Here's some perspective: history, demand and supply.
Brief history of gold price: Gold had sold for $35 an ounce, then shot up to $675 during the last bubble, peaking in January 1980. (I'm using monthly averages throughout this article.) That's cool, buying at $25 and selling at $675. However, as gold was shooting up, plenty of new "investors" were buying, and there were plenty of people who got in on the boom at above $600.
Within two and a half years, gold had lost half its value. It finally hit its trough in 1999, 19 years after the peak, at $257 an ounce. That would have been a good time to buy, but who would have thought? Gold had slumped for nearly two decades. It appeared to be a stupid time to buy.
Now we're up over $1500 an ounce (I'm writing on April 28, 2011). Isn't that great? Let's stay with the history for a bit. Let's go back and adjust that 1980 peak for inflation. In terms of dollars with 2010 purchasing power, that peak was $1,892 per ounce. Another 23 percent upward and those old investors will have recovered all their purchasing power. Whoop de do. Just for comparison, if you had bought stocks in January 1980, you would have a total inflation-adjusted return of 316 percent. But we were headed into a recession in 1980, with fed funds at 13.8 percent, mortgages at 12.8 percent, and everyone knew it was an awful time to buy stock.
Demand for Gold: The big surge in gold demand recently has been speculative, but first let's cover usage. Jewelry is a major use, and the expanding economy in the emerging world is stimulating demand. There's plenty of industrial use of gold. Your computer has gold connections, but not enough to melt down your box and turn a profit. However, we have a lot more electronic stuff than every before, and industrial usage is rising. Gold is also used in dentistry, and I would expect rising incomes in the third world to stimulate demand for gold fillings. There are other industrial uses which should rise with the world economy.
The speculative demand for gold has historically been fueled by inflation fears. The tremendous monetary stimulus of the Federal Reserve warrants some concern. However, here in the United States we have so much unused productive capacity that I can't see inflation emerging anytime soon. Further, one would want to look at worldwide monetary policy, which is not nearly as stimulative as U.S. policy.
Certainly some prices are rising rapidly, but they are primarily commodities (such as oil). No one seems to notice that plenty of other prices are falling. Anyone buy a computer lately? The price changes are predominantly changes in relative prices, meaning the price of one good relative to other goods. They get translated into general inflation only if the central banks of the world print more money. (Here in the United States, the money supply has risen less than five percent in the past 12 months.)
The bottom line is that I think the speculative demand for gold is fickle, and could quickly turn to selling. But that depends on ...
Supply of Gold: In the short-run, it's hard to increase gold production. Mines are capital intensive businesses. The existing mines may be able to run double shifts and increase output, but adding capacity takes time. However, high prices for gold motivate mining companies to ramp up production. The first key thought is that we have a large number of gold mines out there. A typical mine has a variety of mineral combinations in different locations. The mining geologists know that the high-concentration (equal low cost production) ore is over here, while the low-concentration ore (high production cost) is over there. They will sometimes shift production back and forth to keep their workers fully employed. At times like these, though, look for every operating mine to produce at maximum capacity.
In addition to the mines currently operating, there are plenty of mines that shut down in past years when prices were too low for profitability. Nothing like a huge run-up in price to get old mines back in operation. Old mines being reopened was pointed out in this New York Times article.
In addition, prospectors are staking out claims to new fields, as the Wall Street Journal reported today. Supply will increase substantially, but with a long time lag. What happened after that 1980 price spike? It took several years for production to increase, and then it zoomed. And stayed high even as prices were plummeting. (Statistics here.) That's what happens in a capital intensive business. A company says, "At $600 an ounce we can make a lot of money. We invest a bazillion dollars upfront, and then we can mine gold for only $200 an ounce." By the time the mine is operating, gold is down to $300 an ounce. It turns out the bazillion dollars of upfront expense are not justified by the production economics, but the mine continues to operate because it's covering its variable costs. (This might be a good time to review the microeconomics of fixed costs and variable costs.) The bottom line: once production increases, it stays high for years to come.
Forecast of Gold Prices: It's hard to predict exactly when the price of gold will start to decline, but it will come down. And when it turns, it is likely to turn very sharply down, then remain depressed for at least a decade.
Federal Reserve Chairman Ben Bernanke took the unprecedented step of answering questions after today's policy meeting. You can watch the video or read news coverage almost anywhere. What does this mean for a business leader planning his or her company's future? There are three key points.
The Fed is Moderately Optimistic. They expect the economy to grow next year in the range of 3.5% to 4.2%. The average of most economists is about 3.2 percent. The Fed's forecast is in the upper quartile of the range of private-sector forecasts--it's plausible but not average.
In general, the Fed is not any better than others at forecasting the economy, but it's worth knowing what they think. It should also be a wake up call for those who think we're certain to fade soon.
The Fed will keep inflation under control. Ben Bernanke made clear that they are not too worried about rising commodity prices in themselves, but they would be concerned if either of two things happened. First, if commodity price inflation spread across the broad range of prices that people face. Second, the Fed would be concerned if people's "medium-term" inflation expectations rose. Expect the Fed to tighten when they see a high risk of either of those problems. Bernanke also stressed that there were time lags in monetary policy, so they would react to their own forecast of worsening inflation, rather than wait for inflation to actually rise.
So businesses should not expect the Fed to solve the problem of high commodity prices, but they should not worry (too much) about rising costs for labor or manufactured goods.
Interest rates will eventually rise. The Fed believes that current rates are not sustainable, but it's too soon to push rates up. They don't have specific dates in mind for their future tightening, but they know it will have to happen. If you're a corporate treasurer, I'd budget for higher interest expense in 2012, and a lot higher expense in 2013. But Ben didn't say that--it's just my interpretation of Fed policy and the likely shape of future data.
Business is not simple. That's one reason that we who enjoy complexity gravitate into business. However, there are often some simple rules that will get a business into the ballpark of success. Too many people are trying to be pioneers when there is a well-traveled, proven trail not far away.
Outsourcing to China brought up that thought, thanks to a post in the China Law Blog. Dan Harris proposes four simple rules:
1. Choose a good factory....
2. Use an OEM Agreement suited for your situation....
3. Set up a Quality Control System....
4. Register your trademark in China ....
That struck a chord with me I enjoyed beer last week with an excellent China business consultant who told me a story of a company that had failed to follow at least one of those steps and was now at substantial risk.
I see the same thing in bank lending in various niches. As I commented about bank lending to franchisees, there are rules of thumb to mitigate risk in every bank lending niche. In talking to a veteran of equipment leasing, he said there were just four rules that banks had to follow to substantially reduce risk in lending to his kind of business. It's amazing, he told me, how many banks don't learn those rules, or learn but fail to follow.
Is there room for creativity, for blazing one's own trail? Certainly, but here's how I would approach that: learn the rules first. Then test your own variations in a controlled way. So, for example, suppose you don't like Dan Harris's suggestion for how to set up a quality control system. Fine. But don't just ignore the whole question of quality control. Instead, weigh costs and benefits, consider the reason for the rule, and conduct a test in a way that limits your risk. Maybe you'll come up with the next best practice. However, I can pretty much guarantee you'll fall flat on your face if you just ignore the rule with no thought to how to accomplish the goal implied by the rule.
Finally, I regularly meet authors or would-be authors who ask me for advice on getting their books published. Getting a literary agent and a publishing contract is difficult and different from many other business tasks. I tell them how I got Businomics published: I bought a copy of a book on writing book proposals and I took it as my Bible. I followed its instructions and soon had three agents vying for the right to represent me, and a few weeks later an offer from a publisher.
After I tell this story, the person talking to me often tries to explain that his or her unique circumstances don't seem to fit the usual publishing mode. A year later I'll run into the person, ask about the book, and I hear that the search for a publisher continues. Gee, it's not a hard process if you follow the rules.
I friend recently asked if I was still able to forecast the economy in such uncertain times. Gee, maybe someone else wonders that same thing.
Economic forecasting goes on because business goes on. Companies must make decisions about the future. Invest in new equipment? Hire more workers? Pay down debt? Take out more debt? Those decisions all require a view of the future. Anyone who says that he runs a business without an economic forecast is fooling himself. There may not be an explicit economic forecast tab in an official planning notebook, but the CEO has an idea of what he or she thinks will happen.
Some business leaders try to prepare for a range of possible economic futures. That’s wise, but planning for everything under the sun is impossible. Some scenarios are more likely than others, and certain scenarios are logically inconsistent (economic collapse in China and India combined with rising steel prices and a falling dollar, for example).
My job is to help business leaders understand the possible futures. There’s one path that is most likely, in my mind, but other paths are possible and warrant contingency planning. Some possibilities are very unlikely.
Where planning gets fun is taking the next step: what should we do under each scenario. You will often find that some tactical action steps are robust: they should be taken under any of the most likely scenarios. Other steps hinge crucially on the economy. For these steps, a good economic early warning system is needed.
Yes, the economy is uncertain. But looking back on my forecasting experience, I think that perhaps the best forecasts come during the least certain times. That’s because the worst forecasts are made when the future looks obvious.
Every business leader should understand the role that cities play in economic--and corporate--growth. A good way to get that understanding is Ed Glaeser's new book, The Triumph of Cities.
Glaeser makes the critical point that cities are where people communicate the most. That communication includes:
Business opportunities ("Fred's company is looking for a new marketing firm.")
Business methods ("Mary's found a way to re-design her product to reduce waste.")
It's also where many people come to trade. Going to the city means that there will be specilized resources (goods, services, employees) available for purchase, as well as companies and people who may want your highly specialized service. Adam Smith started the Wealth of Nations talking about the wonders of specialization, then explained that the specialization is limited by the size of the market. (Small towns might support a baker and a blacksmith, but not a bookbinder or tool and dye maker.)
Business Strategy Lessons About Cities: Whether you are located in a big city, a suburb or a small town, keep in mind the communication needed to advance your firm. Employees up and down the organization need to meet with other people: customers, suppliers, and even competitors. Don't neglect people in seemingly unrelated businesses. It's not unusual for companies in one industry to learn a trick from other industries. In big cities, a lot of this happens naturally. However, it can always be improved. If your business is located in a suburb or small town, senior management should try to facilitate and encourage interaction between employees and other business people.
One idea for stimulating thought and discussion: bring in someone to meet with your senior management team and present ideas about the business challenges and opportunities that he sees in the world. It will broaden your team's horizons. Here's an excellent choice for a speaker to business leadership teams.
Free Monthly Newsletter The Businomics(TM) Newsletter keeps you up to date in a simple graphical format. We'll email you two or three pages of charts once a month, with Bill's comments. Skim the newsletter for two minutes and you're up to date. View a sample and then sign up.