Highest Gold Value Ever

by Jim Otis, the Optimist | January 2, 2009

Happy New Year

As is obligatory for commentaries written on January 1, I offer my wish for readers to be healthy, safe, happy, and prosperous throughout the new year.

2008 in review

It is also required this time of the year to recap the most significant events of the preceding year. This Optimist does not want to break any rules, so here is my detailed summary of 2008. Precious metals and energy prices rose strongly, and the price of gold exceeded $1,000 for the first time ever, in March 2008. Then the price of everything (except U.S. Treasuries!) plummeted to unbelievable lows. There was also some political stuff in 2008, and some credit problems, and a few job losses, and continuing criminal activity, and the four horsemen of the Apocalypse galloped around the globe. 2008 was just like every other year, but with higher peaks and lower valleys and amplified systemic noise.

Highest Gold Value Ever

Everybody knows, of course, that the price of gold rose to its highest level in history in March. Many people think that gold then dropped a lot and that it is still way down. Although it is true that the U.S. dollar price of gold did drop significantly from its March high, some people will be surprised to discover that the value of gold actually rose to new all time highs on the final trading day of 2008.

The value of gold is independent of the currency fluctuations of the U.S. dollar or any other currency. Since charts of gold priced in a single currency impose the currency variations onto the price of gold, we cannot see the value of gold by simply looking at a price chart. To show value, it is necessary to filter out the underlying currency variations. That can be done by multiplying the price (in a currency such as the U.S. dollar) times the composite currency exchange rate to plot the value independent of the currency. The MoreAu Index is an approximation of that process in which the U.S. dollar price of gold is multiplied by the USDX trade weighted dollar index. Plotting that product over time results in a chart that tracks the true value of gold independent of currency exchange rate changes. A copy of the chart updated through 12/31/2008 is presented below. Readers are also invited to view the updated chart (each weekend) at the link to the MoreAu Index chart page.

This is not your Grandpa’s deflation

To the surprise of absolutely no one, the MoreAu Index shows that the value of gold reached an all time high early in 2008 as the price of gold approached the $1,000 mark. Since then, the U.S. dollar price of gold has completed a substantial correction, and it closed the year below $900 per ounce. Some investors became discouraged during that pullback in price, and more than a few voices proclaimed that a deflationary environment killed the golden bull. My optimistic viewpoint is just the opposite. Instead of a deflationary environment, I see a severe (but relatively short term) credit squeeze that impacted the price of gold as it drove the U.S. dollar exchange rate sharply higher. As that credit squeeze is alleviated, the additional flow of funds that have already been pumped into the money supply will provide the after burners for a high intensity resumption of the precious metals bull. Indeed, using the MoreAu Index to filter out the effects of currency exchange rates, the chart above shows that the real value of gold ended 2008 at its highest value ever. An all time record high value shows that the gold bull is very much alive and kicking.

Predictions for 2009

My understanding of the rules for writing a commentary in early January is that the author must include specific predictions for the coming year. Since every other commentator does that, the Optimist will not shirk his obvious duty. Read the following with a healthy amount of caution, however, because history shows that some (most? all???) of my predictions have been more or less inaccurate.

Gold will hit a new high price – Gold continues to track the expanding “cornucopia” channel I constructed two and a half years ago. As the current credit crunch dissolves into higher inflation, I think it reasonable to expect gold to once again race to the top of that channel. I am hopeful that the U.S. dollar price of gold will approach $1,250 within the next 12 to 16 months.
Silver will do very well – Silver has been a neglected and almost abandoned orphan in the economic storm. The common wisdom says that economic activity is slowing, so industrial metals like silver will have reduced consumption and should be sold. Past readers of the Optimist will attest that my views are neither common nor wisdom, so I am free to take a contrary approach. Just as fewer houses being constructed reduce the need for copper wires, and fewer automobiles being built reduce the need for platinum in catalytic converters, the quantity of silver needed for many industrial uses is also likely to be reduced. In the case of silver, however, the reduction in industrial demand is likely to be more than offset by a greater reduction in the supply of silver which is produced as a by product of base metals mining. As base metal prices and production plummet from reduced economic activity, the sharply reduced supply factor should provide a positive tone for silver prices. Also, if the odd silver sidestep cycle continues in 2009, then it is possible that the price of silver could target $25 per ounce in the next 12 to 16 months.
Energy prices will recover – Not even an optimist like me can hope that energy prices will remain at their current low levels throughout 2009. My guess is that continuing demand coupled with rising world tensions will soon begin to push energy prices back up to around double the levels they had at the end of 2008.
The U.S. dollar will resume its decline – The sharp rise of the dollar in 2008 appears to be directly caused by a major credit crunch, but the fundamentals of the USA will not support a rising dollar for long. The slowing USA economy is contributing to the current credit problems, but it is also significantly weakening the economic strength of the United States. As the economy continues to decline, tax revenues received by all levels of USA government will drop precipitously, and the result will be a widening financial crisis. The dollar will respond as it always has in similar problem circumstances by plumbing new lows in exchange rates.
Inflation will thrust higher – Readers who agree with me that energy prices will increase and the dollar exchange rate will suffer are likely to also support my view that price inflation will resume its acceleration. That does not, however, mean that all prices will increase. Pressure could well continue to depress the prices of housing, and automobiles, and luxury items like big screen TVs. Things that people can do without (such as owning a McMansion instead of renting an apartment, or owning three SUVs when one small car would do) will be under continuing price stress. The things that people must buy (gasoline, food, clothes, rent, etc.) will resume taking ever larger bites out of the available funds that families can spend. The higher prices for essentials combined with added pressure that reduced employment opportunity will impose on families will make 2009 a very difficult year for many.
Buying food and improving security now will be a great investment – Bullish as I am about the prospects for precious metals, I continue to view them as only the second best investment that one can make. This is an excellent time for everyone to review their personal security posture, and to increase the amount of food they have available for emergencies. I hope that readers will not need either improved personal security or increased storage of emergency food, just like I hope that they will not need to collect on fire insurance. In troubled times, it is less important to worry about what we hope we will need, and more important to insure our families against risks that could be severe. Best of luck to everyone throughout 2009. Cheers!

Disclaimer: This commentary presents only the viewpoints of the Optimist and it is intended only for perspective and entertainment. Please do not interpret any portion of this work as investment advice. If any of the concepts discussed here appeal to you, then you must do the work to decide if and when and how you should invest. The Optimist does not ask for any profits you make, and he cannot be liable for any losses incurred as a result of your investment decisions. The Optimist wishes you the best of luck in whatever you decide to do or not to do.

The Optimist cautions all readers to not base their buy or sell decisions on this work alone. This is useful input, however, when determining whether markets are low and green, or high and red, or yellow in between! The Optimist expects that this will inspire many questions and comments. He encourages all readers to add their questions, answers, and comments to the forum sections at the bottom of each page in the Optimist site. Cheers!

Jim Otis, is an author, active investor and retired engineer.

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The opinions of FSU contributors do not necessarily reflect those of Financial Sense.