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Five Reasons to Avoid the Gold Rush
This is the third in a series of what some may consider as “gold bashing” articles. I am not short gold in any shape or form. I have no axe to grind against gold bugs. I am simply presenting the other side of the argument in response to what I deem to be dishonest, gold-pimping commercials (e.g., “If gold prices went up to $5,000 this pile of gold would be worth $300,000”) that we are subjected to all day long on TV. I may be wrong, but I am honest.
Five Reasons to Avoid the Gold Rush
Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.
- Warren Buffett
The reasons why one should sell the cat, pawn the mother-in-law, and use the proceeds to buy gold are well known: the Fed is printing money faster than you can read this, which will result in inflation; the government is borrowing like a drunken monkey, so the dollar will be devalued; this will debase all currencies, so the only thing that will save you is the shiny metal.
However, here are some arguments why one should think twice before jumping in bed with gold bugs, or at least remain sober while determining gold’s weight in the portfolio .
1. For investors (not speculators) it is very hard to own gold, because you cannot attach a logical value to it. Unlike stocks or bonds, gold has no cash flow and has a negative cost of carry – it costs you money to hold it. It is only worth what people perceive it to be worth right now. The argument I commonly hear is, “What about all those Enrons, Lehmans, Citigroups, etc. that either went bankrupt or got near it? What was the value of those?” If the lesson learned is not to own stocks but to own gold, it is the wrong lesson. The lesson should be: own companies you can analyze (the aforementioned companies were unanalyzable) and diversify – don’t put your all net worth into one stock.
2. The gold ETF SPDR Gold Shares (GLD) is the seventh largest holder of physical gold in the world. If its holders decide to sell (or are forced to sell; think of hedge-fund liquidations), who will they sell it to? This is extremely important, as the presence of GLD changes the dynamics of the gold price, both to the upside and downside. If gold keeps climbing, the ease of buying will drive gold prices higher than in GLD’s absence. In the event of a significant sell-off, there are not enough natural buyers of physical gold. It is a bit like a roach motel – easy to get in, hard to get out.
3. In the past, gold had a monopoly on the inflation and fear trade. Not anymore. Now you have competition from Treasury Inflation-Protected Securities (TIPS), currency ETFs, short US Treasury ETFs, government guaranteed/insured FDIC checking accounts, etc. TIPS suffer from the flaw of the CPI being measured and reported by the US government, which has an inherent bias to understate inflation; returns of commodity ETFs are skewed by price differentials between financial derivatives and spot prices of underlying commodities; returns of leveraged ETFs diverge significantly over the intermediate and long run from the underlying index; FDIC reserves are being depleted with the every-Friday-night bank bailout (but believe you me, the US government will not let FDIC go bankrupt, even if it means it has to raise taxes and impose draconian fees on the banking sector).
The bottom line here is this: none of these investment vehicles are perfect, in fact many have significant flaws; but despite their flaws they attract money away from gold, thus undermining gold’s monopoly on the fear/inflation/currency debasement trade. (I’ve discussed it in greater detail in my book).
4. If, because of points 2 or 3 above, gold fails to perform as expected, the perception of what gold is worth may change dramatically.
5. Over the last 200 years, gold was really not a good investment. It may have a day in the sun, but it may not. And the cost of being wrong is fairly high.
Though gold bugs make it sound as such, gold is not the only and not the best alternative if the worst fears come to pass. The best way to deal with the risks of dollar devaluation and high inflation – with a much lower cost to being wrong – is, instead, to own stocks of companies that have pricing power of their product. When inflation hits, they will be able to raise prices and thus maintain their profitability. Also, companies that generate a large portion of their sales from outside the US will benefit from the declining dollar.
Gold bugs look at gold as a currency, but it is not one and unlikely to be one in our lifetime. Here is why: there is not enough of it around, so even if world government were to adopt a fractional system (currency in circulation as a multiple of gold reserves), they will never go for it, because central banks and governments will never give up their monetary tools – inflation is a very addictive tool to fight growing monetary obligations.
There is a wild card in the price of gold, though: China (John Burbank made that argument at the Value Investor Congress in Pasadena). If it decides to switch partially from owning US Treasuries to owning gold, the price of gold will skyrocket.
Vitaliy N. Katsenelson, CFA, is a portfolio manager/director of research at Investment Management Associates in Denver, Colo. He is the author of "Active Value Investing: Making Money in Range-Bound Markets" (Wiley 2007). To receive Vitaliy's future articles my email, click here.
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I wondered that myself...it better be, if not it is probably the dumbest thing I've ever read on this usually great website.
How about the statement "gold has not been a very good investment for the last 200 years." Did this intensive historical study happen to note that the price of gold didn't change for long periods of time....HELLO! gold was fixed and the dollar was convertible.
If great gran'daddy had dug two holes in '24 and stuck $1K of FRN and $500 of AU in the other, which would you like to have luckily stumbled upon while digging up the flower bed?
Time to come to the realization that while the underlying value (goods and services) which should underpin a currency are undergoing an exponential descension, the paper currency necessary to keep up the illusion of the modern market is being replicated at an astonishing exponential moonshot. Those two mathematical functions have such complete divergence that only an absolute ass could miss it. Gold will keep the saavy pinned to reality, while paper has lost all adhesion to the real world. It exists in its own sphere and without any purpose.
One choice will end in tears, the other less so. Gold will be the rod one holds to in mist of darkness, which darkness will carry the blind to a wilderness of misery and want; whereas the handhold of gold will direct the steps of the wise to some semblance of reality.
Unless we are damaged back to completely to the stone age (in which broken flint tools will have primacy), put gold away for safekeeping. Foolishness is a poor bread and a thinner soup.
Gold bugs look at gold as a currency, but it is not one and unlikely to be one in our lifetime.
"Gold still represents the ultimate form of payment in the world. Fiat money in extremis is accepted by nobody. Gold is always accepted." Alan Greenspan - May 20, 1999
Here is why: there is not enough of it around, so even if world government were to adopt a fractional system (currency in circulation as a multiple of gold reserves), they will never go for it, because central banks and governments will never give up their monetary tools – inflation is a very addictive tool to fight growing monetary obligations.
That's the main reason why I own gold
TIPS? the government paper based on faulty inflation assumptions manufactured by the government better protection against government produced inflation than gold?
Don't be so hard on the guy. Imagine him as a low level crack dealer. He's gotta sell the product or the boys he buys it from are gonna be pissed. Of course this guy isn't gonna be pushing gold, it's not in his suppliers pipeline.
I've found Vitaliy's commentaries interesting, for it highlights how utterly devoid of sound economic principles most economic and financial training is these days. Does anyone in the financial world know what money is? I really don't think so.
I'm sorry, Vitaliy, and others of your ilk, but the simple fact of the matter is this: for 5000 years, humans have used for money things that also been a store of value. Every attempt to deviate from this simple truth have failed. Gold won out long ago due to its very unique and intriguing properties.
As the saying goes: the trend is your friend. Humanity has a 5000 year trend going. Gold IS money. Even today, it is still money. All currencies trade ultimately in terms of real money.
Nixon may have closed the "gold window," but that didn't mean gold quit being money. Governments have never succeeded in ending the simple fact: gold is money. Not currency, money.
So, while there are some great reasons for NOT holding gold as an investment, there is -0- reason to avoid gold if you seek to hold MONEY. In a currency crisis, true money, gold, will be the only survivor.
Bummer that Vitaliy and other CFA's are going to learn this lesson the hard way: their wealth and their clients' wealth are going up in a puff of smoke!
hear hear!
i posted a few comments on the definition and
properties of money elsewhere on zh which fell on deaf
ears....but the world is flat dontcha know?
...as you suggest gold is money par excellence...it
is preferred when investments with acceptable
risk profiles are unavailable....
gold is never intended to be an investment - that
is not the purpose of money....
having said that, decades of systemic gold price
suppression have given gold an investment profile
even though that is not its purpose...it is still
seeking price equilibrium...
and now for a different point of view:
http://www.golddrivers.com/gata2.aspx
i can assure you that the "analysis" presented here can be dumped into the round file.
clarification: the disposable "analysis" referred
to this zh editorial - not to the link i supplied.
Ok, enough is enough. I clicked on this one last time, thinking (by the title) that the author had actually taken advice and spelled out a list of good reasons why. Instead, it is simply a rehash of the last two 'contributions.' This just screams out as poor advertising for the author's own product or whatever he is hawking.
I realize that no one has to click on this article if they don't want to, so what's the harm? This third piece offering nothing new - and the same multiple links directly to the author's wares - tastes like harm to everything else on this site now and in the future.
Gilgamesh called it as it is. The guy listened to nothing and learned nothing. He is still conflating paper with gold. He is still ignoring the costs associated with the other financial vehichles he discusses, as if gold is the only one that has these kinds of costs associated with it. Stunning.
'Rehash' is an understatement. I thought I was reading the same thing, but it was only when I couldn't find Project Mayhem's rebuttal that I realized that this was a new post.
and if gold hedges inflation 1:1, it is still not a very good hedge because you will have to pay capital gains tax on its nominal appreciation.
Gold is actually considered a "collectible" in the U.S. for tax purposes, and would therefore be taxed at one's normal income rate. However, in the real world, gold is sold on a "cash money" basis (no sales tax) and as long as the transaction is under $10,000, there is no required paper trail. Being "off the grid" is just one more of the many benefits that physical gold has over other investment mediums.
The GLD is also taxed as collectible.
"you will have to pay capital gains tax on its nominal appreciation."
not if you hold it in a Roth IRA........
not if you hold the physical bullion either, cash transaction
If inflation is to be feared, then why not just borrow more money?
If inflation is a reason to be afraid, then why not borrow more money?
I don't understand your point about gold not being a currency. It has been a currency since we *had* currency. It was the original currency. When did it cease being one in your eyes?
About the fear trade, I think the fear is about debt and the United States' possible inability to pay it back due to plummeting tax revenues. It is not a question of inflation or deflation it is a question of the fear of the insolvency of our financial sector, government and in the end, monetary system. The math does not a add up.
I'm not a gold owner nor a gold bug, but I certainly see the arguments for it...the systemic collapse that the bailouts were able to prevent was actually only delayed. The government put its credibility in front of the failtrain that is the financial sector and is trying to use it to stop it altogether but it is unlikely to work. I only take the argument one step further and would rather endorse food and seeds as a hedge for a loss of confidence in the ponzi scheme.
Using TIPS seems highly risky in terms of using it as a hedge for systemic failure. Tangibility is the key here. Paper's reign as a "sound investment" is long gone.
When was the last time you paid your taxes with gold? The last thread tying U.S. currency to gold was severed by Nixon.
Doh! I forgot that thanks to Nixon I can't exchange gold for dollars now.
as much as gold makes our skin tingle when we touch it, we agree about the food & seeds.
humans do not necessarily need any form of $ to survive.
the same can not be said for food.
http://www.telegraph.co.uk/finance/economics/6146957/China-alarmed-by-US...
"If you don't trust gold, do you trust the logic of taking a beautiful pine tree, worth about $4,000 - $5,000, cutting it up, turning it into pulp and then paper, putting some ink on it and then calling it one billion dollars?
You are going to need a new CFA when Bernanke is done.In fact CFA will be designated just as the birth of Christ was,
BC and AD, in this case Before Credit (Crisis) and After Dollar.
"one billion dollars"
We are calling the funny thing "trillion dollars" now. I call it "thing" because it's not paper any more. The thing is some sort of electronic signal. Upside: we save a lot of papers and printing ink. Downside: we can't even use them to wipe our butts.
I like the logic that gold will never be adopted as a
a currency because the government can't print more of it.
So, what is ultimately adopted as a medium of exchange depends on the holders of the medium, not the issuers. If nobody wants dollars, it doesn't matter what Ben does.
+10,000 fireangelmaverick
... actually, it's old blue jeans that they turn into money idiot.