Gold Meditations

In a Twitter exchange a few weeks ago I mentioned an insight offered by Jacques Rueff into the gold pricing mechanism under a classical gold standard in his book “The Monetary Sin Of The West”.

A few people asked me to expand on that comment. (As usual I’m late in getting this post out.) Long story short, Jacques Rueff tells us that there were two reference points for setting a currency peg with gold. In gold producing countries it was the average production cost of mining gold. In countries without significant gold production the reference point was average exports.

He also talked about gold having a place in the “price hierarchy” of commodities which, by inference, is discovered as a result of mining for gold. (I’ll provide some page references and extracts from Rueff’s book below.) So gold mining had two inter-related pricing functions.

The traditional price discovery mechanism for the commodity price of gold wasn't trades on a COMEX style exchange or a “fix” by a group such as the LBMA. (In the case of the LBMA perhaps it might be more realistic to view the fix as a market maker’s operation. Meaning the LBMA clearing members simply provide liquidity like the primary dealers in the US Treasury securities market by standing in the market with a bid and offer price.)

Rueff’s insights have some interesting implications for the COMEX gold market. If this paper by Douglas Pollitt is on the money then a realistic assessment of the current overheads in the gold mining business means that miners require a gold price many hundreds or even thousands of dollars higher than the price COMEX is signalling. In my opinion the disconnect between the COMEX price and the production cost of gold requires an explanation.

As Rueff points out the price of gold also regulated the supply from mines by disciplining the “marginal producers”. It exerted pressure on them to reduce supply when prices were low and encouraged production to expand when prices were high. Could this apparent mispricing be due to the gold miners sucking in capital without being able to provide a return?  (Mining their stockholders as Pollitt's paper suggests to Uncle costata.) Are other commodities produced for years despite being priced below their production cost?

As I mentioned earlier I’ll provide some page references to the digital copy of Jacques Rueff’s book that I linked above. He described gold as having a place in the “price hierarchy” of commodities (P. 33). He talked about gold residing in the “general price hierarchy” (P. 208) and that gold’s place in this hierarchy was determined by the cost of mine production.

That makes sense to me. The costs that impact on other commodities also affect the cost of gold production – labour, capital, technology, interest rates, machinery, energy, various consumables, land, government fees/charges and so on. Gold mining was the conduit through which the components that make up the “general price level” (P. 142) impacted on the overall cost of gold production. This is Jacques Rueff’s description (P. 58) of the benefits of pegging to one of these reference points:

“No doubt, the fact that legal parity is pegged is the main feature of the gold standard. I would even say that its major virtue is that it maintains the whole scale of prices in the countries that apply it at a level where the average cost of gold production [10] coincides with the legal parity of the currency.

But when its operation has been suspended—as was the case in nearly all belligerent countries during the last two world wars—or disrupted—as was the case as a result of the application in the greater part of the world of a system which, like the gold-exchange standard, stretches nearly to breaking point the link between gold and aggregate purchasing power—then there is no alternative but to jettison appearances to save realities and, while acknowledging the situation that you have allowed to develop, to re-create the basis for continuing expansion without impairing order or stability.

[10] And in the non-gold-producing countries, the average price of gold in terms of exports.”

Gold provided an anchor for the currency to the rest of the commodities that constitute the general price level. When this level increased significantly (e.g. as a result of a major war) Rueff’s policy recommendation was to increase the price of gold in order to restore equivalence. Expressed in currency terms this meant cutting the exchange rate of the currency peg to reflect the change in the general price level. In a situation where prices had doubled a peg set at 50:1 before the rise would require a reset to 100:1 in order to recognize the true position of gold in the general price hierarchy of that currency zone.

Rueff seems to be offering a way of approaching a fundamental analysis of gold pricing. Now I realize a lot of people believe that fundamentals play second fiddle to technical analysis (TA). And the savants of Team TA have certainly been racking up the points against Team Goldbug lately. I posted a comment here recently with a quote from a post that I thought summed up the current situation perfectly. It's from a blogger who styles himself Tiho (at The Short Side Of Long blog) who said: “Fundamentals are useless until the market decides to price them in.” After further reflection I began to have doubts about how the average person could profit from adopting this perspective. 

If you don’t know what the fundamentals are how can you position for the market’s ultimate recognition of their existence? (Perhaps Tiho's statement could be restyled as Technical analysis is useless unless you know when the fundamentals will be priced in.)

If you do know gold's fundamentals (and they aren't being priced in) how can you determine in advance that the market is about to price them in? Can TA answer this question? 

If you think you have the answers to these questions or you would just like to comment about this post please join the discussion.


Bron Suchecki said...

If I read Rueff right, he is saying that the cost of mining gold if a sort of CPI measure in that the costs going into mining are representative of general costs borne by businesses?

If so we have to consider that the specific mix of costs involved in mining may not be representative of the mix of costs across the economy.

I also think that while this idea may have been valid when an economy was predominately composed of primary and secondary industries, in more modern times with the shift to service industries the Rueff gold standard/price level theory may not hold.

costata said...

Hi Bron,

Thanks for commenting. I think gold would probably work well enough today as an indicator under a Rueff gold standard. I don't think Rueff or any of the gold standard advocates were under any illusions about gold's imperfect performance. It simply performed better than anything else that was tried.

There's another dimension to Rueff's book as well - the monetary characteristics of gold. I intend to do a post about that as well. I think it was the dual functionality of gold that made the gold standard so successful.

Rueff's description got my attention because it's the first time I have seen a simple explanation of how gold functioned as the reference point in a gold standard. I'm going to try to translate his mechanism into the current system in order try to describe how it might work today. Perhaps a role reversal would work. Gold becomes the reserve currency and fiat currencies become the price proxies for each currency zone.


AdvocatusDiaboli said...

Good morning,
thanks for the interesting approach of the post. I guess we are all here, because we are fascinated and trying to figure out, how the price determination of assets and in particular gold works.
Team TA thinks, that when looking at the past how bid and ask met, you can determine the future. Team Goldbug measures somehow the assumed total physical amount and flow of gold against whatever.
Let me give you my ugly simple truth I came to over the past years: Something is worth whatever somebody else is willing to give you for it PERIOD.
Once you acknowledge this fact (which lots of biased loons refuse), everything else flows from there:

The production costs do only matter in the term what the miner wants or has to get, but not if a buyer exists or what the potential buyer is willing to pay.

Or the opposite approach, do you remember FOFOAs "BalloonDogs"? Production price of that crap? Nothing. Sold for 50Mio. But just because Team TA will therefore figure somehow that next day it will sell for xyz Mio. forget it. Same for Team Goldbug, because base money has doubled therefore the BalloonDogs will sell for 100Mio....

Just my2cents, sorry that I have nothing further fancy sophisticated highly intelligent to say.
Greets, AD

costata said...


Cranky is OK! There is a lot to be cranky about!

Fr'instance, Uncle costata found and presented the best lemur photo of the decade and the rest of the STFU faculty is missing in action on the fulsome praise for his achievement!! Go figure!!!

On a more serious note I think I'm progressing toward an approach to the fundamental valuation of gold that is more robust than my earlier crude AU$10-12,000. It's probably lower but we'll see how it stacks up.

AdvocatusDiaboli said...


so you acknowledge my facts of wisedom?
Now test it on yourself, you probably have a stash of gold, yes?
Go, turn the tables, are you buying at $12000?
If your answer isn't "YES SURE, GIMME LOTS OF MORE, I HAVE TO GET AT LEAST ANOTHER TON", you just proven that your prediction is nothing but a greater fool game, you are biased in the hope to stick that yellow stuff to somebody else.

The only way gold "works" at higher valuation is, if it is actively used as a reference for currencies by all major CBs. If I look at the dudes of the "Group of 30", aint gonna happen, regardless of what you figure!
Greets, AD

Motley Fool said...

Bron makes a good point.

AD- it's not really that simple.

What someone is willing to pay certainly features, as well as how much of it he is willing to buy at that price. Similarly what someone is willing to accept features, as well as how much of it he has to sell at that price. The combination of all such actors in tandem is what creates the 'market price'. This is fairly basic economic thought.

If I am willing to pay $1 but can find none for that price, what I am willing to pay is irrelevant. If someone is willing to pay $1000 and another $1500 and both are willing to buy 100, and 80 are for sale, then only the highest bid matters, if you are willing to accept that.

The problem is that it is not easily possible to predict how much people are willing to pay or accept, though the market price is an estimate of this in aggregate.

For gold the marginal utility is constant and the function is value storage, so price is quite irrelevant.

Thing is it is currently competing with many other things in that function, though that is likely to change in future, especially as regards its biggest competition government debt.


Cool picture costata.

costata said...

Thanks MF


I'm operating on the assumption that CBs and Treasuries will employ gold to reset the international monetary and financial system. I have also come to accept that it could take a lot longer than I imagined. It amazes me to be reading proposals like EMU composite bonds and a revised SDR as possible solutions yet again in the past few days.

It's like saying if we glue 10 defaulted credit cards together we can create one good credit. But I have to remind myself that economists like Paul Krugman are lauded and their theories are widely accepted and followed by (self-serving?) policymakers. It doesn't seem to matter how many times they are debunked. Their crap economic theories persist.


costata said...

I'll be interested to see if these retail gold shorts get taken to the cleaners:

"Positioning of small speculators in gold futures: from an 11 year high in the net long position at gold’s secondary peak in 2012 to a 15 year record net short position today.

Gary Morgan said...

Rueff was just a dreamer who wanted the gold standard back.

Some others dream of gold rising gently for ever more, or of paper gold vanishing (even as the Chinese advocate a futures/physical ratio of 80/20).

The world is full of dreamers and suckers, and even some who refer to themselves in the third person, one wonders why?

A blog post trying to tie together Rueff's dreams with modern TA does reveal something about the writer though.

AdvocatusDiaboli said...


"For gold the marginal utility is constant..."

Sure it is constant, because its utility is ZERO!!!1111
Like Bron onces wisely stated, it is all the narrative, and I personally really cant hear that FG brainfucked crap any more.

"The problem is that it is not easily possible to predict how much people are willing to pay or accept,"
That's why I have ask Costata personally, since he came up with a prediction, but gotten no answer (which is an answer as well).

Warren James said...

In the meantime, we rely on gold market for pricing information right? Reliable, somewhat! (and global).

AD, we may be busy but please keep it to an acceptable level or swear in german instead, or something.

Gary Morgan said...

The narrative just took a little change of direction:


(H/T DP.)

AdvocatusDiaboli said...

thanks for the ECB speech, interesting to see what somebody says but rather differently does, anyway, you still looking for confirmation bias?

In the past we always saw almost exactly the opposite: Euro and gold moved always in the same/similair direction, compared to everything else. If the ECB would use gold buying to pump liquidity it would be the opposite. Will we see it some day? Hmmm, just look at the public Swiss-Gold-Thing bashing. IMHO nobody will accept or allow the ECB to buy gold, when instead some crooks can load off their ABS instead and the clowns can tell the people that this is to create prosperity in the ClubMed.
Greets, AD

Gary Morgan said...

Slightly off-topic, but relates to the price of money (stability) going forward, versus the price/volatility of assets such as gold:

"The reference point of our trade is fixed: the ECB monetary policy is always based on our price stability mandate." (Mersch)

Bear in mind the ECB is likely to bid for physical gold, next year in my opinion. Gold's price therefore is arbitrary.

AdvocatusDiaboli said...

"Bear in mind the ECB is likely to bid for physical gold, next year in my opinion."

I file this under desperate wishfull thinking and confirmation bias seeking by a holder of a useless yellow piece of rock.

Fact: If nobody wants to take credit and there is no credible debtor that needs or wants a loan, the ECB can buy all gold they want, aint gonna change a single thing to the internal european problems. Currency unions are great, aren't they?
Even after the ECB has purchased all gold in the world driving the € into the ground doing so, every single chinese drives now a Mercedes, but still nobody will eat greek cheese or wine outside the €-zone.
Greets, AD

Gary Morgan said...

Time will tell AD, time will tell.

AdvocatusDiaboli said...

Hi Garry,

yes time did in fact tell:
Yesterday the ECB announced that they did buy further covered bonds.
From whom or what for what reason in particular? I dont know, only proves the fact that any crook can load off their crap in front of the ECB whenever he needs some spending money, and some spokeman will make up a nice storry for their actions.
Greets, AD

costata said...

So, after using "supply and demand" to harvest the retail gold shorts what's next for the BBs?

Perhaps using this sucker rally to lure in the next roster of victims before truly testing the lows?

Gary Morgan said...

Seems to me that gold is the mirror image of the S&P.

So a brief correction in one and rally in the other has been overdue for a week or so, now in progress it would seem.

In line with Armstrongs thinking, golds final low likely to come with the S&P's final rally early next year, perhaps sparked by the ECB ruling out sovereign bond QE, and ruling in GOMO (gold QE).

Commodity prices signalling the economic cycle has definitely turned down, just a matter of time until equity markets grasp that all hope has gone. Credit markets grasp this already.

GM Jenkins said...

Good stuff costata (and fine avatar)! The Pollitt link is an excellent read. Personally, I'm not a dyed-in-the wool TA guy. On a deeper level, I wouldn't write for a coffee or soybeans blog - i.e. I wouldn't be interested in gold if it were not for its historical and even symbolic importance. But (essentially as an experiment) this year I made a vow not to consider fundamentals at all and it's been paying off so far. It was partly a decision of convenience too, as I have no time to be following the news. Easier just to stare at charts for a few minutes when the gambling mood strikes.

costata said...

Hi GM,

Douglas Pollitt appears to be continuing the work of his deceased father. Offering a refreshingly different perspective on the gold miners. Food for thought if nothing else.