Murenbeeld debunks gold myths (April 18, 2011)

One of the gold community’s most trusted economist, Martin Murenbeeld, made a stop in Toronto on April 4 to dispel what he says, are some of the looming myths around gold prices.

Murenbeeld, who is chief economist for DundeeWealth (WD-T), has more than 30 years of independent consulting experience in the gold market, but says that by no means makes him an investment guru.

“I’m the economist,” he said to the packed house at the National Club, “I know boo about investing.”

Murenbeeld then presented data that investors looking for an edge in the market would drool over.

The data was compiled with an eye to breaking down, what he says, are the three most common myths in the gold market.

The first is that gold prices are in a bubble; the second is that prices will fall if jewelry demand decreases; and the third is a widely held belief that gold needs inflation to rise in price.

The first myth cuts right to the fear that keeps gold investors up at night. Does the incredible run the metal has been on mean it is now in a bubble?

Murenbeeld’s response is that investors should rest easy, and he began dissecting raw data to show the price of the metal has not shot up as much as people may first suspect.

To illustrate his point he started with an inflation adjusted chart that measures gold prices in terms of constant dollars. Unlike the regular price chart that most investors are familiar with, the constant dollar chart shows that gold is not at an all-time high, and would in fact need to reach US$2,385 per oz. before it matched its previous peak of the early 1980s.

But inflation adjusted charts can be found with a quick Google search. A more unique chart presented by Murenbeeld was one which measures the price of gold in relation to the price of oil. The chart measures barrels of oil per ounce of gold, and shows that the historic relation between the two commodities is 15 barrels of oil per gold oz.

Currently, the historic average is holding with 15.03 barrels of oil equaling one gold oz.

“Gold doesn’t look out of line with respect to oil,” he argues.

In relation to copper, the same pattern holds with the two commodities hovering around their historic ratios.

But perhaps one of Murenbeeld’s most interesting arguments focuses on the cover ratio – that is how much gold is needed if it were called upon to cover a portion of the U.S. money supply.

Back in 1934, under the gold standard, it was deemed that 35% of the money supply should be covered by gold. If that ratio was in place today it would imply a price of US$3,675 per oz. of gold – and that is just to cover the M1 supply. The price would have to be US$7,931 per oz. if gold were to cover 35% of the M2 money supply in the U.S.

“Gold has not kept pace with monetary developments,” Murenbeeld says.

Further, in relation to financial assets, gold also looks cheap.

Murenbeeld displayed a chart which set the S&P 500 index against gold to a unit of one starting in 1870. The chart spikes as
financial assets outperform gold and dips as gold outperforms the market.

The steepest dips in the chart came after the depression of the early 1930s, the recession of the early 1970s, and the financial meltdown of 2008.

“Something fundamentally changes after each financial bubble bursts,” he argues. “In the wake of a financial crisis we follow policies that are beneficial to the gold price.”

In the prior two financial meltdowns, the S&P 500 index versus gold ratio returned to the original unit of one. That has not yet happened, implying that the price of gold still has room to grow or that the S&P still has room to fall dramatically.

“If it does get back to unity of one, and gold is still at US$1,420 (per oz.), the S&P has to go down to 289,” he says. “But if the S&P holds at its currently level of 1,325, the price of gold would have to be US$6,520 an oz.”

Next on Murenbeeld’s myth buster tour was the idea that gold demand is predominantly linked to jewelry demand.

Murenbeeld says linking gold prices to jewelry demand is simply outdated thinking.

While the metal’s price had been strongly tied to jewelry demand as recently as the 1990s, with the advent of exchange-traded funds and renewed demand from central banks, jewelry demand is now all but inconsequential to the gold price.

To tackle the myth, that gold needs inflation, Murenbeeld turns to global liquidity.

His argument here is that global liquidity, as measured by the U.S. monetary base plus foreign exchange reserves for the world excluding the U.S., is what drives gold. So as global liquidity rises, so to do gold prices.

Murenbeeld concedes that such liquidity is related to inflation, as increased liquidity will often bring about more inflation but that doesn’t mean that inflation is directly correlated to gold prices.

Indeed, such a hypothesis is not borne out by the facts, according to Murenbeeld.

To support his contention, he turns to a chart that shows, counter-intuitively, G-7 inflation has actually been negatively correlated to the price of gold since late 2008.

When such inflation is adjusted for the U.S. dollar, it does turn positive but only comes in at 0.39. That is roughly 60% less than a correlation of 1, which would demonstrate perfect correlation.

Murenbeeld’s idea is that, with loose monetary policies, gold can rise even if the traditional relationship between the printing press and inflation does not materialize.

“There’s money in the system,” he says simply, “so gold goes up.”