Driver of Gold and Silver prices

Oil prices remained relatively flat for 20 years until 2004. Yet the cost of houses, new cars and etc went up significantly during that time. All the commodity markets are economically connected. They share commodity inputs, compete for production capacity and etc. When something moves in one - it sends ripples to the others. Back in the day these ripples traveled slowly in a methodical manner through the markets. Today in the computer age its different. Algorithmic trading models posting instantaneous electronic mega-trades hedged by derivatives is the game. This seems to have tied these markets together even tighter. Frankly speaking it is scary for this dumb o slow pencil pushing farmer. Those little ripples have turned to waves -kowabunga dudes, hang ten and hold on for dear life.

 

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It is common for people to confuse inflation and price inflation. Very simply, inflation is the increase in money supply (this measure is something very few people are even cognizant of). Price inflation is what 10gary22 is referring to and what everyone feels as prices rise; this is what people refer to as "inflation". Inflation can be created by literally printing money (at a rate greater than real growth in the economy) or by foreign governments (who actually begin to spend the dollars they have been paid as the US services US Treasury debt) as they begin to use their dollars to purchase goods. Relatively more dollars chasing relatively fewer goods creates price inflation.

Sooo, technically I agree that rising oil prices are not inflationary (in that they are not the cause of inflation). However, I think to say that the "Fed's reaction to oil prices that determines inflation" (paraphrased) is putting the cart before the horse.

Let's talk about deflation. Deflation occurs as the money supply shrinks. Price deflation occurs as fewer dollars are available to purchase goods. In a deflationary spiral like we saw in the great depression, money was destroyed as the stock market crashed, unemployment rose and there was not enough money supply (M1) in the banks to cover deposits. As money evaporated from the economy, the velocity of money and the price of goods and services fell. In expectation of ever-falling prices, people withheld purchasing decisions until the last minute to preserve scarce dollars. This is the economic depressionary death spiral.

So wrapping up, a commodity like oil can rise because it becomes more scarce or because money becomes worth less. In either case higher input costs (from the standpoint of a manufacturer) of commodities like oil, cotton, sugar etc. put inflationary pressure on prices. In an inflationary environment I want to be holding silver & gold. In a deflationary environment I want to get out of silver and gold and get into cash.

Regards,

Bluesboy65

 

I would modify your definitions somewhat. Inflation isn't a rising money supply and deflation is not a falling money supply. The definition needs to account for both supply and demand for money. If the [upward] change in the supply of money exceeds the change in the demand for money, you have inflation. If the change in the supply of money is less than the change in demand for money, you have deflation. So you could have a 3% increase in the money supply, but if the demand for money increases by 10%, it will be deflationary, etc.

 

What you are addressing is the impact of the velocity of money on consumer prices. Velocity is influenced by monetary policy but is ultimately determined by market activity. So we may disagree on this one but I would stick with my definition of inflation and believe that velocity belongs in the price inflation side of the equation. Regardless of all this hair splitting (but excellent discussion) we do agree that velocity is a key component in inflationary/deflationary pressure.

 

It's partly velocity but also includes growth from other factors such as change in population and technological innovation. That's why I prefer the more comprehensive definition. It explains situations where you could have a rising money supply, constant velocity and still have deflation.

 

Yes, excellent points, I just believe things like innovation, productivity, cost of labor etc. belong in the price inflation equation rather than inflation. Again, regardless of where these components come into play, we both agree that they wind up influencing consumer prices.

An interesting anecdote, In my home town a locally owned restaurant has held prices steady even though their input costs have risen dramatically. They have done things like adjust the air conditioner a little warmer, the heater a little cooler, use lower wattage bulbs, watch their labor costs like a hawk and accept thinner profits. They are experiencing this margin compression because the consumer is beaten up and they have no pricing power. However, they cannot do this forever and as input costs continue to rise they will eventually be forced to raise prices or close their doors. This is how it plays out all across the country. To me, these are clearly inflationary pressures and bode well for investments in silver and gold.

Regards,

Bluesboy65

 

I don't disagree on the relationship of inflation or the expectation of inflation or hyperinflation to the price of precious metals, but I am not sure that it necessarily bodes well at this level. My feeling is that even high inflation has been already figured into the price from the 2007 level low of $ 641 when the price began its strong drive to 1430+. Political unrest aside, the decline of PM prices recently reflected some factor being lowered in the minds of the seller. Perhaps better economic expectations, increase in dividends, etc. I am not beyond thinking that gold may break 1500 or more for a while this year, as world events are hard to predict, but I have the odd feeling that many who hold PM, have no consideration of trading it through the year, they are buy and hold people, and that many have a more than an advisable amount of their investments in PM. My estimations are that the basic price of the metal should be about 1000-1100, the rest is factors already built into the current price.

I know many might disagree, and that is OK, as any one who tells you they know things for a near certain outcome are either lying or deluded. The thing that prompts me to post a cautionary side, is that each time gold takes a pop up, the bullion threads have scores of new people wanting to know where to buy PM, and some are making hasty decisions, and overwhelming encouragement only acerbates their decisions. AIMO.

Jim

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I agree that the expectation of inflation is a current component of PM prices. Stimulus and a fading bond market is having a positive impact in terms of stock prices and this has drawn money out of bonds and precious metal ETF's and into equities. I believe these are the forces primarily responsible for the recent pullback in PM prices.

I don't get the "buy and hold" people but to each his own. To me they are collectors who may or may not get lucky. As for those who have a strong feeling about how events will unfold I would stop short of accusing them of being either a liar or delusional. I prefer "passionate". Regardless, your voice of caution is one that should be considered. Investing in anything including precious metals is not without it's risk.

Regards,

Bluesboy65

 

Very well put. I've noticed the same thing. And although I expect gold and silver to move higher [and perhaps much higher], it is based more on behavioral/speculative/market expectations for the bull market. Gold and silver prices will eventually revert to levels close to the cost of production, which are now slighly below market prices. A lot of people too readily believe what they read on the internet, and mistake rising commodity prices for inflation when it is mostly, if not entirely due to world-wide demand rising faster than supply. It is not due to monetary factors, and that makes all the difference.

 

I got into the metals market in 2008 because I figured prices would be going up based on nothing other than monetary policy. After watching interest rates drop for a few years (and being admittedly a bit naive) I asked myself, what in the world are they going to do when it gets to zero? They can't have negative interest! Well that's when new money began being introduced at a much higher rate, and ever since then metals have chugged along nicely. I plan on holding as long as possible unless I really need the money, because without a gold standard I don't see any force in play to halt the printing of new money. I do see a need to keep printing more money, because when an artificially created bubble begins its downward trend a new bubble comes along to prop it up. While there are certainly many factors in play, and it may just be a coincidence that things happened the way I had anticipated, I tend to feel that these trends will continue until the money printing ceases. However, I would not even sell at that point unless I had to (or wanted a little spending cash!), because should the day ever come that money is only worth its weight in TP I will be glad I have something worth dealing with. A bird in the hand is worth two in the bush.

 

Question, if the value of money continues to decrease, a natural byproduct of increasing the money supply, wouldn't then the cost of production go up? Or am I misunderstanding the relationships here?

 

The answer is a little complicated. On the one hand, a base rate of inflation is implicit in a fiat economy because the growth in money supply over time must be approximately the same as interest rates. So there is always a tailwind pushing prices for everything upward. Offsetting this are improvements in technology. In mining, many of the technological advances and computer modelling have made drilling and mine construction more accurate, reducing costs. But perhaps the biggest factor in producing precious metals is the cost of energy. Some companies have reported that energy costs are as much as 40% of their total cost. This probably drives the cost of production more than inflation. And I know that energy costs are also subject to inflation, but they are perhaps more influenced by the increase in demand relative to the increase in supply. Remember, we had a lot of cumulative inflation from 1980 to 2000 and precious metal prices declined over the same period, and the drop in energy costs was a big factor in keeping the cost of production, and hence the price, low. So there is a relationship, but not dollar for dollar. If the money supply is the primary or only factor you look at when evaluating a precious metal investment, you are almost guaranteed to lose money.

 

You’ve basically got it. The money supply must grow with the economy to maintain adequate liquidity but we have clearly exceeded the normal growth rate for an extended period. It seems a little controversial here but the economic relationship between excess liquidity and inflation is widely understood and accepted by market movers like Mohamed El-Erian (CEO of PIMCO), Marc Faber and Ben Bernanke as well as our trade partners like Brazil, Russia, India & China. This topic is probably THE chief concern of our own US Congress. Our monetary policy is causing huge problems for emerging markets and has repeatedly drawn scathing criticism from China and others.

Money is a medium of exchange and a store of value. When a currency system begins showing signs of stress people turn to gold and then silver; it’s been that way throughout history and likely will continue to hold true in the future. If you are heavily invested in metals at current levels and we get our fiscal house in order you will lose your shirt. If we continue on our present trajectory I believe your investments will serve you well.

 

I am not sure how I missed this thread but here is my 2 cents worth on drivers.

Back in 2002 the prices of PM started to escalate. This was the initial point in time when our Gov knew there was no turning back form where we are headed to. As the years passed the $$ kept moving upward and upward until present time. Along the way, there were many drivers, dispair, fear, greed, and denial to state the most obvious. As we all have heard in one way or another, most all major economists think we are headed down the path of destroying the dollar, so much so that fear is now the main driver.
When it is too late, the driver turns to panic! Will you be ready for the End of America?
It is my personal belief that our United States fiscal well being is just plain horribile!
Like we have terminal cancer and are destined to die a painful death. I feel I am 5 years behind the 8 ball on this one and have a lot of planning to do before the funeral. Who to place the blameon? It was us, all of us for electing the political figures to office, those who mis-handled our money, sold our country and set us up for disaster!
I am dam mad at it all...Wake Up America!!! Or soon it will be too late!

 

I think that those in the know knew that inflation will pick up. Right now it is not on the average Joes radar screen, I think that the price of pms have already been adjusted for inflation, though when it becomes noticable to the average person they will at that time start buying pms, that will cause a bubble, it will shoot up drastically, then fall more drastically.

So what has driven prices til now are those that know inflation is coming, ie reason. At some point the driver will be fear of inflation, which is different than inflation. Sure some people speak of their fear of inflation now, but most people do not have it on their radar yet.

I think that what will drive the collapse is when an administration starts battling inflation by raising interest rates, and attempting to shore up the dollar, at least that is what happened before, and history though it does not repeat itself note for note does play some refrains now and then.

 

Man, this got me in way over my head. I think I will search another box of cents. Maybe I'll find more like the gold plated 2000 D I got last night. Gold plate a penny.............why ?

gary

 

By energy do you mean electricity, fuel, both, other? I'm wondering if it would be worth factoring in oil prices as a potential driver. Appreciate the thoughtful responses guys.

Looks cool? ;] Not exactly practical.
http://img.photobucket.com/albums/v328/MisterSoftee/Auctions/pennies/penny-2000.jpg

 

My understanding is that it is both, but more weighted toward oil products. So if the price of a barrel of oil rises, it hurts the profitability of mining operations.

 

When the ban on ammunition and powder sales takes place. THEN it might be considered too late for many. IMHO Those who plan for a large collapse akin to New Orleans in the wake of Katrina should be able to hold on ?

 

Been watching the steepening yield curve on bonds? Is it a sign of a healthy economy or something a little more sinister? On the long end the 30 year is up in pretty dramatic fashion and Greg Peters, Morgan Stanley Global Head of Fixed Income Research, gave an interview on CNBC today as one of their lead stories; here's a link:

http://www.cnbc.com/id/41459941

More food for thought on a potential driver for commodity/PM appreciation.

Another article I just read from the Wall Street Journal for your reading pleasure:

http://online.wsj.com/article/SB10001424052748703989504576128130543513562.html?mod=WSJ_hp_LEFTWhatsNewsCollection