Gold + Money Supply = A Tool for Gold Analysis
March 25, 2008
Any bull market has innumerable detours and wrong turns. We can easily take one of these wrong turns and find ourselves with moderate gains, a little profit, or a loss. The gold market is more emotionally and politically charged than any other bull market, thereby increasing the chances of becoming diverted.
Are there tools that can help gold investors stay focused on the gold big picture? I believe that there are. It was a sheer act of providence, I believe, that allowed me to see several things that I had never seen before. These have now become tools for me. These new tools have been helpful in setting gold matters in focus for me, and indeed raise questions that have set me on the trail of other answers.
The law of supply and demand does not excluded currencies. Currencies, as much as central bankers may wish otherwise, are and always will be subject to this universal law of supply and demand. So will Gold. Hence, the relationship between the two.
My search took me back to the 30’s, before M3. I found that in 1932, U.S. money supply was at $68.4 billion and that gold holdings of the U.S. were valued at $1.9 billion at the set price of $20.69 per ounce. Gold coverage of money supply was therefore at 2.8%.
In 1959 the U.S. had in its possession 17,335 tonnes of gold (all figures are from: www.gold.org and www.kitco.com ) which was roughly 49% of the world’s total gold supply. This was the same year that the U.S. first published the broadest dollar money supply indicator which was known as M3. Multiply these 17,335 metric tonnes by 32,151 troy ounces (which make up one metric tonne) and you have 557.3 million ounces of gold. If you multiply those 557.3 million ounces by the set price of gold which was $35 dollars an ounce you have $19.506 billion dollars. At that time M3 was at $289 billion. Working out the percentage of gold to dollars, I learned that 6.7% of all dollars were backed by gold at $35 an ounce. Some gold standard, I thought to myself. I was surprised when I continued crunching numbers.
I then looked at 1970 (January), which was the year before the U.S. went off the gold standard. The U.S. had 9,679 tonnes of gold which translates into 311.19 million ounces. At this point the U.S. gold holdings had shrunk to 26.8% of world holdings. The U.S. price of gold had crept up to $37.62 dollars an ounce, but M3 had increased from $289 billion to $616 billion. The number of ounces (311.19 million) times the price of gold ($37.62) yields $11.7 billion dollars. Those $11.7 billion dollars only covered 1.9% of M3.
I saved January of 1980 (the height of the last gold mania) for my last calculation.
My next calculation on the list was October of 2000, which was the nadir of gold. The price per ounce was $264 and M3 was at $7.020 trillion dollars. The U.S. at that time claimed that it had 8,137 tonnes or 261.61 million ounces. This was 24.7% of world holdings. The gold percentage coverage of dollars had shrunken to less than 1% (.98% to be exact).
What about November of 1987, the month after the crash? M3 was at $3.68 trillion, Gold was at $480 and the U.S. had 8,162 tonnes of gold (262.4 million). The percentage gold coverage of M3 was at 3.4%.
The Fed stopped publishing M3 after February of 2006. I have used both www.shadowstats.com and www.nowandfutures.com to find a present day extrapolation of M3. Both sites estimate M3 in the $13.5 trillion range (February 2008). Using that figure times 261 million ounces times the price of gold at $1000 and you have a 2% coverage of the USD by gold.
I added other years doing the same calculations: 1965 which worked out to be 3.5%; 1975 at 4.6%; 1995 at 2.3% and 2005 at 1.5%. For 1980, when gold was priced at $850, M3 was $1.823 trillion. The U.S. gold holdings of 264.3 million ounces covered 12.2% of M3.
Let’s review these numbers:
1932 |
2.8% |
1959 |
6.7% |
1965 |
3.5% |
1970 |
1.9% |
1975 |
4.6% |
1980 (January) |
12.2% |
1987 |
3.4% |
1995 |
2.3% |
2000 |
1.0% |
2005 |
1.5% |
2008 (February) |
2.0% |
My Analysis:
If you consider the four years I’ve cited for which the U.S. was on a gold standard: 1932, 1959, 1965 and 1970, you come out with an average gold coverage of the USD at 3.7%. It appears to me that the gold standard was more pronouncement than fact.
Excluding the gold spike in 1980, the average for the other six years which we were not on a gold standard is 2.47 %. Once again, there is not much difference from when we were on a “Gold Standard”.
Using present day M3 (extrapolated $13.5 Trillion), 262 million ounces and the 1959 level of 6.7%, we would be looking at a gold price of $3,452.29 dollars an ounce. If we were to use the January 1980 spike, then gold would be $6,286 dollars an ounce. Using the non gold standard years average coverage of 2.47% (excluding the gold spike of 1980) you could reasonably expect a gold price of $1,273 dollars an ounce. Using the average of the gold standard years and the non-gold standard years you come up with 2.97% which would bring a gold price of $1,530 an ounce.
In 1975, gold at its high end covered 4.6% of M3 and then declined to 3.0% coverage by September of that year. It appears to me that the powers-that-be want gold to stay in the 3% range at the highest. I believe that they look at these ratios, and target them. Whether they can contain them in the lower digits is another matter. An obvious point is that further M3 growth will energize gold, and perhaps exponentially, since the potential elasticity of the dollar is endless, while gold supply is inelastic. We could well see another spike to 12% coverage of M3 or higher.
Is there another way that investors can look at gold and M3? If history can guide us, then I would look at the percentage gain of M3 versus the gains of gold in the same time frame. From January of 1970, M3 rose from $616 billion to $1.823 trillion in January of 1980. This works out to a 197% increase. In the same time period gold went from $37.52 to $850. This is a 2,160% gain. Gold outstripped M3 creation by a factor of 11:1. Impressive.
Where are we today? Gold has gone from $264 in October of 2000 to $1030 in March of 2008. That is a 290% gain. M3 has gone from $7.027 trillion (October 2000) to $13.5 trillion (March 2008). That is a 92% increase. The ratio of gains in gold price to M3 supply is at 3.2:1. The ratio accelerates in gold’s favor as a bull market increases. I believe that the ratio of the 1970’s gold market will be surpassed. Depending on how much exposure to gold you have, it will either be a wealth preserver, or a wealth enhancer.
Kim Brasington
DISCLAIMER:
I am a private investor, and not a licensed financial consultant. This is for informational purposes only. This does not constitute financial advice. Consult with a knowledgeable accredited financial advisor whom you trust before investing. Do your own due diligence. I am not responsible for any losses other than my own. I believe that I have retrieved accurate information from the sources used.
This article was first published at www.grahamanalytics.com