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Will gold shine again?

Vitaliy Katsenelson's picture


This is the second 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.

Will gold shine again?

Gold is an important but very different asset class that competes with stocks and bonds. Unlike stocks and bonds, its main attractions are scarcity, durability and resistance to oxidation - it simply never stops shining.

In fact, most of the gold ever mined is around today. It is exhibited in museums, worn as jewelry and buried deep in the vaults of the central banks. Peter Bernstein, in The Power of Gold, wrote:

“Despite the complex obsession it created, gold is wonderfully simple in essence. Its chemical symbol AU derives from aurora, which means “shining dawn,” but despite the glamorous suggestion of AU, gold is chemically inert. That explains why the radiance is forever. In Cairo, you’ll find a tooth bridge made of gold for an Egyptian 4,500 years ago; its condition is good enough to go into your mouth today. . . . Stubborn resistance to oxidation, unusual density, and ready malleability-these simple natural attributes explain all there is to the romance of gold.”

Despite its unique properties, gold has not been a good investment. Over the past 200 years, its returns have barely kept up with inflation. Its value has a low correlation with stocks (prices of gold and stocks move independently of each other most of the time), which is a big positive from the portfolio construction perspective; diversifying with gold can reduce a portfolio’s fluctuations(volatility). But the diversification benefit comes at a large cost: Once added to the portfolio, gold substantially reduces that portfolio’s risk-adjusted returns. Its dismal returns negate any benefit the portfolio receives from reduced volatility.

One thing about gold, however - it is real! You can hold it and touch it and see its shine. This tangibility makes it seem impervious to the whims of politics, nature and time, as opposed to paper assets such as stocks and bonds. Gold’s physical attributes attract investors during times of economic uncertainty, and so it serves a purpose in the markets and society - it is a stabilizing influence. It feels safe.

Doomsday currency

The thinking of the so-called gold bug (a believer in gold’s supremacy, a gold aficionado) often takes on a variation of this form: While in the bunker (or any other variance of the “world-falling-apart” scenario), you cannot pay for food with paper money or a stock or bond certificate. You may do so with real tangible assets, such as gold. If this scenario played out (God forbid), it is conceivable that gold could become the de facto currency. In that event, you need to have real gold in a safe or buried in your backyard. The wise gold bug would have managed portfolio risk by also investing in a good arsenal of guns, as the demise of government bonds would likely lead to the end of the rule of law as well. Gold held by your broker or through ownership of gold stocks or exchange-traded funds will not come to the rescue; these bytes and bits are not superior to default-free bytes and bits, for example, U.S. Treasuries. Canned food may actually be a better store of value in this “world coming to an end” scenario.

The ever-increasing complexity and globalization of the financial system, rapid spread of international trade and the availability of risk-free investment instruments that were not available to investors in previous economic crises may have changed investor behavior during economic doomsday times. Financial instruments such as Federal Deposit Insurance Corp.-insured checking and savings accounts, U.S. Treasury bills and Treasury inflation-protected securities may challenge gold’s status as the safest haven in times of inflationary crisis.

Treasury inflation-protected securities may turn out to be the key challenger to gold’s store-of-value supremacy status in the future. Aside from being issued by the U.S. Treasury and therefore backed by the full faith of the U.S. government, they also protect investors from inflation - one of gold’s most-valued qualities. TIPS’ principal is tied to the CPI: The principal value increases with inflation and falls with deflation. When the security matures, the original or adjusted principal is repaid, whichever is greater.

Though TIPS appear to have superior financial properties to gold, they still lack one of gold’s main attractions - tangibility. After all, they are still just bytes and bits on a brokerage firm’s or bank’s mainframe, or pieces of flammable paper stored in a safe.

Holding gold has costs

Any cash flow-generating asset, like a stock or a bond, can be valued on the future cash flows that it is expected to generate. Predicting gold prices is extremely difficult because gold is not a cash-generating asset. In fact, it is important to note that gold actually has a negative yield. Gold is a cash-consuming asset; its safekeeping and transportation cost money. TIPS, as well as any bonds and dividend-paying stocks, have a positive yield; they pay investors for holding them.

Gold is also considered a good currency hedge, especially for the U.S. investors who are concerned about the declining dollar. Again, our financial ingenuity is stealing gold’s long-held exclusivity on that trade, providing options that were not available a few decades ago. To protect themselves against the declining dollar, U.S. investors can use currency futures and options, foreign-currency-denominated mutual funds and certificates of deposit; they can buy foreign stocks on foreign exchanges or through American depositary receipts; and, of course there is a most recent development - currency exchange-traded funds.

In both the long run and the short run, gold prices are driven by fear of the world coming to an end and investors’ expectations of future inflation. Although gold has some industrial applications - in jewelry, dentistry, computers, jet engines, electronics, as a superconductor, etc. - linking its intrinsic value directly to its price is difficult. Perception of its ability to store and preserve real value, especially in an inflationary environment, is the key driver of gold’s price.

As long as investors perceive gold to be a refuge in times of uncertainty, gold will act as such. It is important to note that gold’s monopoly as an instrument of choice at the time of fear and uncertainty has been undermined by other very capable and often superior financial instruments.

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 by email, click here.


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Tue, 09/08/2009 - 04:34 | Link to Comment Mediocritas
Mediocritas's picture

PMs moved nice in HK, right on cue, busted 1000 and 1004 with ease. Let's see if we get a NY response or if the big bad bears are in hiding.

Tue, 09/08/2009 - 05:27 | Link to Comment Gordon_Gekko
Gordon_Gekko's picture

And the dollar just went down the shitter - again. And Bobby Prechter just took it up the ass - AGAIN.

Tue, 09/08/2009 - 05:33 | Link to Comment Mediocritas
Mediocritas's picture

Have to confess China caught me out a bit here. I expected the dollar to go down in flames and PMs to slingshot, but I didn't expect it right now. In fact, I am mainly positioned for a different scenario: equity collapse, dollar / Treasury rally, PM pop and fade. Hedges are holding up ok for now and no need to scramble out of positions but still...not exactly my finest timing.

Sounds like you are on the right side of things. Kudos.

Tue, 09/08/2009 - 02:22 | Link to Comment Mediocritas
Mediocritas's picture

Anyone else expecting to hear the IMF talking about gold sales again real soon? They do like to throw that one out there from time to time when the market gets a bit hot. Hey, this time they might actually have to deliver as the USA will be classed as a 'Heavily Indebted Poor Country'.

CBs seem more willing to sell *cough* lease their gold when a member gets caught with their pants down. I can't wait to see who comes out of the woodwork if a high % demand physical when Sep & Oct contracts come due.

Mon, 09/07/2009 - 23:45 | Link to Comment Gordon_Gekko
Gordon_Gekko's picture

"I may be wrong, but I am honest"

Sure, you may be "honest", but you are definitely stupid.

Mon, 09/07/2009 - 23:41 | Link to Comment Gordon_Gekko
Gordon_Gekko's picture

Again, this just seems like a mish-mash of all the misconceptions about Gold out there rolled into ne single article. I think PM has done a good job with rebuttal (of course I can add plenty more, but I'm feeling a bit lazy at the moment), so I'll just say this (again - courtesy FOFOA):


And there have been TONS of it generated worldwide since we went off the Gold standard. Think about it. A majority of the world population is long cash and short Gold. It's the BIGGEST short position on Gold in the entire HISTORY of mankind. Most people don't even realize that they are short, and won't until it's too late. So your little "storage costs", "cash flow" bullshit etc. is not even gonna matter when the sheeple herd scrambles to cover.

Also, I suggest you read what happened in Argentina before coming up with the "canned-food-is-better-than-Gold" argument. Just because paper money is destroyed DOES NOT MEAN that there will be Armageddon - GET IT?

"Will Gold shine again?"

WTF dude? "again"? Gold has been in a bull market for a f--king DECADE now. Where have you been?

"The thinking of the so-called gold bug (a believer in gold’s supremacy, a gold aficionado)"

Hmmm. So what does that make you - a paper bug (a believer in paper’s supremacy, a paper aficionado)?

Mon, 09/07/2009 - 22:27 | Link to Comment Old. No. 7
Old. No. 7's picture

This is blogging bastinado.

Mon, 09/07/2009 - 21:56 | Link to Comment Anonymous
Mon, 09/07/2009 - 21:23 | Link to Comment Anonymous
Mon, 09/07/2009 - 21:19 | Link to Comment Anonymous
Tue, 09/08/2009 - 00:48 | Link to Comment Mr. Mandelbrot
Mr. Mandelbrot's picture

Look at what's occurring in Zimbabwe.  The laws of supply and demand mean any amount of gold in an economy would be optimal (stable supply with increased demand means smaller amounts are tradable for the same basket of goods in the economy).  Zimbabweans are using gold in increments as small as a tenth of a gram to trade for their bread.  You are thinking along the right lines with your vodka play.  Alcohol, like all nonperishable drugs, do have a function as money (extremely liquid, fungible, divisible, not easily counterfeited, high value to mass ratio, etc.)--hence the drug laws.  Once one understands drugs have monetary qualities (and were used as money in many societies in the past), it becomes clear that the "war on drugs" is actually another front in an effort to stamp out as much competition as possible for the fiat legal tender used by people today.

Mon, 09/07/2009 - 23:07 | Link to Comment Gordon_Gekko
Gordon_Gekko's picture

"the amount of gold ever mined up only amounts to about .7 ounces per person"

This is another big misconception about Gold. So what? All you should be concerned with is the PURCHASING POWER of that Gold, not what it's nominal price is. BTW, what would YOU say is a fair amount of Gold per person? 1 ounce, 10 ounces , 100 ounces? Again, all that matters is what you can buy with those .7 ounces - if it gets you a whole lifetime worth's of goods, then who cares?

Mon, 09/07/2009 - 21:00 | Link to Comment Anonymous
Mon, 09/07/2009 - 23:36 | Link to Comment Gordon_Gekko
Gordon_Gekko's picture


Mon, 09/07/2009 - 20:41 | Link to Comment Anonymous
Mon, 09/07/2009 - 18:47 | Link to Comment Anonymous
Mon, 09/07/2009 - 23:43 | Link to Comment Gordon_Gekko
Gordon_Gekko's picture

Here is what TIPS is:

A promise to pay more toilet paper in accordance with a FUDGED inflation number.

Mon, 09/07/2009 - 17:41 | Link to Comment Anonymous
Mon, 09/07/2009 - 17:31 | Link to Comment Anonymous
Mon, 09/07/2009 - 17:19 | Link to Comment Anonymous
Mon, 09/07/2009 - 16:47 | Link to Comment Gunther
Gunther's picture

“Over the past 200 years, its returns have barely kept up with inflation.” Gold was cash until 1933/1971, since then it is up 28 times. The correlation with stocks is usually NEGATIVE; look for a chart of the DOW/gold-ratio, for example at for illustration. Gold reduces risk-adjusted returns. That is bullshit in any stock bear and gold bull market. Why is government debt considered default-free if history tells otherwise? Do risk-free investment instruments exist outside of financial theory classes? To consider cash deposit risk free in inflationary times is surreal. If you can not value gold, it is the fault of your theoretical framework. The market can do so. It is possible to generate cash from writing out-of-the-money options against the holdings; but that adds risk. Moreover, the storage fees are small compared to any investment manager’s fees. Please provide better arguments for your case.

Mon, 09/07/2009 - 16:27 | Link to Comment Anonymous
Mon, 09/07/2009 - 16:24 | Link to Comment Anonymous
Mon, 09/07/2009 - 16:19 | Link to Comment Anonymous
Mon, 09/07/2009 - 16:16 | Link to Comment Anonymous
Mon, 09/07/2009 - 15:45 | Link to Comment Anonymous
Mon, 09/07/2009 - 21:02 | Link to Comment gookempucky
gookempucky's picture

Please do-- I knew I should not have read the 2nd article as it is copy of what the majority here have known for many years past--most if not all here probably manage their own money and wouldnt give the VK's the time of day.

The same mold of that clown Dave Ramsey--gold is not a good investment paper tigers chasing paper tigers.

Nothing else in the world like it GOLD

Name: Gold
Symbol: Au
Atomic Number: 79
Atomic Mass: 196.96655 amu
Melting Point: 1064.43 °C (1337.5801 K, 1947.9741 °F)
Boiling Point: 2807.0 °C (3080.15 K, 5084.6 °F)
Number of Protons/Electrons: 79
Number of Neutrons: 118
Transition Metal
Crystal Structure: Cubic
Density @ 293 K: 19.32 g/cm3
Color: Gold


Mon, 09/07/2009 - 15:43 | Link to Comment dot_bust
dot_bust's picture

I fail to see how holding fiat money is safe and efficient. Gold provides people with a way to preserve the fruits of their labor, building their wealth in a stable, efficient way. Conversely, Treasuries, equities, and fiat currencies often fluctuate quite unpredictably, and their value is determined by the ultra-rich, whose sole purpose in life is to transfer assets from the middle class to themselves.

Paper assets have become the purview of the rich. They have, in essence, become a giant Ponzi scheme. Presently, countries all across the globe are devaluing their currencies  by using quantitative easing. In such a situation, paper money is devalued as fast as you can accumulate it. It is somewhat akin to trying to run in quicksand.

I think of what is transpiring now as a global theft, and only precious metals are a form of protection from being robbed by the rich.


Mon, 09/07/2009 - 16:11 | Link to Comment Anonymous
Mon, 09/07/2009 - 15:30 | Link to Comment Anonymous
Mon, 09/07/2009 - 15:25 | Link to Comment lookma
lookma's picture

Over the past 200 years, the dollar has lost over 95% of its value


The thinking of the so-called gold bug (a believer in gold’s supremacy, a gold aficionado) often takes on a variation of this form: in the future, I can buy largely the same amount of stuff with my gold as I can now, but I will not be able to do the same with a currently commensurate amount of fiat currency.


Any cash flow-generating asset, like a stock or a bond, can be valued on the future cash flows that it is expected to generate (Of course this analysis makes implicit assumptions about the value of the currency in which those future cash flows are denominated)


To protect themselves against the declining dollar, U.S. investors can use currency futures and options, foreign-currency-denominated mutual funds and certificates of deposit; they can buy foreign stocks on foreign exchanges or through American depositary receipts; and, of course there is a most recent development - currency exchange-traded funds. (Of course this assumes the issue is the value of one fiat currency against another, goldbugs tend to think all fiat currencies are being debased, and thus view the fiat v. fiat a false comparison).

Mon, 09/07/2009 - 15:16 | Link to Comment Anonymous
Mon, 09/07/2009 - 15:06 | Link to Comment Anonymous
Mon, 09/07/2009 - 15:06 | Link to Comment Anonymous
Mon, 09/07/2009 - 14:57 | Link to Comment George the baby...
George the baby crusher's picture

I say COMEX and delivery failure. All this paper gold, now there's a darn scary story.

Mon, 09/07/2009 - 17:22 | Link to Comment Rusty Shorts
Rusty Shorts's picture

If you want to see something scary...


.."you see, the last hundred years of (oil) prosperity on this planet...that was just a freak of nature, a lucky break that we burned up faster than a stick of dynamite stuck up the time line of man".


Mon, 09/07/2009 - 15:27 | Link to Comment Mediocritas
Mediocritas's picture

Already happened once this year. ECB came to the rescue.

The game now is to divert as many people as possible into paper (GLD, SLV, etc), take the heat off. Stated what I think of these things here:

Mon, 09/07/2009 - 17:18 | Link to Comment George the baby...
George the baby crusher's picture

Thanks for the links.  How long will the game keep playing?  I'm constantly at the edge of my chair.

Tue, 09/08/2009 - 01:51 | Link to Comment Mediocritas
Mediocritas's picture

I see two probable scenarios:

1: This really is it. The BRICs are going for it Hunt style and they're going to call bullshit on the entire naked PM / price suppression scam that's been going on for decades. In that case, the game is over. I don't believe CBs have the ability to beat the BRICs if the BRICs go all out.

2: This is a huge head-fake. The BRICs merely want their cut of the action. They'll set up their physical holdings in Hong Kong then launch ETF mania, flood the market with fraudulent paper (just like everyone else does) and tank the price of PMs straight back down again.

My first instinct was #2 and I believe that, ultimately, we will end there. In the short term though, #1 is looking increasingly like the correct scenario. As a PM bug, I hope #1 is the case but we will see.

Mon, 09/07/2009 - 14:31 | Link to Comment Anonymous
Mon, 09/07/2009 - 13:51 | Link to Comment Clive S. Multrum
Clive S. Multrum's picture

You don't need a doomsday type scenario for gold to work out well as an investment.  According to this site (, which is probably close enough to being right, the value of all the gold in the world, including I presume what is in peoples' teeth, is about $4.8 trillion at $993/ounce.

Sounds like a lot of money, but what percent is that of all the investments in the world?  All the stocks, bonds, money market funds, real estate, foreign reserves, whatever, what do they all add up to?   How about if we add in all the currency, M-2, etc., of all the countries in the world, translated into US dollars? Anybody know?

Beats me, but I would guess at least $100 trillion, and if I am very wrong, it is probably because it is $200 trillion or higher.  So gold probably represents a very tiny piece of the overall investment pie.

And that is counting all the gold, but most of it, the stuff in your teeth, in a lot of the jewelry, and in the vault at Ft. Knox and other government repositories, is going to sit there no matter how high the price, and not enter the market.

Given all that, a very tiny shift in investment portfolios around the world, from anything that isn't gold into gold, could have a huge impact on the price of gold.  It wouldn't take a doomsday scenario to cause it, just a small increase in mistrust of central banks, for which there is ample cause.

Mon, 09/07/2009 - 15:23 | Link to Comment Mr. Mandelbrot
Mr. Mandelbrot's picture

My wedding ring is 12 grams total weight of 14 karat (.575 pure) gold, which translates to .222 troy ounces of pure gold.  It will be buried with me as will the gold crown on one of my molars (probably another .5 - .10 troy ounces -- sorry I can't weigh it!).  I've seen the 5 billion ounces of gold mined in all of human history number many times.  Assuming this is the best figure we have, how much of it is in cemeteries on fingers and teeth not to mention all the gold as money era caches in the ground that were lost or forgotten over the six thousand years?  It seems that's figure assumes all the gold mined in history is still in someone, somewhere's possession.  

Mon, 09/07/2009 - 21:13 | Link to Comment ZerOhead
ZerOhead's picture

Can you stake a claim on a cemetary?

Mon, 09/07/2009 - 15:27 | Link to Comment Hephasteus
Hephasteus's picture

I kind of screwed that post up. What I meant to say is that central banks are inflationary while the periphial banking system is deflationary impoverishing. You'd have to look at central bank lending to see the inflationary picture which is completely hidden and the periphial bank returns on loans get's a hit against that inflation in valuation. This is why you get relativities in economy. Since all the central banks are located in the largest population centers most of it's inflation actiivity occurs in the local economies which is why you get such extreme skews of price bubbles on gasoline, housing etc between the large population centers and the rest of the country. You can almost see the flow of the central bank money just by looking at how local economies either grow or remain rooted in the presence of a bubble. Florida isn't a large population area but there is a great deal of central bank activity there because it bubbled hugely in both this depression and the great depression. So it really makes you wonder what the hell the central bank does in florida and why. I personally think it's drug loans. LOL

Edited. Ok. Starting to see how nevada inflated so much from sucking up gambling money and forgot about all the snowbirds in florida driving the housing prices up independant of the full time residents.

Mon, 09/07/2009 - 13:29 | Link to Comment AnonymousMonetarist
AnonymousMonetarist's picture

Have never owned gold but intend to.

Believe though at this time it is too expensive.

One does not have to reject modernity to embrace gold ... one need only embrace the concept of a currency crisis and its' inevitability.

History will rhyme.

Mon, 09/07/2009 - 12:30 | Link to Comment Anonymous
Mon, 09/07/2009 - 16:26 | Link to Comment pivot
pivot's picture

The truth is that gold really is a EOW, mad max type of investment, but as Vitaliy points out, there is much uncertainty as to whether it is the best.  If you think gold is anything but a physical asset that can be exchanged because it is rare, you are fooling yourself.  If you think the US dollar is doomed, ok fine, you can play that a lot easier using 21st century financial infrastructure to swap your exposure (though admittedly as a US citizen you are taking a reasonable-sized risk in that you can't buy a gallon of milk in NYC in EUR... you know, while you're waiting for the world to end). There is no reason to buy an asset that you then have to pay to store (insure?), which generates no cash flow.  Buying gold truly is a gamble because you are betting that someone tomorrow will pay you equal to or more than you paid for it, otherwise what would have been the point?

Another thing that is never discussed (not just in gold bug world but other financial advice too) is what happens if/when you are wrong.  What if the world doesnt end?  I am not convinced that if you have a ton of gold in an EOW situation that that is even appealing (wouldnt you be one of most targeted?), but even if it is, what's your expected return (low probability event tied with uncertain payout = not appealing)

Mon, 09/07/2009 - 12:25 | Link to Comment Anonymous
Mon, 09/07/2009 - 12:19 | Link to Comment Anonymous
Mon, 09/07/2009 - 12:05 | Link to Comment Hephasteus
Hephasteus's picture

I appreciate him taking the opposing side too but I am quite disturbed by the "holes" in his education that seem to be in everybody's education because they in fact would allow people to have much deeper understandings of financial systems that the people who really run them don't want them having.

Please watch "The Money Masters". You can buy it or watch it on you tube.

Nixon had to close the gold window in 1971 due to the extreme fractioning of the underlying assets. To understand this I want you to try a few numbers. They don't have to be even very good guess. i want you to run the average houshold mortgage the average amount of commercial paper etc etc until you get a good idea of what you are dealing with and then find a good loan amortization program and you'll find that roughly every house mortgage carried to maturity on a 30 year mortgage roughly doubles the money supply. Do the same thing for all the car loans and everything. Now do that for 1950's america where people didn't debt much. Maybe 1 low interest house loan, maybe 1 relatively cheap car loan. Then go on through the 60's and see how much the fractioning has accelerated. The system indebts more and more so the amount of fractioning happens at an exponential rate.  Then you will become aware how the consumer behavior in late 90's through 2007 affected everything. In fact had the bubble kept going it would have had tremendous amounts of inflation. Since wages don't keep up it just dumps people off on the side of the road as it steams towards meaninglessness. Had it been done at 10 times fractioning it would have been rediculous. But at 20 30 times on the bigger banks the inflation was just FLAT OUT LUDICROUS. I mean the way it sets up it doesn't actually inflate the money supply that much but it does deflate the buying power of everyone under it's thumb. It turns poor into rediculously impoverished middle class into poor, upper middle into middle etc.

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