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“Find the trend whose premise is false and bet against it.”
-- Attributed to George Soros

I couldn’t help but remember Mr. Soros’s words when I read Thomas Kaplan’s recent opinion piece in the Financial Times. Kaplan, Chairman of Tigris Financial Group, writes that gold, even after its 10-year bull market, still only represents 0.6% of total global financial assets. This is double the all-time low of 0.3% hit in 2001 — when gold was just beginning its ascent — but far below the 3% it was in 1980 or the 4.8% that it was in 1968. Kaplan notes that if gold rose to just 1.2% of global investments — less than half the 1980 level — this would equate to 26,000 tons, or ten years worth of current production.

The implication, of course, was that the gold bull is only getting started. As more investors diversify parts of their portfolios into the yellow metal, the increase in demand will cause the price to soar ever higher.

There are so many flaws in this thinking it’s hard to know where to start, but let’s give it a shot.

We could start by noting that the global economy has grown by leaps and bounds since 1980 and that assets that reflect this surge of wealth creation — such as the stocks and bonds of the companies that have benefitted from the growth — should be a larger piece of the global asset pie relative to gold.

Furthermore, the last thirty years has seen the arrival of China, India, Brazil, and other emerging markets. Many of these countries had no capital markets at all until recently; today, all boast world-class companies that are profiting both from rising incomes in their domestic markets and from globalization and trade. Carving out space in the global investment portfolio for these emerging market equities would have to come at the expense of existing asset classes. Gold — which pays no interest and generates no earnings — would seem like a good candidate for reduction. Investors might consider the EG Shares Emerging Markets Consumer ETF (NYSEARCA:ECON) for exposure to emerging markets.

Looking beyond the traditional stock and bond markets, investors have a host of other options that were barely in existence 30 years ago. One asset class I’ve always liked is master limited partnerships (MLPs), which tend to be dominated by productive oil and gas pipelines. If you fear inflation and crave real assets, might not MLPs — which pay handsome tax-advantaged yields—be a better option than an inert chunk of yellow metal? There are several ways to get access to this sector. For broad exposure to the sector, the JP Morgan Alerian MLP ETN (NYSEARCA:AMJ) is a good option.

What about real estate investment trusts (REITS)? The present lingering property crisis notwithstanding, REITS give investors liquid exposure to an asset class that has always been a favorite of the rich — productive, income-producing real estate. My preferred way to get instant access to this sector is via a broad basket like the Vanguard REIT ETF (NYSEARCA:VNQ), though experienced stock pickers can try their hand at picking individual securities.

Even if you argue that gold ought to be a part of a diversified portfolio — and let me emphasize that this is folk wisdom at best — it is unreasonable to assume that gold “should” command as large a place in a diversified portfolio as it has in decades past.

Hey, I like gold. It’s pretty, and it makes my wife happy. But that is about the extent of its value.

Meanwhile, the Financial Times reported separately that Chinese investment gold buying was up 30-50% in the month of January, creating a scarcity of investment-grade gold bars. China also launched its first gold-based ETF and raised $500 million under management almost overnight. At the same time, investor buying of gold was up 80% in India last year, even while Indian jewelry demand plummeted. Remember, India is a country where brides are practically covered in the stuff and where gold jewelry that would seem excessive in the West is a cultural norm. (As an aside, a soon-to-be-married Indian friend told me that the high price of gold has led many Indian brides to use fake gold in their wedding ceremonies. What would the neighbors say!)

Meanwhile, gold mining production hit a new all-time high of 2,652 tons in 2010.

So, we have record supply coming at a time when the buying is shifting from institutional investors in the West to inexperienced retail investors in emerging markets. Does this seem like ripe conditions for a prolonged bull market?

I have no way of knowing how much longer the gold bubble will last, but I can say with certainty that the arguments supporting it are deeply flawed.

My recommendation? Stay out of gold for now. If you are an aggressive investor, you might want to look for a good opportunity to go short.

Disclosure: I am long VNQ, AMJ, ECON.
Source: Gold: A Bad Investment and Getting Worse, Part II