The Price of Gold: How High Can it Go?

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The price of gold has declined so far in 2005 and the market does seem "gloomy." As of this writing, gold is dipping under $420 per ounce (now in the $440s). However, there are some bright forecasts out there for 2005 and beyond. Dr. Murenbeeld expects gold to average $430 an ounce in 2005 with a thirty percent probability of the average price being as high as $470. Analysts at Canaccord Capital maintain their gold and silver forecasts for 2005 at $465/oz and $7.15/oz, respectively. Over the last few years we have heard and read forecasts of $500, $600, $750, $1000, and $1200 per ounce.

So how high (or low) can the price of gold go?

My thesis that I present to you today is that all of the above mentioned forecasts are correct, and they are all incorrect.

The price of gold will go to $430, it will go to $465, and it will go to $470, although we cannot be certain that it will achieve these goals in 2005. I must admit that there is a good chance that the price of gold could continue to soften in 2005 and even to dip back below the $400 level; I also believe that there is a good chance of gold reaching $470 this year.

But will gold reach $500, $600, $750, $1000, or perhaps even $1200 per ounce?

The answer is almost certainly yes.

However, the reason for this affirmative and quite bullish answer also implies that the price of gold will go even higher than $1,200 per ounce. In fact, it implies that gold will exceed $5,000 and $10,000 per ounce.

Discounting any numismatic value for dollars, the ultimate price of gold will be infinity. That’s correct. Those in charge of the printing press will continue to print up dollars until they drive the value of the dollar to zero, making the price of gold infinite in terms of dollars. They will destroy the dollar because they have the power to do so.

You might be thinking that Thornton is crazy or that he is planning on publishing a book along the lines of Dow 36,000, Dow 40,000, and Dow 100,000.

Surely, you would think that the powers that be in Washington, DC had better sense. That they would look at the situation rationally — that they would pull back — why would they ruin the geese that laid the golden egg; that in effect allows them to write bad checks and get away with it to the tune of trillions of "dollars?"

But I am not calling their rationality into question. They will "pull back." They will get together with their monetary buddies from around the world (Britain and Japan, especially, but also the EU, China, Canada, etc.) and sign agreements for the purpose of reestablishing monetary stability and to realign exchange rates. But they will not truly mend their inflationary ways.

What I am bringing to this question is the rationality of the people — you and me — all of us. Eventually "we the people" will realize that they (politicians and their central bankers) have no real plans to stop inflating. This realization means that people will hold fewer dollars and this will fuel the depreciation of the purchasing power of the dollar and a higher dollar price of gold.

The value of the dollar lost 95% of its purchasing power between the founding of the Federal Reserve in 1913 and 2003 as measured by the Consumer Price Index (CPI), but CPI is a flawed measure. It systematically underreports price inflation to help cover up the activities of the Federal Reserve.

Most economists actually think that the CPI overreports inflation, but this is because they are rewarded for coming up with new ways to "adjust" or calculate over time. If an item in the Consumers’ basket rises in price it can be dropped from the calculation, but when consumers turn to cheaper substitutes they get included in the statistical basket. Quality improvements, technological advances, and gains in productivity all need "adjustment" so that inflation can be accurately measured.

This tainted view of the CPI by mainstream economists basically takes the benefits of the market economy and uses them as justifications to underreport the impact of monetary inflation. It’s really a cover-up story. Help the Fed cover up the signs of its nasty practices and you will be well rewarded.

If you didn’t give the Fed credit for all the gains of the market economy in terms of quality improvements, technology, and productivity, we can easily see that the dollar has lost more than 99% of its value.

There is a story that says that if you throw a frog into boiling water it will jump out, but if you place a frog in a pot of warm water and slowly raise the temperature, the frog will allow itself to be cooked and killed. Actually, this is an urban legend. If you throw a frog in a pot of boiling water it will be killed and if you place a frog in warm water it will only stay as long as it is comfortable and jump out long before being cooked. I’m not exactly sure who tested this theory, but I’m quite sure it is correct.

I’m also quite sure that the frog can be seen as analogous to people and inflation. If the economy is thrown into hyperinflation the economy will be "killed" or at least thrown into shock, cardiac arrest, or a coma. If people are exposed to low rates of inflation they can be quite comfortable, at least some of them, like our frog in warm water. However, as the rate of inflation is driven higher, eventually we will jump out. The sooner the better.

The rate of inflation has already risen in recent decades and most of that lost value in the dollar has occurred since the early 1970s when Nixon took the dollar off the Bretton Woods-style gold standard. Since that time, the dollar has lost 80% of its value. Monetary inflation continues apace and some measures of the quantity of money depict even higher rates of monetary inflation.

The case against the long-term health of the dollar:

  1. The Federal Government’s debt continues to increase.
  2. The Federal Government’s deficit continues to increase.
  3. Social Security will not be "fixed."
  4. Growing US population of tax eaters (Social Security, employees, retirees, welfare, contractors, NGOs)
  5. Rebalancing of world economic power (Euro, Japan, China, India)
  6. Holding onto the Empire (Iraq, Afghanistan, etc.)
  7. US dollar as reserve currency (China, Japan?)

The case for owning gold:

I’m not going to tell you to sell everything and buy gold bullion — as much as I’d like to. This scenario — the demise of the dollar — could take decades to finally play itself out. Also, gold is a volatile commodity, and even though this is largely because of the government’s erratic inflation policies and warfare tendencies — the price of gold is still volatile in both directions.

Traditional investment advice says to hold 5—10% of your money in gold and other inflation hedges. The danger levels are now much higher than traditional levels and so that percentage should also be increased. If I were Tom Ridge, I’d call this one an orange alert or even a red. Certainly over the next two years we are looking at more borrowing by the federal government, higher prices, a lower dollar, and eventually a recession in the economy.

A friend of mine whose job it is to help promote gold sales tells people to only buy gold with the money that you cannot afford to lose. For most Americans this would be everything they have except the ordinary expense money in their checking account. The really scary thing is that the majority of Americans are net debtors (symptoms of inflation and the bias against savings created by Social Security and the tax code).

I’m never sure about my own predictions and forecasts and am always amazed when they come true. If you want to hedge your bets then only put 50% of your money in gold. Then you are partially covered if gold skyrockets and partially covered if it flounders over the next couple of years. With at least 50% of your assets in inflation hedges like gold, every drop in the dollar will be compensated to an extent by increases in the gold price. Inflation hedges like art and real estate have certain advantages, but they also have disadvantages, so if they are in your portfolio you need to know what those disadvantages are. I am personally invested almost 100% in inflation hedges including gold, collectables, and natural resource companies, such as gold and oil companies. Oil is the hot commodity at the moment.

Despite these dire words I am optimistic about the economy in the long run. I even hold illusions, possibly delusions, that future politicians will see paper fiat money for what it is and make the rational decision to shut down the central bank, recall its paper, renounce its monetary authority, disgorge itself of our gold, and balance its budget at a greatly reduced level.

Even this optimistic scenario, gold investors will still have invested in something as good as money.

This article is based on a talk given at the Mises Institute’s 2005 conference on Austrian Economics and Financial Markets.

Mark Thornton [send him mail] is an economist who lives in Auburn, Alabama. He is author of The Economics of Prohibition, is a senior fellow with the Ludwig von Mises Institute, and is the Book Review Editor for the Quarterly Journal of Austrian Economics. He is co-author of Tariffs, Blockades, and Inflation: The Economics of the Civil War and is the editor of The Quotable Mises (available soon).

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