Saturday 4 December 2010

When Money Dies and Gold Priced in British Pounds (GBP) – December 2010 Update

With us living in a world where:

- governments around the world are in an apparent race to devalue their currencies the most through various policies including Quantitative Easing (or as I like think of it, money printing) if you are in the US or UK;

- Central banks in countries like the UK are running crazily low interest policies while allowing inflation to run a ‘little’ allowing the reckless, including the government, to inflate some debt away while thinking they can keep it all in control;

- Europe is implicitly promising to bail out every dodgy Euro zone economy which in my opinion will soon see them also heading down the money printing route to buy government debt; and

- many developed countries are carrying so much debt that it seems inconceivable that they will ever repay it and instead will attempt to inflate away the debt (or maybe forcing bond holders to take a haircut);

I thought it best to start understanding what happens in an economy when inflation rips and disaster strikes. I have therefore started to read the book “When Money Dies – The Nightmare of the Weimar Hyper-Inflation” by Adam Fergusson. This book charts the collapse of the Weimar Republic’s Mark which in 1923 had an exchange rate to the dollar of 4,200,000,000,000 Marks. This was a time when the “Republic was all but reduced to a barter economy. Expensive cigars, artworks and jewels were routinely exchanged for staples such as bread; a cinema ticket could be bought for a lump of coal, and a bottle of paraffin for a silk shirt.”

I’m only in the early stages of the book as I find it quite hard going at times. So far though, we have a country which is effectively massively indebted through having to pay massive war reparations payments and the government has decided that massive money printing is the answer. This doesn’t sound too different from some countries today or Europe tomorrow except for now maybe the scale. So is it any wonder we are continuing to see gold in both real (inflation adjusted) and nominal terms heading upwards.

Today I’d like to look at what’s happening to gold when priced in British Pounds. My 1st chart shows gold currently sitting at £895.80. Comparing monthly nominal values this is a record high. Of course inflation hides a lot so when looking in real terms we can see that we are still not at an historical high. That honour goes to 1980 where gold reached a monthly high of £1,086.63 meaning we still have 17% or so to go. Given the current economic climate and current government activities I can see no reason why it is not possible to reach a new high going forward.

I should however point out that while we have not reached a new real high we have however reached a milestone by passing through the 1983 high of £875.73.

Of course real gold today is well above its long run average of £456.98 and also well above the trend line as shown on the 1st chart. So by both these measures gold currently looks well over priced in GBP terms.

Today’s 2nd chart shows the price of gold in GBP divided by the seasonally adjusted average earnings index for the whole UK economy (LNMQ) since 1990 which has now been superseded by the Office for National Statistics (ONS) and replaced by the Average Weekly Earnings (KAB9) which I also show since 2000. This ratio shows that gold was ‘cheap’ between 1998 and 2005 (remember Gordon Brown sold 400 tons of the UK’s gold reserves between 1999 and 2002 in a series of auctions). In earnings terms gold is as of October 2010 (the latest available data for KAB9) 3.4 times more expensive than the low of that period and continuing to rise.

When it comes to my own gold holding which currently makes up 5.4% of my portfolio I’m still doing nothing. I haven’t bought since May 2010 and my mechanical investment strategy hasn’t forced me to sell to rebalance either.

As always do your own research.

Assumptions include:
- Last gold price actual taken at close on 03 December 2010
- All other prices are month averages taken from the Bank of England.
- November and December 2010 inflation is extrapolated from the retail prices index (RPI).


  1. Yes, gold in an inflationary environment is an interesting situation. Clearly "ordinary" inflation tends to favour the yellow stuff, but I suspect that the Weimar experience suggests that when economic disaster strikes, it's not as reliable as having a share in productive assets.

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