Scott Sumner On Gold

This is the first commentary on the gold market that actually made sense to me:

About those high gold prices

...As far as I know there is really only one respectable argument that inflation expectations are approaching dangerous levels in the US. We know that 5 year TIPS spreads are low, and we know that the near to medium term consensus inflation forecast is low. We know actual inflation is low and falling. But then there are those gold prices.

I’ve never been convinced that the high gold prices were signaling US inflation fears…

...I seem to recall someone pointing out that Asian gold demand couldn’t be the problem, because the totals were fairly stable. But that confuses shifts in demand with movements along a demand curve. When world output is falling, it is necessarily true that total quantity demand will also fall. If you confuse demand and quantity demanded, it will never look like higher demand is pushing up prices when output is declining...

...Here’s what I would expect. Global gold prices would be expected to rise strongly over the next few decades. If markets are efficient and nominal interest rates are very low, the expected future rise should also raise current gold prices. The intertemporal arbitrage necessary to make this happen would be provided by gold speculators who buy up lots of gold, driving current prices much higher…

…The fact that Chinese quantity demanded increased rapidly despite a huge rise in gold prices suggests that the Chinese demand curve is moving to the right at a truly explosive rate. Indeed in this model it would be possible for future expected Chinese demand to explain 100% of the world’s recent gold price rise, even if the current quantity demanded were falling slightly. Speculators might be holding gold stocks in readiness for future expected Chinese demand. But of course Chinese consumption (Qd) is rising fast despite the high prices...

...One interesting question is why Chinese inflation is rising sharply. It’s clearly not due to any rise in US inflation; rather the most likely explanation is the Balassa-Samuelson effect. I’ve been predicting a huge appreciation in the real value of the yuan for quite some time, and so far I’ve been right.

The comments following in this blog post are almost as interesting – but note that Scott doesn’t believe that the Fed’s quantitative easing policy has anything to do with gold’s dramatic price rise. That means that if there is a reversal in monetary policy in the west (the other likely explanation is that low interest rates have lowered the holding cost of gold), you might not see a pullback in gold prices.

Which explanation actually informs gold prices, I won’t pretend to know – but it’ll be interesting to watch and see which is it.