How are Gold and Money Supply Related?

Mish

M2 Money Supply is surging. Will gold follow?

Let's investigate an alleged relationship between gold and M2, a measure of money supply in the US. 

"There’s a clear correlation between the annual growth rate in M2 money supply and the price of the yellow metal. "

Clear Correlation?

The Tweet claims something different than my lead chart depicts. So let's investigate the above idea in other time frames.

Gold vs Rate of Change in M2 Money Supply

Gold vs Rate of Change in M2 Money Supply

If we look at longer time frames, the rate of increase in  M2 theory falls flat on its face.

One can force a correlation starting in 2010 but that is purposeful cherry-picking a timeframe. and even then, the time period in the box is counter-trend.

Cherry-Picking Timeframes

If you have to cherry-pick timeframes, especially when there are totally random results outside that timeframe, the relationship is imaginary.

Similarly, one can find times when gold is correlated to the dollar, the Yen, and most likely the popularity of peanuts at Cub games in some time frame. 

Gold vs Faith in Central Banks 

Gold vs Faith in Central Banks 2020-01-01 PNG

The best correlation I can find to the price of gold is faith in central banks. Gold collapsed from $850 to $250 under Greenspan's "Great Moderation". Greenspan was viewed as the "Maestro" until the dot-com bubble collapsed.

Gold went on a tear during the housing bubble, but put in a top when ECB president Mario Draghi gave his famous speech: "We will do whatever it takes to save the Euro, and believe me it will be enough."

Draghi Q&A

  • Q: What did Draghi do? 
  • A: Absolutely nothing!

Draghi did nothing. His speech was enough. Bond yields on Greek, Portuguese, and Italian bonds started collapsing right after that speech. It was not until years later the ECB resorted to negative interest rates and QE.

Gold started rising again when the ECB went nuts with QE and the Fed started talking about "normalization"that anyone in their right mind knew was not coming.

Massive QE and Inflation

Yes, the Fed has turned on QE to an extent few thought possible. 

But that did not ignite inflation in any meaningful way, at least as measured by the CPI. 

The Core CPI Declines 3 Months for the First Time Ever

On Jun 10, I noted The Core CPI Declines 3 Months for the First Time Ever.

My headline will have the inflationistas howling from the rooftops because they will not even bother reading what I said inside. 

Poor Measure of Inflation

These indexes supposedly measure inflation.

They do nothing of the kind. The indexes do not include home prices, only rent.

The purported medical inflation is a joke. Anyone who buys their own medical insurance will tell you their costs are up more than the reported 5.9%.

Anyone in college has not been pleased with the rising cost of tuition and rent in college towns.

And anyone with an ounce of common sense knows the current stock market bubble is a measure of inflation.

Lie of the Day, Month, and Year

The Fed and economists pretend that "inflation" is only up 0.1% year-over-year.

The Fed and economists in general do not know how to measure "inflation".

And the Fed's efforts to produce it has created destructive bubbles sure to pop causing the deflation they hope to prevent.

BIS Deflation Study

The BIS did a historical study and found routine price deflation was not any problem at all.

"Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive,” stated the study.

For a discussion of the BIS study, please see Historical Perspective on CPI Deflations

Asset Bubble Deflation

It’s asset bubble deflation that is damaging. When asset bubbles burst, debt deflation results.

Central banks’ seriously misguided attempts to defeat routine consumer price deflation is what fuels the destructive build up of unproductive debt and asset bubbles that eventually collapse.

The Problem is Not Deflation, It's Attempts to Prevent It

For discussion of asset bubbles and inflation, please see The Problem is Not Deflation, It's Attempts to Prevent It.

Struggle to Maintain Control

The Fed is struggling to keep things under control. It is afraid of another credit bust like we had in 2008-2009, and rightfully so. 

Are things under control? Clearly not.

Is money supply an indicator?

Perhaps, so, but the important point is not the QE, but rather that people know the Fed has again lost control. 

Speculators Dump Gold But Price Goes Up Anyway

Misconceptions about gold are rampant.

Here's another example: Contrary to popular belief, jewelry purchases are meaningless to the price of gold.

It's monetary demand that sets the price.

For discussion, please see Speculators Dump Gold But Price Goes Up Anyway. 

Mish

Comments (9)
No. 1-4
aqualech
aqualech

Seems like the recent history of gold price in the western, developed countries has been greatly influenced by lots of factors besides macroeconomics. It, and miners are a tiny market compared to equities and the bond market. So it is possible to manipulate it somewhat through deep pocket shenanigans in futures markets. And because it is relatively small, during periods of trendy popularity, as during the 2010 period, it has mania or FOMO popularity and can bubble, but then just sort of run out of steam when whatever crisis does not play out. Then investors who lost money sour on gold and remember the lesson for years. Another factor is goldbug mentality amounting to looking for get rich quick alternates to mainstream investments. I’m convinced that in the last several years crypto’s and pot stocks have sucked in a lot of goldbug funds that otherwise might have gone into gold and miners, only to prove also to have been manic flash in the pan trends. So no, gold is not tied to M2 or anything else directly.

Scooot
Scooot

In my opinion Gold has no correlation with anything on a long term basis.
I agree Mish, it is affected by confidence in Central Banks but I think it’s more than that. Confidence in fiat money as a store of wealth, confidence in the financial system generally, interest rates and to the extent that we can accurately measure them, real interest rates and the relative cost of holding Gold all affect it’s attractiveness. Currently, to the extent that M2 is exploding, in many currencies not just the USD, is a good measure of how fiat generally is deteriorating and is causing a loss of confidence in fiat money. Despite current conditions being obviously deflationary, common sense tells me there’s no such thing as a free lunch, so we will eventually have to pay for free fiat somehow. In the meantime Gold seems like a safer haven than anything fiat based.

Realist
Realist

I remember buying gold throughout the 70s because I was worried about inflation, as was everyone else at the time. (It did get to double digits.) I sold it all in Jan 1980 to buy my first house. A few months later I was upset because gold went from $500/ounce to $800. A year later it was back down to $400, and I wasn’t upset anymore.

Today, to me, gold represents just one more investment alternative in a very diversified portfolio. I keep it at 5% or less, and rebalance several times a year.

I consider that to some people it represents insurance; or a fear gauge; another currency position; or a hedge against inflation or deflation.

I have never been worried about deflation.

The only thing that could destroy a significant amount of my wealth is hyperinflation. And I am not at all worried about that in our current environment. So gold will remain 5% or less of my portfolio.

As to what the price of gold correlates to: it depends.

dr smock
dr smock

Sending good paying american jobs overseas and bringing in H-1B workers is massively deflationary. The private bank called the federal reserve greases the wheels for these operations by creating huge sums of money, which also counteracts the deflation. And yet, the inflation rate in this country is still around 4% over the years. If the product is cheapened and yet the price remains the same, that is still inflation. Over the last 10 years, this has especially been the case.


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