Gold: Assumptions vs Reality

Expected Returns's picture

From Expected Returns Blog

One of the hardest things to do as an investor is to think through investments without presuming anything. The data will tell a story and paint a picture for you that you can  then interpret. Most people shun this obvious approach to investing and instead choose to invert the process by allowing their assumptions to cloud their analysis. This is simply not a sophisticated approach to investing.

A combination of history and quantitative data analysis will give you a perspective that 95% of investors do not have. For example, most people alive today have not lived through the gold exchange standard, and therefore have no clue how it functions. To most, it is a peculiarity of our ancestors; a relic of the past; and a product of a crude economic system. They cannot imagine the possibility of gold playing a role in the global monetary system. Their knowledge of history is small, and so is their sense of economic possibilities.

It is presumptuous to assume that gold will not eventually play a role in the international monetary system since it happened before in history. It is also presumptuous to assume sovereign nations will not default since sovereign defaults are prevalent throughout history. Most of the anti-gold arguments are based on assumptions that simply aren't true. Here are a few.

Jewelry Demand?

It is incredibly difficult to argue with someone who pulls the "jewelry demand" card on you. Why? The jewelry demand argument is so false that its defenders are invariably a special breed of stubborn. You can never win these kind of arguments.

Now as investors, let's test the assumption that there is some kind of relationship between jewelry demand and gold prices. As you can see below, if there is a relationship, it is a negative one.



If you invested based solely on an assumed relationship between gold and jewelry demand, you would have lost money 9 out of the past 10 years. While the data suggest we should change our assumptions, most people won't. This is the irrationality of human nature at play that allows a minority of investors to profit.

Investment Demand, Anyone?

The real demand is coming from institutional investors, retail investors, and governments. Chinese, Russian, and Indian central banks have recently become major buyers. This is a positive trend for gold since these governments hold so small a percentage of their reserves in the form of gold.  Since the dollar dominates foreign reserves, diversification into gold equivalent to dumping dollars.




Retail investors have also begun to protect themselves from spendthrift governments. Objectively speaking, retail investment is a far better indicator of gold prices than jewelry demand.


Marginal Demand, Human Irrationality, and Gold

A fundamental tenet of economics is that humans act rationally. Why I have no clue. Nothing in my experience has shown that people act rationally and to their best interest at all times.

Understanding human irrationality is central to understanding the future price movements of gold.  For example, are people more likely to buy gold at $250 dollars after 20 years of being the most hated asset in the world or at $2500 dollars? You don't see lines around the block at gold shops at bottoms; they are an indicator of tops. This is a reflection of both gold's unique marginal demand characteristics and the nature of bubbles in general.

The marginal demand aspects of gold run contrary to those of most other assets. Generally speaking, a rise in price results in a decline in demand. For gold, a rise in prices results generally in an increase in demand. This is its natural state. Add to the mix human irrationality and the panic buying that is bound to come and you start to understand that the monster moves in gold are still ahead.

Financial experts are telling us the gold trade is crowded. Ironically, gold will become a crowded trade only when the "gold bubble" experts start buying. Not to be flippant, but this is one of the top 3 indicators I'm looking for to signal a top in gold. Fortunately, the gold bubble experts are still out in force expounding on the threats of deflation-  an argument so riddled with holes that it should not be taken seriously. Making linear comparisons between fixed exchange and floating exchange systems is like comparing apples and oranges: It makes no sense and it is bound to result in flawed conclusions.

We should all try to test our assumptions against facts. That most investors don't is great news for gold bulls. We are on the precipice of a major move in gold that will make all blind assumptions concerning gold look foolish.

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Lighty's picture

The chart of jewellery demand against gold price crushes almost every article I've readen on "gold bubble".

Combined with this one:

 comparing its rate of increase with the previous '70s bull run and Nasdaq bubble, deals a final blow to bubble thesis.

valeriobrl's picture


Only the breakdown of 1160 will open the Eye to the Gold's Bull.

Gold is in a secular bear market and it will breakout 1400 but starting from wich level ? From here or from 980 ?


JackAz's picture

Apples & Oranges? No. More like comparing apples and bicycles.

Diogenes's picture

Gold is a peculiar substance that turns the law of supply and demand on its head.

We already know that investors run from gold when the price is low and flock to buy when the price is at its peak. This is typical of any investment.

But gold is peculiar in that an increase in price can result in a slowdown in production. Here is why.

Any gold mine has rich ore and poor ore. A smart manager will process the poorest ore that will show a profit. If the price of gold goes up, and they can process X tons of ore per day, they will switch to a lower grade of ore and get less gold out of the same amount of ore. But they will make a profit because the price of gold is so high.

By saving the rich ore for a rainy day, if the price of gold drops, they can process the rich ore and still make a profit. If they use up all the good ore right away, if the price drops they are up the creek.

So, a rise in the price of gold can mean an increase in demand and a decrease in supply, and vice versa.

Of course a high price for gold can also result in new mines being opened but it can take years before a new discovery can be developed and begin producing gold.

AUD's picture

Indeed Diogenes, and apparently the last 30 years or so has seen many gold mines exhaust their reseves of high grade ore. More gold being mined in this period than in any other.

Despite this massive increase in supply, the gold price has risen since 1999?



akak's picture

Indeed, whereas 50 or 100 years ago a decent ore grade may have been 1 ounce per tonne, today many mines are extracting gold from ores with less than 1 gram per tonne, and ore grades overall continue to diminish.  When you combine that with the likely future increase in energy prices (and gold mining is TREMENDOUSLY energy intensive), it is hard to foresee any significant and prolonged fall in the price of gold going forward. 

Of course, this same argument can be applied to many other metals and minerals as well, particularly the platinum group metals and certain specialty metals such as zirconium, indium and gallium.

akak's picture

it can take years before a new discovery can be developed and begin producing gold.

Not just can take years, but increasingly, does.

DavidPierre's picture

Gold sentiment is still horrible with everyone waiting for the bottom to fall out. I just don't see it happening. The current poor sentiment numbers are "U.S. based" while the rest of the world is looking out the front window and gobbling up physical like there is no tomorrow!

The "sell in May and go away" crowd is now being left behind and the 2nd half of this year looks to be a spectacle in the making!

The paper game is being over run by physical and now even the shares are finally de-linking from the general stock markets. It has been frustrating and has been 4 years now since the juniors had a "blow off" top but what should soon be coming will be more than worth the past aggravation.

This is it, we are now at the point where "reality meets the road", the U.S. Treasury and Fed will come into the spotlight in grotesque fashion.

Finally Gold is becoming seen for what it really is (and always was), MONEY! This last phase where the solvency and credit quality of the U.S. is questioned will shake every investor, every financial institution, every central bank and for that matter every human being on Earth.

The only real beneficiaries will be Gold and Silver in unimaginable fashion.

The scary thing is that even the owners of Gold assets will be peeing their pants because they know what higher Gold means, the end of the financial world as we have known it since WWII!


RockyRacoon's picture

There are some scared pundits, Big Dave.

Watched Ron Insana the other day and he is scared to death.

He tore up on Ron Paul, and it was pitiful to watch. 

GATA has its day in the sun coming, but it will be too late to the party when the regular folks get it.  Those who will need the stability of PMs are now tuning in to some inane TV show and ordering pizza.   Sad.

akak's picture

"The scary thing is that even the owners of Gold assets will be peeing their pants because they know what higher Gold means, the end of the financial world as we have known it since WWII!"

I think that is a very astute observation often lost in the hype and high expectations surrounding gold, David.  As I have been saying for a long time, if and when the current monetary system collapses, those who hold gold will STILL be hurt along with everyone else --- they will just not be hurt as badly.  I doubt almost anyone is truly going to come out ahead when the mess is all said and done.

Rebel's picture


You could not be more right. As things crumble, whether it is through deflation or hyperinflation, many businesses will go under. Things we could buy before, will no longer be available. PM's will perhaps help to preserve assets, but what will still be available to buy is a different question. 

AUD's picture

Ahhh, but gold will still buy anything that is available for sale.

DoChenRollingBearing's picture

Correctamundo Rebel. 

Everyone who holds gold should look at laying in at least some critical supplies (water filter, solar battery rechargers, prescription meds, first aid kits, etc.).

Diamond Jim's picture

you can always buy diamonds or high end colored stones..sapphires never seem to lose value or their appeal....where you usually get screwed on diamonds for re-sale.

StychoKiller's picture

Saffron currently trades for around $1,710/oz.

akak's picture

Actually, that would be more like $1700 per pound.  A good grade of saffron can be had for around $175 per ounce --- still pretty impressive!  But if you know of or have seen the mind-boggling amount of labor (all done by hand and bending back) necessary to harvest that single ounce, picking the three threadlike stamens from the inside of a saffron crocus flower that grows very close to the ground, you would probably price it even much higher!

akak's picture

Yeah, buying an average new diamond is even much worse than buying a new car.

40% loss for taking it off the lot, so to speak.

DoChenRollingBearing's picture

Yeah, diamonds are terrible in that the spread is so bad.  Personal experience...

Der Kommissar's picture

Gold is money...and it does not go bad

GoinFawr's picture

Just stretch your chart a tiny bit; include 1209 'til today... there now, that doesn't look so bad does it?

I do believe that may have been one of the weakest 'dbl tops' I've seen in awhile. Or was it a 'triple top'. Er, what does a 'triple top' mean anyway, TA'ly speaking?







Oquities's picture

"there is a season, turn, turn, turn...

i am happy to be sitting on my physical (eagles, maple leafs, krugerrands, and philharmonics, at about $350/oz cost.  now i turn to silver, as it is the current bargain.  if it goes down, i'll double down.  if it halves, i'll triple down.  i'd rather buy a car, coin or a dividend with my green paper right now.  don't get me wrong, i'll have some cash left for intangibles when they properly deflate.

GoldSilverDoc's picture

So, you traded your paper for gold at 0.08 grams/dollar.  And now you can buy dollars for around .023 grams/dollar.

Talk about the price of dollars dropping like a rock.  Man.  They must be getting worth-less every day.



GoldSilverDoc's picture

Chumba, you are right.

What is the old saying about "a voice crying in the wilderness".....

The hilarious thing is that all of these "pundits" and "experts" continue to make the same, basic, simplistic mistake.  They price gold in terms of dollars, instead of the other way round.

It is insane to "price" a money in terms of a fiat currency.  It is stupid.  It is ignorant.  It demonstrates a lack of education, and a lack of understanding of history.  It is a fool's errand.  And for those of you who abjure "ad hominem" arguments against those so situated, I say... Stalin wasn't really an evil man.  Just....incorrect.

Gold is gold.  It is money.  Over the very long term, one (pick your measurement term) of gold is that same (measurement term).  Different amounts of governmentally-decreed fiat may be able to be purchased with that amount of gold, but THE AMOUNT OF GOLD NEVER CHANGES, because the LAWS OF PHYSICS DO NOT CHANGE (much).  

Now, that is not so with other commodities, as much.  Wheat - production methods have improved, thus the absolute (measured in gold) price has gone down significantly.  Manufactured goods: same deal.  Computers: excellent example of a truly astounding price reduction over time (also, btw, an excellent example of how almost-free markets work when some dipshit bureaucrat isn't decreeing how many keys each keyboard should have).

So, we, patient few, just wait, and wait, and watch the idiots who talk too much make fools of themselves, as fundamental money reemerges and government paper turns to ass-wipe.   

Good luck to the rest of you.  You're gonna need it.

Johnny Bravo's picture

Everybody that disagrees with you is stupid, ignorant, the same old shit, blah blah blah....

Gold is money, it's pretty and shiny, gold never decreased in value, if you held gold since the Roman times, you'd be rich, biatch!

The amount of gold never changes, because people can't ever mine more.  It can't be synthesized or created by natural processes, like fusion from Supernovae explosions.  Oh wait, I just study astrophysics... what do I know?

Good luck to all the people that don't buy at 1250 an ounce, because we just have better investments.  Yada yada yada.

DoChenRollingBearing's picture

Bravo, I for one am glad to see you back here duking it out on the gold threads.  Your argeuments help some of us study more carefully what we do re gold!

I think most of us who like gold are not traders of it.  We want the insurance and wealth protection vs. .gov malfeasance.  Few of us are BIG percentage holders of our own wealth in gold.

But, History tells us that things change, sometimes overnight.

I feel REAL COMFORTABLE buying gold up to $1500 to reach 7%, 8%, 9% of my assets in gold.

Even if you yourself JB have little money, YOU shoudl consider having at least a few ozs in case you are wrong.

I have often been wrong.  But, on important occasions I have been right (who I married, etc.).

Read up on History JB, open up your mind to having a little of the Ancient Metal of Kings.  You can buy silver too if you cannot afford gold.


Now, where is dumpster?

Close 2 the Edge's picture

Yes, spot on.

We have about 10% in gold and about the same in silver.  Then there are more mainstream investments and a farm.

PM's are physical, so the current paper price doesn't mean squat to me other than if I want to add a little more.  It isn't something we "trade", it isn't part of our investing, nor part of what we are using to "make money".

It is simply a store of what has been taken off the table...


Close 2 the Edge's picture

Heard your line of crap 4 years ago when we were told we were nuts to be buying and suggested it to friends.

Was still hearing it 3 years ago when we were still buying and dumping financials prior to the blow up and everyone thought we were nuts for even suggesting they might want to do the same (a friend who lost over 3 million doesn’t seem to think we were crazy after getting creamed though...).

Was told that again 2 years ago when we were still buying and telling a few trusted friends they might want to think about it...

Stopped bothering to try and explain any of it to anyone as they still think our Gov. is actually going to pay the debt and somehow all that non funded stuff that will have to be funded won't cause hell.

Trust me, none of us are going to be overtly willing to help the likes of you when it happens because we already tried.


Maybe you should stick to astrophysics because you sure don’t get finance.


dnarby's picture

OK, smart guy astrophysicist...


Einstein or Lorentz?




Yeah, I thought so.

akak's picture

Johnny is not actually an astrophysicist --- but he did stay at a Holiday Inn last night.

Fucker stole the towels and bathrobe, too.  Just a coincidence that they had gold trim on them.

GoldSilverDoc's picture

You must be an econ major, Johnny.  You have the (lack of) brains for it.  The rate of change of gold stock, in case you didn't know it, is miniscule compared to the rate of change of fiat stock.  That is the point.  Which you made.  Well, part of it anyway.

But, of course, you forgot the part about the fiat currency.  Again.

And you wonder why I think folks like you are stupid?  


RockyRacoon's picture

You must be an econ major, Johnny.  You have the (lack of) brains for it.

Now, that's funny!

Johnny Bravo's picture

You mofos can junk deez nuts, bitchez!

valeriobrl's picture

Even if I hate to do that (IT Bear , ST BULL), I have an order to go long @1236 and this is why:

Johnny Bravo's picture

Sorry, I don't think you'll get your limit order.

1240 seems to be about the bottom trendline of the rising wedge.

Oh wait... TA isn't valid.  Gold will never have a top.  Silly me.

valeriobrl's picture

Wich is Your view on $Gold ST-IT? 

U could see my view on the Blog...:980 before 1400, I'm bear IT on Gold, but short term I have sign of another push @least to 1252 area.


I will play small on the long side waiting for a reversal bearish sign. The res @1265 must to hold, in other case I will turn to Bullish also my IT

Johnny Bravo's picture

I just don't see it really hitting that low before the wedge breaks down.

I could be wrong though.  My trendline says a little bit higher than that.

You'll get your limit, but not for a little while.

RockyRacoon's picture

China's Cheng Siwei, a high-ranking economic representative is quoted as follows: "Gold is definitely an alternative, but when we buy, the price goes up. We have to do it carefully so as not stimulate the market...China is buying the dips"  One can draw one's own conclusions, but it does suggest controlled price manipulation by mitigating the gold price downside.

There's your market, smart guy.  There is demand.  If you are going to base your assumptions on supply/demand then perhaps you should realign your paradigm.

China is already the world's largest gold miner, and many analysts now assume – following the country's announcement last year that it had been building up its gold reserves for six years unknown to the West – that it is still expanding its gold holdings in a way that does not necessarily show the gold going into official reserves. And now it appears to be looking elsewhere to purchase supplies of the yellow metal without overtly impacting the market.


What is significant, perhaps, is that this suggests that China's commitment to gold is both ongoing – and likely to increase. The country, through its financial institutions and state television advertising, has been persuading its ever growing middle classes to purchase gold (and silver) as a good investment. There seems little doubt that the state is doing the same thing itself as a means of diversifying its huge reserves.

Full article here.

...the "mechanism by which we convert our concentrate into revenue will be much faster than is typical. China Gold will be paying upfront, which means that in terms of timing, Coeur will get paid seven days after shipping vs. the typical two-three months that most concentrate producers must wait, while the metal is being processed at the smelter/refinery."

Translation:  The Chinese (and who knows how many other Central Banks as well as the oil producing countries in the Middle East) are buying gold hand over fist.   Get on board or else...

akak's picture

It might also be worth considering that, for the very first time, China has made arrangements to buy the majority of the gold production of a North American mine, the newly starting-up Kensington Mine in Juneau, Alaska --- the gold is not even going to be refined at the mine, but the ore merely concentrated and then shipped for refining in China:


(Inside information from sources at the mine indicate that the Chinese may end up buying the ENTIRE mine's production of gold, but this is being downplayed for the moment due to the public relations black eye it would give the owners.)

DoctoRx's picture

The gold bull market began when money printing began in earnest immed after 9/11/01.  The only important pause in gold's ascent came during the brief peak liquidation phase after Lehman collapsed.  Even then at gold's panic lows it only dropped to the buying panic peak price of 2006.  So long as the PTPB continue "fighting recession" and "fighting deflation" as they have been, gold is going to trend up in nominal (fiatsco) terms.  But of course what is really happening is that fiatscos are seen to be depreciating against the unvarying standard, gold.

Gold peaked in 1980 when its price vastly exceeded the fully costed production cost AND people saw that Volcker was sticking it to Reagan again with interest rates way above even the monumental inflation rate.

Since gold is money, it is likely to remain the best investment  until the public at large and TPTB so acknowledge it to be.  If that happens, no one will consider it an investment any more than we consider fiatscos in our wallet or quarters in our pockets to be investments. 

akak's picture

Good points, all.

Yes, it is often overlooked that at its 1980 price peak of around $800, the cost of producing an ounce of mined gold was less than $100 everywhere in the world, and in some places and mines quite a bit less than that.  Whereas today, the fundamental production cost is ranging anywhere from maybe $450 to $800, with an average of at least $600 (and probably more), while production costs continue to rise well above the rate of overall price inflation.  So it is ludicrous to talk about $300 or $400 gold ever again, as every mine in the world would shut down at such prices, instantly negating them.

(Do you hear that, Robert Prechter?)

dnarby's picture

Commenters like you are the other reason I read ZH.


flag as awesome (1)

akak's picture

If that comment was directed at me, dnarby, then thank you very much, although I am hardly deserving of such praise, being mostly out of my league here on ZH and sometimes a hothead to boot.  I only commented so relatively much in this thread because I feel I have rather more knowledge of this particular topic than of most other topics discussed here.  I hope my small contributions here may be of some value to the conversation.

Johnny Bravo's picture

"Maybe 450 to 800"

So you don't know.  You're just assuming and saying "maybe."

Why was gold 600 as recently as 2008 if the production cost was 800?

Doesn't make sense to me.  I think you're repeating things that you aren't sure about.

akak's picture


No, the answer is that you have your head up your ass, troll.

There are a vast number of varying costs involved, as well as vast differences in labor and regulatory costs, energy inputs, ore grade, method of extraction and concentration, underground vs. open pit mines, heap leaching vs. flotation vs. gravity concentration, associated minerals interferences, etc. etc. etc. that affect the cost of production at each mine, so no one production cost figure is correct.  There are so many constantly changing variables involved in calculating production costs, and varying methods of doing so, that you will find that this is one of the most difficult numbers to pin down, and is not agreed upon even within the industry itself.

But of course I know nothing about such things.

idoubtit's picture

akak, you sound like a guy that can name all the parts to a car but can't explain how it works.

Pricing of assets are related to costs but more importantly are caused by monetary policy and macroeconomic factors.  For proof of that, just look at the insanity in the housing bubble.  For gold to be considered as "money" as everybody loves to claim, it will need to be accepted as a legal tender in society.  In other words, when you can take your gold to McDonalds or Walmart. Traditionally, the best that gold can do right now is to hedge against the purchasing power of what is accepted as currency at the moment - the dollar.  The people that hold gold don't actually expect to use it, but only hold it in order to preserve purchasing power. 

RockyRacoon's picture

Nobody here expects to carry around gold to buy bread.  That is an old, tired argument.

You are correct that gold is being used as a store of value.

To understand gold's role in all of this you should be able to roll the phrase "stock to flow ratio" off the tongue within context.

Thanks for your input.

Here is a kick-ass graph:

Chart of the Day

Today's chart presents the median single-family home price divided by the price of one ounce of gold. This results in the home / gold ratio or the cost of the median single-family home in ounces of gold. For example, it currently takes 153 ounces of gold to buy the median single-family home. This is considerably less that the 601 ounces it took back in 2001. When priced in gold, the median single-family home is down 75% from its 2001 peak and remains well within the confines of its five-year accelerated downtrend.

idoubtit's picture

Or you could of just sold your house in 2007 and stayed in cash and been up even more than 75%.

My point is that timing matters.  Whether in gold, USD, real estate or anything else.  I go long gold all the time but I also realize that the gold train will end one day.  The "gold forever" dogmatism will end the same way the the real estate boom ended.

And then gold will rise again.

akak's picture

You are thinking from a blinkered trader's perspective, and are failing to perceive the larger dynamic playing out here with gold.

It's not a bull market ---- it's a monetary paradigm shift.