Satyajit Das on Gold
Well known market observer and commentator Satyajit Das has written an article on gold which has been published at Naked Capitalism. As is usually his wont, he is adopting a very neutral tone of voice, with the occasional barb thrown in almost imperceptibly. Both detractors and fans of gold are ribbed a little bit, while Das enumerates their lines of argument seemingly without passing judgment.
Still, we see the publication of this actually quite non-controversial article as an opportunity to add a few comments. Quite early on in his article, Das relates an anecdote from post war Germany that one would do well to keep in mind. He writes:
“As a banker asked an old woman in 1918: “where is the State which guaranteed these securities to you? It is dead.”
Every discussion of the ‘political metal’ gold should probably be prefaced with an anecdote of this sort so as to make clear what the main difference between a market chosen money like gold and government-imposed legal tender actually is: the latter depends on promises that are rarely kept.
What we would like to comment on are a few of the observations Das makes regarding gold’s investment merits as well as his presentation of the lines of argument forwarded by supporters and detractors of a gold standard. In this article we will discuss the 'gold as an investment' portion of his article.
Gold as an Investment
Das begins by enumerating the various avenues open to people that want to invest in gold today, listing their advantages and disadvantages as well as the associated risk factors. This is an excellent overview that highlights all the important points one should be aware of, but most of these things are probably well known to our readers anyway.
Then he segues into the topic of how tricky gold can be as an investment. Below are a few excerpts with our comments interspersed.
“The investment case for gold is mixed. Gold’s tactical value over specific periods is significant.”
Of course the case for every investment asset is ‘mixed’, and every investment asset has ‘significant tactical value over specific time periods’. It is well known that various investment classes are subject to long term cycles. However, this is nevertheless an important point, see also further below. He continues:
“The period from 1999 to 2001 is referred to the “Brown Bottom” of a 20-year bear market during which gold prices declined. The reference is to the ill-fated decision by Gordon Brown, then UK Chancellor of the Exchequer and subsequent Prime Minister, to sell half of the UK’s gold reserves via auction over 1999 and 2002. At the time, the UK’s gold reserves were worth US$ 6.5 billion, constituting around half of the UK’s foreign currency reserves.
Any investor who purchased the gold sold by the financial astute UK Chancellor would have made a substantial profit.”
Believe it or not, there were actually a number of investors that said so in real time and acted on the recognition that yet another sale of British gold was like a bell ringing. After all, there was a historical precedent: the last time before Brown's sale Britain sold a large amount of gold was in the late 1960's, when it dumped 800 tons at the princely price of $42/oz. – only to watch gold's price soar by 2,400% over the next decade. That was actually a much larger loss for UK tax payers than Gordon Brown's gold sale, especially in real terms (of course, Brown may well still catch up; we fully expect him to). Of course the 'number' of such investors was really very small. It is characteristic of major lows that they occur amid a dearth of interest. Das continues:
“But gold is not itself a great store of value, at least over long time periods.
Gold bugs excitedly speculate about gold prices reaching $2,300. But even at that price gold would merely match its January 1980 peak price after adjusting for inflation; in other words, the holder had earned nothing on the investment over almost 30 years!”
Now, this is something we have to take exception to. For one thing, allow us to point out that anyone who bought stocks at the market peak of 1929 had also gained precisely nothing in real terms by the time the low of 1982 arrived. That's a cool 53 years of earning nothing, and although dividends are obviously not included in this calculation, the 'survivor bias' of indexes isn't reflected in them either. Countless companies that were listed in 1929 were long bankrupt when 1982 came around, so a passive approach would have done considerably worse than earning nothing.
Moreover, one must ask here, how are 'real terms' even defined? Presumably Das refers to values deflated by the government's official CPI data. If we apply a different metric to calculating gold's real value, such as e.g. the Austrian money supply measure TMS-2, then we arrive at a 1980 high equivalent of roughly $3,000 today, not $2,300 ($2,300 is incidentally the very conservative gold price target of our friend Ronald Stoeferle, who writes the excellent annual gold report for Erstegroup).
Furthermore, Das adopts here, whether consciously or not, a method always trotted out be assorted gold bears when they try to denigrate gold's investment merits. This is to say, they mention the 1980 peak as the relevant yardstick by which to measure gold's performance, a price that lasted for all but a second and was attained after several days of frantic panic buying when news of the Soviet invasion of Afghanistan hit. Gold went from about $550 to $850 within three weeks, was at that price for one second and then collapsed immediately again. How many people actually invested at that peak?
What these gold bears usually gloss over is that only four years earlier, in August of 1976, gold could be bought for $108/oz., and that another six years earlier, in 1970, it could be bought at prices ranging from $35 to $42/oz. Why not mention the returns that have accrued to investors in gold since then? Could it be the fact that it turns out that gold actually beat the pants off the stock market?
Besides, it should be pointed out here that gold is actually not an 'investment' in the conventional sense. Obviously it pays no dividend, but why should it? It is money after all.
Don't get us wrong: gold is certainly not money at the moment per the correct definition of money as the general medium of exchange. And yet, the market treats gold as though it were money: while it does not currently fulfill the role of a medium of exchange, it still retains all the characteristics that flow from a commodity that has become a medium of exchange, such as its function as a store of value. The reason for this is simple: although gold has been 'demonetized' by legal tender laws, the markets know that it would be our money in the absence of such laws. It is the market-chosen money commodity that would be used as money in a truly free market. It is also noteworthy in this context that central banks continue to hold some 32,000 tons of gold, obviously for monetary reasons.
Given though that gold is currently not a medium of exchange, we may concede that it has become an 'investment asset'. Only, in gold's case one might say: monetary demand equals investment demand. After all, the fundamental backdrop most conducive to rising gold prices is a desire by economic actors to increase their cash balances and savings on account of regime uncertainty, declining economic confidence, coupled with a growing conviction that the fiscal and monetary authorities are about to devalue their liabilities at break-neck speed in a vain and misguided attempt to cover up their previous mistakes by adding fresh mistakes atop them, only on an even greater scale than before.
So we should then after all perhaps hearken back to the first sentence of Das' ruminations about gold as an investment mentioned above: there are times when it makes sense to invest in gold and times when it doesn't make sense and one will do better with other types of investments. Obviously, since about the year 2000, it would have been best to have held a very low weighting in equities and a very large weighting in gold.
“The gold price adjusted for inflation is the same as the price in the middle ages. Dylan Grice of Société Générale summed up the case for gold as a store of value in the following terms: “A 15th century gold bug who’d stored all his wealth in bullion, bequeathed it to his children and required them to do the same would be more than a little miffed when gazing down from his celestial place of rest to see the real wealth of his lineage decline by nearly 90 per cent over the next 500 years.”
First of all, we think it is nigh impossible to make such an estimate. How would we actually know what the 'real price of gold' was in the 15th century? Here is a chart that has been published in the late 1990's that contains such an estimate (note that the 'real values' depicted on the chart all refer to 1999 dollars – today the numbers would all be considerably higher):
An estimate of the 'real price of gold' over 600 years published in 1999; some of the data seem questionable to us (for instance, we miss the Mississippi and South Seas bubble spikes, as well as the post-revolutionary French hyperinflation episode in this chart).
We do of course know that gold was subject to considerable inflation in the 16th century when Spain's conquistadors flooded the old world with gold they had discovered in the new world. At the time, these additions due to a higher mine supply actually still made a big difference to the purchasing power of gold, as they were of very large size relative to the then existing stock of gold. So it is credible that there was a big decline in gold's purchasing power during the 16th century.
This is no longer the case; today the mine supply has become largely irrelevant, as we have discussed on several previous occasions. However, one must ask, how much stock should one put in such an estimate anyway? We think it's a good bet that if anyone still has a 15th century gold hoard at home, that it has actually preserved value through the centuries far better than any other type of investment would have (for one thing, the likelihood of still possessing that original store of gold is a good deal better than possessing anything else that one might have invested in during medieval times; also, well preserved medieval gold coins trade at well above their bullion value).
One thing is certain though: against all other forms of money, i.e., state sponsored fiat monies and the debts denominated in them, it is really no contest: a large percentage of the currencies that existed a century ago has been repudiated, some of them more than just once. The promises of the State eventually always wither on the vine. Gold just stays gold.
One should not make the mistake of believing that the current paper money standard is likely to fare any better. Longer-lived though it may be than many of its predecessors, it is still beset by the same flaws. It is a system that was destined for an eventual conflagration on the day it was born.
Lastly, even if gold's 'real value' in 1350 a.d. was estimated to be $2,400/oz. (or even higher in 2012 dollars), what could actually be bought with that gold back then? One sure couldn't buy an iPad in the year 1350 to name an example. In fact, there existed no mass-produced consumer goods at all. Choices were extremely limited even for the select few that actually possessed gold at the time. So how can one say the 'real value' was a number 'X'? It really doesn't seem to make much sense to make such an assertion. The only thing that is certain is what we have already noted above: as far as money goes, gold has almost always managed to preserve the purchasing power of savings – the gold inflation of the 16th century represents a notable one-time exception to this rule. State-produced and administered legal tender money never did and never will.
“The gold price can also be very volatile. In late 2011, after reaching record levels, the gold price fell nearly 20% very quickly.
Warren Buffet observed that if stock investors are driven by optimism about prospects then “what motivates most gold purchasers is their belief that the ranks of the fearful will grow.”
Let us rephrase that: “equities can also be very volatile. Shortly after having reached record levels in late 2007, they collapsed by 58% into early 2009, with most of the decline happening very quickly indeed.”
It is really a non-sequitur. Gold is volatile? Even if it were, why should one be particularly worried about it? As it is, it is actually a lot less volatile than most other commodities and investment assets. A brief look at the bull market from 2000 to date shows this remarkable lack of volatility. It simply makes no sense to even mention gold's volatility unless one wants to specifically stress that it exhibits a distinct lack of it so far:
The recent gold bull market: so far it is one of the least volatile bull markets of all, if not the least volatile one. To complain about gold's 'volatility' strikes us as rather strange – click for better resolution.
Regarding Warren Buffett's observations on gold, generally they are not worth much. Buffett doesn't like gold, we get it, but then he regularly betrays his utter ignorance about it, so why would one even bother to mention his gold-related bon-mots? The specific quote Das has picked has been well chosen though: when economic confidence is strengthening and the social mood is optimistic, then it is usually better to be invested in stocks than in gold. Gold investors obviously do expect the 'ranks of the fearful to grow', and for very good reasons. The problem is that economic confidence has been on a roller-coaster with a very negative bias since the flaming out of the great stock mania in the year 2000, which is why it was better to be invested in gold since then, something that continues to hold true in our opinion.
It must be pointed out that gold is certainly no longer the bargain it was at the lows over a decade ago (at which time Warren Buffett undoubtedly hated it just as much as today). This is by no means akin to saying that there is no longer a bull market in force though. The bull market can of course take a breather, even an extended one, at any time. That is something we obviously cannot know for certain – market perceptions are notoriously fickle in the short term.
What seems however extremely unlikely to us is that the long term bull market is anywhere near to being over. After all, the people in charge of fiscal and monetary policy all over the globe are applying their 'tried and true' recipe to the perceived economic ills of the world in ever bigger gobs of 'more of the same'. Until that changes – and we feel pretty sure that the only thing that can usher in profound change on that score is a crisis of such proportions that the ability of said authorities to keep things under control by employing this recipe is simply overwhelmed – there is no reason not to hold gold in order to insure oneself against their depredations.
As a result of these policies, real interest rates are either negative or minuscule, the money supply is inflated at astonishing speed and the economy is undermined structurally at every turn. It is precisely the environment in which it makes sense to hold gold.
Few holders of gold bullion are likely to be worried over the short to medium term fluctuations in the price of gold, since their motives for holding it are as a rule not comparable to those of short term speculators. Futures traders and gold stock investors obviously must apply a more active approach to managing their exposure. Especially the latter have had very little joy of late, a topic we also plan to discuss again in more detail shortly.
Lastly, every long term bull market of course ends at some point. However, most of the time the final phases of a long term bull market exhibit certain characteristics that can be observed in a wide variety of markets over and over again. Bull markets don't die with a whimper. They end with major blow-off moves that often occur at a time when the fundamental backdrop is already clearly shifting from bullish to bearish. This is something that has yet to happen in the current gold bull market.
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