By Elliot Turner
Since the dawn of this financial crisis, my portfolio has included an allocation to gold via the SPDR Gold Trust ETF (GLD). I viewed this as an important element of stability and protection and I believed in a longer-term story taking hold. Last week, I kissed the precious metal goodbye for now and this is my explanation as to my reasoning.
Since gold is an emotional investment vehicle, let me make clear that my sale does not belie the fact that I believe gold will go down in price. From this point forward, it could just as easily go up as down and my sale is more a matter of the dynamic of the story changing and the opportunity cost of tying money up in gold while other better investments are calling elsewhere.
I owned gold because historically, the precious metal has been the single greatest protection in times of financial crisis. It takes more than your run-of-the-mill recession to ignite the gold bull and we were in such an event. The financial crisis created such systemic instability that something as solid and as long-standing in its value as gold seemed appealing.
In 2008-09 the gold luster generated global appeal. 2009 saw the first net accumulation of gold reserves at world central banks since the early 1980s. There was a clear supply/demand story taking shape. Export intensive economies who accumulated significant dollar reserves in order to generate exchange rate stability accumulated gold in order to diversify their holdings. One such example came this time last year when India purchased 200 metric tons of gold from the IMF.
My very first post to appear in the blogosphere, written on November 13, 2009 explained my view of gold in the new global financial paradigm and here is the most pertinent excerpt:
All this action points to a fundamental paradigm shift in global finance. Countries reliant on exports will seek a global basket of currencies and assets to replace the dollar as the world’s reserve currency. This movement should continue regardless of whether the dollar reverses higher. Maintaining such a high proportion of national wealth in one denomination generates too much instability.
Ultimately in my vision of the directional current in global finance, gold would be but one component of a much larger basket of global currencies. This may or may not come to fruition, but never do I think, nor did I think that a gold backed currency would be in the cards. While the world has yet to come together in creating a global reserve currency, many countries have continued to embrace the notion that their reserves must be more diverse than just U.S. dollars. Along those lines, this year Russia added the Canadian dollar and is in the process of considering the Australian dollar as the next addition to their reserves. This marks a shift in global central bank behavior from 2009 when gold was the diversification of choice.
Where Is the Gold Story Today?
While 2009 was the year of central banks buying gold, 2010 saw a different story unfold. There were no large scale accumulation central bank accumulations. Instead, the Glenn Becks of the world have co-opted the gold story and my dual-catalyst is no longer enough to move gold upwards. Today the arguments have taken a new step that requires the precipitous collapse of the global economy combined with an extraordinary leap of faith in order for gold to be a solid investment.
In the traditional stock market narrative, when the mainstream press catches on to an in investable thesis, the story is nearer the end than beginning. While this isn’t an absolute indicator, it’s a pretty good guideline to follow. While Glenn Beck may be more fringe than mainstream, his following is vast and predominantly inexperienced in investment terms. Add the presence of cash-for-gold schemes and gold vending machines and you have the construct of mainstream bubble behavior.
Today the gold story points to inevitable hyperinflation and the accompanying collapse in faith in fiat currencies and/or the ultimate movement to gold backed currencies. While this has always been an element of the “Gold Bug” story, it’s now the primary engine behind continued upside and I could not disagree more (in order to avoid the necessary digression, if you are interested in my historical economic analysis as to why hyperinflation is most certainly not in our future, read this article I wrote not too long ago).
Gold as Currency
Not only do I think fiat paper will withstand the necessary dilution of the printing press in the short run, but also, I feel that gold itself requires the same risk that fiat paper does. Let me explain. Gold today is not a consumed commodity like oil, silver or copper. It’s used primarily as a store of value. This is so because through centuries, gold has been generally recognized across the globe as a universal metric of value that is transient in nature. Stated another way, gold has been accepted as a currency. With that in mind, I tried to answer the following question for myself: “If fiat currencies crash, will gold be accepted in lieu of currency, and if so, why?”
If you’re using gold to bet on the end of our financial world as we know it, then you better be sure that gold will work as currency. In searching for an answer, I couldn’t really find one. First of all, should global currencies fail then there will be widespread disorder and chaos. In such an environment, why would someone be more or less inclined to accept a gold bar than anything else? Why would anyone even care that I owned shares in the GLD ETF? Would that even be of any economic consequence?
No one knows what will happen in the event of chaos, but to me the only real answer would be to buy a cave stocked with canned goods. Forget about gold, as that would do nothing in a state of anarchy. Gold ultimately relies on the same psychological comfort that fiat currencies do in universal acceptance, and therein lies the gold as currency paradox.
The Tipping Point to Sell
This latest leg up in gold has far more to do with a speculative element betting on the decline in fiat currencies rather than on the actual decline. The gold bugs would have you believe that this move up in gold is the loss of faith in fiat paper, yet looking at the charts one can clearly see that the U.S. dollar is actually slightly HIGHER today than it was at this time last year, while gold is about 16% higher. The move in gold certainly can’t be explained in terms of the much-hyped but mostly mythological “dollar decline.” To me, this disconnect between rhetoric and reality reeks of fear and speculation.
Perhaps the key tipping point for my inclination to sell came this summer when gold provided little to no safety in the aftermath of the Flash Crash and Greece/euro fallout. Sure gold outperformed the S&P during that time, but the outperformance was little consolation for the risk in holding the metal. Most importantly, many individual stocks with more compelling stories outperformed both gold and the S&P by a substantial margin during that time period.
Moreover, I believe that we are on the path to recovery and at the very least, are at a point where good companies can perform well even in a weak tape. This latest market down move in March conclusively proved that point. While markets crashed, leading stocks and sectors ignored the fear and plowed higher. That was but one factor in my bullish inclination throughout the summer. When reviewing my gold investment recently, ultimately my reasoning unfolded as follows: “yes gold may go up, but in selecting the right stocks there is far more upside.”
Disclosure: No position