06/07/10 Gaithersburg, Maryland – During a week when almost everything went wrong, the gold market went very right. In fact, gold has been going very right for more than a decade. The gold price has more than quadrupled during the last 10 years. So is it too late to buy the stuff?
My short answer is, “No.”
Admittedly, gold is not like any other investment. It is not merely a financial asset; it is the ultimate form of money. But that doesn’t mean it is always a good investment. Many investors make a case for gold laden with ideological fury over the government’s printing press. These investors are always saying buy gold. Their arguments are timeless, but not always timely.
If you bought gold in the 1980s and 1990s, your return was abysmal. So, as with all assets, there are times when gold is a really good buy and there are times when it is not. Sounds obvious, but many people seem to want to think that gold is an exception to the order of things. It isn’t.
But how do you know if gold is cheap? Well, intelligent people usually advance a couple of arguments:
1) On an inflation-adjusted basis, gold is 30% less than its all-time high in 1980. Okay, that’s true, but it’s not particularly timely because by that measure gold has been cheap for three decades. And who’s to say that the 1980 gold price is a benchmark we should pay attention to anyway? By that way of thinking, the NASDAQ is a bargain, too, because it trades at a big gap from its 2000 high. But is it? I think not.
2) The other point often advanced by the “gold is cheap” crowd is the old monetary base argument – that gold’s price tends to track the monetary base over long periods. The monetary base is essentially bank deposits and currency. It’s like the seedlings of inflation.
This second argument is a little more interesting. Yet, as the government has added huge piles to the monetary base in the last year or so, the gold price has responded in a muted way.
The hedge fund QB Partners really likes this argument. QB writes:
“True capital has already begun to flow where it is being treated best – to capital-producing economies and to global stores of wealth, from paper money and financial assets to hard money and hard assets…We think gold is cheap by a factor of almost 7 times.”
If a gold price of $7,000 an ounce doesn’t strike you as implausible or absurd, QB’s next comment might. QB says, “The gold price could move higher than [$7,000 an ounce] if it experiences a blow off top, like all other bull markets tend to do before exhausting themselves.” So, $7,000 an ounce, you see, is just some kind of base case.
Maybe it’s not so implausible. Strange stuff happens all the time in markets. If I had told you on May 6 that Accenture – a $40 stock with a $29 billion market cap – would trade for a penny a share the next day, you would have thought I was nuts. Yet, on May 7 it did just that, if only for a second.
As investors, we tend to think too narrowly within the confines of what seems probable. Yet, the really big money lies in the outlying events. As QB puts it:
Most investors allocate to the markets by playing the odds, which by definition gravitates capital to the middle of a bell curve of possible outcomes. This fools the investor into thinking that the probability of future events is somewhat predictable. Of course, history is rife with startling social, economic and political “tail” events. Stuff happens – things like earthquakes, the bombing of Pearl Harbor, the 1980 US Olympic hockey team, the demotion of Pluto, dotcom bubbles, liar loans and even periodic global economic failures and the re-assertion of gold as money.
This is essentially the familiar “black swan” argument made popular by Nassim Taleb. This is really the best argument for gold in my view. It is a hedge against really bad stuff happening. And when really bad stuff happens, gold holds up.
Of course, over the last decade, it has more than held up. Gold has been the best-performing asset class from December 1999 to December 2010.
People often invest by looking in the rearview mirror. They feel better investing in stuff that has done well. Even professionals feel this way. Money follows performance, which is why so many investors get mediocre results. They hop into the hot fund or sign up for the hot newsletter just as it is about to go cold. They abandon apparent losing strategies and sell poor-performing stocks just as they are about to turn up.
But the gold market is different because it’s so small. Even a small amount of interest in gold will send it up a lot. Just imagine if people decide a small sliver of that tall bar of financial assets should be in gold. We’re talking about some serious pressure on the gold price.
Frankly, the gold market is set up perfectly these days. You couldn’t design it better. Bad stuff is happening – see the crisis in Europe. And you can surely bet more bad stuff will happen, given all the debt and leverage that still remains in the system. Even if you don’t know exactly what will happen or when it will happen, you know a monetary crisis is good for gold.
As an added bonus, gold has a track record, which will attract fans soon enough. And when it does, it can’t really accommodate many buyers because the market is small. This means the chance of the gold price spiking upwards are pretty good. It’s like being in the lifeboat business on the Titanic. No price will seem too high!
Chris Mayer
for The Daily Reckoning
Chris Mayer
Chris Mayer is managing editor of the Capital and Crisis and Mayer’s Special Situations newsletters. Graduating magna cum laude with a degree in finance and an MBA from the University of Maryland, he began his business career as a corporate banker. Mayer left the banking industry after ten years and signed on with Agora Financial. His book, Invest Like a Dealmaker, Secrets of a Former Banking Insider, documents his ability to analyze macro issues and micro investment opportunities to produce an exceptional long-term track record of winning ideas.
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prehaps the goverment should purchase a large quantity of gold or platinum and sell again in six months to a year after the price has gone up its better than issuing gilts or investing more money in the banks
“Frankly, the gold market is set up perfectly these days. You couldn’t design it better. Bad stuff is happening – see the crisis in Europe.” So investing in gold is really good when bad stuff is happening is like hoping that the house you have just bought is right in the path of a lava flow and hoping that tree in front is going to split the bad stuff “lava” and miss your house. It won’t matter that every other thing around is burnt to a crisp. It doesn’t matter that bad stuff is happening and it just might be a good idea to do something about changing things from bad to good. No lets just hope for more bad stuff. Pathetic.
“As an added bonus, gold has a track record, which will attract fans soon enough.”
I can’t wait. The frenzy will grow to a frenzy.
“And when it does, it can’t really accommodate many buyers because the market is small.”
uh, yeah, and will become crowdd, think Studio 54 in the ’80′s
“This means the chance of the gold price spiking upwards are pretty good.”
did someone say ‘no kidding’?
“It’s like being in the lifeboat business on the Titanic. No price will seem too high!”
That’s when I’m gonna open a combo lemonade stand and silver stand. I won’t care if
I make money selling a cool, refreshing quaff. But the demand for silver, as poor man’s gold, will make for an enjoyable day in the sun.
I’m sceptical.
I still own the gold and silver that I bought in 1998 to 2003. I don’t need the money, so I have no reason to sell right now. However, I’m hedged with GLL and ZSL.
I live in the USA, so all my bills have to be paid with the other “real” money, the $US. I don’t have any debt, but I have to pay taxes, utilities, drive around, and eat. All of this requires $US.
Those who have debt, will have to repay in $US or lose their stuff. I’m not one who would do well with a shopping cart, living under a bridge. I have too many guns and too much ammo.
The way I see it, most gold is bought on margin. There isn’t a lot of money available to loan for margin for gold. So the present price is being supported by our old friends at Goldman and J P Morgan, still sitting on very large short positions. But they appear to be systematically reducing these positions, to avoid a spike.
Too many small investors, like myself, are now beating the bushes for gold coins. 1998 to 2003 was the time to do that, so I believe that this is a flashing red contrarian indicator.
I can be wrong of course. I took a beating in value when gold and silver sold off after I bought in 1998. I was down by 33%!!!! But I would rather be down 33% at $350, than $1200. And the gold was bought with cash, not on margin or an equity line of credit.
I for one, don’t see gold as an investment. It is the “other” money, and should be treated as such.
Therefore, the “price” of gold is incorrect. It is, in fact, the exchange rate, just like the exchange rate of dollars vs. yen or Swiss francs, pound Sterling and the like.
Today, the exchange rate between Federal Reserve Notes (FRN) and 1 troy oz. of gold is around 1200. And sinking fast for the FRNs….
Chris,
It’s a real pleasure to read such an intelligent article on gold and its growth prospects. Most articles I read are so subjective, and so biased in one direction or another, they are rendered pretty much useless.
I guess it will always be so. Gold always incites extreme points of view, and brings out the craziness in people.
Thanks again. I’ll have to dig around now and find more of your articles on gold!