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US economic strength has been purchased at the price of a massive monetary expansion, which in turn puts a floor on the gold price

US economic strength has been purchased at the price of a massive monetary expansion, which in turn puts a floor on the gold price
Over the longer term, gold has held its value against a depreciating dollar

The gold price crept up over the US$1,200 mark at the end of the week, showing stubborn resistance to the downward pressure being applied to it by the Federal Reserve’s stated programme of interest rate rises. To be sure, the price has dipped towards US$1,180 during the past week or two, but it keeps recovering the lost ground.

In a sense, you could argue that gold is somewhat rangebound at the moment, hovering around US$1,200, and moving just a few dollars either way on the relative strength or weakness of the US dollar itself.

But that would belie the medium term trend, which is firmly down, as well as the much longer-term trend, which is still firmly up. In the past six months alone the gold price has dropped by almost US$150, as the Fed has ratcheted up the pressure and the perceived political and international risks surrounding the Trump Presidency have receded.

The gold price reached its 30 year high back in 2011, when the global financial crisis was already several years old and quantitative easing by the Fed had reached its maximum level of effectiveness. Thereafter the pattern has been one of steady decline, to the point where the third and final round of quantitative easing introduced by the Fed barely moved the price at all.

Those days are gone, policy is now more inclined to tightening than loosening, and those who bought at peak gold are now well out of the money.

Still, it’s worth bearing in mind that even if gold isn’t soaring away as it once was, the arguments in favour of investing in gold remain as valid as ever. The global economy is run on fiat money with no intrinsic worth, the global debt pile, including US debt, is alarmingly high and, in a more recent development, US bond yields are starting to drift upwards too.

It’s against that economic backdrop, trotted out time and again by gold bulls, that’s keeping the price where it is, and stopping it from dropping off a cliff.

After all, the last time the US economy performed even close to as well as it’s performing now was in the early part of the 2000s, when the gold price was trading at less than half the value it is now. Gold only topped out US$500 in 2006 and didn’t really start on its bull run until the following year. By the time US$800 and US$900 were breached Lehman Brothers had collapsed and the world was already in full-blown crisis.

Received wisdom says gold is the ultimate hedge against economic crises and uncertainty, and that would appear to have been borne out by the subsequent jump towards the US$1,800 level in 2011/12.

But with the US economy roaring away and growth at 4%, it could hardly be said there’s even a whiff of crisis around at the moment. If there is, it’s either over emerging market currencies, a product anyhow of the strong US dollar, or over a possible trade spat between the US and China.

Mr Trump has demonstrated that he’s no fool though, and he must surely know that now, a time when the US economy is at the strongest its been for a long while, is the best time to undertake a trade war. To do it times of economic weakness would be folly. So, his moves are calculated acts, and the market is pricing the associated risk accordingly.

What then accounts for the continued high level of gold, which still remains above the level it traded at at any time between 1973 and 2010. The re-rating is beginning to look permanent, though such a statement is surely tempting fate.

There’s inflation to consider, of course. But there’s also the increased money supply. There are more dollars around than there were forty years ago, and each dollar is worth less precisely because of that increased money supply. So it takes more dollars to buy gold.

The huge monetary expansion undertaken by the Obama government after the global financial crisis is unlikely to be properly unwound, or at least not any time soon. M0 money supply increased fourfold between the beginnings of the global financial crisis. It was a momentous enough decision to stop the monetary easing, significant tightening is unlikely to follow.

The most we’ll see is a couple more points on the interest rate dial, and then some retrenchment as the US economy cools, as it inevitably will at some stage. The dollar looks rampant at the moment, but remember, it’s coming back from a long way down. It’s hardly the US’s fault if emerging market economies took out dollar loans when rates were cheap and are now finding it hard to cover the debts.

That dynamic will lead to a few shocks, but what we are seeing is the bedding down of a new paradigm: increased money supply, higher long-term average gold prices, and the continued dominance economically, at least for a while yet, of the United States.

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