"A free gold market ... reflects and measures the extent
of the lack of confidence in the domestic currency."
Ludwig von Mises
In the past two columns, I've highlighted the uses and
misuses of gold. Despite occasional calls for a return to a gold
standard, the Midas metal has largely lost out to hard currencies as a
preferred monetary unit and monetary reserve. Most central banks are
selling gold.
Gold has also done poorly as a crisis hedge lately. It
has not rallied much during recent wars and international incidents.
U.S. Treasury securities and hard currencies such as the German mark and
Swiss franc have become the investments of choice in a flight to safety
Nor has gold functioned well as an inflation hedge over the past two
decades. The cost of living continues to increase around the world, yet
the price of gold has fallen from $800 an ounce in 1980 to under $300
today.
What's left for the yellow metal? I see two essential
functions for gold: first, a profitable investment when general prices
accelerate and, second, an important barometer of future price inflation
and interest rates.
Gold as a Profitable Investment
Since the United States went off the gold standard in
1971, gold bullion and gold mining shares have become well-known
cyclical investments. The first graph demonstrates the volatile nature
of gold and mining stocks, with mining shares tending to fluctuate more
than gold itself. The gold industry can provide superior profits during
an uptrend, and heavy losses during a downtrend.
One of the reasons for the high volatility of mining
shares is their distance from final consumption. Mining represents the
earliest stage of production and is extremely capital intensive and
responsive to changes in interest rates. 1
Gold as a Forecaster
Gold also has the amazingly accurate ability to
forecast the direction of the general price level and interest rates. In
an earlier Freeman column (February 1997), I referred to an econometric
model I ran with the assistance of John List, economist at the
University of Central Florida. We tested three commodity indexes (Dow
Jones Commodity Spot Index, crude oil, and gold) to determine which one
best anticipated changes in the Consumer Price Index (CPI) since 1970.
It turned out that gold proved to be the best indicator of future
inflation as measured by the CPI. The tag period is about one year. That
is, gold does a good job of predicting the direction of the CPI a year
in advance. (All three indexes did a poor job of predicting changes in
the CPI on a monthly basis.)
Richard M. Salsman, economist at H. C. Wainwright &
Co. in Boston, has also done some important work linking the price of
gold with interest rates. As the second graph demonstrates, the price of
gold often anticipates changes in interest rates in the United States.
As Salsman states, "A rising gold price presages higher bond yields; a
falling price signals lower yields.... Gold predicts yields well
precisely because it's a top-down measure. It is bought and sold based
purely on inflationdeflation expectations; thus it's the purest
barometer of changes in the value of the dollar generally." 2
In sum, if you want to know the future of inflation and
interest rates, watch the gold traders at the New York Merc. If gold
enters a sustained rise, watch out: higher inflation and interest rates
may be on the way.
At the time of the original publication, Dr. Skousen
was an economist at Rollins College, Department of Economics, Winter
Park, Florida 32789, a Forbes columnist, and editor of Forecasts &
Strategies. He is also the author of Economics
of a Pure Gold Standard, 3rd Edition (Foundation for Economic
Education, 1996), and He was working on his own textbook Economic
Logic.
1. For further discussion regarding the inherent
volatility of the mining industry, see my work The Structure of
Production (New York: New York University Press, 1990), pp. 290-94.
2. Richard M. Salsman, "Looking for Inflation in All
the Wrong Places," The Capitalist Perspective (Boston: H. C. Wainwright
& Co. Economics), October 15, 1997. For information on his services,
call (800) 655-4020.
Reprinted with permission from The
Freeman, a publication of The Foundation for Economic Education, Inc.,
November 1998, Vol. 48, No. 11.
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