July 2022

We have all heard that history does not repeat but it rhymes. Yes, but that truism is not always true. While some things ebb and flow in somewhat cyclical patterns, other things change.

Nature often is characterized by cycles. There is nothing natural about financial markets. Financial history is cluttered with secular changes that blew away cyclical expectations.

This is readily apparent in the gold market, where beliefs about “close” correlations between gold prices and exogenous variables such as the dollar, inflation, money supply, and federal debt abound.

Yes there are relations between gold prices and these factors, but they are not point for point, and they do not move in lockstep.

Since 1970, shortly after gold prices were freed from being tied to the U.S. dollar in April 1968, only 9% of the monthly moves in gold prices have correlated to moves in U.S. CPI measured inflation.

Over the same time an investor trading gold on a monthly basis against the dollar would have lost 66% of the time. The monthly correlation between gold and the dollar has been -34%.

We could go on but do not need to. The point is that yes inflation, the dollar, monetary largesse, interest rates, profligate government and private debt-fueled spending, and other factors affect gold prices, but the relationships are not quantitatively close, and they have changed dramatically over time.

Knowing what things have changed in a non-cyclical fashion can save investors a lot of money and grief.

Additionally, understanding the differences between past economic, financial, and political periods and the current environment helps.

The inflation of 2021 – 2022 is radically different from the inflation from 1968 through 1982. The relationship between the Treasury yield curve and economic activity changed with the radical revision of interest rate and monetary policies in 2008 – 2011. The past is prelude to the present and future. It is not the present or the future.

Looking at inflation and gold, a lot of investors and others are drawing corollaries between the 1970s and today. But look at the state of play in the 1970s. The Fed targeted interest rates, not inflation, many industries were heavily regulated, international trade was a much smaller portion of the U.S. and other economies, and many other differences existed. There were no futures, options, and other derivatives on inflation, inflation-adjusted interest rates, currencies, equities. If you were worried about inflation, the dollar, or other factors, gold and silver were the only inflation and currency hedges that existed.

Another difference is that the inflation of the 1970s lasted 14 years. The current bout of inflation began in March and April 2021, 16 months from the time of this writing.

In 1979 – 1980 inflation reached 14.3%, after a decade in which inflation regularly was mostly above 5% and already had risen to 12.2% in 1974.

In 2022 inflation reached 9.0% in June. It had been 1.7% just 16 months earlier in February 2021 and core inflation (excluding food and energy) already was falling for three months.

In conclusion, in terms of inflation, this is not 1979.

On top of that you have that 9% historical correlation between changes in gold prices and changes in U.S. consumer prices. The chart below shows how gold prices have risen since 2001 in the absence of inflation. Put it together and the conclusion is that one should rise the same percentage in 2022 as it did from 1976 to 1980.

Money Supply, Inflation, and Gold

Another issue that many pro-gold investors cite as evidence of an inevitable sky-rocketing of gold prices has been the massive monetary accommodation. The view is that the massive issuance of money will unleash, if not it already has, an incontrollable period of inflation that will last years or lead to a collapse of the global financial system.

Strangely these investors ignore the even more massive fiscal stimuli, multi-trillion dollar deficit spending, and other factors that threaten to be far more inflationary and damaging to global economics than the monetary policies. That’s another story, and not for here today.

There are several weaknesses with this theory. First, there have been massive rounds of monetary accommodation since Paul Volcker rolled out and demonstrated modern central bank crisis management techniques in 1982 – 1983, none of which have contributed to short or long periods of higher inflation.

In other words, the theory that massive bouts of increased money supply inevitably causes much higher inflation does not stand up to empirical evidence over the past four decades.

The table above shows a simplified correlation between changes in money supply, inflation, and gold prices. This is for concurrent changes in each variable. Some economists will argue that excessive money creation’s effects on inflation are delayed. Some say the delay averages a year and a half. Gold enthusiasts do not try to quantify the lagged relationship; they just say that excess money supply ultimately, someday, must lead to inflation.

The charts on this page dispel the idea of a lagged effect. Such has not appeared in any of the multiple periods of unusually large increases in M1.

Two versions of this chart are shown. The first one goes through June of this year. The massive 373% increase in money supply in 2020 and early 2021 during the global lockdown masks the previous periods, so a second chart that ends at 2019 is presented to show that while previous monetary efforts to stave off recessions and depressions have been small compared to the current one, they nonetheless were large, significant, and led a lot of people to conclude incorrectly that inflation and gold prices had to rise sharply in response. Neither did.

The reality behind this is that monetary policy changed completely in 1979 – 1983, when Paul Volcker became Fed chairman, destroyed the 1970s-style inflation, brought the world out of the ensuing recession, and then sterilized the inflationary impact that the massive increase in money supply in the second half of 1982 otherwise might have caused.

When Volcker announced his plans to reflate the economy along with the central banks of every other major economy in July 1982, gold prices were $298 per ounce. Gold investors saw what the Fed was doing and bought large volumes of gold, pushing the price to $510 by early 1983. By that point the economy had been kick-started into a recovery. The Fed sold Treasuries to finance the Reagan budget deficits, sopping up the excess liquidity of the previous six months, obviating any bout of higher inflation, and ending the gold price rally.

Other factors were at play in 1982 and 1982. It was not just monetary policy in the United States and other nations that pulled the world out of what was at the time the deepest recession since the Great Depression. But insofar as monetary policy is important, the Fed’s program had a central role in getting the U.S. and global economies out of trouble. More important, the policies set the stage for central bank monetary reactions to economic crises that have been deployed by every major country in every major financial or economic crisis since 1982.

This is one of the reasons why one needs to understand that monetary policies’ effects on inflation and gold prices are not what they were in the 1970s, prior to 1982. Other major changes further reduce the comparability of today’s monetary and financial systems to those of the past, including major changes instituted in and since 2008.

The Madness of Crowds

One thing that has not changed is the periodic flood if investors racing into often valueless “investment fads.”

Just in the past quarter century the world’s financial markets have been whacked by first the tech and internet stock boom of the late 1990s and 2000. Investors poured money into empty shell companies that were saying they would create various internet companies and services. Some of these companies raised hundreds of millions of dollars from investors looking to make fast fortunes based on three and five page ‘business plans’ written by college students. Theranos learned how to do what it did watching this drama unfold.

The tech bubble burst in 2001. Estimates are that at least $1.8 trillion dollars were lost, and possibly three or four times that amount.

The next ‘easy money’ investor rush was based on something more substantial: Housing. The investment craze from 2003 into 2006 had little to do with real estate values. There was widespread misrepresentation by some financial intermediaries marketing real estate investments.

Novice investors were flooding into a housing market that was clearly speculatively over-valued, populated with many unethical brokers, and clearly heading for a fall. Professional real estate investors started selling properties, getting out of a market which they saw as insupportably over-valued and crowded with novice investors driven by dreams of short-term millions.

Many of these real estate investors put their money into gold and silver. More than a few became CPM clients, until the mania in precious metals gave the signal to take profits there. (CPM lost them as clients once the sold their metals. Some have returned in the past three years.)

Comparing today’s crypto markets to these and other such investment manias, reasonable people see the writing on the wall.

All Is Not Lost

None of this is to suggest that gold and silver prices will not rise. CPM has laid out its expectations for future precious metals prices, stating that it expects a wave of higher prices. We have a more sober, fact-based, realistic view of where metals are going, however.

The point of this report is to say, yes gold and silver make sense as investments, but investors ought not to be expecting prices to rise to unrealistic levels based on specious thinking about how gold has behave during past periods of persistently high inflation, past investment fads popping, and a wave of inflation caused by large money growth rates that has not appeared yet, over the past 40 years.