Do Bull Markets in Gold and Silver Always Portend Recession or Depression?

Throughout the history of civilization, gold has been the most stable and truest store of value. Currencies, cities, governments, empires, and even entire nations of people have all fallen, but gold has remained. It is this property of gold that led to the Wall Street adage, “Put 10% in gold and hope it doesn’t work.” But do rising price levels in gold, or for that matter silver, always predict an oncoming economic collapse, or can gold and silver be bullish while the rest of economy prospers?

The Fiat Currency Problem

Hndreds of times throughout history, governments have debased their currencies and ultimately given in to the temptation of printing paper “fiat money” — money that’s backed by nothing but the “full faith and credit” of the issuer. And each and every time, thus far, the fiat money has ultimately collapsed and become worthless.

Why should the U.S. government’s Federal Reserve Notes, which went off the gold standard in 1971, be any different? This, at least, is the case made by hard-core goldbugs and silver bulls. They believe that holding precious metals is the only hedge against an impending and inevitable “Financial Armageddon.”

One thing is indisputable gold and silver have traditionally increased in value as the supply of fiat money expands. This is a natural function of supply and demand: as more and more fiat dollars are put into circulation, the supply of gold and silver, which is relatively “fixed” by comparison — fails to grow at the same speed, and thus, the number of dollars needed to buy one ounce of gold or silver becomes greater and greater.

Whether this actually produces more purchasing power for the precious metal is another story, as this is only the case if the total number of goods and services produced expands faster than the supply of newly mined gold or silver, which, in the case of severe economic downturns, is not always the case. Regardless, the relative buying power of gold and silver has held up better than paper money throughout most periods of time, even in the modern era.

Gold and Silver: A Historic Review

The main problem with measuring the historic performance of gold and silver against the U.S. dollar or most other currencies is that, historically, most money has been pegged to specific weights of gold, silver, or both. Prior to the modern era, purely fiat currencies failed rather quickly. It’s impossible to measure the buying power of gold versus the dollar when, for most of the twentieth century, the dollar was redeemable in gold at the ratio of $20.67 or $35 per ounce.

This leaves historical analysts a relatively brief window of time — 1972 through the present — to examine. During this time, the value of gold relative to the dollar has been allowed to float. As monetary inflation has accelerated, the price of gold in dollars has risen. As inflation — or more importantly, inflation expectations has abated, and gold has had at least one rather precipitous crash.

For example, when President Nixon “closed the gold window” in 1971, the price of gold immediately spiked from the $35 an ounce at which it had been pegged. By the early eighties, inflation was raging in the double digits per annum, and gold eventually hit an all-time high of $850 an ounce. ($2,100 in inflation-adjusted dollars). But when Paul Volker effectively hit the reset button on the economy, dramatically hiking interest rates and intentionally causing a recession, gold plummeted, and as the Federal Reserve had a better handle on fiat-money management, gold eventually fell to just $272 per ounce by the year 2000.

This is a strong empirical case for gold as a hedge against economic collapse. Theoretically, the price of gold reached $850 an ounce because investors anticipated perpetual inflation and the potential collapse of the U.S. economic system, but when the truly unexpected happened — the government became more responsible with the money supply — the per-ounce price of gold fell. Crisis averted. But can gold and silver see significant price movements to the plus side even if the U.S. economy remains strong?

Gold and Silver: 2001 and Beyond

The horrific events of September 11th — though emotionally devastating to all — resulted in substantial gains for gold investors. Although most who profited in the aftermath of 9/11 would trade it all away to save even one life lost on that fateful day. The fact is, it’s quite likely gold would have turned bullish even in the absence of the terror attacks.

In the years following 9/11, even in the face of an expensive war and an extravagant new Medicare prescription-drug benefit, the U.S. economy has hummed along, with inflation relatively under control and the stock-market indexes all hitting new highs — and yet gold has also been tremendously bullish. Some goldbugs argue because the market is smart enough to realize that the U.S. fiat-money system is ultimately unsustainable, but others point to a real increase in the demand for gold.

After all, non-inflationary economic growth — the kind of growth in which extra dollars compete for even more goods and services produced by the booming economy can still produce a greater demand for gold, and if the supply of gold cannot keep up with demand; then clearly, the price of gold is going to rise. Since 2001, gold has nearly tripled — a feat which, in the absence of near-hyper inflation, has never happened so quickly.

Silver, on the other hand, has forged a different path. Many silver bulls allege that the price of the commodity has been artificially suppressed by a cabal of concentrated short sellers. They cite increased industrial demand for silver, which is used in many high-tech applications, as an ultimately bullish indicator for silver, and this particular trend is amplified by economic growth, not the potential of recession.

Thus, while gold and silver have historically fared best in the face of impending economic doom, it appears things have changed in this new millennium. Now it looks as though gold and silver will perform well in the case of recession or depression, or in the case of continued economic strength. Although, there is a bearish side to every investment story, gold and silver seem uniquely poised to be solid investments under all economic scenarios in the foreseeable future.