An aphorism passed down over centuries says that you should always have enough gold to bribe the border guards. In modern industrial societies, that concern has rarely been the motivation for gold ownership. In most time periods, only those labeled “gold bugs” pay any attention to the investment merits of the precious metal. Periodically, however, some political, economic or monetary condition gets gold’s price rising. If it climbs far enough, publicity pushes gold into the consciousness of those whose otherwise closest connection is their jewelry box.
While I have never been counted in the “gold bug” camp, I have counseled for several decades that holding some gold is a prudent insurance policy against any number of potential political, economic or monetary disruptions. Prior to this week, however, we have not established long-term positions for clients in gold or gold stocks. This week we changed that practice.
With a nod to Reinhart and Rogoff’s comprehensive history of 800 years of financial crises, 'This Time Is Different', for centuries, governments and central banks have resorted to money creation to cover up prior eras of overspending and overleveraging. As our country faces its mother of all long-term debt crises, it appears virtually certain that our politicians and monetary gurus will eventually choose the easy way out-- by way of the printing press.
The unconscionable inaction by the Congressional supercommittee, charged with carving out a mere $1.2 trillion from the next decade’s projected deficits, announces clearly that there is no real commitment to getting our budget under control. Fiscal discipline won’t happen--if at all--until we demand term limits that would eliminate legislators’ need to bribe the electorate with near-term goodies in a seemingly perpetual bid for reelection.
Similarly, our august central bankers have demonstrated their utter disregard for the elderly, retired and generations unborn. Their expansionary bailout attempts benefit primarily the current working generation, whose budgetary imprudence has constructed the bulk of our precariously tottering debt edifice. Almost certainly, the Fed will ultimately choose more money creation rather than accept the consequences of a decade and a half of dangerous central bank decisions.
The logical result of excessive money creation is the depreciation of the currency, which has led many analysts to forecast the decline of the U.S. dollar. In fact, the U.S. dollar’s purchasing power has been systematically reduced throughout the nearly one-century life of the Federal Reserve. Relative to a basket of foreign currencies, the dollar is worth far less than it was a decade or a quarter of a century ago, although it is above its 2008 low and about 10% above its May low in this most recent cycle. The recent rise comes not from any dollar strengthening moves from our central bank, but from persistent weakening conditions in other major currencies. And in the short run, that could continue.
Several asset categories demonstrate a negative correlation to the worth of the dollar. Gold, especially with the wide acceptance of the GLD exchange-traded fund, is an extremely liquid and easily accessible investment choice. Following the significant decline from GLD’s September price high, we began to build what could become a meaningful portfolio position in gold.
Above price levels that would be largely determined by jewelry demand, there is no sound way to value gold, notwithstanding the many authoritative-sounding analysts who grace the airwaves. Most are short-term traders. Rather, gold’s price is largely a reflection of investor fears and emotions.
The timing of factors that will stimulate investor fears and emotions is highly uncertain. Europe appears to be on the brink of a regional recession with the possibility of a banking collapse. Should Europe weaken markedly, it is likely that the rest of the world will follow in varying degrees. Such a condition would be disinflationary--even deflationary--which would logically be negative for the price of gold. On the other hand, such a condition would also logically prod central banks into action. As the aforementioned Reinhart and Rogoff have pointed out in great detail, inflation is typically the method of choice to rescue economies from debt crises. There is little reason to expect this episode to vary from the historical norm.
Given the uncertainty of the coming sequence of events and their timing, we began to construct our position in GLD this week at two potential levels of support: the trendline in effect since January, then GLD’s 200-day moving average. Given the current poor technical condition of gold, it was not surprising that prices broke through both levels. Because most gold surprises for the past decade have been positive, we wanted to begin our holding with a small portion of a desired full position at these levels, in case central banks got itchy trigger fingers and began to print earlier than we have reason to expect. Should such printing occur soon, we will likely see nice profits but on a relatively small position. On the other hand, should gold experience a larger correction of its earlier substantial price advance, we plan to add to the position over the weeks, months or quarters ahead at price levels where gold has found support in the past. Should the price decline last for a while, we will experience some loss of value on the small early positions, but we will build the potential for much larger gains from larger positions purchased at lower prices.
Whatever the near-term course of events, we anticipate that governments and central bankers will honor their genetic predisposition to avoid current pain without regard to longer-term economic dislocations. In fact, I suspect they are actively oiling their printing presses today.