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

For more about us, please see our web site: http://investing.meetup.com/21

China's Olympic Sized Bubble

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 credit bubble in the U.S. did not exist in isolation, but was inextricably linked to a bubble in China U.S. trade. One of the many manifestations of this bubble was a Chinese stock market that started going straight up in late 2006, reaching extreme valuation levels based on any historical standard. The New York Investing meetup discussed this issue in its October 2007 meeting in a presentation entitled, "Thinking Outside the Bucks" (please see: http://investing.meetup.com/21/files).

In the 1990s and early 2000s, China was the most significant economic success story in the world. Rapid industrialization and trade grew the Chinese economy and kept consumer prices down in the West. This was accomplished by utilizing China's large pool of inexpensive labor to produce an increasingly greater number of goods for export. Since labor is the largest cost component for almost all manufactured goods, this lowered prices globally for a number of items. However, China went one step further to insure it could continue to sell its exports at low prices - it pegged its currency to the U.S. dollar (an idea originally suggested by the American monetary authorities, much to the later regret of U.S. politicians). The dollar peg allowed China to keep its currency undervalued, just as Japan had done during its decades of spectacular growth, and provided its exports with a huge advantage in world markets. It also insured the creation of a massive bubble.

As Chinese exports to the U.S. increased, China accumulated a growing hoard of dollars that it used to purchase U.S. treasury bonds. This in turn kept interest rates low in the U.S. and allowed Americans to borrow ever greater sums to finance a purchasing-based consumer economy and for the U.S. government to borrow cheaply to finance a ballooning national debt.
Pegged currencies are not without their downsides, however, as China eventually found out when its internal rate of inflation began rising. In July of 2005, China officially, but not actually depegged the Yuan from the U.S. dollar. The Yuan was allowed to float in such a narrow trading band that by September 2007 it had fallen only to 7.50 from 8.28 to the dollar. Since the Yuan wasn't allowed to float to a realistic level, inflation started taking off in the mainland and the Chinese government announced price controls that month to try to halt it.

Meanwhile, the greater wealth created within the Chinese economy led to an exploding stock market. This bubble in stocks was further fueled by asset controls that prevented most Chinese investors from moving their money outside of China. The effects of this could be seen by examining prices of Chinese stocks that traded in both the mainland and Hong Kong. The prices on the mainland exchanges were much higher than those in Hong Kong. In August of 2007, the Chinese government announced a policy shift that would allow mainland investors to buy and sell stocks in Hong Kong. The effect of stock prices in Hong Kong was explosive and only days later the Chinese government announced this policy change would be on hold for the foreseeable future.

For more on this topic, please see the video: "Global Perspectives on the Decline and Fall of the U.S. Dollar" at: http://www.youtube.com/watch?v=dbHxbOvjYis&NR=1

Next: All that Glitters Isn't Gold, It's Also Silver

Daryl Montgomery
Organizer, New York Investing meetup

For more about us, please go to our web site at: http://investing.meetup.com/21.