Wall Street Journal Columnist Jason Zweig believes he is not a moron (his words) when gold is concerned. He certainly is not a moron from the many excellent columns I have read. On gold he is missing the big picture. In his column on gold he argues; Gold is too high and provides examples of difficult times when gold was actually lower or when it did not shield against distress. Four of his arguments:
From its peak of more than $800 as inflation raged in 1980, gold fell relentlessly over the next two decades even as the cost of living continued to rise.
In October 2008, the depths of the global financial crisis, the gold price was 30% lower than it is now.
In August 2011, when Standard & Poor's downgraded the U.S.'s credit rating, gold was nearly 40% higher than it is now.
Is today's chaos that much worse than the financial crisis? Was the summer of 2011 so much darker than today?
There are two main reasons why this time its different. Yes, really different.
1) Gold is actually a rockstar when hyperinflation strikes. It didn't always protect full purchasing power but is a lot more robust compared to many other assets. According to this CFA paper, its expected value is very sensitive to hyperinflation once the odds of experiencing hyperinflation are one in a billion or less:
By the time I reach a one-in-a billion chance of hyperinflation, the expected value of gold is $72,970. So, I conclude that even a small probability of hyperinflation has a big impact on the price of gold.
2) We are now in the 8th year of ultra low interest rates. There have been many QE programs worldwide. Europe and Japan are experiencing negative interest rates. Something of a currency war is going on. Tarullo of the Fed has just said he wants to see the white of the eyes as inflation is concerned.
What does this do for the odds of hyperinflation?
Gold's expected value rises to $70k+ when the odds of hyperinflation reach one-in-a-billion.
Meanwhile, by Zweig's own admission gold is a reasonable store of value over the very long term. I actually agree it is very imperfect in this regard and gold is often misunderstood to be safer than it really is. You can lose money on gold easily enough. If you hold it or pass it on to your kids, it's likely still going to be valuable. In that way it is different from a company stock. Apple (NASDAQ:AAPL) stock, just an example, is an even more imperfect store of value.
This gets me to my main point that the market may be right to be paying up for gold. The upside is enormous while the downside is actually fairly limited. If you put a small percentage of your position in gold it is hardly going to hold you back when all turns out well. If hyperinflation does strike, you may get an enormous amount of mileage out of your gold allocation.
True, it is a high variance play. As I wrote in my recent article Why You Should Buy Gold, it could be so gold bugs are actually right. The expected value of gold may far exceed the expected value of a portfolio of stock. Yet, even being right doesn't mean you will be proven right in your lifetime. The odds may even be greatly against you ever being proven right even though you really are.
The way I like to get my gold fix is through the streaming companies like Royal Gold (NASDAQ:RGLD), which I reviewed favorably end of 2015 publicly and Silver Wheaton (SLW), which was discussed on Off The Beaten Path back in January. Both did very well since but to be fair I also recommended the Market Vectors Gold Miners ETF (NYSEARCA:GDX) which has been a bust. If anyone who wants to get a little bit of exposure simply by holding the Gold Trust ETF (NYSEARCA:GLD) that's fine by me.
Disclosure: I am/we are long RGLD, SLW.
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.