How Gold’s Price Varies with the US Money Supply

One of the most attractive parts of owning gold is the fact that it stores value. The metal has acted as a tangible representation of wealth for thousands of years, and there’s no reason to think it will ever stop being a valued and precious commodity.

However, its price in terms of national currencies fluctuates constantly, and that price varies in relation to some of the other factors present in the currencies’ underlying economies. One of those factors in the United States is the US money supply.

Whether you are a seasoned, savvy gold investor or simply a person interested in the shiny stuff, it is important to understand what the money supply is, how it is calculated, and, most importantly, what we can glean from money supply statistics to inform our gold investment decisions. This page examines all of those issues and should serve as a handy reference for you in the future.

What is the money supply?

If you’ve never heard the term “money supply,” it might sound like a strange combination of nouns. However, the term refers to the total amount of currency present in public at any given time. 

The concept is simple at its core, but there is obviously more to it. As it turns out, there are several different money supplies that incorporate different types of currency into their calculations, including the liquidity and status or usage of the currency in question.

Although the numbers involved are large, especially in the US, the basic calculation used to generate the money supply reports is addition. The US Federal Reserve – specifically, the branch in St. Louis – endeavors to estimate or acquire reasonable figures for the various parts of the money supply that they want to include in their calculations, then publishes the reports on a monthly basis.

The money supply is an important measure because it is a function of many other factors in the overall economy, including inflation, prices, and a country’s GDP. Since gold is also a reflection of these factors to some extent, it’s easy to see how there might be some sort of relationship between our money supply and the price of gold in US dollars.

What are M1, M2, and M3?

As mentioned, there are several different measures of the money supply in the US. The Federal Reserve generally views the money supply in three different ways. 

M1, the base standard, is the most restrictive measure. M1 is confined to the most liquid parts of the money supply. So, the sum total of M1 is generally a sum of the actual cash in the country and the actual cash stored in banks in checking (also known as demand deposits) accounts. 

M1 does not include any bits of currency that are not immediately available as cash. Examples of elements of currency include savings accounts, money market accounts, and other cash repositories that aren’t as accessible as checking accounts or cash. These bits of currency, which are collectively known as “near money,” are collected, along with the liquid assets in M1, into a new measure called M2. 

M3, therefore, is an even broader measure. It includes both M1 and M2, but also includes large time deposits into banks. Time deposits are investments that have a firm maturity date. The most obvious example of a time deposit is a certificate of deposit – a CD – where you can deposit your money into one but cannot withdraw your cash early without incurring a penalty. M3 also better captures the money supply as it relates to financial and corporate entities, rather than individuals. If M2 involves “near money,” then M3 involves “near near money.”

The exact measures that the Fed reports have changed over the years. Until 2006, it issued reports on measures M1, M2, and M3. Since then, it has ceased to include M3 as part of its issuance, but you can still track down the M3 measurements if you are diligent. 

In addition, M1 is no longer used to guide monetary policy in the US due to its constrictive nature. In many ways, the optimal measurement for economics and policy analysts is M2, as it gives a more vivid picture of the money supply than M1, but does not require the additional work to compile that M3 does (since the Fed doesn’t publish it anymore). 

Regardless of which measure you want to use, the simple truth is that the money supply in the US is at or near historic highs at present. In other words, there have never been more dollars in circulation than at this moment in time.

The Velocity of Money

One other element of the money supply that portends outcomes for us, the savvy gold investing community, is the velocity of money. Where the money supply is the amount of money available in the country, the velocity of money is a measure of how much money is spent during a period of time. 

Velocity matters because it helps to differentiate between whether people are spending the money they have, or they are squirreling it away into the various money and near money accounts and sitting on it.

As a general rule, higher money velocity correlates to a stronger and more robust economy. Unfortunately, the M2 velocity bottomed out in 2020 and has not even threatened a return to its previous levels in the 2000s and 2010s. 

One side effect of the low velocity and high money supply combination is that inflation’s effects are slightly blunted. Because people are sitting on their money and not spending it, the weakened dollar and inflated prices are not having quite as profound an effect as the injection of new dollars might indicate.

What do all these measures tell me for future investments in gold?

As a general rule, the price of gold follows the trajectory of the money supply. As M2 rises, so does the price of gold.

Gold prices in recent years have certainly climbed to new heights. However, the actual ratio of the price of gold to M2 has fallen quite low. 

In addition, the low velocity indicates that the American economy isn’t terribly healthy at its core. At some point, people are going to start searching for better stores of value than their paper money.

What do all of those things mean?

Even at its current zenith, gold likely remains undervalued and retains growth potential for investors for the foreseeable future.

We don’t have any good estimates for the “true” price of gold at this point, but the data indicates we haven’t reached it yet. So, don’t be discouraged by the market rate right now. Gold remains the solid investment that it has always been, and there’s no reason to think that it won’t be a valuable part of any smart investor’s portfolio in the years to come.