Gold and the EURO Connection; Another Nail in the U.S. Dollar Coffin?

Financial Advisor’s who don’t diversify their clients into gold typically give as one of their reasons not to invest in gold, it’s long term record as compared to stocks and bonds.  In one sense they are right.  In many other ways they are dead wrong and their clients will suffer from their lack of understanding about how gold fits into a well diversified portfolio.

How Financial Advisor’s Are Right About Gold Not Being a Long Term Good Investment

They’re right in the sense that gold hadn’t kept pace with the interest paid on dollar denominated bank accounts, stocks and their dividends paid, or bonds.  The U.S. government was doing a good job of keeping gold out of the public eye since confiscating gold in 1934.

But why was gold not a good investment for all these years?  You’ll have to look at a different perspective of the history of gold and see what was really happening.

Some Historic Analysis of the Price of Gold Just the facts because if you understand the history of gold, it can give an indication as to the present and future.

What helps the Financial Advisor’s case against gold is the fact that gold was not allowed to trade freely or be invested in by the general public for a period of just over forty years (1934-1975).

The price of gold was fixed by the U.S. government during this time and was only adjusted higher from the $35 amount in 1934 to an average of $42.72 by August of 1971.  The general public was limited to just $100 of gold in their possession since 1934.

The dollar was still tied to gold (backed by) up until August of 1971.  Within three years of the decoupling of gold from the dollar, the inflation rate hit double digits.  1973 and 1974 were also bad years for the stock market seeing the DOW fall by 46.3%.  Gold meantime had more than quadrupled in price going from the $40 range to the low $180’s by December of 1974.

In 1975, U.S. citizens were finally allowed to own more than $100 worth of gold through the passing of a bill signed by President Gerald Ford legalizing private ownership of gold coins, bars and certificates.

Gold was trading at $175 an ounce at the beginning of 1975.  But the nation was coming off an inflationary period where the inflation rate hit a high of 12.34% to a low of 6.34% by February of 1978.

The price of gold fell and languished during this time frame until breaking to a new high in 1978 at the $180 range again; the calm before the storm.

By March of 1979, the inflation rate hit double digits again and broke out to almost 14% by January of 1980.  Gold during this time went to its then all-time January 21st at $850 an ounce.

During this run up in the price of gold, the U.S. government needed to pull a feather out of their Federal Reserve hat to stop the fear that people had about the economy and especially the plummeting value of the U.S. dollar compared to gold.  That “feather” was provided with the installing of Paul Volcker as Fed Chairman in August of 1979.  Within a short time of leading the Fed, Volcker instituted an interest rate policy that increased the Federal Funds Rate to much higher levels.

As the interest rates paid on bank savings and CD’s started to rise, Americans clamored to take advantage thus dumping gold.  The inflation rate came down to the mid 2% range by 1983.   You see, there was no competition to the U.S. dollar at that time except for gold.  Paying higher interest rates restored confidence in the Almighty Dollar.

Gold languished for 17 years hitting a bottom of $252.80 in July of 1999.

Gold started to bounce off it’s low in mid 1999 and some of this reasoning could be contributed to the “end of the world” panic with the end of one century and the dawn of the next.  While the bounce wasn’t too big, gold did maintain a mid to upper $200 price range for the next couple of years, never falling below it’s 1999 low.

Now this is where Financial Advisor’s will tell you that when you include all of this data about the historic price of gold, it doesn’t paint a pretty picture.  For the most part, they are right.  But there is something that changed in 1999 that wasn’t a factor before.  This “something” was the introduction of the Euro in 1999.

The first year or so of some new financial instrument is sometimes a probationary period to see how it will do compared to the competition.  The Euro during 1999 fell to where it was at par with the dollar by the dawn of the 21st century.  By October of 2000 though, the Euro had bottomed against the dollar.

Gold prices during this time-frame of the introduction of the EURO languished.  This was due in part because of the September 1999 Central Bank Gold Agreement by G10 countries  to dump 2000 tonnes of gold on the open market over the next five years (through 2004).

Even with the dumping of gold on the open market, gold managed to break $300 an ounce in 2003 and $400 an ounce by 2004 in anticipation of the end to the Central Bank selling of gold.

Another story was developing at this time; the EURO had bounced off its lows and become a much stronger currency.  As the dollar was sinking, from its high in 2002, and the uncertainty of what affect Central Bank sales would have on the price of gold, the EURO became the only other “safe haven” in the mind of those who were looking to get out of the dollar.

The EURO Joined Gold as Competition to the Dollar

Had the EURO not been around, we might have seen the price of gold be much higher than it was.  But the Central Banks were also making sure that the price of gold wouldn’t take off too.  As the first Central Bank Sales Agreement ended, a second Agreement took its place in March of 2004, to last five years.  This time the agreement was to sell 2,500 tonnes of gold.

I wonder how much the Swiss citizens are enjoying the fact that their Central Bank has been selling their gold at depressed prices since 2002 and is still selling today?  What would U.S. citizens do if the U.S. started to dump its gold on the market?  I do realize there is a mystery as to how much gold the U.S. really has since the government never allows it to be audited.  It’s supposed to be around 8,033 tonnes.

But keep one thing in mind, the second Central Bank agreement to sell gold ends in September.  How much more can these countries take of selling an appreciating asset?

The Competition to the Dollar Has Grown

During the time-frame of 1971-1999 there really wasn’t any competition to the U.S. dollar.  The U.S. Dollar was king of the world.  Gold was not on the tips of everyone’s tongue’s because the U.S. education system hardly ever mentioned gold except something about a California gold rush in the 1850’s and an Alaskan one (Klondike) in the 1890’s.

But that changed when the EURO became available as an alternative in 1999.  But the EURO is also a fiat currency and subject to inflation just like any other currency (Inflation defined as the increase in money supply by printing and additions to fractional reserves).

In fact, over the last ten years, gold has increased over 161% versus the EURO as can bee seen in the chart below.

It’s also true that its easier to invest in gold now than in the 1971-1999 era because of the introduction of ETF’s like GLD and IAU (although, I personally would only recommend trading with these instruments and not include them in one’s long term holdings….but that’s another story).

Does anyone find it interesting that ever since the introduction of the EURO the price of gold has gone up every year in U.S. Dollar terms (outside of its first year)?  This despite Central Bank Sales Agreements to suppress the price of gold.

Does anyone think that U.S. government policies are dollar bullish?

Being that financial advisor’s hardly ever recommend gold to their clients, who is going to tell them they need to protect themselves from what really backs the U.S. Dollar?

Financial Advisor’s Need to Change with the Times and Stop Bashing Gold as an Investment and include it as insurance in their clients portfolios.

The EURO, while having it’s own vulnerabilities as it is fiat money, is just another nail in the U.S. dollar coffin.  All the other nails are golden.