Gold: Assumptions vs Reality

Expected Returns's picture

From Expected Returns Blog

One of the hardest things to do as an investor is to think through investments without presuming anything. The data will tell a story and paint a picture for you that you can  then interpret. Most people shun this obvious approach to investing and instead choose to invert the process by allowing their assumptions to cloud their analysis. This is simply not a sophisticated approach to investing.

A combination of history and quantitative data analysis will give you a perspective that 95% of investors do not have. For example, most people alive today have not lived through the gold exchange standard, and therefore have no clue how it functions. To most, it is a peculiarity of our ancestors; a relic of the past; and a product of a crude economic system. They cannot imagine the possibility of gold playing a role in the global monetary system. Their knowledge of history is small, and so is their sense of economic possibilities.

It is presumptuous to assume that gold will not eventually play a role in the international monetary system since it happened before in history. It is also presumptuous to assume sovereign nations will not default since sovereign defaults are prevalent throughout history. Most of the anti-gold arguments are based on assumptions that simply aren't true. Here are a few.

Jewelry Demand?

It is incredibly difficult to argue with someone who pulls the "jewelry demand" card on you. Why? The jewelry demand argument is so false that its defenders are invariably a special breed of stubborn. You can never win these kind of arguments.

Now as investors, let's test the assumption that there is some kind of relationship between jewelry demand and gold prices. As you can see below, if there is a relationship, it is a negative one.



If you invested based solely on an assumed relationship between gold and jewelry demand, you would have lost money 9 out of the past 10 years. While the data suggest we should change our assumptions, most people won't. This is the irrationality of human nature at play that allows a minority of investors to profit.

Investment Demand, Anyone?

The real demand is coming from institutional investors, retail investors, and governments. Chinese, Russian, and Indian central banks have recently become major buyers. This is a positive trend for gold since these governments hold so small a percentage of their reserves in the form of gold.  Since the dollar dominates foreign reserves, diversification into gold equivalent to dumping dollars.




Retail investors have also begun to protect themselves from spendthrift governments. Objectively speaking, retail investment is a far better indicator of gold prices than jewelry demand.


Marginal Demand, Human Irrationality, and Gold

A fundamental tenet of economics is that humans act rationally. Why I have no clue. Nothing in my experience has shown that people act rationally and to their best interest at all times.

Understanding human irrationality is central to understanding the future price movements of gold.  For example, are people more likely to buy gold at $250 dollars after 20 years of being the most hated asset in the world or at $2500 dollars? You don't see lines around the block at gold shops at bottoms; they are an indicator of tops. This is a reflection of both gold's unique marginal demand characteristics and the nature of bubbles in general.

The marginal demand aspects of gold run contrary to those of most other assets. Generally speaking, a rise in price results in a decline in demand. For gold, a rise in prices results generally in an increase in demand. This is its natural state. Add to the mix human irrationality and the panic buying that is bound to come and you start to understand that the monster moves in gold are still ahead.

Financial experts are telling us the gold trade is crowded. Ironically, gold will become a crowded trade only when the "gold bubble" experts start buying. Not to be flippant, but this is one of the top 3 indicators I'm looking for to signal a top in gold. Fortunately, the gold bubble experts are still out in force expounding on the threats of deflation-  an argument so riddled with holes that it should not be taken seriously. Making linear comparisons between fixed exchange and floating exchange systems is like comparing apples and oranges: It makes no sense and it is bound to result in flawed conclusions.

We should all try to test our assumptions against facts. That most investors don't is great news for gold bulls. We are on the precipice of a major move in gold that will make all blind assumptions concerning gold look foolish.

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Johnny Bravo's picture

I guess that we'll never see a zerohedge convention then.  

RockyRacoon's picture

When we do we will roast you on a spit over a crackling campfire.

A Nanny Moose's picture

Oh....can we have s'mores!?!? please?

akak's picture

Just how does one roast a troll over a fire anyway?

I'm guessing that it would really stink, no matter how it was done.  And taste really, really bad.

I'll stick to the hotdogs.

Johnny Bravo's picture

That's all you'll be able to afford if you're investing in gold.

jeb3's picture

You should use ShitTalker's (v 1.2 by Jaundice) 'random insult' buttom to use as comment material. At least then the rest of us will be mildly amused. You're trolling ways are having little effect, in case you haven't noticed.

Johnny Bravo's picture

If you're waiting for 25000 dollar gold, you'll die first.

How'd that 2000 an ounce prediction by June work out for you all?

Hephasteus's picture

You mean where the majority of zero hedge users 69 percent said it wouldn't hit 2000 by june. Even when you win arguements you lose them.

Keep fucking that chicken even though it's not a chicken.

akak's picture


Yeah, how many times has JB repeated that lie of his already!

I refuse to feed the troll any more.

percolator's picture

When Denninger throws in the towel and buys gold that's when I'm selling my holdings and just in case he never capitulates I've got a few other signals that the top is in that I'm following.

reave the sheeple's picture

The FedRes will throw in the towel long before Douschinnger ever bothers.

MayIMommaDogFace2theBananaPatch's picture

I like Karl, really, but he seems almost prepared to bathe in petroleum to make a point about the gusher...

I'm betting NEVER is when he capitulates on gold.

akak's picture

"When Denninger throws in the towel and buys gold that's when I'm selling my holdings"

At this point, I don't think Denninger would buy gold if the Four Horsemen of the Apocalypse came riding through his living room accompanied by the AntiChrist himself.

"Can I interest you gentlemen in some far-out LEAP calls?"

percolator's picture

Too funny, akak, but its probably true.  That's why I had a disclaimer saying if Karl never capitulates I've got a few other signals that I'm watching to sell my gold.

lawrence1's picture

No... paper is paper is paper.

Ungaro's picture

When gold bullions appear on the cover of Business Week, accompanied by a bullish article, is the time to sell. Until then, just keep buying.

Attitude_Check's picture

1st one is about Michel Phelps Gold medals

2nd article is primarrily a news story about Gold's recent rise above 1260.  More fact reporting wth xome thin background why

3rd article is pretty negative on Gold (implying it's a bubble)


So if your point was to show that the MSM still isn't Gold bullish-you are correct.

cyclemadman's picture

People still look at me like I'm nuts when I tell them to buy some gold and silver. We're no where near a bubble yet.



RockyRacoon's picture

Would they believe an "expert" like Dennis Gartman?  He was touting gold this morning on CNBC.  Maybe those 2 negatives would make a positive!

Rebel's picture

DG is schizophrenic, but he is a trader/investor trying to time things to make money. He is trying to pull dollars out of those ups and downs on the chart.

I am not a gold investor nor trader. I am an accumulator, and don't pay too much attention to how many wads of paper I have to send in each month for PM's.

I measure my assets in ounces, not $$. 

akak's picture

DG on gold is positively schizophrenic --- I can't count how many times he has publicly changed his position in the last two or three years.  And almost invariably, from what I have seen, in an almost perfect inverse relation to moves in the gold market.  It would be fascinating (and embarrassing --- for Dennis) to make a chart of his gold buy/sell calls vs. gold price movements.

Pladizow's picture

Why waste your time arguing with the uneducated?

technovelist's picture

Sounds good to me. Bring it on!