Gold Is Good For Short Term Speculation But Long Term Investors Should Beware

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Includes: DGL, DUST, GDX, GDXJ, GLD, IAU, NUGT, SGOL
by: Gold Bug

Summary

Over the long term gold is only worth its cost of production and any deviation from this price is the result of unsustainable speculation.

There is a great deal of misinformation and pumping that is influencing the price of gold.

Gold has been mistakenly characterized as a good long-term investment when in reality it only performs well for short-term speculation.

I came here to write a bearish article on gold but first some backstory: I dabble in the contrarian side of investing, subscribing to the Austrian School of economics and favoring a loosely Libertarian fiscal policy without all the hysterical cries of "free-market infallibility" and "currency is worthless" dogma that plagues such philosophies. Some level of contrarianism is healthy for an investor as it keeps you grounded and one step ahead of all the other lemmings in the market.

However, the gold crash in 2013 proved that contrarians are the biggest lemmings. I would hate to add more fuel into that echo chamber so I wanted to use this platform to expose the risks of investing in gold. In my opinion when we look at the fundamentals is clear that gold is not a good long-term investment. But it is one of the best tools for short-term speculation out there. If you decide to speculate on gold make sure you know what you are getting into.

Historically, the case for gold is bearish:

When you look at the past 200 years gold has only been an impressive asset in 5 major modern periods: The Napoleonic Wars, The Gold Rush, the end of Breton Woods/80s oil shock and finally, the Quantitative Easing Crisis in the late 2000s.

In every single of these instances gold was a bubble and quickly crashed down to its 1800 price (around 300 to 700 USD) as soon as the stimulating event was over.

To put this in perspective; if you bought an ounce of gold during the Battle of Waterloo and sold it in 2000, you would have made a profit of about $1 over the course of 200 years. If an investor had invested that same money in a productive economic entity, the Dutch East India Company for example, his money would have been earning 12% to 63% in dividends for the 200 years of that company's life. It's hard to be a gold bug isn't it?

However, when we extend the map from 200 years to 600 years a shocking revelation emerges:

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This commonly circulated visual suggests that the "real" price of gold is almost $2000 an ounce.

First, I want to point out that this is a manipulated chart. If you look at the Y-Axis you will see that it starts at 160 instead of 0. This is a visualization trick used to make a sum look larger to scale than it actually is.

So while at first glance this chart appears to be bullish, it isn't really. What we see here is that the price of gold has been shelved in between $300 and $700 since the late 1500s. This was around the time when the Spanish began conquering the new world! The fact that gold bugs constantly manipulate and mislead the public with charts like this one demonstrates the lengths people will go to pump this asset. Nothing you hear or see about gold should be taken at face value.

Gold extraction prices appear to be increasing exponentially:

This was a data set that initially made me question my bearish outlook on gold, but further analysis reveals that it too is misleading. The term "all in sustaining costs" is mining jargon that has very little to do with the actual cost of extraction.

Visualizations like the following chart from Smaulgld are pure obfuscations designed to mislead the public. When you apply logic to the claim this graph is making it falls apart. Why on earth would the cost of extracting gold sextuple from 2000 to 2011? Not only do I doubt that "all in sustained cost" reflects the actual cost of extracting gold, but I doubt that whatever it represents actually increased so conveniently that it matched a gold market price driven primarily by speculation about Fed policy.

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We must remember that the gold mining company has a perverse incentive to make gold look rarer than it actually is. Production cost figures are flagrantly exaggerated in an attempt to impose an artificial floor on prices. "All in sustained costs" refers to a combination of exploration cost, selling and administrative expenses, sustaining capital and other overhead expenses far removed from the actual action of removing metal from the ground.

We also must remember that as gold prices increased sites which had previously been unprofitable were reopened. When gold prices went up it also increased the amount of money invested in exploration. This combination of factors is what resulted in the Frankenstien statistics gold pumpers have used to mislead the public about the actual cost of gold production.

Here are some more representative visualizations:

According to mining.com gold miners cash costs of production were, quote: "Averaging just $649 and $620 in Q2'15 for the actual gold miners among (NYSEARCA:GDX)'s top 17 and next 17 component companies."

Gold is not immune to inflation:

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The biggest mover of gold prices is fear, especially fear of inflation. What many gold speculators do not realize is that the supply of gold also inflates. The amount of gold being produced grows every decade and recycling techniques are becoming more sophisticated. In addition to this, a large amount of gold is currently tied up in jewelry. If the price of gold increases enough, this backup supply will quickly be melted down and sold, driving down prices.

When you compare gold to a crypto-currency like Bitcoin it is obvious that as a viable currency gold has become obsolete. Block-chain technology does the job better. Unlike gold, the supply of Bitcoin is fixed and more of them cannot be pulled out of the ground. In addition to this, crypto-currency is more adapted to modern life because it is digital and can be used online or carried via a card. Bitcoins are also supposedly almost impossible to profitably counterfeit (a claim I would take with a grain of salt). But in the apocalyptic scenario where people lose all faith in modern civilization and return to using gold as currency we suddenly run into the problem of the rampant counterfeiting of gold, which unfortunately is rather easy to do with gold plating and lead.

All that being said, I strongly advise investors to stay away from Bitcoin for the time being.

Beware of gold bugs.

Gold is the most pumped and manipulated asset in the world. Many gold pumpers constantly harp that gold is "going to the moon" all the while selling you their gold for dollars.

Do not buy the hype. If these people really believed gold was so valuable they would not be trading "real money" for worthless fiat currency. Remember that gold gets its value from demand instead of from actual economic value. The only way to benefit from gold is to convince someone else to buy it from you at a higher price than you paid for it. This creates incentives for people who hold the metal in large quantities to increase its demand.

There are many people who are bullish on gold and most have legitimate reasons for their opinions. I am not trying to say that gold bulls should be ignored or that they are dishonest. I just want investors to be skeptical. In my experience honest gold bulls will typically tell you to use gold as a hedge, (no more than 10% of your total portfolio) while the ones with less noble motives try to convince the public that gold is the only thing of value in the universe.

Conclusion:

Fundamentally, gold is not a long-term investment. However, it is a great tool for short-term speculation and hedging your portfolio. I cannot honestly tell people that they should avoid gold but what I can say with certainty is that only way to make money with this metal is to profit from the frequent and unsustainable bubbles that plague its history. If you really want to go this route, leveraged ETNs like (NYSEARCA:DUST) and (NYSEARCA:NUGT) offer great exposure and small cap miners can be long strangled with options to profit from news volatility (more on this later).

As with all investing, speculating on gold carries risks. It is impossible to say what exactly gold is going to do next. For all we know gold could be on its way to $2000. The only thing we know for sure is that if it ever gets that high it won't stay there. When we look at the history of gold it is clear that when you make money on this rock you need to cash in your gains and get out. Don't bag-hold it for eternity like the gold bugs tell you to.

An article of interest for holders of: (NYSEARCA:GLD), (NYSEARCA:DGL), (NYSEARCA:IAU), (NYSEARCA:SGOL), (NYSEARCA:GDXJ).

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.