Monetary Influences On Demand
Let's start by charting gold's price behavior over a longer period of time. Nearby is a chart that begins in 1973 when gold was just under $90 oz. Before we discuss the subsequent price developments, we need to highlight some important things that took place in the US between 1970 & 1975.
Way back in 1933, by executive order of FDR, it became illegal for Americans to own more than $100 worth of gold without a special license! During the ban, gold's price for purposes of dollar convertibility (available only to foreign holders) was fixed by statute at $35 oz. On August 15, 1971 President Nixon announced that the US would no longer convert dollars to gold at a fixed rate, effectively taking the US currency off the gold standard! FDR's ban on ownership by private citizens was finally lifted by President Gerald Ford in December 1974.
While gold was still unavailable to US investors, but right after the US abandoned convertibility, gold's world price shot up from $35 to $150 oz. between 1971 and 1974. In the chart above you can see that gold then proceeded to wobble between $100 and $200 before exploding toward $800 between '78 and '80. As many readers will recall, that was a period in US history when general price inflation catapulted into double digits. Gold historians ascribe the late '70s gold price increase to the rampant inflation and concern that our currency, now untethered to any dependable metric, would be continually abused by government and the central bank. With the CPI vaulting ahead at 13% a year in 1980, hyperinflation seemed but a skip and a jump away.
Not to worry! Paul Volker came on board as Fed Chairman in the waning days of the Carter administration. Not a man to be trifled with, Volker took seriously his responsibility under the Federal Reserve Act to maintain price stability. Cranking up short-term interest rates as high as 20% by June 1981, he succeeded in driving inflation down from 13.5% to 3.2% in just 2 years!
Gold's price wasted no time getting with the program; it collapsed by about 60% and proceeded to bounce around between $250 and $500 for the next 24 years. During most of that time the Consumer Price Index was well behaved, increasing less than 3% a year.
So, to the extent that investor demand for gold is driven by inflation concerns, the Volker experience shows us that seriously conservative monetary policy seems to quiet those worries and dampen demand for gold.
You can see the gold price-CPI relationship in the chart above comparing the trailing 10-year change in gold's price with the trailing 10-year change in the CPI since the early 1950s. The overall connection between inflation (aka erosion of the dollar's value) and the price of gold seems undeniable. However, one thing is a little puzzling about the patterns. The trailing 10-year rate of inflation has trended lower ever since 1981; the gold price fell and then flatlined, which seems consistent. But around 2005 gold started accelerating upward without any apparent provocation from CPI inflation. Is there another price driver that a prospective gold investor needs to be aware of?