If one had bought gold on December 31, 2001, and simply held the position, the total return would have been 409.33%, far exceeding the 30.10% total return achieved by the Standard & Poor's 500 Index (SPY). Gold has been an incredible investment over the past decade for those who correctly predicted the coming end of the leverage cycle by Western countries, the resulting risk (and dislocation) of Sovereign debt and the demand in the markets for an old world safe haven and store of currency value. This was truly a great call, both in seeing the forthcoming debt crisis and in predicting the shift to gold as a safe haven. However, based upon what we know already and what the markets have priced in, it may be time consider why the considerable uptrend cycle in the yellow metal has come to an end (or at least, slowed considerably).
The reason to own gold today is under the following premise: the continued deterioration in the credit quality of the West will ultimately undermine the current fiat currency system, leading to a return to the gold standard. If you were buying gold at the beginning of this decade, you had tailwinds forming as the levered real estate cycle and overall standard of fiscal responsibility were set to drive the discussion around the failings of government and the security and history of gold (call it the rumor, as part of the buy the rumor and sell the news adage). I have read more than my share of articles, papers and letters from financial authors and prominent investors talking about the end of fiat currency and the need to hold gold as a result. At this point, if gold is to return another 400%+ over the next decade for speculators, an end of fiat currency is exactly what is going to have to happen. And this is where the argument begins to falter.
Why? Let's take this discussion forward. Thanks to a full out credit crisis around Sovereign debt, with the United States falling apart as the final piece, paper money fails, and central banks throughout the world are forced to acquire gold to serve as the underpinning of all currency. Should this ultimately prove true in the future, as the real gold bulls believe, is it realistic to think that anything (and I mean, anything) will hold value? I mean, aren't we talking about complete economic chaos (the dollar, and paper money, fails, on a global scale) and an end to the financial system as we know it? How could anything hedge that event? Further, if I remember my history correctly, wars have been fought over gold. If gold proves the underlying base of value behind all government currency, is it realistic to think that the more powerful countries (and their military) will sit back and simply buy gold through the open market, or (more likely) with the world evolving into complete chaos on the back of the financial system falling apart, wars will ensue and gold will be "taken"? I mean, even the current logistics around buying gold don't make sense under the fiat currency system failing, as it is pretty safe to assume that banks, mutual fund companies and other financial organizations will have fallen apart and thus, holding the "GLD" probably won't work.
My point (and I could go on endlessly) is that if fiat currency fails, everything will be such a mess that expecting gold to "work" is a bit crazy. It is one thing for gold to trade on the fear of Sovereign debt and currency failure, as the globe continues to manage through a deleveraging cycle thanks to a decade (or more) of complete fiscal irresponsibility (and that trade has been a smashing success). It is another to expect that trade to actually work as expected if the fear becomes a reality.
Now, I have no idea what the price of gold will be in 12 months. It could be $2,000/ounce or $500/ounce. I do know that the market is well aware of the high levels of debt through the West, as well as the bond market manipulation being undertaken by the Federal Reserve, Bank of England and ECB to backstop the leverage (by buying it, to force rates lower and provide a bid of last resort), leading leverage to be the cure to leverage at the government level. The smart money knows this won't play out well over the long term. The smart money has played gold over the past decade, and has been substantially rewarded for doing so. I am not sure, however, that the smart money will remain with this trade. As noted, it just appears that the old adage buy the rumor and sell the news may just be applicable here.
Final note: why would the world go back to the gold standard? Wouldn't it make much more sense to go to an oil standard? I mean, gold is used for jewelry and has very limited industrial usage. Oil is the underpinning of everything, in that very little moves (literally) without oil. It is interesting that oil has held value at around $100/barrel through the second half of 2011 market turbulence, while gold has had some real trouble (falling from the $1,900.23/ounce to the current $1,554.55/ounce). Maybe the age of energy supply determining the global world powers is upon us, and gold is a distraction. I digress, but this stuff can really bake your noodle when you think about it.
Disclosure: I am short GLD.