We’ve oft discussed gold as a hedge against not inflation, but the cause of it, which is governments run amok.
Moses Kim of Expected Returns provides us a brief look at gold in the last century. As you’ll notice, gold didn’t necessarily move in the upward direction in times of inflation. Rather, it was when the private sector began to lose confidence in the public sector (government), that we saw gold make significant gains.
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Collapsing Public Confidence and Gold
by Moses Kim
As I’ve mentioned repeatedly in the past, gold is perhaps the most misunderstood asset in the world. Try to explain to people the true nature of gold and expect to be greeted with petulant disdain. It took more than a little arm twisting for me to convince people that gold is a currency and not a commodity. With a bona fide meltdown hitting Europe, people are starting to wake up and smell the roses.
Gold will eventually trade at obscene levels because of a collapse in public confidence. Only then will people realize that it was only public confidence that propped up our entire monetary system.
The confidence model suggests there will be a day of reckoning. The confidence model is dynamic, for it accounts for the vagaries of human nature. As Newton so famously quipped, “I can calculate the motion of heavenly bodies but not the madness of people.”
Humans are slaves to false paradigms. We think in terms of bell curves and linear progressions. We presume order in markets when, in fact, chaos reigns supreme. Linear models fail to predict the truly monster moves because the world is dynamic. For example, models cannot predict stock market crashes because they are fueled by panic selling and human vicissitude. Likewise, you simply cannot model the type of panic buying that will come into the gold sector as public confidence collapses.
Gold is unique because it serves as a global referendum on public confidence. Humans always behave the same historically; they mimic the crazy behavior of others. Why do you think the French Revolution followed the American Revolution? It is this “contagion effect” that leads me to believe civil unrest will intensify around the world. With rising civil unrest comes collapsing public confidence.
Inflation Hedge or Government Stupidity Hedge?
Is gold an inflation hedge? Yes to an extent. But the inflation argument is far too simple for it doesn’t explain the rise of gold in the 1930’s – a clear deflationary period. It also doesn’t explain the $1000 dollar rise in gold over the past 10 years in a period of mild inflation.
To truly understand gold, we must look at the 3 periods over the past century when gold made major moves: the 1930’s, the 1970’s, and the present. The 1930’s was a period of deflation; the 1970’s was a period of massive inflation; and the present is a period of neither inflaton nor deflation. So what theme unifies all three periods?
The collapse in public confidence.
Baby Boomers often remark that the last time they remember public confidence so low was the 1970’s. You know what? They’re right. Here’s a quick rundown of the 1970’s.
Failed war in Vietnam. Richard Nixon. Collapse of Bretton Woods. Watergate. Price controls. Oil price shocks. Hostage crisis in Iran. Jimmy Carter. Stagflation.
This was a period of low public confidence. Gold exploded.
The 80’s and 90’s
Ronald Reagan. Paul Volcker. 1989 and Fukuyama’s “The End of History”. The fall of Communism. Bill Clinton. Budget surpluses. Bull market in stocks. Mild price inflation.
This was a period of high public confidence. Gold promptly collapsed.
2000 to the present
9/11. Terrorists. George Bush. Bear market in stocks. Stock market crash. Housing crash. Bailouts. Budget deficits. Record low approval ratings for Congress. Tea party protests. Failed wars in Iraq and Afghanistan. Global riots.
We are in a period of low public confidence. Gold is flying.
What I’m trying to offer my readers is a different way of looking at the world. It is never so simple as inflation vs deflation, good economy vs bad economy, or high interest rates vs low interest rates. We live in a complex world. Most analysts, quite frankly, do not have even an elementary understanding of gold. Think big picture folks. There are way too many indicators pointing to much higher gold prices. Make no mistake about it, we are in the middle of a megatrend in gold that will be fueled by a collapse in confidence. All gold projections go out the window when human emotions are involved, and believe me, we will see panic buying eventually.