” instead of “if” simply because all fiat currency has collapsed in the entire history of man.

    While gold’s value relative to cash dropped 25% in 6 months, that does not mean it is or is not an investment because the volatility of an asset has absolutely no bearing on if that asset is an investment or not. For something to be an investment, it must have the ability to produce income. Stocks pay dividends (and the stocks that don’t retain those earnings for dividend payments later). Bonds pay a coupon. Real estate earns rents. Gold is simply not in that category because over the long-term all it does is hold’s its value. Sure, you might get some short-term volatility, but long-term it goes down in price as other goods go down in price or gold goes up as other goods go up. All gold is supposed to do is maintain purchasing power over the long-haul. Nothing more and nothing less.

    Currencies can and do drop 25% in less time than that, although this hasn’t yet happened to the US Dollar.

  3. Anonymous


    Great article. Since Nixon eliminated the Gold standard, Gold will always be the anti dollar. When the dollar goes up gold will go down. Given that the American economy is on the rebound, and that the price of Gold is at a high, I can only see it reducing in the next few years. Invest in other commodities!


  4. Anonymous

    My point is: nobody “invests” in cash. Cash is an extremely liquid and universally accepted form of payment for goods and services (unlike gold). If you want to spend your gold-wealth, you need to convert it into cash first — and lose some of that wealth on conversion/dealer fees in the process.

    Cash is a horrible “store of value” when you are talking about long periods of time – hence why nobody uses cash that way. The US dollar, by design, is extremely stable over the short-term, yet will lose 1-3% of its purchasing power every year on average. This is by design, it is not a conspiracy.

    Gold Bugs always use this comparison to cash to make gold investments look superior. You claim gold is not an investment but it is: otherwise how do you explain a 25% drop in a 6 month timeframe against a currency that is inflating at 3%? Speculative investing is the answer.

    Why not do your gold comparison against what us gold-bashers actually use for our long term store of value: stocks, bonds, income generating real estate, etc?

  5. Anonymous

    I’m not saying you literally have to bury it in the ground. If you did, you could use $1 coins if you’re concerned about it rotting.

    While the very short-term value of cash and gold is up in the air, the long-term value is not. With nearly absolute certainty, gold will maintain its purchasing power whereas cash will not.

    Something to keep in mind is that the gold to oil ratio is seriously out of whack right now. Despite gold prices being in a long-term bull market and still relatively high vs. past years, most gold mining companies cannot make a profit mining the stuff because mining costs (related to the cost of oil) have increased much faster than gold prices. As a result, new mining is being taking off production and new gold supply is quickly drying out.

    This means one of two things will happen. Gold is either indicating that oil prices are going to crash in the near future or oil prices are indicating that gold prices will surge in the near future.

  6. Anonymous

    Who would bury $10,000 in cash in the ground? I agree if the goal is to bury something in the ground, then you use gold for that, not cash.

    Cash will rot — gold stays gold and the atoms are unaffected. However the future “value” of gold is just as much up in the air as the future “value” of cash.

    If you dig up the gold you buried in January, and traded it in for cash today, you’d find that you lost 25% of the “value” — so to each his own.

  7. Anonymous

    I’m a gold bug and I think we will see $2,500 gold within the next 18 months. I think it is important to remember that gold is not an investment or a alternative to investments. Gold is money and it is therefore an alternative to cash, not stocks or bonds. If you buried $10,000 in cash or $10,000 in gold in the ground and dug it up 50 years later, which do you think will be worth more? The answer is obvious to me.

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