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Gold & Silver are Not Investments

Gold and silver prices may have been manipulated, but that does not necessarily mean that the current prices are severely undervalued.

Below, I argue that the present fair market value of the gold price should be near $2,400 per ounce, about 30% higher than the current price of $1830, while silver price should be near $35 per ounce, also about 30% higher than the current price of $26. In other words, there is some undervaluation, but no severe undervaluation as many gold & silver fans would like to believe.

However, that does not mean the gold and silver prices are not going to enter into a bull run the next few years to become overpriced up to several multiples, and then come back in line again.

An overview

The discussions below relate to gold, but the same or similar arguments apply to silver as well except that specific numbers are different.

Without manipulation, the gold price should roughly stay FLAT if adjusted by the total inflation of the fiat money. Alternatively, gold price should remain FLAT if it is measured in human-time-units. See George Gilder’s “time price” (money is time) thesis.

Put simply, gold does not inflate.

However, gold does not appreciate in real economic terms either.

This is because fundamentally gold does not contribute to productivity increase, while technology does. Warren Buffett has a point when he said gold is just a pet rock. Gold has golden attributes, but let us not pretend it actually performs work to generate productivity in a real economic sense.

It is true that, even in a CPI inflation-adjusted gold price chart, the gold price trends higher rather than stay flat. But this is because CPI inflation adjustment does not provide a solid unmoving baseline, but rather a soft line that trends down itself. This in turn is because technology is deflationary. Technology improves productivity, and thus makes most consumer products cheaper and cheaper.

In other words, it’s not that gold price goes up, but only that the consumer prices go down due to higher productivity brought about by technology. Before you say, “consumer prices never go down,” please bear with me, because I’m not talking about consumer prices measured by fiat money.

However, whether you expect it to be a flat line or an upward straight line, the gold price, even after being CPI inflation-adjusted, goes through large swings. The large swings are a result of a dynamic interplay between macro manipulation and irrational market reactions to the manipulation. The result is not a permanent depression of the gold price, but rather large cycles of boom and bust. It is like a steaming pot, they cover the lid for some time (resulting in undervaluation), then when they can no longer hold, it blows away (resulting in overvaluation).

A fundamental economic analysis

Most gold and silver discussions and speculations are superficial, ignoring the fundamental economics. Some people may be highly experienced due to their long and deep exposure in the gold and silver markets, but may still not understand the fundamental economics. They just talk about their experiences and feelings.

One of the fundamental economic factors of gold or silver is the mining costs, which are rather stable, and have never had a significant spike in history, and will unlikely have one in the future.

The current gold-mining cost is around $1000 per ounce. Considering the keeping, distribution and marketing costs and markups, $2400 is probably reasonable. The current silver-mining cost is around $15 per ounce. Considering the keeping, distribution and marketing costs and markups, $35 is probably reasonable.

One should note that, compared to consumer commodities that heavily rely on advertisements and multilayered channel promotions, gold and silver do not need (suffer) high distribution and marketing costs. The costs of keeping or storage are non-trivial, especially when professionalized, but are usually modest and predictable. As a result, gold and silver do not, and should not, have a high ratio between retail price and the cost like many consumer products do.

Given the above, how can one reasonably expect the gold price to go to $5000 per ounce in the near term when the total sustaining cost is below $1000 per ounce with no sign of going up significantly? Or the silver price to go to $100 per ounce?

Therefore, when measured against a stable fiat currency, if there’s any spike in gold or silver price, it cannot be based on real economic fundamentals, but can only be a result of something unusual, irrational or even illicit.

On the other hand, gold and silver mining costs do not suffer technology pressure to go low with time in long term if measured by real human time cost (see George Gilder’s time is money theory). Most consumer goods suffer the technology pressure, meaning that as the technology improves, productivity improves, and the real price of a product decreases with time. Gold and silver maintain an excellent stable line against technology.

Above are general principles. But let’s look at the historical data.

If you analyze the history of gold price in the last hundred years, in view of the large cycles, a quite convincing argument can be made that the present gold price is modestly undervalued but not severely undervalued as many gold fans would like to believe. More specifically, the present fair market value of the gold price should be around $2,400.

The year 1934 is a good starting point because that’s when Gold Reserve Act was enacted and all gold in the United States was transferred to the US Treasury, a point at which the gold price and US dollars were linked on a wholesale scale.

From 1934 to 1971, US dollar was pegged to gold at $35 per ounce, so there was no market data during that period. However, since the end of gold standard on August 15, 1971, the market has been trying to find the proper gold price, and despite the manipulation, has established a fairly clear average pattern.

From 1934 to the present time (2021) is 87 years.

Now, if we assume a 5% annual appreciation of gold price against US dollar (see discussion below), today’s gold price should be $2440, having gone up from $35 over the 87 years.

But why this assumption? That is, why should the annualized appreciation rate of gold (nominal appreciation against US dollar without adjustment) be roughly assumed to be about 5%?

There are two reasons. The first is empirical. When a moving average over long periods (e.g., five years) is taken, the overall historical chart of the gold price over the last century trends up roughly with a 5% annual appreciation.

The second reason is theoretical, but more fundamental, and it happily coincides with the above empirical result.

The technology premium

The theory assumes a roughly 3% difference between the appreciation of the gold price and that of the stock market in order to account for the 3% technology premium of the stock market. The technology premium exists because of the productivity-increase brought about by technology.

The stock market (Dow Jones index) has had an 8% annualized growth in the same time period, therefore,

8% -3% = 5%.

This is not a secondary observation, but rather a fundamental economic assumption. The 3% difference is commensurate with the annual productivity increase created by the technology. Because gold does not contribute to this productivity increase, it is only reasonable that technology may enjoy this productivity premium, but gold may not.

If the above assumption were not true, then the value of the growth driver (namely technology) of the entire human economic activities would be in doubt.

But we know that’s not the case, and therefore know the technology premium is real.

On the other side of the equation, given the fact that gold does not directly participate in the economic activities, gold should not suffer the volatility induced by such activities. That is, gold should have enjoyed stability. The gold price should have much less volatility than stock prices do.

But did it enjoy the stability? In reality, gold did not enjoy the stability in a full sense.

Although gold price is indeed less volatile than stock prices when looked through shorter time periods, it actually has just as bad if not worse volatility than stock prices when looked at from larger cycles, evidenced by huge swings spanning over years. It is fact, whether it is a result of macro manipulation and irrational market reactions or not.

What about the future?

The above analysis suggests that the current fair market price of gold should be about $2400, higher than the present $1800, but should not be much higher. But that does not mean the gold (or silver) price is not going to enter into a bullish run followed by blow-off top in the next few years to become overpriced up to several multiples.

When that happens, however, one should bear in mind that it is in an overvalued state if viewed from a fundamental point of view, and the price is bound to come back in line again.

The truth is that when gold price goes down, it always goes far below its fair market value, but when it goes up, it always overshoots. Compared to the stock market, gold has very large and long cycles of 10, 20 even 30 years, making it even harder to manage than stock market cycles.

The idea of buying gold being a long-term growth investment is fundamentally unsupported by the history and economics (see above comparison between gold and stocks).

Further, the idea that buying gold is for stability is also a total illusion. It is the opposite when looked at in long terms.

Given the above analysis, it would take another 15 years for gold to reach a fair market price of $5000, a price point that is being eyed for a near future by many gold fans. This is assuming that the US dollar does not become significantly more inflationary than it has been before in the next 15 years.

If for some reason US dollar collapses or enters into unusually high inflation times, even a feared hype-inflation, then talking about gold price in US dollars would need a new context. See below.

Gold and silver are insurances, given the present special circumstances

Timing can be critical, so is the special circumstance, considering the existence of the large cycles.

Therefore, buying gold or silver at the present time may be a good hedge or insurance against disasters given the following factors:

(1) the particular timing (gold and silver are underway to recover from a low of a historical cycle and therefore is likely to overshoot for this reason alone)

(2) the unusual circumstance (the Fed destroying US dollars, making an unusually good case for gold and silver)

(3) extreme uncertainty of the economy and the stock market.

Money is looking for a good place to hide, and gold & silver look quite attractive now.

However, gold and silver are not investments. They are hedges or insurances. Considering the crazy monetary and economic environment, they are great insurances.

Gold and silver are an excellent insurance against a collapsing dollar or very high inflation. If the dollar collapses, the gold and silver prices will go up disproportionally. For example, if the dollar quickly halves (depreciates 50%), the silver will not merely double to compensate, but is likely to quadruple (up 400%, or four times). This would happen not because of fundamentals but because of market and psychological reasons.

Get some gold and silver as an insurance, but don’t buy gold and silver expecting to get rich quick. Anyone who thinks that buying gold and silver will get exceptionally high return against a fairly stable dollar is delusional. Look at both the historical data and the fundamental economics behind it.