Many people will understand the idea that gold, priced in US dollars, is likely to appreciate if more dollars are printed. The question however, is by how much?
Two facts are worth noting. The first (whatever your views on gold as a currency) is the extraordinarily close relationship between the price of gold and the US monetary base. In the 52 years between 1959 and 2011, the correlation between the US monetary base and the gold price has been an astonishing 0.90 and has never been less than 0.58. Given the amount of data involved in the analysis, this is extremely statistically significant – that is to say there is less than a 5% probability that this occurred by chance.
The second is the extent to which the monetary base has been inflated. Before 2008, the largest increase in the US monetary base was 15.8% in 1999 (in anticipation of a Y2K crisis and followed by a contraction in 2000 when the anticipated crisis failed to unfold). The 2nd largest increase in the monetary base was of 11.3% in 1978 as authorities grappled with the protracted economic crisis of the 1970s. By contrast, in 2008, the monetary base increased by 99%, in 2009 it increased by another 21% and in 2010 it increased by another 27% – all told, an increase of US$1.8tr, from US$0.8tr in 2007 to US$2.6tr as at the end of 2011. As Senator Everett Dirksen was fond of saying, “A billion here and a billion there and pretty soon you’re talking real money” .
So, what’s the effect of an additional US$40bn per month? As of end-2011, the gold price implied by the size of the US monetary base (and the above regression analysis) was US$1,370/oz. Adding to the monetary base at a rate of US$40bn per month implies a gold price of US$1,446/oz as at December 2012, US$1,676/oz as at December 2013, US$1,906/oz as at December 2014 and US$2,136/oz as at December 2015. As such, the current price of gold (c US$1,771/oz) can be perceived as discounting QE3 continuing for 20 months until c May 2014. In this respect, one further point is worthy of note: during bull markets (and the last big bull market of the 1970s in particular), the gold price traded at between 0.9 and 1.8 times the price implied by the US monetary base regression analysis above. At the moment, it is just 1.2 times.