2014-02-24

Gold: The Quantum of Idiocy

I've seen a lot of weak arguments for and against gold. But I've never seen one quite so......special.

Take this article, prominently featured front and center on Yahoo! Finance's homepage and which originally comes from the Wall Street Journal.

A Word of Warning on Gold: Investor Fear May Be Fading

According to sentiment indicators, investors are very bullish. Fear can fade a bit more because it increased during the January correction in stocks, but it was at multi-year highs in January. Some indicators showed the most bullish readings since prior tops in 2007 and 2000. So even this headline is wrong.

Gold is the stuff myths are made of.

Among the myths: It is a store of value, a hedge against inflation or a hard alternative currency.

Its behavior over recent decades suggests that it has been inconsistent in those roles. It has done better as something simpler: a bet on fear.
Hedge against inflation? Not unless interest rates are negative. Store of Value? Absolutely. You just need a long enough time horizon. As for alternative currency......gold is money. It represents savings and wealth, not currency. The store of value and currency aspect of gold are linked.

Gold rose on basic economic fears in the 2000s but fell starting in 2011 as those fears abated. Now fears are spreading again about waning Federal Reserve stimulus and about global growth. Gold has rebounded 11% since mid-December.
Economic fears in the 2000s? Where were there economic fears in the 2000s? Zimbabwe? Yes, gold did do very well in Zimbabwe, people were panning for it in order to find a little gold to buy bread with since the Zim dollar was worthless.

Elsewhere, from China to the U.S.A., there was a bull market in optimism. Gold went up along with all other commodities as part of a global credit boom tied to investor optimism. When gold peaked in 2011, there was certainly a lot of fear, but most of the fear was driven by expectations of inflation. People were negative on the U.S. dollar, but quite optimistic on China and emerging markets.

Experienced gold analysts are warning clients to be careful: If the fears subside, the price of gold could do the same.

"Gold goes up as an insurance policy and then it is sold at a loss when people no longer want insurance," said Rhona O'Connell, head of metals research and forecasts at Thomson Reuters GFMS, a research firm known for its work on gold.

Here we see the creation of straw idiots to knock down. Gold can serve as insurance, but against what? If you're worried about a stock market crash, you go to cash, not gold. Gold is insurance against bad central bank and/or government policy of the highest order. It is insurance against currency and wealth destruction on a mass scale when few/no other options are available. Did everyone suddenly become worried about this in January?

Gold could move higher temporarily, but Ms. O'Connell says its price is likely to have trouble making significant gains before 2016 because economic confidence has improved.
Gold fell from $1900 to $1200 based on improved confidence and no inflation from QE programs. In order for the price of gold to move lower, confidence needs to improve from where it was in Q4 2013 when everyone thought the spike in inventories in Q3 presaged a faster recovery in 2014. Thus far, confidence is falling, not rising. At worst then, your gold investment will be dead money if confidence stays strong (based on her argument).

Sameer Samana, senior international strategist at brokerage firm Wells Fargo Advisors, suggests clients use gold's rebound to sell anything they have left.

"What we have found in our work is that a broad basket of commodities is a better hedge against inflation, a greater diversification and a better hedge against the dollar," Mr. Samana said.

Gold does well "when you are very nervous about the world," he said.

He prefers copper, aluminum and zinc in a time of recovery.
Gold hasn't even rebounded $100 and this guy wants to pull the trigger and have people dump whatever they have left. Second, the strawman again. No doubt there are people out there who wrongly believe that gold is always a hedge against the dollar and inflation (gold can most certainly rise along with the U.S. dollar as it did in 2008, when gold behaved exactly as expected), but this assumes the argument. If you own gold for these reasons and these reasons alone, then by all means sell it; you own the wrong asset. For everyone else looking for long-term wealth protection, buy more as the idiots sell.

Gold does very well when fiat currencies die. To say people are nervous about the world at that time is an understatement. The entire economy grinds to a halt and if the government moves to intervene with a positive step, it's usually the step of devaluing the currency by a huge amount over the weekend. You wake up on Monday with 50% of your savings gone. When people are nervous about the existence of the currency, the government, the nation, that's when gold really shines because gold doesn't die. The currency, the stock market, the bond market, the government itself can all be wiped out, but gold will remain.

As for preferring copper, aluminum and zinc in a time of recovery.......which recovery? China is the marginal consumer of most raw materials. It is China's recovery that is important, not America's. And copper is weak right now because China is weak.

Gold differs from other investments in an important way: It isn't very useful. Some is used for rings, watches, dental implants and electronic connectors. But the vast majority is hoarded as bars, coins or, in developing countries, heavy jewelry that serves more as a protection against disaster than an adornment.

Unlike stock, gold doesn't offer a stake in a business's results. It doesn't pay dividends or interest. It doesn't grow crops like farmland or provide shelter like a building. It is useful when people are fearful and flee to it.
Everything he says is true and everything listed is exactly why gold is money. If something is useful, like silver (!) then it doesn't work well as money because it gets consumed or people who need it don't like it if you hoard it. If someone started hoarding oil, for example, and cutting off the global supply, you can bet all manner of industries and consumers would complain to the government. Hoard gold? Go ahead, you're hurting no one but yourself (don't throw me in that briar patch!). Gold is money precisely because the most widespread use for gold is storing wealth, which includes wearable wealth, aka jewelry.

To say gold is only useful when people flee to it though, implies that people are irrationally fearful and pushing up the price. Sort of like saying, bomb shelters are only useful when people are fearful of war. What happens when the bombs are dropping? You don't need to be fearful to realize it's a good idea to be in a bomb shelter. Similarly, if the central bank in your nation destroys the currency, it doesn't matter if people feared it or enjoyed it. The net result will be the same: destruction of wealth and savings held in fiat currency and preservation of wealth stored in gold because gold is not a promise to pay. Gold is itself. Gold settles the debt, gold repays the credit. This is why it survives, because it is not dependent on another person's actions. Its value does not depend on the existence of the current government.

Gold soared in the 1970s amid oil crises, runaway inflation and a volatile stock market. When the economy recovered gold collapsed.

Gold rebounded in the troubled 2000s but peaked in 2011, the year Standard & Poor's downgraded U.S. sovereign debt and stocks fell nearly 20%. Economic stability since then has put a lid on gold.

Particularly disappointing, gold has never come close to returning to its 1980 record once inflation is taken into account.

Gold futures hit a record $825.50 in New York on Jan. 21, 1980, which in today's dollars is $2,481.98. Gold's 2011 high was $1,950.15 in today's dollars, 27% short of a record. On Friday, gold futures closed at $1,323.90.

Stocks have hit inflation-adjusted records repeatedly since 1980, most recently in December and January. Gold hasn't. It is barely halfway back to its 1980 record, taking inflation into account.

Gold in that time has worked better as a speculative bet on fear than a store of value. Because Western economies tend to experience more stability than fear, gold is typically a risky holding there.
Again with the fear of the 2000s. Gold soared in the 1970s because the existence of the U.S. dollar was at stake. The link to gold was severed and people weren't sure what would happen. The Boomers were buying homes and launching a consumption boom. The Soviet Union was seen as ascendant and people believed the Soviets might win the Cold War. When inflation was killed by Volcker and confidence in the economy and military restored by Reagan, all these trends reversed.

As for stocks, they are the beneficiaries of 30-years of credit inflation. Not base currency inflation; credit inflation. Credit inflation flowed into assets such as stocks and real estate. It did not flow into gold. The flow of credit stopped rising in 2008 and it wasn't pretty. Even though the Fed more than quadrupled base money in the past 5 years, credit only increased because of U.S. federal deficits. The only clear inflation in assets has occurred where Fed money has flowed directly: into the financial system. Now the Fed is pulling back on its inflationary policy. Stocks are not a good bet.

The Permanent Portfolio, a San Francisco mutual fund that invests in bonds, gold, stocks and foreign investments, ballooned to $17 billion a year ago from $57 million in 2000. Now it is back to $9 billion.

Michael Cuggino, its president, says gold wasn't the only reason for redemptions; investors have fled bonds and other conservative investments. Some money has returned to his fund since gold began recovering in December.

Still, "when people got concerned about gold in the second quarter of last year, there were more redemptions than previously," he said. He is optimistic about gold but sees the mentality shifting. Investors, he said, are more concerned about returns than protection.

One reason for gold's recent rebound is demand in China and India, where economic worries have risen. Swiss refineries have worked overtime to recast big bars favored by Western banks into smaller ones preferred in Asia.
Last one first. Gold buying has been consistent in India and China. There are those who fear currency problems, including the yuan, but they are the minority. Most people in China are better off thanks to rising incomes. Gold is an aspirational good or a speculative investment. If fears rise and people in India and China start really buying gold for financial protection, the Shanghai market alone will break the world gold market. Premiums for physical metal will climb by hundreds of dollars over fixed and futures market prices in the West.

As for the Permanent Portfolio example, it refutes the arguments above about fear. Clearly investors are not fearful, that's why they sold gold and are now buying stocks to chase returns.

In this entire article there are zero reasons given as to why you should be confident. There are zero reasons given for rising confidence. The argument boils down to: people are less fearful now in February 2014, so you should be less fearful too. Dump your gold because it'll do badly now. What happens if people are very fearful in September 2014? What if they look at a long-term U.S. debt projections?

A bad argument against something does not mean the argument for it is right. In terms of the debate between gold bulls and bears, this article does nothing. It is a waste of time and frankly, I wouldn't fault the kooks if they thought it was an intentional piece of misinformation designed to shake some more physical gold out of investors. Maybe the Chinese Politburo has a mole in the WSJ writing anti-gold articles to keep the price suppressed as long as possible. Stranger things have happened.

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