Gold: It's OK To Be Wrong, It's Not OK To Stay Wrong

Includes: GLD, IAU
by: Robert Wagner

The title of this article is a quote that Barry Ritholtz, CEO of Fusion IQ, made while he was discussing his "12 (Misguided) Commandments of Gold Bugs." He made the point that early in his trading days he learned that "it's ok to be wrong, it's in not ok to stay wrong," basically making the point that the sooner you recognize a bad trade the better off you will be. Investing is a long-term process, and you simply can't expect to be right with every trade. Sometimes it is best to admit the trade is bad, and move along and live to fight another day.

Ironically, just recently I wrote an article debunking the myth about the Central Banks being behind the collapse in gold. In the above linked article/video, that myth is discussed in a far more blunt and entertaining manner then I did in my article, but the end conclusion is the same. The entire article is an attempt to highlight the fact that many of the key issues supporting gold are myths. I've been trying to make that point with a series of articles published on Seeking Alpha:

Central Bank Buying Of Gold Is A Double-Edged Sword

Why Deflation Is Bad And Inflation Is Good: Monetary Policy 101

Bitcoin: I Hate To Say I Told You So... But I Told You So

Gold: I Hate To Say I Told You So ... But I Told You So

Stars Continue To Align Against Gold, Goldman Sachs Targets $1,270 Per Ounce In 2014

Stars Are Aligning Against Gold; Hope Versus Fear

Gold Is Behaving Like A Leveraged Long Bond

One of the interesting points made in the video is that there is an emotional aspect attached to gold or SPDR Gold Trust (NYSEARCA:GLD). Barry points out that he can "see the comments already" when he claims that gold isn't a currency. I have personally experienced that, and in my opinion the emotional attachment to gold and in a similar manner "green" stocks, makes it very difficult to reasonably discuss these investments. Back in 2008 I rushed to appear on a local radio show in an attempt to calm people's fears about the collapse of the US Dollar, the coming hyper-inflation and the need to return to the gold standard. I took the blasphemous position that Ben Bernanke and the Fed were going to be able to prevent the collapse of the financial system and that TARP would actually make money for the taxpayers. I had no idea what I had done. I ended up losing some of my best friends over the issue. I thought all I was doing was reciting what is written in every Econ 301 Money and Banking text book, but I soon found out that using reason, logic, facts and commonly accepted economics teachings were not an effective way to defend the Federal Reserve or argue against gold. The pitch forks and torches were out, and someone was going to pay.

Fortunately, now with 5 years of economic and financial history, we can look back and say that 1) the Fed did succeed in staving off another Great Depression 2) we did not, nor are we likely to experience hyper-inflation and 3) the US dollar did not collapse and remains the reserve currency of the world. Not a single insured US dollar deposited in an FDIC banks was lost. That is a huge success, and should be celebrated not criticized. Simply watch "Its a Wonderful Life" to see what could have been.

Unfortunately we are now having this conversation about gold only after it has entered bear market territory, and only now are the critics of gold being given a seat at the table and a fair opportunity to voice their positions. I'll use the 12 Commandments article as a tool to attempt an unemotional, logical and reasoned discussion about gold.

Commandment #1: Gold is a Currency: Gold is not a currency. It is only a currency if it is an accepted means of exchange. The only way gold becomes a currency is if someone takes a weight of it and stamps a value on it. More on this topic can be found here. A brief history of the gold standard can be found here. Also, in my opinion the most important aspect of a currency is a relatively stable value, which gold as a commodity lacks.

Commandment #2: The price of gold cannot fall, it can only be manipulated lower: The current events in gold have proven that wrong, and totally ignored the drop in gold post 1979 to the mid 2000s. Gold is falling after QEs and all this money has been printed out of thin air. People can't have it both ways, either printing money does or doesn't drive gold higher. This circular argument reminds me of the global warming theory where warming can cause cooling.

Commandment #3: If the price of gold is rising, it is doing so despite enormous and desperate efforts by manipulators to prevent the rise: If the Fed has been "printing all the money out of thin air," just where is the manipulation that could be keeping gold down? Central bank buying has been near record levels. These are the kinds of arguments you frequently hear about gold that are extremely difficult to disprove, but then again, so would proving them. What evidence is ever presented to prove such claims? You often see these kinds of claims when oil goes higher also. Funny how there is never a conspiracy when oil falls in price, only when it increases.

Commandment #4: The world MUST return to the Gold Standard one day: This is one of if not the most difficult myths to debunk. A gold standard in a disaster, and would be extremely disastrous in today's global economy. Flexible "elastic" currencies are needed to maintain a stable, growing and dynamic global economy. A gold standard would inject inflexibility into a system that demands extreme flexibility. We got off the gold standard for a reason, and we should not repeat the mistakes of the past. By the way, the boom and bust cycles of the late 1800s early 1900s was largely due to the US being on a gold standard. A gold standard is an inelastic currency that requires fixed exchange rates, basically a one world currency so to speak. A one size fits all anything rarely fits all situations, yet a gold standard treats all economies the same, and that is why it inevitably results in imbalances, and breaks down.

Commandment #5: Central Bankers are printing money relentlessly, and this can only drive gold prices higher: This is another myth that is very difficult to debunk. Our Federal Reserve doesn't just "print money out of thin air," they are guided by a set of rules. Their #1 rule is don't allow inflation to take hold in the economy. Their #2 rule is to maintain full employment. That is what is called the Fed's "dual mandate." Unlike the Republic or Zimbabwe today, our currency system has a set of rules that constrains its printing. If there is anything the Fed knows how to do, it is stop inflation. Critics will say that even after QE we still have slow growth and high unemployment. That is true, but no amount of stimulus can compensate for contractionary fiscal policies and deleveraging. Congress and the White House are to blame for the fiscal mess, not the Fed.

Commandment #6: Gold works whether the economy is good or bad: That is not true, in fact the major problem with a gold standard is that it is often the cause of a bad economy. Inelastic currencies often exasperate business cycles and can result in catastrophic banking system failures. The Federal Reserve was created to be the "lender of last resort," to address this very problem. JP Morgan "bailed out the banks" and acted as the "lender of last resort" during the 1907 financial panic. The panic was triggered by a natural disaster that resulted in the removal of gold from the banking system, triggering a financial collapse. People need to ask themselves if they want a monetary system that can wipe out your life savings because of an earthquake? That is what you get with a gold standard.

What was the Panic of 1907, and what caused it?
The Panic of 1907 was a six-week stretch of runs on banks in New York City and other American cities in October and early November of 1907. It was triggered by a failed speculation that caused the bankruptcy of two brokerage firms. But the shock that set in motion the events to create the Panic was the earthquake in San Francisco in 1906. The devastation of that city drew gold out of the world's major money centers. This created a liquidity crunch that created a recession starting in June of 1907.

Andrew Jackson triggered a similar financial panic when he didn't re-charter the Nation's Central Bank, resulting in foreign nations and individuals pulling their gold out of the US banking system.

By the spring of 1837 as Van Buren was succeeding Jackson in the presidency, a deep depression was taking hold as credit contracted. Without a national bank, the federal government lacked the tools to deal with the situation ... New Orleans banks began to suspend specie payments even before they learned that New York banks were taking similar actions. The result was paralysis of financial markets as specie concentrated in private hands.

Commandment #7: Gold will survive after the world economy crumbles: That is factually true, but if you truly believe in the Armageddon theory, I would invest in guns and bullets. I'm pretty sure that in a post-apocalyptic world, if a man with a loaded gun meets a man with gold, the man with the loaded gun walks away with the loaded gun and the gold...only possibly less one bullet.

Commandment #8: Never admit that gold is essentially a sucker's bet: Gold is the classic investment that defines "the greater fool theory." It is totally valued upon what others will pay for it. It is much like the Bitcoin. Today People are paying $1,400 for a piece of metal the size of a wheat thin when just a few years ago they were paying less than $300 for that same piece of metal. Gold doesn't pay a dividend, so you can't value it as a stream of income like most investments. It is literally a shiny piece of essentially useless metal, unless you consider taking up space in your basement a "use."

Commandment #9: Gold is a rejection of government, and their control of fiat money and finance: That is actually true, but misguided. Now that people have experienced the crash in gold, most now understand that they would rather have that "inflationary" US Dollar than the "deflationary" gold. Three years ago $1 would buy me a McDonald's sausage biscuit. Today $1 will buy me a MCD Sausage Biscuit. Today an oz of gold will only buy 3/4ths the number of biscuits it did at its peak.

Commandment #10: All Gold discussions must contain ominous macro forecasts: That seems to be the case, and fear rarely is a sound foundation for an investment. I like to say "the doom and gloomers are always proven wrong throughout history, and that is why we are so much better off today than we were even 10 years ago." The historic accuracy of Armageddon claims is literally zero. We're still here aren't we?

Commandment #11: Gold is always rallying in one currency or another: That may actually be true, but functionally irrelevant. Buying gold in different currencies is more currency speculation than investing in gold, and it requires the ability to time currencies which few if anyone can do successfully over time.

Commandment #12: China and India know the value of gold; the Western world does not: I don't really know how this is relevant. If gold goes down in value, China and India suffer as well. Personally I would rather China and India have all the gold, and we get all the useful resources, goods and services that the gold could buy. I would rather have food on my table, a roof over my head, a car in my garage and my child in college than a stack of gold is some vault.

Bonus Command: Never admit gold might be falling because it trades on human emotions and psychology and has no intrinsic value whatsoever: This gets back to the title of the article. Acceptance is the first step towards healing. Emotional attachments to gold, political ideology and personal beliefs won't make gold a better investment.

In conclusion, my hope is that now that the perception of invincibility has been shattered for gold, more reasoned, logical, analytical, objective and unemotional discussions can be had. Granted the above analysis may challenge some of those goals, but sometimes a little laughter is needed to get the conversation rolling. The critics of gold have sustained such abuse over the last few years they've earned the right to shout "see I told you so." My opinion is that many investors could have prevented losing money in gold and the Bitcoin if they had been given truthful analysis and a full understanding of how our monetary system really works. The facts have always been there, and are recorded in almost every money and banking text book. By the way, The Creature from Jeckyll Island, the source of many of these myths and misunderstandings, does not count as a text book.

The empirical evidence is also there, if only people will put aside their ideological philosophies, personal biases, fears, emotions and simply attempt to understand how our system works. Investors in gold need to start asking the gorilla in the living room questions like "why don't we have hyper inflation?" "why hasn't the dollar collapsed?" and "tell me again how this Bitcoin works?" The biggest gorilla in the living room question is "if we do 'End the Fed,' who will be the lender of last resort and how will we stop bank runs and panics?" I've asked that question many times and have not once gotten an answer, in fact when asked, the people asked appeared to have never even considered it.

If people understand that question, then the reasoning and logic behind owning gold that supporters give doesn't sound so convincing. It is hard to convince people that repeating the systemic banking system collapse of the Great Depression is a better alternative than having the Federal Reserve of 2008 that can "print money out of thin air." Yes we did have a Federal Reserve in 1929, but it was collared by a gold standard, didn't "print money out of thin air," there was no TARP and they failed to effectively act as a lender of last resort. 2008 has proven beyond any reasonable doubt that the Fed has learned from its past mistakes. Because the Fed has proven its worth, the vast majority of reasons to hold gold are made moot.

Disclaimer: This article is not an investment recommendation. Any analysis presented in this article is illustrative in nature, is based on an incomplete set of information and has limitations to its accuracy, and is not meant to be relied upon for investment decisions. Please consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice.

Disclosure: I 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.