TMF Sinchiruna wrote:
"With respect, the relative scarcity of gold relative to the supply of dollars results in disparate percentage moves between the two currencies without providing any of the evidence you claim of a failed correlation."
This was in response to my point that, since October 2007, gold has nearly doubled, while the US dollar index has only dropped by a couple of percentage points. To give some context: Sinch had just made the point that the purpose of investing in gold is to counteract the devaluation of the US dollar (or other currencies). And I agree with that point.
However, my point is that numbers matter, and specifics matter. I believe his mentioning of "disparate percentage moves between the two currencies" is a complete cop-out. Is he really saying that every time the US dollar drops by 5%, the price of gold should rise by 75%? It just doesn't seem rational to me.
I believe that there are only 2 logical ways to come up with a "fair price" for gold. One is to compare the price of gold to the devaluation of the US dollar. The other is to compare the price of gold to the increase in the money supply (these are different because an increase in money supply does not necessarily result in a devaluation of the dollar).
Anyway, on a long-term historical basis, the price of gold seems to move in a fairly rational and predictable way, with regards to each of these two measures. However, these correlations have completely fallen apart since the start of the financial crisis.
I believe Sinch has fallen into the trap of "falling in love" with gold, and as a result he has become a permabull on gold. That's why he does not use correlations or numerical analysis to come up with a fair price for gold - instead, he relies on macroeconomic and political arguments. But that takes me back to my earlier statement: numbers matter. That's why we need some way of differentiating between a 5% increase in gold price, and a 75% increase in gold price. They are different.
Even on a theoretical level, his claim of "disparate percentage moves" is nonsense, and in my opinion it is just a way of ignoring the numbers, and continuing with his perma-bullness.
Let me put it another way: Sinch has said himself, that the true "value" of gold does not change over time. The price of a fine men's suit, expressed in ounces of gold, has changed very little over the past 50 or so years. Think about that for a second. The purchasing power of gold does not change over time. But the purchasing power of US dollars does change over time, due to inflation. If we experience 5% inflation for 1 year, then your US dollars can purchase 5% fewer men's suits or gallons of milk as a result.
Next, let's perform a quick thought experiment. Let's say you decide to convert your money from US dollars into men's suits. Then, you convert it from men's suits into gold.
You repeat this experiment again a year later, but, much to your dismay, you finish with less gold the second time. Using the associative property of mathematics, it should be obvious that a 5% devaluation in the US dollar should result in exactly a 5% increase in the price of gold.
Therefore, we can conclude that something fishy has been going on over the past 3 years. My opinion is that gold has been overhyped; the Glenn Beck effect. Everywhere you look, there are people talking about gold. Gold this, gold that. As a result, large numbers of people have sold their stocks and bought gold, resulting in a bubble. Here's a visual aid that I just put together to illustrate the effect.
To reiterate: I'm not saying that the price of gold shouldn't increase at all. I'm saying the extent of the increase has gotten completely out of whack.