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| Chart showing the 100 year history of gold prices. From the chart alone, gold price looks overvalued, but is it really? |
Just before Brexit, I almost bought gold at SGD 1746 on SilverBullion. I created a new account, added one ounce of Canadian Gold Maple Leaf into my shopping cart, filled in my address and all the other details required to place an order, but backed-off at the last stage.
Well, we all know what happened after Brexit. Gold price had a good run-up amidst the uncertainties, and I missed my chance of getting my bullion at a good price. At the time of this post, one ounce of Canadian Gold Maple Leaf is more than SGD 1900 already.
I actually wanted to buy gold in December last year, but I chose to buy silver Maple Leaf instead. Silver prices at that time reached 2008 level. That simply doesn't make sense to me. We all know how much money printing there was since the GFC, so how can silver prices not go up given the huge increase in monetary base? Same for gold as well, but I was more compelled to buy silver. I bought a total of 50 ounces of silver Canadian Maple Leaf from Bullionstar at about SGD 23 each.
So anyway, back to the main reason for this post. Post-Brexit, Dow Jones Index (DJI) immediately plunged 610 points, or 3.1% to close at 17,400. The market continued to be jittered by the unexpected turn of events and shed another 1.5% on the second session. After which, stocks made a u-turn. Somehow, somewhat, the uncertainties subsided, and suddenly everyone started to think that Brexit is actually good for the economy. I don't know what caused the u-turn, or if there was an invisible hand orchestrating all these, but here is my observation:
When the market plunged in the two trading sessions following Brexit, gold price shot up by about SGD 100 per ounce. This did not came as a surprise because during uncertain times, gold is the safe haven. Investors were selling British Pounds to buy USD and Gold. But, when DJI recovered subsequently to hit 18,000 points, gold prices remained stable. This is not usual. DJI and gold prices are usually inversely related.
Well, in the short term, perhaps this is nothing out of the ordinary. Perhaps there were still many people cashing out their British Pounds and buying gold, which explains the sustained demand, and hence price of gold. I don't want to guess why all these happened because admittedly, I have no clue, but my hunch tells me that something is brewing. Perhaps this is the last rally before the storm. Or so I wish.
That observation prompted me to look for some charts to verify my perception of the inverse relationship of DJI and gold prices. I chanced upon marotrends.net, which boasts of many interesting charts. Here's a snapshot of the homepage.
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| A snapshot of the different types of charts offered by macrotrends.net. |
1. Fed Balance Sheet VS Gold Price
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| A chart showing the relationship between the Fed Balance Sheet and Gold Prices, taken from macrotrends.net. Looks like there is an unlikely divergent uh? |
2. Gold to Monetary Base Ratio
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| A chart showing the Gold to Monetary Base Ratio, taken from macrotrends.net. We are at a century-low. |
In the first chart, we can see that percentage gold price increase (referencing gold price at 2004) tends to track the monthly percentage growth of the Federal Reserves balance sheet from 2004 up till around 2013. After which, there is a divergence. Fed Reserves balance sheet continues to climb, but gold price actually dropped. If history is a good teacher, sooner or later, the gap between the orange line and the blue line has to narrow. This can happen in three ways: (1) Fed Reserve balance sheet got to come down, (2) gold price has to go up, or (3) both. How can the Fed's balance sheet come down though? Let's take a closer look.
Just like any other balance sheet, Fed's balance sheet comprises of assets and liabilities. When the Fed buys something, that automatically becomes its assets. Traditionally, the assets that Fed holds in its balance sheets are high quality government securities and the likes. However, to save the economy during the last GFC, the Fed embark on a series of Quantitative Easings (QEs), which is just a fancy term for printing money. Well, most of these money doesn't actually end up in the pockets of the citizens as physical notes. The Fed merely bought over massive amount of toxic assets that threatened to bankrupt the largest of financial institutions. These actions means that a good proportion of the assets held by the Fed are low quality assets that actually no one wants. To reduce the Fed's balance sheet, Fed has to sell their assets. But, how much of their assets can actually be sold?
If the Fed's balance sheet can't be reduced easily, how else can the gap between the orange line and blue line converge then?
Then we have the second chart showing the Gold to Monetary Base ratio. We are at a 100 year low, meaning that gold is very lowly-priced now relatively to the amount of currencies slushing around the the market. Even with gold prices having been already risen quite substantially compared to 2008 levels, the rise is nothing compared to the increase in monetary base. Will we continue to hit new lows? My guess is as good as yours.
Till date, I am still not vested in gold bullion though. Always missing the lows and refusing to chase the run-up. It's just hard psychologically to buy something that cost 150 dollar cheaper just a few days ago. Maybe if viewing gold as a form of insurance is the right perspective to adopt, I should not be too overly concerned with short term fluctuations.