The Age of Gold

Previously by Robert Blumen: Mad Men: The Show About Business

Jay Taylor: Welcome back to "Turning Hard Times into Good Times," I am your host Jay Taylor, and I'm really pleased to have with me my friend Robert Blumen. Robert is a software developer who writes and blogs frequently for the Ludwig von Mises Institute, their website. His articles have appeared in, Economic Affairs, Marc Faber’s Gloom Doom & Boom Report. We've had Marc of course on this show on a couple of times in the past. He also writes for the Agora Publications' daily emails.

Good to have you with us and I did mention to the folks your background, a little bit about your background. So welcome to "Turning Hard Times into Good Times."

Robert Blumen: Thank you, Jay!

Jay Taylor: Well really a pleasure to have you here from San Francisco. You are a lucky guy I think living in San Francisco. I wished, I would trade San Francisco for New York, I think, and probably at least the climate, that’s for sure.

Robert Blumen: I think we are in a – to see which is going to go broke fastest.

Jay Taylor: Yeah, I think you guys will beat us on that score, but not by much. We had some people on this show not that long ago, who actually talked about San Francisco and the finances in San Francisco. So we do know something about it, but the whole idea is that you can – I guess that you can have wealth and you can – you don’t really have to work for, you can just sort of imagine it and create it out of thin air.

But let’s talk about gold-mining today, Robert. This is what we wanted to talk to you about. This show as you know is so much about gold mining, about gold, about protecting wealth. And we are constantly hearing on this notion, I mean, because people really look at gold like as any other commodity. They think that higher prices of gold are going to increase gold-mining, that’s happening.

We know – I see a boom in the junior mining sector, see companies going out, spending money, putting holes in the ground and discovering deposits. We are seeing it rising, gold-mining profits are occurring now. Certainly, this is what I call a buying opportunity of a lifetime, the bull market of a lifetime for gold-mining stocks.

So normally, you would think that with rising supply you would have a declining price, but you wrote an article called Mining Doesn’t Matter, in which you claimed that gold-mining has little impact if any on the gold price. Well, what motivated you to write that article?

Robert Blumen: Well Jay, as you are just saying, anywhere you look around in the media people are aware that mine output is increasing. I read tons of these reports from analysts, people at banks, things in the media about gold. I would say 90% of the time if there is a 50-page report about gold that 40 pages of it is going to be about gold-mining and then they give their forecast.

Any one, all these analysts who hear Jon Nadler, Jeff Christian, anyone who writes about this, does quantitative studies of mine supply and they base that on their forecast.

So the reason for writing about this is I know that this is the wrong way to look at it and I wanted to help people understand how it really works.

Jay Taylor: Well why is it the wrong way for looking at it? I mean it certainly seems to be logical. If you have rising supplies, normally all other things being equal you would expect the price to decline. Wouldn’t that hold true for gold as well?

Robert Blumen: Certainly, that is true, but there are two ways of looking, or there are two different kinds of markets, there is commodities and there are assets. I’m going to define these in an idealized way, nothing really is perfect. But for the purpose of discussion, a commodity is something where there are no accumulated stockpiles of it.

So in the case of a commodity whatever gets produced also gets sold, it gets purchased and it gets consumed. And by consumed I mean it’s destroyed. It’s transformed into a form where it is taken off the market permanently.

An example of that would be gasoline or any agriculture, something you eat. You buy it and you destroy it. So for a commodity the supply and the demand have to be very tightly balanced and if one of them changes the other one has to change. And the way that is accomplished in a market economy is through price. If you would have more supply the price has to go down.

The other type of market is what I am going to call an Asset Market. And let’s say for the moment an asset market in an idealized way is the market in which there is a certain stockpile of the asset, which doesn’t change. And in asset market, you can’t really look at quantity supplied and quantity demanded, because the quantity is the same. In asset market, the quantity of the existing stockpiles is traded around among different people. So gold is an asset.

Now the gold supply does grow a little bit each year, it’s between 1% or 2%, but the market is dominated by trade among the existing stockpiles of gold, and that’s how the price is formed.

Jay Taylor: All right, so we’ve had – so basically what you’re saying is that the gold is the mine going back, maybe thousands of years is still in a stockpile somewhere –

Robert Blumen: That's right.

Jay Taylor: – or around world.

Robert Blumen: There's about five billion ounces of gold above ground according to some estimate.

And the mine supply is somewhere in a 1-2% of that amount each year.

Jay Taylor: So gold is not an annual market then, it’s more like a financial asset as you are saying, were existing holdings the trade essentially. So what’s driving the gold price. We’re seeing a rise in the gold price from $250 back in 2002 to over $1400?

Robert Blumen: You could ask the same question if you’re looking at any other financial asset like suppose there was a company you follow, Jay that had a 100 million shares outstanding and that a company for whatever reason did not see the need to issue anymore shares, and yet you see the price going up. Then I don’t think anyone who is looking at that would say that the prices moving primarily because of anything to do with the quantity of shares, that people are revaluing the existing asset.

So what is happening with gold is people are revaluing mostly the existing gold in terms of Fiat money that they are placing a higher valuation on it, and we don’t know necessarily why that is exactly but it’s got to have something to do with the quantity of Fiat money increasing or people anticipating that there will be further increases in the quantity of money. And that quantity of money I can make a pretty confident prediction that quantity of money is going to grow faster than the quantity of gold over coming years.

Jay Taylor: Well, that would seem to be a somewhat safe bet right now, Robert, I think that given – the mindset of Mr. Bernanke and others, I don’t think you’d find too many people who would be willing to take you up on that bet.

So we’re seeing a rise, a dramatic rise in the price of gold. It is definitely a spring gold-mining production, those of us who follow this industry closely know that it is a very difficult thing to put a gold mine into production, it’s not, I mean it takes years and years to do it.

But you’re saying even if there was a sudden surge in the gold supply it wouldn’t necessarily have much to do with the gold price if the quantity of money was increasing at an equal or greater pace perhaps.

Robert Blumen: I’d say that, yes. Part of if you – I was just reading an article in the Canadian Globe and Mail the othe I’d say that, yes. Part of if you – I was just reading an article in the Canadian Globe and Mail the Globe and Mail the other day, and I have probably seen a hundred articles like this. If you look at the annual figures somebody was writing about how the gold supply annually had increased from 1500 tons per year to 3000 tons per year, and that looks like wow the supply of gold has doubled.

You look it on an annual basis but if you look at the total amount of gold out there, it’s not really that impressive. It may be is up 10% or 20% over that period of time, which is probably the amount of money supply grows in a year. So definitely, money supply is far outpacing than growth in gold supply.

Jay Taylor: Of course, the last great bull market in gold ended in 1980, when Mr. Volcker slammed on the brakes, well, I don’t know if that’s the right terminology or not. Let’s say he reduced the growth and the money supply very dramatically, and we did see gold fall from 850 to I don’t know 300, ultimately to 250 or so. I guess you don’t think that prospect is very great, that’s not likely to happen again anytime soon in your view.

Robert Blumen: I don’t think there is a political will to do that. Volcker was willing to take a lot of heat and Reagan was in his corner. Reagan understood what he was doing and said, look people hang in there, things are going to get better once we get this inflation under control. I see no real understanding of that among the political class in this country anymore and no political will to endure pain for any length of time in order to fix the problem.

Jay Taylor: Well would you suggest that the pain might be greater this time around than it was in 1980 or the problems much bigger than they were in 80s, so that even if that solution were proposed or if it were, it implemented that it would resolve and considerably more pain than we had in the 1980-1982 time-frame?

And I remember, I was fairly a young man then, and I remember it was a very severe recession, it was at that point in time the deepest recession that we had since the Great Depression, but do you think it would be much worse if they tried to impose a policy like that now?

Robert Blumen: I’m sure, Jay, you and your listeners have seen these charts of Debt-to-GDP ratios and debt compared to other things. All those charts have been in a pretty steep uptrend. There is a lot more leverage in the system now than there was back then. They figured out kinds of creative ways to make things more highly leveraged, so there is a lot further to fall on the downside.

Jay Taylor: So going back to this – it’s sort of the general consensus or the approach that analysts take these days. Essentially the analysts of the gold price, you’re saying basically they are really focused on supply, do they look at the demand side at all?

Do they look at the notion that because money supply is growing very dramatically that we are going to have the surge in demand for gold as they store a value?

Robert Blumen: The majority of analysts do not look at demand in that way. What they look at is they will give a number for demand. They'll say this year demand was, for jewelry was this many ounces and investor demand was this many ounces. The reason they do that is because they are trying to compare it to this supply number, which they got from mine supply and maybe they throw in scrap. But in my view, that number, they come up with for demand is a meaningless number and let me explain that.

Suppose we were talking about shares of a stock, you had some stock, you told me to go analyze it for you, I come back to Jay, the demand for this stock last year was 10 million shares and the demand for this stock next year will be 20 million shares. What would that mean? When we are talking about something – you could look at the trading volume.

Let’s say that I went and looked up on my favorite financial website, there were 10 million shares traded. That tells you nothing about the price because as you know, a stock could go up on increasing volume or it could go down on increasing volume or it could go side-ways on decreasing volume, the trading volume tells you nothing about the direction of the price.

Now we can’t say that if there were 2500 tons mined that there is going to be a buyer for everyone of those tons or ounces so the volume of gold in the market during any given year will be greater than the amount supplied. But that still really tells you nothing about where the price is going because the real question is, what value will those ounces be traded at? And that depends on the evaluation that the existing market places on the gold versus the dollars. It doesn't depend on any kind of number. You can’t analyze gold quantitatively the way you would analyze a commodity where there is no stock pile.

Jay Taylor: So it really boils down to a confidence or not in the dollar, and if there is a loss of confidence of dollar, we are certainly seeing this happen, people are trading in their paper money internationally as well as people that sort of understand what you are talking about. To an extent, people understand that their paper money is losing value. They understand that Mr. Bernanke does these QE maneuvers that he is basically debasing the currency.

I mean, it’s amazing to me when you think about the Chinese, maybe a mass something like, what, 2 or 2.5, or 2.7 whatever the number is trillion dollars by working hard, sending us products and accumulating foreign reserves and Mr. Bernanke came with a few keystrokes to basically create two trillion dollars out of nothing, and sort of without doing anything, it’s just amazing, and I guess some people are starting to get it.

So to what extent though and to what extent do you think that some of the analysts might finally catch onto this, I mean I think you can go to place like Sprott in Canada, Eric Sprott and his analysts certainly understand this, but John Nadler has been calling for lower gold prices every year over the last ten years and we've had nothing but higher gold prices every year.

I mean you have to wonder why he doesn't change his thinking, but anyway, you wrote an article, The Myth of the Gold Supply Deficit, what was that about?

Robert Blumen: That was about, this is a related error in looking at the gold price. It’s based on the idea that there is a supply deficit. This idea of the supply deficit prominently promoted by GATA, it’s an organization. I know you had on your show and I think they do a lot of great work, but in this particular case, they are wrong. So I will explain why.

Suppose we had a commodity like oil and a given country had a 30-day stockpile of oil. Let’s say they doubled their consumption. So each day they are drawing down their stockpile by one day’s worth. We can be sure that in 30 days that process has to end. That is a reasonable definition of deficit because you are exhausting a stockpile, and when that stockpile is down to zero, either they have to produce more or consume less, which is going to require a higher price.

But in the case of an asset, let’s say the environmentalists win. No more gold mining, we just have to make due with the gold we have. So you notice that during a given year, there was ten million tons traded.

Well does it make sense to call that a deficit? I would say, no, because the gold is not destroyed. It’s simply shifted around among different ownership, and there is no limit to how much volume of shifting around can occur. You never run out because you are not destroying it, you are moving it around.

So the idea that there is a supply deficit because more gold is traded than is produced, that is an incorrect way of thinking about the gold market.

Jay Taylor: All right. We have had Bob Hoye on this show, and I don't know you’re somewhat familiar with Bob Hoye’s work. Bob has talked about these great credit contractions that occur and he’s noted that the real price of gold, that is the price of gold in terms of what you can trade gold for other commodities and other items, goes up during these major credit contractions. Bob Hoye points out that during these times it does serve to increase the gold mining profits, gold mining activity, gold mining production, and that it actually tends to then re-liquefy the banking system with honest money. But I have an idea that you wouldn’t necessarily buy that argument?

Robert Blumen: There is something really important about what you just said, I wrote an article about how the gold – mining does not really influence the gold price, but in the other direction certainly the gold price will influence the gold-mining, because the higher the price of gold, the more sub-marginal deposits become economically mineable.

So it totally makes sense what you’re seeing in the market and what Bob Hoye describes that as the price of gold goes up you would see a boom in gold production and maybe the supply grows by 2% a year rather than 1% a year.

Jay Taylor: Okay, well we’re getting this gold supply increase, that is true, and as you say it’s not very big relative to the total amount of stockpile of gold, but do you think there will be a problem with the markets absorbing this new supply? I mean, it doesn’t seem like there would be given the kind of quantitative easing that’s going on, but –

Robert Blumen: One of the things you see in all these articles that people are saying that gold supply is 1500 tons and half of that was jewelry and half of that was investor and now it goes to 3000 tons where is all the new demand going to come from?

So I went and looked up some figures for the LBMA, which is Bullion Investor Bar Market in London, it’s one of several bar markets in the world. Just based on LBMA volume, they absorb an entire year’s mine supply in about 12 trading days.

Jay Taylor: Wow!

Robert Blumen: Now there are other bar markets in other nations and there are coin markets. So the volume of these markets is so great that entire year’s mine supply can be absorbed in just a few days. So now, I see no problem in the market absorbing the supply.

Jay Taylor: Robert, I can sympathize totally with you because I am battling a cold and it’s really a difficult task. We’ve got a couple of minutes left, so I hope we can hang in there with this. If it’s not mining, so how is the gold price set then? I mean we could just be little bit more clear about that, then if it’s not the supply and the gold is coming from the mines, so what is really setting the gold price?

Robert Blumen: It’s the valuation that people who hold gold, at what valuation are they willing to sell, and the people who hold dollars at what valuation are they willing to bid. And the market brings that all into a balance where you have a price in the same way that it does for stocks or land or any other asset.

Jay Taylor: Okay, so how can we forecast the price then? Now we’re looking at increases in money supply, is that what we’ve to look at, not only the US dollar but currencies around the world?

Robert Blumen: Yeah, it’s bit of a tough asset to forecast because unlike stocks it doesn’t have a net asset value, and it doesn’t have a dividend, it’s something that people value in order to hold it and it’s a little bit hard to get your head around that quantitatively.

Really, you've got to have something to do with money supply growth, but I think anyone who has a quantitative model, they’re giving you a very precise forecast that’s probably baloney.

Jay Taylor: And baloney why because you can’t predict human behavior or what?

Robert Blumen: We can’t – in the case of – let’s say a stock that you analyze and it’s – you can get your head around the net asset value because you’re looking at what their assets would trade at in an external market, and you can make the argument that a stock should eventually trade at its net asset value. But gold, you can’t really decompose it any further. It just comes down to the valuation that people place on it, and you can’t have a quantitative model that will tell you that to any real precise degree.

Jay Taylor: Well, we’re just about out of time here, Robert, we have 30 seconds left, but let me just ask you all that said, are you bullish or bearish on gold at this point in time?

Robert Blumen: I’m bullish.

Jay Taylor: Why?

Robert Blumen: I can’t quantify it, but I give you my very confident forecast that money supply growth will be faster than gold supply growth and I’m expecting that whatever imprecision there is in that model that I can get the direction right, which is up.

Jay Taylor: All right. Well, thank you so much for that. It certainly does seem to be almost as sure as day following night these days, the way that the mindset is in terms of the Keynesian Economic Models upon which all our policymakers are operating.

Well, thank you very much, Robert Blumen, for being with us, we hope to have you on again for some of your Austrian Economic insights.

Robert Blumen [send him mail] is an independent software developer based in San Francisco.

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