Don’t look now; we’re traditional

Can it be that the market for gold and silver is becoming traditional?

The self-perception of the online hard money writers and readers is of a plucky band of far-seeing investment pioneers.

However much truth there is in this self-perception, the actual price movements of gold and silver on the markets currently are occurring in a very traditional way.

When the Federal Reserve, the central bank of the United States, says interest rates will likely rise, gold and silver prices fall.

Minutes of the September meeting of the Fed board of governors released yesterday indicate that they will likely leave interest rates alone for a while because of a weakening global economy.

Gold and silver prices are rising this morning.

Why is this traditional?

Well, interest rates were the mechanism by which gold flows were regulated between countries during the days of the international gold standard led by the Bank of England.

When oweners were converting their paper British pounds into the gold behind them and shipping the metal out of the country, the Bank of England’s response was to raise interest rates to make it more attractive to hold pounds.

Individuals acting in their self interest took the higher profit generated by the interest rate rise and gold flows stopped or even reversed.

When gold was entering the country, the money supply increased and interest rates could be lowered, again restoring an equilibrium.

Nowadays, the self interest is in the form of relative returns.

When interest rates rise, holders of cash get a higher reward and the implied cost of holding gold rises. (Just think of it as if all gold is held with borrowed money and the cost of that borrowed money rises when the Fed raises interest rates.)

Conversely, holders of gold incur no additional costs implied or otherwise when interest rates remain the same.

The cost of holding gold and silver falls when interest rates are actually cut.

This interest rate mechanism is a traditional long-term tool of central bankers.

Bullion markets that set the prices of bullion currently are behaving within the logic of it.

That makes them very traditional.

Buzz blogger Dave Harper has twice won the Numismatic Literary Guild Award for Best Blog and is editor of the weekly newspaper "Numismatic News."

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