Murenbeeld debunks gold myths (April 06, 2011)

One of the gold community’s most trusted economist, Martin Murenbeeld, made a stop in Toronto on April 4th to dispel what he says, are some of the looming myths around gold prices.

Murenbeeld, who is chief economist for DundeeWealth, has over 30 years of independent consulting experience in the gold market, but says that by no means makes him an investment guru.

“I’m the economist,” he said to the packed house at the National Club, “I know boo about investing.”

Then Murenbeeld proceeded to lay out an array of data that invetors looking for an edge in the market drool over.

The data was compiled around breaking down, what he says, are the three most common myths in the gold market.

The first is that gold prices are in a bubble, the second is that prices will fall if jewellery demand decreases and the third is the widely held belief that gold needs inflation to rise in price.

The first myth cuts right to the fear that keeps gold investors up at night. Does the incredible run the metal has been on mean it is now in a bubble?

Murenbeeld’s response is that investors should rest easy, and he began dissecting raw data to show the price of the metal has not shot up as much as people may first suspect.

To illustrate his point he begins with an inflation adjusted chart that measures gold prices in terms of constant dollars. Unlike the regular price chart that most investors are familiar with, the constant dollar chart shows that gold is not at an all time high, and would in fact need to reach US$2,385 before it matched its previous peak of the early 1980s.

But inflation adjusted charts can be found with a quick Google search. A more unique chart presented by Murenbeeld was one which measures the price of gold in relation to the price of oil. The chart measures barrels of oil per ounce of gold and shows that the historic relation between the two commodities is 15 barrels of oil for every ounce of gold.

Currently the historic average is holding with 15.03 barrels of gold equaling one ounce of gold.

“Gold doesn’t look out of line with respect to oil,” he says.

In relation to copper the same pattern holds with the two commodities hovering around their historic ratios.

But perhaps one of Murenbeeld’s most interesting arguments centres around the cover ratio – that is how much gold is needed if it were to called upon to cover a portion of the U.S. money supply.

Back in 1934, under the gold standard, it was deemed that 35% of the money supply should be covered by gold. If that ratio was in place today it would imply a price of US$3,675 per oz. of gold – and that is just to cover the M1 supply. The price would have to be US$7,931 it gold were to cover 35% of the M2 money supply in the U.S.

“Gold has not kept pace with monetary developments,” Murenbeeld says.

Further, in relation to financial assets, gold also looks cheap.

Murenbeeld displayed a chart which set the S&P Index against gold to a unit of one starting in 1870. The chart spikes as financial assets outperform gold and dips as gold outperforms the market.

The steepest dips in the chart came after the depression of the early 1930s, the recession of the early 1970s and the financial meltdown of 2008.

“Something fundamentally changes after each financial bubble bursts,” he says. “In the wake of a financial crisis we follow policies that are beneficial to the gold price.”

In the prior two financial meltdowns, the S&P Index versus gold ratio returned to the original unit of one. That has not yet happened, implying that the price of gold still has room to grow or that the S&P still has room to fall….dramatically.

“If it does get back to unity of one, and gold is still at US$1,420, the S&P has to go down to 289,” he says. “But if the S&P holds at its currently level of 1,325 the price of gold would have to be US$6,520 an ounce.”

Next on Murenbeeld’s myth buster tour was the idea that gold demand is predominantly linked to jewelry demand.

The basis of Murenbeeld’s thesis on this point is that the linking of gold prices to jewelry demand is simply outdated thinking.

While the metal’s price had been strongly tied to jewelry demand as recently as the 1990s, with the advent of ETFs and renewed demand from Central Banks jewelry demand is now all but inconsequential to the metal’s price.

To tackle the third myth, that gold needs inflation, Murenbeeld turns to global liquidity.

His argument here is that global liquidity, as measured by the US monetary base plus foreign exchange reserves for the world excluding the US, is what drives gold. So as global liquidity rises, so to do gold prices.

Murenbeeld concedes that such liquidity is related to inflation, as increased liquidity will often bring about more inflation but that doesn’t mean that inflation is directly correlated to gold prices.

Indeed such a hypothesis is not borne out by the facts, according the Murenbeeld.

To support his contention he turns to a chart which shows that counter-intuitively G-7 inflation has actually been negatively correlated to the price of gold since late 2008.

When such inflation is adjusted for the US dollar it does turn positive but only comes in at 0.39. That is roughly 60% less than a correlation of 1, which would demonstrate perfect correlation.

Murenbeeld’s idea is that with loose monetary policies gold can rise even if the traditional relationship between the printing press and inflation does not materialize.

“There’s money in the system,” he says simply, “so gold goes up.”