Gold: The Last Cheap Asset Class

The year is 1980…

While everyone else has been losing money, you’ve made an absolute killing. You’ve made so much money, in fact, that you move out of your $75,000 house into a $150,000 mansion. You also treat yourself to a couple designer pinstripe suits with extra-large shoulder pads.

What’s your secret, investment genius?

One word: GOLD.

While everyone investing in stocks watched their portfolios get decimated— last year BusinessWeek published its legendary cover “Equities Are Dead”— you rode gold from $35 to over $650. You even flirted with an all time high of $850. Your stake has increased more than fivefold in two years… while the S&P 500 languished around 130.

Fast forward to today.

The S&P 500 has risen tenfold. Today it trades around 1,360. Similarly, housing prices have more than doubled to $195,000… and that’s after the housing bubble’s collapse. Emerging markets, which barely even existed in 1980, are near all-time highs today. Just about every investment you can name has exploded upwards in the last 27 years.

Except gold.

In 1980, gold peaked at $850 per ounce. Today it’s only slightly higher. Name one other investment that trades where it did 27 years ago. You can’t. There are none. And bear in mind, inflation has been eating away at the dollar over the last 27 years. So 2007 dollars are worth a lot less than 1980 dollars.

I know, we’ve all heard the claim before: Based on inflation, gold would have to trade above $2,000 an ounce to match its 1980 high. However, it’s only when you really consider the precious metals’ performance relative to other assets —stocks, real estate, etc— that you begin to see what value gold has even as it hits record highs.

Since 2001, gold has outperformed stocks, bonds, and just about every investment you can name. And it’s done this with no yield, no cash flow, and no Wall Street gurus pushing it on their clients. Yet I would wager that fewer than 1 in 10,000 investors actually own the stuff. Only 10% of worldwide demand for gold is for investment purposes.

This won’t last for long.

Globally, entire gold markets that didn’t exist in 1980 are now beginning to buy the precious metal. Vietnam started trading gold futures in June 2007. Already the exchange trades around $100 million in gold futures a day. China’s Shanghai Futures Index started trading gold futures just a few months ago. The latter country has already surpassed the U.S. as the second largest consumer of gold behind India.

Gold is a great inflationary hedge. However, in light of the growing number of gold investors, it’s going to be a great investment simply due to supply and demand as well. Sure, $2,000 gold may sound ridiculous. But $1,000 gold sounded ridiculous just three years ago. And we flirted with that level earlier this year.

I strongly suggest buying gold during this recent pullback if you haven’t already done so. Bear in mind, I’m not a trader. I’m an investor. I look for investments of value. And to me, gold remains one of the last cheap asset classes relative to its historic levels.

Disclosure: Author is long GLD.

Comments

[keo]

don't forget silver ;)

[Vince]

Why is it no one talks about IAU? same operating expense but less tracking error to the metal...

[Nate C]

The Central Banks will never allow Gold to get $2000, as it would threaten the all mighty Federal Reserve note. I think gold is going to correct further, down to 800 before it resumes its long term up trend. Unless the Central Banks manipulate it lower.

[globalmacro]

1 in 10,000 investors own gold...are you crazy? GLD and IAU are held very widely. You're delusional if you don't think everyone has been talking about gold. I overheard two old ladies talking about gold at Walmart and another middle class couple talking about silver over lunch just in the last week. Anecdotal, I know. But I think you need to do a bit more research before you make outlandish claims that discredit your argument.

[BHAKTA]

Gold is real... Paper is cheating.. Stick with GOLD and SILVER.. You will sleep in peace.

[goldie007]

What do you think of the recent addition of DGP? Leverage is good, no?

[satur9nine]

Remember this people, Gold and Silver are only valued for their physical uses. Stocks on the other hand represent ownership in a company, if that company generates profit (most good ones do) and you were the outright owner of that company you would get to keep that profit.

Right now gold is hot and the price is up because everyone is buying it, but what are you (and everyone else) going to do with it when you want to retire or buy a house? You have to sell it and who is going to buy it from you? Venture capitalists and businesses who buy and sell stock won't buy your gold from you, they want to buy companies because companies generate profit, gold on the other hand just sits there. The best you can hope for is to avoid inflation when buying Gold, and right now you can expect the price to drop from it's speculative high right now, there is no reason in the world for the price of Gold to outpace inflation by so much. So go ahead and buy it now, but expect to cut your losses when stocks start looking good again and people start selling all that useless Gold they bought.

[Heisenberg]

If, as you say, gold is a great inflationary hedge, then why isn't it at $2000 oz. ?

[Llama Money]

Who knows why it isn't at $2k per ounce. Gold is a good inflation hedge, though it certainly doesn't always perform as expected. In times of high inflation ( right now ), it tends to show it's true colors. When inflation is tempered and the economy is running great, investment dollars go elsewhere seeking higher returns. Can't say I blame them.

[eric hart]

Gold is a horrible inflation hedge when prices are stable, or falling, as they have been for last 25 years. And the central banks of the world collude to keep prices low by: (1) shorting the metal, 2) leasing the metal, 3) producing bogus inflation numbers--aka cpi, and lets not forget 4) selling the metal from their vaults and replacing it with paper derivatives.

But, just as plate tectonics alters the landscape invisibly beneath our feet, until the silence is broken by an unexpected earthquake, inflation is building but is masked by debt deflation, bogus cpi data, and recessionary fears.

Everyone knows that recession and inflation don't go hand in hand...right?

Gold is a terrific asset to own during periods of rising inflation. Such as now. The great bubble of the day is not gold, or commodities, it is debt of all kinds.

Look at the 10 year treasury: 3.56% (give or take). This means that you are locking in a loss for each year you hold the paper with reported cpi inflation at 4.1%. Real inflation is closer to 8%.

Gold is rallying not because of speculation but because people and institutions are beginning to wake up to the reality of rising inflation, and yet, why is it not $2000?

See numbers 1-4 above. The IMF, the US government, and central banks of the world have systematically been selling yearly to depress the price for decades. The quick and dirty reason gold isn't at $2000 or higher is because gold doesn't trade in a free market. Its quasi free.

Moreover, it is a frequently misreported "fact" that in order for gold to return to its inflation adjusted high, it would have to clear $2000.

But again, this assumes that the CPI is correctly gauging real price increases, which is false. In reality, the inflation adjusted price of gold is closer to $4000 per oz.

Look for gold to hit $4000 oz in the next five years.

And finally, don't suffer the false dichotomy of the crazy gold bugs vs. the rational sensible investors. This may seem odd, but you can own commodities and stocks and bonds and real estate all in the name of investment.

Its not an either or argument. (although I certainly wouldn't be owning too much debt right now).

[john2]

llama money- who knows? lots of people do anyone that even considers gold should know. the reason why gold is undervalued is becuase central banks globally want it to be that way. go to gold price.com they have whole videos on the obvious attempts they make to decrease its values. one diplomat came to the u.s. and even claimed diplomatic immunity becuase he was trying to decrease it im not sure of details watch the videos.

[misterchan]

eric hart - Great comment. Just the other day I thought of something for the first time, something no one, to my knowledge, has ever mentioned in all the articles, namely that if gold were to settle at $700.00, all the goldmines would be flourishing. THEY don't need $2,000 gold to be profitable. They have been in business for many years when the price of gold was half what it is now. So, in my opinion, investing in a carefully selected mining company is not any different from investing in any other category of stock. I'm doing it. Just look at FCX, BHP and RIO, a few of my favorites. There is the answer to the question of whether gold can really be considered an investment. Also, as regards oil, I have a sizeable position in HTE, a CANROY, which pays me over 16% dividend on a monthly basis. By the way, the other mines mentioned also pay generous dividends and FCX has wonderful options for people like me who like to write naked options, both puts and calls. These are all huge, reliable companies and of course they need monitoring as do ALL stocks.

[eric hart]

yes, check out nytimes article today on Global inflation. The world economy is at a tipping point and the next decade will be nothing like the last two. www.nytimes.com/2008/0...
tml?_r=1&th&em...

[vnewspaper]

once the banks run out of gold to put into the markets to keep it's price down that's when gold will really take off. the funny part is that it may correct but all that is happening when gold gets released into the markets is that it is helping dealers fulfill demand for gold worldwide.

and i saw a comment that it's hard to liquidate gold...um no. it's actually the easiest to get your money out of if you have physical gold. you don't have to show ID, you don't need a social security number. you just need to give the coin and get the cash.

[Bens]

The fact that there are many comments here makes me feel that gold is at a high point.

[matt...]

I've wondered that too, but I think we're in the minority in that we actively follow and care about this stuff... It's when you start hearing people talk about it at cocktail parties that you know things are getting crazy...

It's been interesting to note the media start to pickup on food inflation, that might start to accelerate things!

[philly jim]

Why does Cramer keep using the magic number $1,600.00 when talking about gold? Does he know something we don't or is this just another one of his gambles? I personally think it will be the only thing worth holding as an asset if we slip into environmental chaos and governments lose control. Something we investors tend to forget about while all caught-up in the money game; our environment is being ripped to shreads by the developing world, faster than the West could ever! NASA officials have even warned that the Whitehouse censors data which suggest we are past the tipping point.

[oldgoldbug]

A couple of comments from one who was there in the deep dark mysterious past of the 70's and 80's:
In addition to the reasons eric hart has given, I believe another reason gold was in a trading range for so long was the increase in production due to the cyanide heap leaching of low grade deposits like Round Mountain in Nevada and the rest of the world. Combined with declining inflation from the high rates of the late 70's and early 80's, the economy made a "soft landing". A lot of commentators thought we were going to have "hyperinflation&q... ala Germany of the 20's or a "deflation" like the 30's. Instead we had 20 years more or less of "prosperity"... We were amazed by Volcker and Greenspan and their ability to blunt the business cycle. Economic contractions seemed fairly short and contained. (Though I do seem to remember a big real estate crash in 80's and early 90's caused by a change in the tax code but lo and behold the RTC cleaned things up and everything was good).
So here we are today and everyone hopes the Fed and the Treasury (and JPM) can clean things up again. Maybe gold over $1000 says they can't and gold falling below $900 says they can.
As someone who has been out of touch with investment markets for quite awhile it does seem very odd to have Treasuries at really low rates and gold so high. It's almost as if the Treasury market is looking for a depression and the gold market is looking for major inflation.
Satur9nine brings up a good point. I would answer with something I read years ago in, of all things, Car and Driver. This was in the mid 70's when Mexico was about to dramatically devalue its currency but we of course did not know that. The magazine related a story about a fellow in Mexico City that ordered several $100,000 AMG Mercedes. (Back when $100,000 was actually real money). Who needs 6 really expensive Mercedes?? Anyway, the obvious reason he did it was to maintain purchasing power when the peso was devalued. Evidently when currencies devalue, anything that might have value is bought up and held as a store of value. That is all gold is - a store of value and an imperfect one at that. But I can assure you that you will always be able to buy it or sell it (unless Uncle Sam makes it illegal but that is another story). So gold has not gone up from $300 to $900 - the dollar has gone down.
By the way, for those of you who have studied the past, enlighten us on the bank holiday in the 30's and the outlawing of gold ownership by Americans. The gold price was increased from $20 to $35 which apparently was how the money supply was increased in the old days. That seems so arcane - now we can create billions with the click of a mouse!

[blacksilver]

go to you tube and type in jones on gold and silver

[enviro111]

The real driver of gold is the relationship between interest rates and inflation. Normally, the interest rate is higher than the inflation rate (i.e., 3% higher) on risk free bonds. Today, the inflation rate (even the official rate - forget the actual rate) is considerably higher than rate of return on risk free assets such as short term government bonds, CD, checking accounts ,etc. Such a difference makes holding gold very appealing.

Thus, the lower the 'real' interest rate go, and the longer they stay negative, the more gold will rise because of investor demand.

[eric hart]

The Central Banks of the world are running out of gold...10 years, 20 years, who knows? But they are the old guard and they have been net sellers for decades.

This explains much of the reason that "gold has been a poor investment" for 25 years.

There is a tipping point under our noses however. The new guard is the BRIC countries, and the sovereign wealth funds, and the Gulf States. These are entities that are net buyers of gold.

Central Banks selling will have less and less effect going forward.

Additionally, the various gold ETFs hold a total of 10% of all dollars that are invested in gold. This will only increase going forward, and is held by long term investors like you and me.

Tens of Trillions are invested globally in treasuries, and various government bonds. Many of those trillions are DECLINING in VALUE, after inflation.

There is no such thing as a risk free asset. Inflation matters, and matters more than ever. Where will that capital go to preserve buying power?

Gold is increasing in value not just in dollar terms, but in all currencies. This is not merely a dollar flight story, its a global inflation story.

The big story is not that gold is rising but that worldwide, bonds are in an incredible bubble as the "smart money" seeks flight to "safe assets".

The bond market and the commodity markets both cannot be right--bonds predicting deep downturn and deflation, and commodities predicting sharply higher inflation.

Or can they? In fact, we will see both deflation in the housing markets and the debt markets--from CDOs, to treasuries, to corporate bonds--all these assets will deflate in value. Yields will rise as the debt prices decline.

The assets inflating will be commodities. All commodities are higher after five years, and almost all currencies are lower relative to commodities.

This is not speculative buying ala NASDAQ 1999, rather it is economic fundamentals driving investor asset allocation.

Capital is switching out of the assets that are impaired and at risk, and into assets that have some protective value against the ravenges of inflation.

To recap: We are experiencing a global wave of inflation that is not contained to the US; almost all debt, but particularly treasuries are in a gigantic bubble; Central banks selling explains past gold price behavior, but is likely less and less of a factor going forward; price behavior or commodities is rational and is firmly tied to economic fundamentals as investors reallocate capital to asset classes that can protect against inflation; we are at a tipping point as the markets adjust to this new ecology of capital flows.

[REBEL]

Hey Bhakta: "Gold is real... paper is cheating." You are 100% right. That is why ALL WORLD GOVERNMENTS, (is there a righteous government on the earth?), would see us all dead before they conform to an honest gold standard. Governments lie, cheat, murder and call it 'war', (to fool their populations), in order to stay in control. Gold will hit $2000 an ounce when $2000 will only buy a months worth of groceries because of government - caused inflation.
Remenber inflation is an increase in the supply of money over the increase in the supply of goods produced by a nation. And who supplies the money? Federal governments. They have TOTAL CONTROL over paper currency, (which they produce), and very little
control over gold. So GOLD IS EVERY GOVERNMENT'S ENEMY AND MUST BE CRUELLY SUPPRESED.