Three months ago, there was some confusion when SocGen's Dylan Grice, one of the brightest big picture strategists out there, released a report profiling the long-term real return on commodities (which was zero), leading some to speculate he was bearish on gold and/or other precious metals. Today, Grice puts the matter to rest with his latest Popular Delusions piece: "Why this commodity specific value investor likes gold." To wit: "In the hard sciences knowledge builds cumulatively. It propels the relentless growth in man’s ability to do more with less, which makes commodities such a lousy investment in the long term. Yet in the realm of social decision-making mankind is a fool, unable to learn the wisdom of posterity and doomed to repeat its mistakes: the first credit crunch occurred in the Rome of 33AD and the ancient Greeks lived with high inflation. Confidence in central bankers’ ability to learn from past inflation is as likely to be misplaced as it was in their ability to learn from past credit booms. Gold remains the cleanest insurance against such overconfidence." And confirming gold's very unique position in the investment pyramid, Grice's conclusion borders on the ontological: "Shorting mankind’s ingenuity isn’t a smart thing to do. But ingenuity isn’t wisdom. And shorting mankind’s ability to absorb wisdom … well, aren’t you silly if you don’t? With less of the technological risk you’re taking when you buy any other part of the commodities complex, gold is the oldest, purest and simplest way." It appears ever more are starting to agree with this perspective.
Grice's summary observations on gold, explaining why to so many the concept of precious metals is sufficiently inexplicable to be analyzed through the prism of religion:
I recently showed that the long-term real return on commodities since the 1870s has been zero (Popular Delusions, 15 December 2010), and so I am sceptical of long-only commodity investing. The history of our species has been one of adaptability and innovation, and I argued that to buy commodities was to go short human ingenuity. But some thoughtful observers - see Sean Corrigan profiled on zero hedge for a good example - questioned exactly how “ingenious” humanity really is. They suggest that shorting human ingenuity might not actually be such a bad idea!
This is a valid point and one that I want to explore in more detail this week. In the original note I explicitly excluded gold from my analysis, as I have done in subsequent writing. But I have never properly explained what, on the surface at least, appears to be a stark contradiction: how can such a commodity-sceptic as I be so comfortable owning physical gold? What follows is such an explanation. I’ll let you decide whether it’s any more than an elaborate attempt to relieve a particularly nasty case of cognitive dissonance.
Gold is not like other commodities, and other commodities are not like gold. That difference is central to the reconciliation to come. But it is actually much more. It lies at the heart of the absurd contradiction innate to the human condition: how can a species as capable of the creative resourcefulness embedded in space travel, wireless communication, genome mapping, Viagra, be at the same time, so hopelessly incapable of learning past wisdom, and apparently doomed to repeat past follies?
Previously, when we discussed Bernanke's hubris when testifying in Congress that it would be impossible to get a gold standard back because there is not enough gold, we countered with the simple argument: just raise the price of gold. Indeed, as Grice points out (again) at $7,500/ounce all the dollars in circulation would be backed by gold.
And Dylan brings the thesis full circle: gold is nothing but insurance, but not so much against deflation, inflation or the end of the world: it is insurance against pure human hubris, such as that exhibited by Central Planners, pardon, bankers, each and every day.
Two thousand years ago, Marcus Cicero said “any man can make mistakes, but only an idiot persists in his error.” By such logic our species is idiotic indeed. For our ability to pass knowledge down through the generations applies only to the physical sciences. In the realms of the social decision making, where humility and realism are so often the dupe of hubris and self-delusion, each generation is condemned to relearn the mistakes of generations past.
The abuse of political power, wars and popular uprisings are as prominent in ancient history as in today’s newspapers. In the 5th century BC the helot serfs tried in vain to overthrow their Spartan masters. Today the Libyan rebels’ struggle to topple Gadaffi may be going the same way. Harry S. Truman once said “there is nothing new, only the history you don’t know.”
Financial history is no different. Indeed, it is the systematic tendency towards precedented folly which is such a fascinating feature of our financial heritage. During the South Sea Bubble, as the stock of the South Sea company entered stratospheric proportions, John Martins of Martins Bank bought stock at the ludicrous price of £500 and justified it thus, “when the rest of the world are mad, we must imitate them in some measure.” Nearly three hundred years later, the then CEO of Citigroup, Chuck Prince, echoed identical idiocy with the now infamous utterances “ … as long as the music is playing, you’ve got to get up and dance.”
Tacitus refers to what may be the first recorded credit crunch in 33AD. An edict on usury from the Emperor Tiberius forced money lenders to call in loans and borrowers to sell property at distressed prices, during a “great scarcity of money.” Only when the emperor advanced 100m sisterces to distressed debtors to borrow for three years without interest (the world’s first ZIRP) did the crisis pass. So the credit crunch of 2008 wasn’t the first, and it won’t be the last. Yet only a few years ago we were told that financial crises were a thing of the past.
Central banks knew better. They’d learned the lessons from the past. But history shows that in the realm of social decision making such confidence is rarely warranted. Hubris plays the lead role in all great financial tragedies.
And what is an inflation crisis if not a financial tragedy? Today our central bankers are as confident in their ability to control inflation (Mr. Bernanke claims 100% confidence) as they were in the soundness of the financial system in 2006. Yet history suggests they shouldn’t be, for inflation goes back almost as far as we do. In the ancient Greek comedy, The Frogs, written in 405BC, Aristophanes writes that “the full-bodied coins that are the pride of Athens are never used while the mean brass coins pass hand to hand”. His reference to Gresham’s law predates Sir Thomas Gresham’s first observation during the medieval inflation of Henry VIII’s England by around two thousand years. As the play was written during the closing years of the epic Peloponnesian Wars which would have stretched the government’s budget, we can assume that Aristophanes and his audience witnessed inflation first hand.
Like credit crunches, there is nothing new about inflation crises. It’s not something which happened in the past but which we now understand well enough to ensure it never happens again, any more than systemic banking crises were. Yet when we talk about past inflationary episodes, whether in classical times, medieval times or industrial times we read of the same two villains of the peace each time: financially pressured governments and the politicised issuance of money. With the festering off-balance sheet liabilities threatening public sector solvency throughout the developed world, and central banks little more than fiscal puppets and economic cheerleaders (with the exception of the ECB, for the moment), we’re set to reacquaint ourselves with those villains in the flesh.
Shorting mankind’s ingenuity isn’t a smart thing to do. But ingenuity isn’t wisdom. And shorting mankind’s ability to absorb wisdom … well, aren’t you silly if you don’t? With less of the technological risk you’re taking when you buy any other part of the commodities complex, gold is the oldest, purest and simplest way.