The reality for gold bulls may fall short of their expectations of ever-increasing prices that run ahead of gold supplies, says a self-described gold bug who forecast the initial run-up of gold at the turn of the millennium but who now finds himself frequently cast into the bear camp for bullion.
“I’m not always a gold bull but I am a gold bug,” says Paul van Eeden, president of Cranberry Capital Inc., a private Canadian investment holding company, ”Gold to me is money. But the price of gold when we quote it in US dollars is merely the exchange rate between gold as money and dollars as money. That's what the gold price is. It's an exchange rate.”
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Van Eeden told the 2012 Chicago Hard Assets Investment Conference that for gold to be worth three times more than it was in 2007, when afternoon London gold price fixing ranged from $609 to $841 per ounce, would require 300% inflation.
“The gold price has now tripled from from 2007,” Van Eeden says. “But where is the inflation? So I have a question. Why would you buy a safe haven? Why would you buy an asset like gold to protect yourself against inflation of the money supply but you are prepared to pay three times what it was five years ago? Is that rational? Does it make sense to pay three times more for gold than it was five years ago because you're afraid maybe, maybe there will be future inflation that would make gold worth more than what you’re paying for it?
“Understand this: for gold to be worth three times more than it was in 2007 we’d have to have 300% inflation. Is that what you expect -- 300% inflation? Over what period of time? How many years will you have to wait for the inflation to catch up with what you're prepared to pay for gold today?”
He noted that the actual inflation rate of the US dollar between 1900 and 2012 had been 6 1/2%. “Remember the 70s with all that inflationary boom?” he asked. “The average inflation rate for that decade was 8.8%. That's statistically different from 6.5%. It was in fact a genuinely bona fide period of high inflation.”
The period from 2000 to 2009, selected by Van Eeden because it predates the US Federal Reserve’s first quantitative easing, showed an average inflation rate of 8%. And since QE1 was introduced the average inflation rate has been 6.7%.
“I ask you, ladies and gentlemen, where is this inflation that everybody is so afraid of? Where is it? Why pay $2,000 for gold to protect you against this inflation? Why is it rational? Look at what the gold price is doing lately,” he says.
A chart of recent gold prices can be looked at in one of two ways, Van Eeden says. “You can be bearish and say, well, the top is in and that's the beginning of the downtrend. Or you can look at the little tail, the little upswing at the end. That's QE3. And you can say ‘Oh, QE3 was announced. It's all over now. Game over. Dollar is toast.’
“But look at the expectation that's already built into that price. Ask yourself is that expectation rational? This expectation that it's over for the dollar -- is that rational? And even if QE3 – because of the psychology of the market -- does take the gold price higher, much higher – $2,000, $3,000, $5.000, I don’t know, how high can it get? Very high. But why? Why would it get so high? It would get so high because of momentum, fear and expectations -- not reality.”
Van Eeden notes when gold and the dollar is reviewed over a longer period of time one finds more interesting things but that this also first requires statement of the basic assumption of the analysis. “The basic assumption of the analysis has only two aspects to it. The first thing is that gold is money. That's my belief. I believe gold is money and if gold is money then the relative value between gold and another form of form of money like US dollars is determined by the relative inflation rates of those two supplies of money.”
Both of these can be calculated reasonably accurately, Van Eeden says. “Gold inflation is merely mine production on an annual basis,” he notes. “That's how much the gold supply increases every year. US dollar inflation I can calculate because the Federal Reserve is kind enough to publish the data. So we look at the gold price relative to a figure -- what I call a value basis of gold. That value figure is calculated by looking at the relative inflation rate of gold vis-à-vis the inflation rate of the dollar since the year 1900. That’s a lot of data. Its 112 years worth of of data.”
Focusing on the period of the late 1970s, which he points to as the period of the highest inflation in the last 100 years, Van Eeden notes that the US dollar was then busy falling against world currency markets. “The dollar was doomed,” he says. “The investment public in 1979 said ‘The dollar is over. It’s going to zero. The United States is toast. We have to buy gold. We have to protect ourselves against inflation.’
“And that expectation of future inflation was so high that they were prepared to pay on average three to four times more for gold than what the gold was worth -- to protect themselves just in case. Maybe in the future these fears would come true. Of course that's history.
“We know what happened. The fears were unfounded the dollar didn't go to zero and the gold price started a long period of decline. It took from 1980 to about 1995 –15 years for the gold price to decline and the value gold to catch up. That value gold is catching up because dollar inflation is greater than gold inflation.”
Dollar inflation, Van Eeden says, is 6 1/2% on average for the past 112 years while gold inflation for that same period is about 2% and it is a little lower right now because mine production is slowing down. “But it took a long time for the value gold to catch up with where gold was trading -- 15 years. But the momentum of that, the momentum of gold going down now carried on so the gold price fell below its value
“You'll remember 1995 to 1999 – actually ‘96 to ’99, that’s when the gold price fell. Try to remember what did the market say about gold then? ‘Gold is doomed. Gold is going to zero. Gold will never be used as money again. It's been the demonetized. The central banks are selling it, the public doesn't believe in it. Gold is going down. Gold will never go up again. It's over for gold. The dollar is king. The dollar is where we should be.’
“My how things change. Expectations changed. Expectation of inflation changed into expectation of no inflation or even deflation. And those expectations were just as real as your expectations now of inflation.”
Van Eeden recalls that it was around that time – 1999 – that he gave his first public talk on gold when his analysis showed that gold should probably be trading closer to $500, $600 or $700 an ounce. “I went out on the speaking circuit and gave my analysis and said I think gold is going to be $700 an ounce. Gold was at the time trading at $250 an ounce and people said ‘You’re crazy. You’re a lunatic. Gold will never go up again. There is no inflation. Gold is not money.’
“Look what happened now. Gold did go up to $700 and then the momentum carried on. And now there's all this fear of inflation. We’re back where we were in 1978 or 1979 or 1980. I don't know on an analogous time basis where we are. Are we in ‘79 or 1980? I don’t know. But what I do know is that history repeats, never exactly the same but more or less. And those that refuse to look at history are doomed to repeat it.
“People who bought gold in 1979 and 1980 on unfounded fears of potential future inflation had to wait 15 years for that gold to become worth what they paid for it. That’s a long time. That's a long time to hold an asset.”
Paul Van Eeden will give a welcom keynote addess on Friday, Nov. 16 as well participate in a "Bulls and Bears" keynote panel and conduct a free education workshop on on Saturday, Nov. 17, during the San Francisco Hard Assets Investment Conference.
Phil Burgert is managing editor of ResourceInvestor.com. He can be contacted at pburgert@resourceinvestor.com