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QE and the Price of Gold



September 19, 2012 – Comments (6) | RELATED TICKERS: GLD

I often read a lot of talk about QE and the price of gold. Many have claimed that all of this QE will result in surging gold prices (read the comment section at Zero Hedge for some examples). What I haven't heard is how that actually works. What I'd like to see is a decent theory (model) with actual supporting data. 

What I'll present are some data that, at least, call the idea into question. I'm well aware that the issue is probably far more complicated than I'm presenting it but that's actually my point.

First, let's look at Gold and M0 from 2009 to the present:

There seems to be a nice linear relationship between M0 and the price of gold. Unforutnately if we attempt to apply this relationship back in time the picture doesn't look so pretty:

Why it doesn't work can be easily seen by looking at gold and M0 from 1968-2009. 

The relationship is clearly not linear. It wasn't even always an increasing relationship which I think is a critical conclusion from the simplistic model that increases in M0 should result in increases in the price of gold. 

I think the evidence suggests to me that I ought to remain skeptical about the alleged relationship between M0 and gold. That isn't to say that there isn't one; there may very well be, but I think it's far more complicated than many make this out to be. 

I am sympathetic to the fact that there's probably a psychological factor to all of this. So long as people believe that there is a relationship, that alone could drive prices in the short-term. But I don't see why that would result in a long-term effect. There are other variables to consider, of course, (but that's kind of the point).

Anyone out there with a better model? 

6 Comments – Post Your Own

#1) On September 19, 2012 at 1:55 PM, XMFSinchiruna (26.44) wrote:

Historical correlative analysis will offer little help when interpreting global monetary developments of unprecedented nature and scale.

I understand your reluctance, value the contrarian tendancy, and applaud your quantitative efforts, but you can rest assured there is every reason to anticipate a substantial price impact upon gold from expanding central-bank balance sheets not just in the U.S. but worldwide.

In short, I do believe I can offer a better model. It's a qualitative one:

Best of luck to you, and I hope you'll consider even a tiny allocation to gold to participate on this QE3 rally.

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#2) On September 19, 2012 at 3:01 PM, somrh (85.34) wrote:

The unprecedented nature of this actually makes your case that much more difficult to make, imo. I wouldn't draw any conclusions from unprecedented developments. The sample size is too small. 

When I get time I'll take a closer look at your blog (and may respond there.)

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#3) On September 19, 2012 at 9:32 PM, awallejr (35.12) wrote:

Well just to throw another curveball here, gold really has two influences on price, hedge on inflation and hedge on chaos.  Unless your model factors in both you could get distortions I suppose.

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#4) On September 19, 2012 at 10:10 PM, somrh (85.34) wrote:


That actually does remind me that I was eventually going to get around to the hyperinflation element to gold. I actually attempted to construct a model for "hyperinflation insurance".

The problem is its extremely sensitive to initial assumptions. You basically have to model the probability of an hyperinflation event happening and also model the magnitude of such an event. 

They looked at something similar in The Golden Dilemma (see exhibit 16 on pg 21 - they only vary the probabilities and leave the hyperinflation magnitude fixed).

So I think you're right, if there's a relatively high expectation of chaos then that could easily drive the price of gold. 

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#5) On September 19, 2012 at 10:33 PM, AvianFlu (< 20) wrote:

For more perspective of money printing not only in the US but historically in various other nations you might want to read some Milton Friedman. I suggest "Free to Choose" and "Money Mischief". A great biography is "Millionaire : The Philanderer, Gambler, and Duelist Who Invented Modern Finance" about hyperinflation and money printing in 1700s France. Also, "When Money Dies" a book about Weimar hyperinflation. I felt that this last book was a little disappointing as regards cause and effect, but the accounts of what happened to the mass psychology was of great interest.

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#6) On September 19, 2012 at 11:40 PM, Lulupoopsalot (62.73) wrote:

I think the second chart you put up deserves a lot of attention.  Up till about 2008 gold to me there reads like a historical snapshot of our country in the highs and lows of fear against a backdrop of steady M0.  But look at the recent trend with the huge increase in both.  Now we're in for some serious trouble because we don't have historical analysis that is going to be able to give any insight on the inflation we're about to experience.  That makes me afraid and therefore I want to own gold.  It's all about fear in the end.  Fear of inflation even.

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