Why Gold Is the New Currency

Thanks to Alan Greenspan and Ben Bernanke’s pro-inflationary policies, the dollar has lost nearly half of its value since 2002. Please take a moment to consider that ... you and I have become roughly 50% poorer in the last six years through no action of our own.

The wealth destruction is simply incredible. And it’s made us the laughing stock of the world. Europeans and Brits now see the US as a tourist trap where they can come to feel rich. Oil exporting nations have seen their profits explode as the weaker dollar pushed oil through the roof.

Simply put, the dollar is no longer a great store of value. True, it has rallied recently due to the belief that the Fed won’t cut interest rates again—and that other countries will soon start cutting rates to deal with their own financial issues—but until the Fed turns off the liquidity faucet, any rally in the dollar will be brief.

Investors should find a new currency to plunk their money into. And that currency is gold.

The pundits have made a big deal of stocks’ recent rally and gold’s plunge. However, if you look at the big picture between these two asset classes, it’s clear that stocks are still expensive while gold is quite cheap.

According to Dr Marc Faber, editor of the Gloom Boom Doom report, gold and financial assets move in distinctive long-term trends. Over the last 110 years, this trend has staged six major phases:

• 1900-1929: stocks outperform gold
• 1929-1932: gold outperforms stocks
• 1932-1966: stocks outperform gold
• 1966-1980: gold outperforms stocks
• 1980-2000: stocks outperform gold
• 2000-???: gold outperforms stocks.

Most recently, gold has completely trounced stocks. In fact, based on “real” terms—i.e. the price of gold—stocks actually peaked in 2000 and have since fallen 72%!

And they’re still expensive.

The median stock (as measured by the Dow Jones Industrial Average) to gold ratio over the last 106 years was 5.4. In other words, during the 20th century, on average 5.4 ounces of gold would buy one unit of the DJIA.

Today, it takes more than 12 ounces of gold to buy one unit of the DJIA. So in spite of gold’s mammoth rise from $250 to $860, the precious metal is still quite cheap relative to stocks.

So while the mainstream financial media and the Federal Reserve might be proclaiming an end to the commodity boom and the beginning of a new bull market in stocks, I don’t buy it. In real terms, stocks are anything but cheap. Gold on the other hand, is clearly undervalued.

And thanks to this recent dip, it’s gotten even cheaper.

Comments

[JCCIII:]

Author, please define the term "one unit of the DJIA." Thank you.

2008 Aug 06 12:13 PM

[Larry House:]

Thanks, Graham, I agree with you. How in the world can the purchasing power of our currency be restored when when the supply of paper money constantly increases, there is nothing intrinsic to give it value, and so providers constantly demand more of it for goods and services? We have to turn to the one repository of value that is recognized around the world. It is our best hope. During times of inflation, holding things of value is better than holding dollars or investments in dollar-valued vehicles. Gold may not be the perfect investment, but it is the best I see for long-term security.

2008 Aug 06 12:35 PM

[jetsby10:]

1 unit of the Dow is that number you see flashing everyday. If the dow is at $5000 and the price of gold is $5000, 1 oz of gold buys you 1 unit of the Dow.

2008 Aug 06 12:58 PM

[jetsby10:]

they've been calling the end of the commodity boom since it started. The boom will be over when we stop hearing about food shortages around the world.

2008 Aug 06 12:59 PM

[deuxsous:]

I'm a long term gold bull too. Ditto for cobalt, copper, silver, cotton, lean hogs, and all the rest of the commodities. However this is due to increased demand since 1998 and the rundown of the ability to deliver enough supply due to falling prices from 1980-1998/2003. This is the approximately 27 year up and 27 year down supply demand cycle.

Volcker got the praise for defeating inflation in 1980 (at the end of the up cycle) and Greenspan and Bernanke get the blame for causing it since 2000 (at the beginning of the up cycle), but in point of fact they are only very marginal players in total world supply and demand.

2008 Aug 06 01:04 PM

[Michael Fit...:]

Although I agree with your position that gold is a good investment in these turbulent times, your statement "...you and I have become roughly 50% poorer in the last six years through no action of our own" puzzles me. Bush was re-elected in 2004 even after people saw what he had done in the previous 4 years (!) The fervent support Bush has received by the American people due in part by their allowing paid mouth-pieces like Rush Limbaugh and Larry Kudlow to brainwash them on economics policies is part of the big problem here. The American people should be out-raged at Bush and the so-called "conservative" Republicans for their radical economics that have caused the dollar to plunge precipitiously, our debt to double in Bush's 8 years, and our economy to enter a black hole. The fact that the American people allow their "leaders" to trick and fool them is part of the reason why we are in the situation we're in. In general, Americans are uninformed, uncaring, and lackadaisical when it comes to real economic issues. Instead, they let labels like "conservative", "liberal", "greens", etc. etc colour their thinking, play on their emotions, and prevent the US from taking the strategic policy steps needed to address our biggest issues: oil, and the fiscal policy.

2008 Aug 06 02:12 PM

[David Tanner:]

I don't know that I fully buy the gold/stock ratio, since they are always tinkering with the Dow components, which can make the true ratio an unknown. But I fully agree that gold is still undervalued LONG TERM.

Short term I think you will see stocks rebound strongly for 2 reasons. First, as boomers approach retirement realizing that they are needing to put away massive amounts of money over the next few years, this demand for stocks will push up their prices regardless of whether they are overpriced or not.

Second, as foreigners are dumping their dollars they are buying US assets.....real estate and companies/stocks. The Arabs just traded some of their dollars for a stake in Citibank. They see value here, and they have shown themselves to be pretty astute investors.

It is the DOLLAR that gold is tremendously undervalued against. I can see gold going to $5000 against the dollar. But if the historical 5/1 ratio holds true, then look for the Dow to hit 25,000.

Tangible assets...gold, stocks and real estate are the only safe harbors.

2008 Aug 06 03:20 PM

[Larry House:]

David Tanner, I am a retired but working boomer, and I don't think boomers are going to plow tons of money into to stocks over the short term. I think they will go for greater safety over potential greater return with less safety. Also, assets are getting cheaper all over the world, so the U.S. may not be the brightest cherry on the tree.

2008 Aug 06 03:52 PM

[phdinsuntan...:]

??? = 2007 looser: Europe, China and Japan are reducing the value of their interest rates, stocks and currencies to have a trading partner, the lucky, overweight and broken Americans. s time for you guys get a "strong currency" again, at least from here to the february 2009, and buy other peoples manufactures with cheaper commodities.

2008 Aug 06 03:54 PM

[CLH:]

You buy gold and I will buy Americas productive corporations. I will beat you 10 to 1. Over the long term gold stays the same. In the 1600s an oz of gold bought a suit of clothes--it still does. It hasnt changed because its not productive. It pays no interest and makes no product. Yes cash is trash but so is gold.

2008 Aug 06 06:46 PM

[Melancholy ...:]

So, the trade is to buy gold as it keeps getting cheaper?? Short the dollar as it starts to get stronger? uh, ok.

2008 Aug 06 10:25 PM

[deuxsous:]

CLH,

In the very long run you are absolutely correct. If you are under 40 years of age, just buy the S&P500 and maybe an EAFE index fund and forget about it. Older than that you just can't risk losing 50% of your money in 1-2 years as happened to many people from 2000-2002. You don't have enough years left to come back.

Gold only makes sense in a gold bull market, which we're currently in and will be in for another decade.

2008 Aug 06 11:17 PM

[richrdinbel...:]

Despite gold's recent sell off, an investment demand for gold is abiding.

We are approacing PeaK Dollar.

Then gold will arise as the global currency and the means of preserving wealth.

2008 Aug 07 02:10 AM

[richrdinbel...:]

Despite gold's recent sell off, an investment demand for gold is abiding.

We are approacing PeaK Dollar.

Then gold will arise as the global currency and the means of preserving wealth.

2008 Aug 07 02:10 AM

[Dan Walker:]

The Fitzman: Bush was not elected or re-elected because he was the superior leader. He was elected in both cases because he was the lesser evil. Until our current party system can provide choices better than 'dumb and dumber' or 'bad and worse', nothing will change and that also applies to JM, BO, Pelosi, Reid, and the rest of the village idiots. You are part of the problem for blaming one person for what required the entire village. For my opinion on the chances of better choices under the current system, see the disclaimer.

There is a point most people seem to miss on this subject and that harkens back to basic finance class. When banks lend money, the proceeds are deposited in some bank and it is loaned again subject to the prevailing reserve requirement. Repeat as needed. This is money creation under the fractional reserve system. Money is destroyed when the loans are repaid and the money supply contracts. What you never hear in finance class is that loan default has the same effect on the money supply as repayment. By the time subprime, prime, HELOC, and credit card bubbles are all fully deflated, we are possibly looking at 2 trillion dollars missing from the money supply. Old Ben may seize the bearings on the presses trying to keep up with that kind of money destruction. Clearly (I hope) we will not bail out the foreign holders of these assets. That portion of the money supply will be destroyed for good. If Ben 'n Hank can hold their bailouts under the amount of dollar destruction caused by the default of dollar based mortgage assets owned by foreign holders, gold looks overpriced. I'm betting that they have already budgeted their estimates of that amount as the dollar amount they can spend on bailouts. For my guess on the accuracy of their estimates; Disclaimer: I am buying gold, already loaded on silver and seriously pondering these points. There will be spikes and dips as we discover the truth. Proceed at your own risk.

2008 Aug 07 06:30 AM

[Sidj:]

Warren Buffett earlier this year said to expect lower returns from stocks in the coming years. He said stocks had delivered above normal returns for several years and now the market would experience a "reversion to the mean". Anyone disagree with Buffett?

2008 Aug 07 08:21 AM

[huangjin:]

Was anyone alive during the 1980's and 1990's? Remember the Plaza Accord? The U.S. dollar has fallen before and it will rise again. The long-term trend of fiat money is down, but it doesn't mean there won't be massive multi-year bear rallies.

If people are laughing at America because of the low dollar then all I can say is the joke will be on them.

2008 Aug 07 08:45 AM

[User 30121:]

Sonofabitch! Add Dan Walker to the ever-growing list of THINKING people that should be sought out whenever we decide to turn this country of our around! Thank you Dan!

CLH, you are such an ass! BUT, I have hope for you yet!

2008 Aug 07 09:49 AM

[dieuwer:]

We need fools like CLH to keep the secular bull market in gold healthy. I would be worried if every man on the street was lining up outside coin shops to try to buy the last gold coin.
We're far from that.
However, if you see CLH outa there, watch out! Because he will buy at the top!

2008 Aug 07 11:04 AM

[BBtwist4454...:]

Physical gold is not an investment, it is a currency, a store of wealth and preserves spending power. It shouldn't be compared to stocks. That's apples and oranges. It should be compared to the dollar, in which it has outperformed. How much did a 'suit of clothes' cost in US dollars in 1930, and how much does it cost now in US dollars. (hint: a lot more). You are correct that the same amount of gold then buys you the same amount of goods now, but that is the point. Gold protects your wealth, instead of it just inflating away like the USD.

2008 Aug 07 11:11 AM

[Kunst:]

phinsuntanning, CLH, Brian Pursley, mixter: so sad

2008 Aug 10 02:12 AM

[User 30121:]

Kunst, the only sadder thing is the f..king MANIPULATION of gold and silver markets by that phantom US Bank that continues to short PMs! When that "bastard" is outed, then the PMs will fly high! Anyone not having plenty of gold and silver physical holdings is an IDIOT! Why? Because they have been WARNED here countless times!

2008 Oct 15 06:59 PM