Roosevelt’s number

The market price for gold

Irrational exuberance in the gold market

These articles are part of a 4 part series. The last and most anticipated article will not be posted until next week, however, Paul's articles on theoretical gold are so fascinating, that I wanted to make you aware of them even before this series is concluded.

In his first article, Roosevelt’s number, Paul discusses the details of the US Gold standard. When a country is on a gold standard, it means that its currency is backed by gold. For example, if a government had a billion ounces of gold in its treasuries and a billion dollars of paper currency in circulation, then each paper dollar would be worth exactly one ounce of gold on a gold standard. When a country is on a 'gold standard', not only is its paper currency directly backed by gold, citizens and foreigners can directly exchange their paper money for the equivalence of gold. Likewise, if a country prints more paper money, but its gold reserves remain the same, the price of gold will go up and the price of the paper money will fall.

During the days of the gold standard, the US set the price of gold by law. Prior to 1933, the US set the price of gold to $20.67. However, in 1933 Roosevelt raised the price of gold to $35 an ounce. When Roosevelt raised the price of gold to $35, it caused the price of US currency to raise overnight. Subsequently, this caused foreigners to trade in their gold to the US in exchange for Dollars, which were suddenly now worth more overnight. This also caused the US gold reserves to raise by over 50% from 1940 to 1957.

However, after 1957, this trend reversed and gold began to leave the US treasury as foreigners did the opposite - by trading in their Dollars for gold. What happened to change this trend? The US government was printing more money each year (M3) during this time. Whenever more money is printed, it causes the 'real value' of gold in increase. As more and more money was created from 1957 to 1971, the 'real value' of gold increased, even though the official price of gold was set at a constant $35 an ounce. Savy foreign nations realized this and began to trade their paper Dollars in exchange for gold which greatly depleted the US gold reserves.

I have long wondered why the US went off the gold standard in 1971, the above information explains it all: Apparently, Nixon went off the gold standard in a desparate attempt to save what gold was left in the treasury. If gold would have remained set at $35 and had the US stayed on the gold standard, all the gold reserves in the US would have eventually dried up. Even though gold was set by law to a constant $35 an ounce, because many more Dollars were being put into circulation year after year (measured as M3), the intrinsic value of gold was actually much higher then $35 an ounce.

As you can see from the chart below, form 1959 to 1971, the amount of Dollars, measured in M3 greatly increased, while the price of gold was set by law to $35 an ounce.

Paul shows that in 1971, while the price of gold was set at $35 an ounce by law, the actual intrinsic value of gold was really about $102.78. Paul calculated the intrinsic value of gold by comparing the total amount of gold being produced every year with the amount of new Dollars that were printed. Obviously, the amount of new Dollars being printed year after year vastly outnumber new gold production - thus the intrinsic value of gold was also rising, despite the actual price of gold that was legally anchored to $35.

Naturally, after the US went off the gold standard in 1971, the price of gold quickly shot up to the intrinsic value in just a couple years.

Paul then calculates the intrinsic, or theoretical, price of gold based on gold production and M3 money. Paul shows that the market price of gold follows the theoretical price of gold very well, oscillating above and below it like a wave.

In the late 70's and early 80's, gold was way overvalued with respect to the theoretical price of gold, and could not maintain its lofty levels. Obviously, whenever the actual price of gold deviates largely from the theoretical price of gold, either way above or way below it, a large price moment will soon occur to correct the anomaly.

As stated above, Paul is not yet finished with this series of articles on theoretical gold. The chart below stops at 1988 and next week Paul will bring this chart up to date.

The reason I am showing you this incomplete chart now is that it tells us so much about the strength of this gold bull market.

Notice the consistent uptrend in the theoretical price of gold, which is due to the ever increasing M3 money supply. Because I am very impatient, I took this curve an extrapolated it to the current date.

By extrapolation, I calculate todays theoretical price of gold at between $750 - $800 an ounce!!! We'll see how I well my guess fared when Pauls next article comes out. I preformed the extrapolation by am assuming the uptend in the theoretical gold keeps the same slope. Obviously, M3 money support has continued to increase since 1988, especially during after the mid 90's and 2000s.

This tells me that gold metal is far undervalued and will eventually come back to, and likely surpass its theoretical price of gold - which will probably happen within the next few years.

However, we all know that markets over-react, therefore I think the price of gold will go back to, and well past, the theoretical price of gold in the next few years. Therefore, I can now easily see gold going to $1000 an ounce and possibly beyond.

If had a few million dollars, I would buy gold metal, confident that I would more then double my money safely in a few years.