Gold as a Hedge, Not an Investment 24 comments
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There is a simple fact that all Goldbugs miss: and that is the American economy, and most all others in the world, have just experienced a massive asset DEFLATION (still underway in some segments like commercial real estate). This deflation in America was about $15T over the past two years according to New York University's Nouriel Roubini (from $40T to $25T). That asset deflation was completely psychological. One day American assets of all types were worth $40T in dollars and just a little bit later, were worth quite a bit less. There was no massive physical destruction of assets as in a war (counter to the weak Weimar hyper-inflation argument), only economic.
The basis for my opinions on monetary reflation are derived from Hyman Minsky's work. PIMCO's Paul McCulley has written on "The Minsky Solution" many times in the past two years. In early January, I featured one of McCulley's articles in a post.
To deflate assets requires the value of the currency those assets are denominated in to increase (this is counterintuitive for many) as the quantity decreases. In essence, $15T of dollars were destroyed or disappeared (not physically, but notionally with debt paper markdowns). Less dollar supply at a given demand = higher price / value. Central bankers everywhere understand this dynamic. So, in a coordinated way to restore stability to global assets, currencies are being expanded to replace those notionally destroyed (through markdowns during 2008 of the paper that underpinned all those assets, CDOs, RMBS, etc).
The most intelligent dissertation I have seen on repairing a deflation was printed in Barrons last February. Ray Dalio, a rare Barrons contributor, was interviewed. I reference this interview on my blog.
To recap what Dalio said, then, and most presciently: this CB driven monetary expansion is NOT inflationary to the extent that aggregate asset values are being returned to 2007 levels. "How can this be?", say the skeptics. My answer: by definition, the reduction of the value of $40T national assets to $25T assets is deflationary. In America, $15T of the global reserve "currency" (almost all of it electronic bookkeeping and not "paper") can be created to replace the "paper" that was lost in 2008, with mostly positive effects. There is no deleterious effect so long as the recreation of the lost currency is done slowly enough as to not be disruptive to global currency flows (currency destruction in 2008 was disruptive enough, don't we all agree)?
$80 Oil and $3 copper is probably in the area of "fair value" vs. the dollar given a mid 2007 USD reference. But $1100 Gold? Unlikely. Gold is now trading on speculative fear of inflation, not the reality of inflation itself. So far, the dollar has not even been expanded (reflated) sufficiently to move asset values back to mid-2007 (check local house prices). Monetary expansion is definitely not inflationary, in America, at this point in time. For gold to be worth $1100, let alone $1500, then global central banks must be unable to stop the expansion that has started in an effort to stabilize asset values.
Maybe that is a reasonable speculation, and maybe not (and I own a prudent number of gold shares as a hedge, just in case it is). But like others here on this post, as a more significant inflation hedge, I would rather take my chances with commodities that have fundamental value, and not merely the psychic value of gold. As is pointed out, gold is worth nothing unto itself. And worse, gold is not consumed, so supply forever increases. This ever-increasing supply dynamic is NOT the hallmark of a good investment.
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This article has 24 comments:
Gold is a CURRENCY in a world of devaluing fiat currencies and will go much higher. I called gold $720 last November here on SeekingAlpha as the last chance you were going to get to get in low. Hopefully you listened. I see $1,200 to $1,300 as no problem by March. Seasonally gold peaks in late Feb - March.
The inflation-deflation debate is dead. When the massive foreign holdings of the dollar need to diversify, their choices are depreciating paper currencies or gold.
Gold production has been decreasing for a decade now and the number of people on the planet has been increasing at an increasing rate. Also, the economic revolutions in India and China have created 300 million more middle class consumers.
Therefore, the supply of gold relative to consumers that can afford a gold chain or gold earrings or to invest in gold is DECREASING. Gold per population is the appropriate metric here.
But then there's the threat of currency collapse. Country A's economy begins to super-heat and they are obliged to hike rates. Country B is still in the doldrums and can't raise rates without risking rampant foreclosures and unemployment. What happens to the value of country B's currency? What if gold is priced in that country's currency? What happens if that country's currency happens to be the world's reserve currency?
For this reason, I am heavily invested in Fluor (FLR), the dominant heavy industry construction-engineering company in the world. Once supply is cranked back up (from 30 years of increasing neglect), supply will exceed demand and the price for gold will decline. I did not write about this in the body of my article, but I appreciate your prompt for this ancillary point.
On Nov 16 10:23 AM Robert Perrego wrote:
> In response to gold supply never decreasing...
>
> Gold production has been decreasing for a decade now and the number
> of people on the planet has been increasing at an increasing rate.
> Also, the economic revolutions in India and China have created 300
> million more middle class consumers.
>
> Therefore, the supply of gold relative to consumers that can afford
> a gold chain or gold earrings or to invest in gold is DECREASING.
> Gold per population is the appropriate metric here.
Gold as a trade against all the world's currencies makes no sense. Gold might trade higher in a relative sense, one currency against another (as Oil does), but as an alternative to paper currency? I don't think so. Global fiat currency is based on the aggregate asset base of the world. There is not enough, nor enough interest in gold as a representative of the global asset base for it to serve as currency (and really no need). It is a speculative play only, and therefore is as likely to go down as up, especially once supplies begin to increase.
On Nov 16 10:25 AM User 195787 wrote:
> The Mona Lisa is worth nothing unto itself. But it sure is pretty
> to look at. Why would someone pay so much money otherwise for just
> so much oil and canvas?
>
> But then there's the threat of currency collapse. Country A's economy
> begins to super-heat and they are obliged to hike rates. Country
> B is still in the doldrums and can't raise rates without risking
> rampant foreclosures and unemployment. What happens to the value
> of country B's currency? What if gold is priced in that country's
> currency? What happens if that country's currency happens to be the
> world's reserve currency?
On Nov 16 10:33 AM ManAboutDallas wrote:
> Yet another educated fool, deluded by others ( Roubini, Minksy, et
> all ), who knows the price of everything and the value of nothing.
The US$ is still the world's reserve currency because the U.S. still, for the moment anyway, holds The World's Biggest Gun Barrel. If it didn't, the US$'s status as the world's "reserve currency" would have ended on August 15th, 1971. The US$ is "indexed" to other currencies because, as yet, no other nation/s has/have decided to call the U.S.'s bluff. As you may have noticed, there is a growing rumble of discontent over this paradigm, and the bluff is close to being called.
> Global fiat currency is based on the aggregate asset
> base of the world.
Global fiat currency is based on NOTHING but the speed of the press doing the printing.
Don't worry; what's about to happen will wipe that Village Idiot grin off your face. But your Village will still love you, I'm sure.
On Nov 16 11:03 AM Brian McMorris wrote:
> You hit on a key point that others somehow miss: The US Dollar is
> the world's reserve currency. This means that one way or the other,
> almost every other currency is indexed to the dollar (China's link
> is direct). So, when the dollar goes down, all currencies go down,
> more or less depending on the degree of linkage.
>
> Gold as a trade against all the world's currencies makes no sense.
> Gold might trade higher in a relative sense, one currency against
> another (as Oil does), but as an alternative to paper currency? I
> don't think so. Global fiat currency is based on the aggregate asset
> base of the world. There is not enough, nor enough interest in gold
> as a representative of the global asset base for it to serve as currency
> (and really no need). It is a speculative play only, and therefore
> is as likely to go down as up, especially once supplies begin to
> increase.
Oh yeah - and now central banks are buyers as well.
Inflation does not figure into this equation anymore.
On Nov 16 10:58 AM Brian McMorris wrote:
> Gold is like any other mineral: it can be discovered and mined at
> a given cost. As gold continues higher (for now), mining companies
> will step up their exploration and mine development projects. It
> is just the same as for oil, copper or phosphates.
>
> For this reason, I am heavily invested in Fluor (FLR), the dominant
> heavy industry construction-engineering company in the world. Once
> supply is cranked back up (from 30 years of increasing neglect),
> supply will exceed demand and the price for gold will decline. I
> did not write about this in the body of my article, but I appreciate
> your prompt for this ancillary point.
Large cap multinationals are a much better hedge against a falling dollar than gold
The power of the reinvested dividends and the low price of most multinationals are better and provides cash flow
in 1990 Gold was 400 dollars and Coke was 5 dollars to today gold is up 180% and Coke is up over 1100%
and the last 7 years of dividends ecxeeds the total profit and gold
and you receive better tax preference
A printing press without the underwriting of assets is what happens in Zimbabwe or Agentina, and why they are such bad examples of what happens with fiat currency. My point, and it might be too subtle for many, is that when there is a massive deflation that increases the value of the currency, as in the current asset deflation, then to revalue the assets back to where they were, requires more units of that currency to come into existence. It is pretty basic math. It is the commutative principle to be precise.
The only argument that is valid is whether or not that currency in the form of printed dollars (electronic book entries, really) can be taken out of circulation as debt replaces the currency. Again, another subtelty is that all the debt that was destroyed in 2008 was in fact, currency.
I don't doubt that gold will run a bit as the speculation cranks up. I just don't believe it will stick, any more than it did in 1980. I don't think it will fall back to $250, but I do think it will fall back towards $1000 once more supply comes on line to satisfy all the demand by speculators and central banks. That is why for those who want to exploit this trend, buy stock of the people who supply the miners (sell the picks and shovels). My choice is Fluor (FLR).
On Nov 16 12:20 PM ManAboutDallas wrote:
> The scariest part of this is that you really seem to believe it.
>
> The US$ is still the world's reserve currency because the U.S. still,
> for the moment anyway, holds The World's Biggest Gun Barrel. If it
> didn't, the US$'s status as the world's "reserve currency" would
> have ended on August 15th, 1971. The US$ is "indexed" to other currencies
> because, as yet, no other nation/s has/have decided to call the U.S.'s
> bluff. As you may have noticed, there is a growing rumble of discontent
> over this paradigm, and the bluff is close to being called.
I have pushed against the real estate zealots in the 2003 to 2007 period and the internet maniacs in the 1996-2000 period and it is always the same sound and fury. Your derogatory statements just reinforce the correctness of my position. Good luck to you! I hope you get out the door in time.
On Nov 16 01:47 PM bobbybutte wrote:
> as a person who has become financially independent SOLELY from allocating
> capital let me add some things here
>
> Large cap multinationals are a much better hedge against a falling
> dollar than gold
>
> The power of the reinvested dividends and the low price of most multinationals
> are better and provides cash flow
>
> in 1990 Gold was 400 dollars and Coke was 5 dollars to today gold
> is up 180% and Coke is up over 1100%
>
> and the last 7 years of dividends ecxeeds the total profit and gold
>
>
> and you receive better tax preference
Hmmmm Why are Central Banks still holding on to this barbaric metal?
The Wise know they are Foolish, and the Foolish think they are Wise.
The golden Rule: He who owns the Gold makes the Rules.
You can follow the gold market live 24/7 at coininfo.com
I don't know about you, but I am no nationalist. Based on our willingness to buy imported goods as a nation, few of us are. We are a free country.and anyone who wants to come here with some money and buy up our assets is welcome to do so. Again, that is what is meant on the dollar where it says "backed by the full faith and credit of the United States". That means you can use dollars to buy a part of America.
And this is what makes America and its economy great. And it is why America will continue to hold the world's reserve currency.
And no, those dollars moving back to America WILL NOT cause inflation. Inflation = too many units of currency chasing too few goods. But America has a lot of assets to sell that apparently no one wants. That is why we are in an asset deflation. We WANT people to bring their money back to buy those deflated assets. That is called reflation and is exactly what the Fed is trying to orchestrate.
Try to think outside the box that other gold bugs have put you in.
On Nov 16 07:57 PM The Recusant wrote:
> Are you dismissing the fact that all those U.S. dollars and debt
> denominated in dollars held by foreign banks and companies MUST someday
> come back to the U.S.? Foreign countries and companies will use their
> U.S. dollars to buy up the U.S. businesses and physical assets to
> deplete their reserves of our devaluing currency. It is that massive
> amount of dollars flowing back into the country that will cause the
> inflation. Regardless if dollars are destroyed internally by mortgage
> or credit card defaults, there exists much more government debt out
> there in the world that needs to be feared. In such a scenario, which
> would you rather hold, dollars or gold?
There's naturally some truth to that. But gold's price has quadrupled within the past decade--and yet gold production has fallen. It hasn't responded to the price signal. This suggests that it will not be as easy to ramp up its supply as it is with other minerals, whose reaction times are much quicker.
As for demand, that is something that is not going to be easily satisfied. Demand is growing among major moneybags. The shock of 2008, and the phenomenon of QE, has scared many of them, including central banks, into thinking that there's a risk in holding "safe" investments like bonds. And the poor performance of all supposed "diversifiers" besides gold during that period has convinced many moneybags that they should add it as a beta blocker. Moneybags provide a massive source of demand--not at current prices, or in the current bull market, maybe, but 10% below, or in a sideways or bear market.
Of course, at the moment speculators on the futures market are driving its price upward at what seems like a shocking rate. So gold could drop a bit--especially if there's a rally in the dollar for a few months, as happened in 2008. But, long term, the stars have realigned, and gold will find big buyers on dips. Speculators like Paulson and Einhorn are ahead of the crowd in recognizing this.
"I would rather take my chances with commodities that have fundamental value, and not merely the psychic value of gold."
Of course that depends on their relative price and risk. Sure gold can be over-valued at some point, and commodities cheaper. But there's a risk in commodities whose price depends on economic activity. What's the "fundamental" value of copper in a depression? Not as solid as the word "fundamental" implies--that “fundamental” is dependent on a fairly good economy. Similarly, thinking that gold is fundamentally worth nothing ("gold is worth nothing unto itself") reveals a blinkered/bullish/good... bias.
Gold isn't an investment. In good times it's better to buy a productive asset, or one that pays interest. But, if bad times are on the horizon, and if gold's price isn't excessive, then it's a buy as insurance--at least up to a certain %age of a portfolio. For that matter, it's a buy (up to a point) even in gold times, as a beta blocker.
And, at this price level, it's a buy as a bearish speculation. Five years from now, if the economy and the dollar do poorly, gold will be an out-performer.
"Gold ... is not even a claim on the productive assets of a country. Its value is completely subjective and prone to whim."
Czarist Russian bonds were a claim on the productive assets of the country--but that "claim" has turned out to be "prone to whim." That's true of all bonds.
"Free Cash Flow is the name of the game. Last I checked, gold doesn't generate ANYTHING."
But, when an asset stops "generating," as happens from time to time, its value can really tank. GM is a recent example. Gold lacks that downside.
"Its value is completely subjective and prone to whim."
Absurdly overstated. Gold doesn't drop or rise in the way that the price of an unfashionable piece of art-work does. Stock and bond and real estate prices are pretty whimsical, aren't they? Gold is more "fundamental" than those assets. Gold is nature's money.
In this context, yes, gold can be a trade against all the world's currencies. In fact, it often has been throughout history.
On Nov 16 11:03 AM Brian McMorris wrote:
> You hit on a key point that others somehow miss: The US Dollar is
> the world's reserve currency. This means that one way or the other,
> almost every other currency is indexed to the dollar (China's link
> is direct). So, when the dollar goes down, all currencies go down,
> more or less depending on the degree of linkage.
>
> Gold as a trade against all the world's currencies makes no sense.
> Gold might trade higher in a relative sense, one currency against
> another (as Oil does), but as an alternative to paper currency?
> I don't think so. Global fiat currency is based on the aggregate
> asset base of the world. There is not enough, nor enough interest
> in gold as a representative of the global asset base for it to serve
> as currency (and really no need). It is a speculative play only,
> and therefore is as likely to go down as up, especially once supplies
> begin to increase.
You're right, except our companies, land, and commodities. And when they buy those up with all of those foreign reserve greenbacks that will disappear into the black holes of banks, what will the people living in the U.S. have? Most consumer products are created overseas as is our most treasured import, oil. We may be in a deflationary period right now for U.S. goods. But foreign goods are already beginning to increase in cost due to the devaluing dollar. You may stick to the old definition of inflation, but even if I had no money and the products I wanted to buy still increased in price, excuse me, but that's inflation.
...Gold Bubble?
Gold has gone from roughly $250 in 2000 to $1,100 in 2009, an increase of roughly $85 dollars a year. That really doesn’t point to gold turning into a bubble. Furthermore, the man on the street is not treating gold the way he treated dot com stock in 1999 or housing in 2005, more likely he is selling his gold to the "we buy gold" hucksters on TV and print ad.
When the “we buy gold ” dealers advertise “we sell gold” and Joe Sixpack is talking about how great an investment his Krugerrands and Maple leafs are, then we will be in bubble territory.
.........................
....Gold is now trading on speculative fear of inflation, not the reality of inflation itself. So far, the dollar has not even been expanded (reflated) sufficiently to move asset values back to mid-2007 (check local house prices). Monetary expansion is definitely not inflationary, in America, at this point in time. For gold to be worth $1100, let alone $1500, then global central banks must be unable to stop the expansion that has started in an effort to stabilize asset values.
...Inflation is a monetary event, too much money chasing after too few goods. While it can be claimed that we have no inflation since ‘prices’ are not rising, it depends on what prices we are talking about. The gas pump and my food bill both state there is inflation in spite of the best arguments made by economists and their hedonic CPI. Perhaps we are enduring a new form of stagflation, wages are stagnating while prices of some items go up.
As for the argument
“ the dollar has not even been expanded (reflated) sufficiently to move asset values back to mid-2007 (check local house prices)”
It should be remembered that house prices were in a mega bubble and when it burst everything else was taken down with it, reminiscent of the Florida housing bubble of the 1920’s that was the precursor of the stock market crash of 1929.
.........................
There is not enough, nor enough interest in gold as a representative of the global asset base for it to serve as currency (and really no need). It is a speculative play only, and therefore is as likely to go down as up, especially once supplies begin to increase.
....If gold is a speculative play then why did the Central Bank of India buy 200 tons of gold? Why did China increase its gold reserves by 600 tons? Why is China preventing its gold from being exported to earn fiat currencies?
Maybe China has learned the lesson of fiat (paper) money since it was the first one to try to use fiat and end up with steep inflation.
.........................
It has been said that an ounce of gold would have bought a man a new suit back when George Washington was president and will buy a new suit today, yet the buying power of the money in our pockets has declined for decades. Even if you can find a company that pays excellent dividends, the buying power of those dollars earned as dividends are eroded over time, and lets not forget about taxes on dividends taking an additional bite out of dividends earned.
I will agree that the job of gold is not to make you rich, the job of gold is to keep you from growing poor as the paper money in your wallet loses its value over time.
...The most productive mines in the world, South African Gold Mines, have been declining in production, they went from 1,000 tonnes a year in 1970 to 238 tonnes this year, I doubt new supply will pick up the slack either short term or long term. China has ended exports of gold from its mines, The cost of gold exploration, the reluctance of banks and lenders to loan to miners to explore for gold, the 20 years of the gold bear market reducing the demand and number of trained geologists who can find gold deposits, environmental laws, Environmental NIMBY movements around the world all work to prevent new mines from opening at a rate to replace the mines that shut down.
......................
Once supply is cranked back up (from 30 years of increasing neglect), supply will exceed demand and the price for gold will decline. I did not write about this in the body of my article, but I appreciate your prompt for this.
….New mines will be opened, no doubt, but not as fast as can be expected. You don’t just blast a hole in the ground and viola, new mine. Miners must be hired, trucks must be rented or bought, tracks and mining cars must be obtained, the mineral itself must be found in core drilling which is not an easy or cheap undertaking, all these things and financial backing must be obtained before the first nugget of gold is extracted from the earth.
If pulling mineral wealth out of the ground were so easy then why isn’t crude oil going down in price with the ease of extracting the plentiful supply?
.......................
Any currency is based on the assets that underwrite the currency. This is what is meant by "backed by the full faith and credit of the United States". This is a phrase that means the aggregate assets.
A US Dollar Bill is backed by US Bonds, US T-bills and US Treasuries. The US Treasury also holds US Reserve Assets consisting of Euros, Yen, Special Drawing Rights and gold, but these assets have a value of less than 140 billion US Dollars.
Most of what backs the US Dollar is US Securities (US Bonds, US T-bills and US Treasuries)
So basically all of the currency issued by the US is backed by 140 billion in assets, not including the US bonds, T-Bills and Treasuries, and of course, the government’s word.
Search the US Treasury website and see what they state backs up the US Dollar besides “the full faith and credit of the US Government.”
Here is the US Treasury's own website, please look for yourself and please, please prove me wrong.
I would really like to be proved wrong that the US Government has assets other than debt and 140 Billion in currencies and gold to its name.
www.ustreas.gov/
I agree with most of what you say. The economics of gold extraction are the reason why I think $1000 is probably the new price floor. I made that point in my post. This is exactly the same case for oil, as you correctly point out. There is lots of oil in the world, but it is increasingly expensive to produce. Nat gas is the same. Horizontal drilling in shale for formations that are just a few feet deep and quickly depeleted, is very expensive and raises the break-even point.
But you missed my point on the backing for the dollar. The aggregate assets of the USA are not the $140B you reference. I don't even know what the Treasury bothers with that. What is meant by the expression "full faith...." is the assets owned by all the citizens of America. All those assets are taxable to citizens, so back the currency of the government. If the $140B in Reserve were all the US had to show for its assets, it would already be bankrupt, don't you think? But as long as the govt can tax its citizens (themselves "assets" in the sense they produce income that can be taxed), enough to cover interest costs it has the ability to create tradeable money without incurring hyperinflation. Creating money in the modern era is just a way of liquifying the value of assets. But it will be a sad day if all the assets of America are surfeit to our national debt. I am all for fiscal discipline, of which our current govt (and the one before, for that matter) has little.
On Nov 17 09:05 PM Bundee wrote:
> Gold is like any other mineral: it can be discovered and mined at
> a given cost. As gold continues higher (for now), mining companies
> will step up their exploration and mine development projects. It
> is just the same as for oil, copper or phosphates.
>
> ...The most productive mines in the world, South African Gold Mines,
> have been declining in production, they went from 1,000 tonnes a
> year in 1970 to 238 tonnes this year, I doubt new supply will pick
> up the slack either short term or long term. China has ended exports
> of gold from its mines, The cost of gold exploration, the reluctance
> of banks and lenders to loan to miners to explore for gold, the 20
> years of the gold bear market reducing the demand and number of trained
> geologists who can find gold deposits, environmental laws, Environmental
> NIMBY movements around the world all work to prevent new mines from
> opening at a rate to replace the mines that shut down.
> ......................
> Once supply is cranked back up (from 30 years of increasing neglect),
> supply will exceed demand and the price for gold will decline. I
> did not write about this in the body of my article, but I appreciate
> your prompt for this.
>
> ….New mines will be opened, no doubt, but not as fast as can be expected.
> You don’t just blast a hole in the ground and viola, new mine. Miners
> must be hired, trucks must be rented or bought, tracks and mining
> cars must be obtained, the mineral itself must be found in core drilling
> which is not an easy or cheap undertaking, all these things and financial
> backing must be obtained before the first nugget of gold is extracted
> from the earth.
>
> If pulling mineral wealth out of the ground were so easy then why
> isn’t crude oil going down in price with the ease of extracting the
> plentiful supply?
> .......................
=