Why has gold bullion increased so much in price?
Understanding and predicting gold bullion prices can be difficult because, unlike a public company or a stock market index like the Dow Jones Industrial Average with earnings that are eventually paid out to investors in the form of dividends; gold doesn’t have a price/earnings ratio or dividend yield. But if you look into the actions by central banks over the past decade or so, you can certainly figure out why gold bullion prices have risen.
When the gold standard was abandoned, central banks sold their gold and flooded the world’s market with their currencies, something that was not possible when the gold standard was in place. My goal here is not to argue for and against the gold standard or money printing (I’m sure loyal readers know my view on that topic). What I’m trying to prove is that the rise is gold bullion prices is justified and the rise in the metal’s price will continue.
Just by looking at actions of our own Federal Reserve, we can get a general idea about the actions of central banks around the world and how they’re impacting the price of gold.
Since January of 2000 to September 2012, the amount of U.S. money in circulation (the “M1 money supply”) has increased 112%, or $1.25 trillion. That’s a lot of money printing.
Similarly, the “M2 money supply,” which includes the M1 money supply plus savings deposits, balances in money market mutual funds, and deposits, has increased 118%. M2 is a better measure of actual money supply. Since the beginning of 2000, M2 money supply has increased more than $5.4 trillion. (Source: Federal Reserve, October 11, 2012). Again, the printing presses have obviously been on overdrive.
The chart below shows how the M1 and M2 supplies have significantly increased.
Copyright Lombardi Publishing, 2012; Data
source: Federal Reserve
Keep in mind; these numbers are only from our country’s Federal Reserve. If you start to bring in money supply numbers from other central banks around the world, what you will see is that the supply of world fiat currency (paper money) has ballooned. As the money supply around the world has increased, gold bullion prices have increased.
Sadly, I have mentioned in these pages enough already about how printing presses owned by central banks are working at full throttle and how I expect more fiat currency printing, not less, in the years ahead. This means the price of gold bullion will continue to increase.
Gold bullion can be looked upon as a global currency. The U.S. dollar, because it is a paper currency, has limitations and setbacks, such as too much supply and inflation erosion. Gold bullion has the opposite—limited supply and an inflation hedge. Central banks can create money out of thin air; they can’t do the same with gold bullion and that’s why I expect gold prices to continue rising.
The growing epidemic of failing municipalities and struggling states across the U.S. economy reveals an ugly truth. Cities cannot keep up with their budget deficits and are failing at a staggering rate.
Who are going to be the ultimate victims of these budget deficits and uncontrollable municipal and state government spending? The answer: the pension for public employees and the retirees in the U.S. economy.
Pension funds are emptier than ever, according to Milliman Inc., one of the world’s largest actuarial firms. Milliman says there are unfunded liabilities of $1.2 trillion in the 100 largest pension funds in the U.S. economy—that’s $300 billion higher than previously estimated. (Source: Chicago Tribune, October 15, 2012.)
Yes, $1.2 trillion is certainly a huge number; but the number could be much larger than that if you look at it from my point of view. Many pension funds are basing their calculations on an annual rate of return of eight percent. I really don’t have to go into detail about how, in this low-rate environment when equity markets have gone into a big slump and the yields on government debt are next to nothing, an eight-percent rate of return is far-fetched—and five percent, in my opinion, is still too optimistic.
On the other side, as cities and states across the U.S. economy are facing budget deficits, they are using desperate measures to recover. Cities and states are reducing or completely removing the health-care coverage of retirees. For other public employees, they are cutting coverage of family members or increasing the eligibility age. (Source: Reuters, October 15, 2012).
Since 2009, 45 states have cut back on the health benefits of their police, teachers, firefighters, and other public workers. (Source: Wall Street Journal, September 21, 2012) More of these types of cuts will soon follow, as the budget deficits of cities and states in the U.S. economy continue to increase.
Be careful, dear reader; this is a huge problem in our struggling economy. The U.S. economy has been severely hurt, and we continue to suffer. The budget deficits created by the local and state governments will eventually trickle higher to the federal level. The result of it will simply be more money printing to pay for the liabilities.
The situation with struggling U.S. cities and municipalities is strikingly similar to what happened in Greece. The government there created a huge budget deficit and eventually couldn’t pay its suppliers. Now Greece needs more funds and more austerity measures, and the pension payouts of retirees are one of the main targets.
Where the Market Stands; Where it’s Headed:
On Friday, the Dow Jones Industrial Average fell 1.52%. One popular financial news site ran this headline across their web page: “U.S. stocks hammered on earnings news.”
I’ve been warning my readers for weeks that third-quarter earnings will surprise on the downside. That’s exactly what is happening now. Caterpillar Inc. (NYSE/CAT) announced this morning that its profit for 2012 will be between five percent and six percent below its previous estimates. This is characteristic of many large companies right now: they are pulling back on their earnings projections.
The focus is clearly off of the market’s “win” of getting the Fed to announce the third round of quantitative easing (QE3). Now the focus is back on the earnings of the companies that trade in the market. The reality that corporate earnings and the economy are slowing rapidly is settling in. A drop of 1.52% in one day for the stock market? Investors had better get used to it.
What He Said:
“Bonds could now be a buy: Bonds rise in price when interest rates fall, as their return makes them more valuable. After a bear market in bonds that has lasted for months, the action in the bond market, as I read it, indicates the bear market in bonds could be over. I’ve always preferred quality when buying bonds, going with government bonds over corporate bonds. If you have some cash lying around, bonds could be a great deal.” Michael Lombardi in Profit Confidential, July 24, 2006. The yield on 10-year U.S. Treasuries fell from five percent in the summer of 2006 to 2.4% in October 2011—doubling the price of the bonds Michael recommended.