Wednesday, July 16, 2008

Gold, Silver and Oil - Basics of Price Movements

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

The Fed's easy money campaign that began in August 2007 started when the U.S. dollar was hoovering just above its historical low. It was inevitable that lowering interest rates at that time would weaken the dollar till it hit a new all-time low and once this happened how far the dollar would fall would not be predictable and stopping its fall would prove to be difficult. Since commodities are priced in dollars and gold and silver move opposite to the dollar, a new rally phase began for oil, gold and silver.

Price movements for oil, gold and silver usually do not take place simultaneously, but in sequence. Oil tends to move first and since it has such a strong impact on inflation, people then bid up gold because prices are rising and the U.S. dollar is falling. Gold is being purchased during this time because it is seen as a monetary substitute that will retain its value unlike paper currency. Since gold is the preferred monetary substitute, its price moves up first. When the gap becomes too big in the price between gold and silver, the price of silver, the second choice for 'real' money, then starts to rise.

The value assigned to gold and silver as monetary substitutes is minimal during periods of steady prices, but this aspect overwhelms their pricing during periods of high inflation and their value for jewelry and industrial purposes can become almost irrelevant. Nevertheless, analysts and financial 'pundits', continue to estimate reasonable prices for the precious metals as if their functional uses were the only source of their value. This approach will have worked successfully during the as much as 20 years of steady prices that precede an inflationary period, so it is continued even though a period of rising inflation has begun. During this period, gold and silver appear to become increasingly overvalued based on the exclusively non-monetary price calculations of analysts. The claims that the precious metals are overvalued become widespread and shrill in articles with charts 'proving' they are overvalued. The vested interests, such as jewelery makers, who want the prices of gold and silver to come down because high prices are affecting their profits are behind much of the news warning investors against buying 'overpriced' gold and silver.

It is highly likely if not inevitable that oil, gold, and silver will experience price bubbles once inflation starts rising. The cries that they are in a bubble will first occur years before the actual end of the bubble and it's blow off phase when prices explode upward. By the spring of 2008, claims that gold was in a bubble as it's price reached a $1000 an ounce were already being heard. Late in the spring, as oil soared way past $100 a barrel the same was being said about it. Experts on bubbles were wondering when in the decade of 2010 and 2020 these bubbles would actually end.

NEXT: Gold, Silver and Oil - Spring 2008

Daryl Montgomery
Organizer, New York Investing meetup

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1 comment:


You can bank on gold silver and oil.