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Hidden Dangers in Gold
Hidden Dangers in Gold
Based on an article by Dr. Paul Price in the Dec. 4, 12 issue of the Market Shadows newsletter: A Failure to Communicate: Numbers, Rates & Lies
Why isn't Paul currently buying gold bars, gold Electronically Traded Notes (ETFs), and mining companies? Wouldn't owning gold offset the (understated) inflation that we see daily and that may soon spiral out of control? While Paul argues that Washington’s Biggest Lie is its denial of real inflation, he also believes that pouring money into physical gold, gold-tracking assets, and shares of mining companies, is very risky, even if it makes logical sense. (Gold - The Biggest Risks Are The Ones You Don't See)
It makes sense because the supply of gold is limited and gold cannot be magically created by the Central Banks. Gold has also been used as a store of wealth for centuries. And of course, gold is presumed to be a good inflation hedge. But is it really?
Going back to 1980, gold peaked at about $850 per ounce. It bottomed in 2000 at about $250 per ounce. Annual inflation in 1980 and 1981 was in the double-digits. Later in the 1980s and through the 1990s, inflation fluctuated from under 2 to over 5 percent, drifting lower over those two decades.
Paul's chart below shows the nominal price of gold beginning in the 1970s. The second chart shows the nominal price of gold from 1979 to July 2012. (Click on charts to enlarge.)
Nominal Gold Prices 1979 - 2012
Chart from allaboutinflation.com
Paul notes that from 1980 to 2000, the CPI inflated by a cumulative 137% (compounded). Gold dropped to $250 during this period. But what about yearly inflation rates vs. the price of gold - is there a correlation?
The following chart shows gold prices vs. annual inflation rates. Apart from a clear correlation between inflation and the price of gold in in the 1970s, the correlation has weakened in recent years.
Gold Prices vs. Inflation Rate
Chart from Bloomberg
Describing the chart above, SymmetricInfo wrote,
It's clear that the lines seem correlated back in the 70’s and 80?s, but lose their relationship in the past decade. This makes it difficult to believe that the recent increase in price of gold has been solely due to a change in realized inflation and weakens the case for gold as a good inflation hedge... There isn’t much empirical evidence to make one believe that the decade long gold rally has exclusively to do with either realized inflation, inflation expectations or the federal reserves balance sheet. (Is gold really an inflation hedge?)
In Gold vs. Inflation, Barry Ritholtz noted that the link between gold prices and inflation is limited. The correlation between gold and inflation year over year is 0.42. On a month over month basis, it's only 0.11. According to Merrill, "Gold is not a great hedge against inflation. Investors would be better off owning TIPS if they are looking for protection against a potential rise in inflation." (Merrill Lynch via Barry Ritholtz)
Paul doubts that gold prices will soar to new heights anytime soon. He questioned the wisdom of amassing physical gold, buying gold in a custodian's care, and loading up one's portfolio with assets reflecting gold prices:
Recent history shows at least some custodians of your warehoused Gold to have been unreliable. For example, commodity brokerage firms MF Global and Peregrine Financial both failed to protect customer interests in the physical gold ‘safeguarded’ by them.
If you correctly bet on Gold going up you still may never even see your original stake returned, let alone any paper profits. Speculators were willing to risk price fluctuations. They didn’t know they were also subject to outright theft of their property.
Many traders today play Gold movements with ETNs (Electronically Traded Notes) without knowing these have bigger risks than simply the metal's price action. These ETNs are unsecured obligations of their issuing financial sponsors....
Physical delivery of Krugerrands, American Eagle gold coins and or bullion bars, and holding them in your own safe seems to avoid the custodial problems. Now, word from ZeroHedge.com confirms that Chinese companies have been actively promoting the sale of assorted counterfeit gold plated items ‘for legal purposes only’. (Gold - The Biggest Risks Are The Ones You Don't See)
Fakes and Frauds
Besides the risks that inflation won't skyrock and that custodians of your gold-based assets will go belly up, Zero Hedge noted that tungsten is being used to fill fake gold items. A firm called ChinaTungsten Online is marketing its broad 'tungsten-alloy services.' These services include "the gold plating of various tungsten formulations among them 'gold' bricks, bars and, yes, coins." The company is openly advertizing its tungsten gold-plating and precious metals replication services.
Zero Hedge also relayed a story about counterfeit gold being found in Manhattan's Jewelry District. "Myfoxny reported that a 10-ounce gold bar costing nearly $18,000 turned out to be a counterfeit. The discovery was made by the dealer Ibrahim Fadl, who bought the PAMP bar in question from a merchant who has sold him real gold before. 'But he heard counterfeit gold bars were going around, so he drilled into several of his gold bars worth $100,000 and saw gray tungsten -- not gold. The bar was filled with tungsten, which weighs nearly the same as gold but costs just over a dollar an ounce.'"
Will we soon be drilling into the cores of our shiny golden trinkets, bars and coins to test for purity? This is expensive, time-consuming, and decreases value and transferability.
The fraud in the metals market is here in the US, and not limited to physical pieces. In a Fool’s gold? CFTC says 12 firms sell phantom metals, Rob Varnon reports:
The U.S. Commodity Futures Trading Commission announced Wednesday, it filed a civil injunctive enforcement action in the U.S. District Court for the Southern District of Florida against 12 firms and their executives for fraudulently marketing illegal, off exchange retail commodity contracts...
According to the CFTC complaint, the defendants claim to sell physical metals, including gold, silver, platinum, palladium, and copper, to retail customers in retail commodity transactions. Under the defendants’ retail commodity transactions investment contract, customers allegedly make a down payment on certain quantities of physical metals, usually 25 percent of the total purchase price. Defendants allegedly claim to arrange loans for the balance of the purchase price, and advise customers that their physical metals will be stored in a secure depository.
But the CFTC alleged that the defendants do not purchase any physical metals, arrange loans for their customers to purchase physical metals, or arrange for storage of physical metals for any customers participating in their retail commodity transactions. Instead, all the transactions are just paper transactions, according to the complaint. Defendants allegedly do not own or sell metals to customers; customers are charged storage and insurance fees on metals that do not exist; and are charged interest on loans, which are never made by the defendants... (Fool’s gold? CFTC says 12 firms sell phantom metals)
Mining companies may seem like viable alternative to other gold-based investments involving trusting custodians or stockpiling one's own gold supply. However, particularly for mining companies with foreign operations, forward estimates and past performance may not be good predictors of future profits.
I used to favor shares of international resource and mining companies as a safer, liquid, back-door play on rising inflation. Worldwide political forces and heavy government debt have been catalysts for repudiation of long-term contracts and unilateral nationalization of foreign assets. This puts downward pressure on the earnings power of resource companies with significant assets in less developed countries.
Argentina-based oil company YPF (YPF) lost about half it value overnight some months ago after local authorities basically seized its assets without fair compensation. Indonesia has threatened to abrogate signed contracts with FCX because it now wants bigger royalties than previously agreed to. Australia is raising taxes dramatically on BHP, which cut back on its development there in protest.
The good old days of paying contractually promised royalties to less developed nations while mining their natural resources appears to be coming to an end. This explains what look like bargain prices on industry leaders like BHP Billiton, Rio Tinto (RIO), Freeport Mc-MoRan (FCX), Newmont Mining (NEM), American Barrick (ABX) and others.
All forward estimates may be shot to hell in the political climate that looms just over the horizon... (Gold - The Biggest Risks Are The Ones You Don't See)
A Gold Bubble?
It is not easy to find financial gurus and writers who are currently bearish on gold. There is Warren Buffett, who prefers buying something that generates income. Joe Weisenthal posed the bubble question in writing about Felix Salmon's attempt to go shopping with a gold bar. "It sounds silly, but if gold is a currency, then it should be usable as a medium of exchange... Felix goes up to a guy loading wholesale beer, and the guy knows instantly (!) what a gram of gold is worth: right around $50! When the guy loading wholesale beer knows the price of a gram of gold instantly, you've just got your famous example of the taxi driver giving you stock tips. DANGER!" (This Is The Best Proof We've Ever Seen That Gold Is In A Bubble)
Safe Haven Built on China?
Jordan Weissmann at The Atlantic argues that China's problems are gold's problems.
Investors who love gold tend to think of it as a sort of bomb shelter. It's supposed to be a secure place to park your money when the rest of the financial world is blowing up...
In the past decade, much of the new demand that set gold off on a wild tear from around $300-an-ounce at the turn of the century to almost $1,900-an-ounce last year has come from two places: India and China. Combined, they account for 45 percent of the world's demand for gold jewelry and bars...
For today, let's focus on China, which passed India as the world's top gold market earlier this year. The country deregulated its gold market in 2001, and since then, it has gone from consuming about a third as much gold as the developed west to overtaking it by 2011. Let me repeat that: the Chinese buy more gold than the entire west combined...
Just as China's rich have found new places to invest, the country's economy has been slowing down frighteningly, which dropped demand for jewelry this last quarter by 9 percent from a year earlier.
Source: Why Is the Price of Gold Falling?
Updated and based on Paul's article in the latest Market Shadows newsletter: A Failure to Communicate: Numbers, Rates & Lies.
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I wouldn' touch gold right now as I didn't touch real estate in 2006-2007 just beause I don't have this herd mentality. Everybody is buying gold right now. There are all kinds of different assests to hedge against inflation.
not false, but you need data. About 500 billions of US mutual fund went into bonds, what is the new supply for Silver as investment worlwide. The anti-Gold or the reverse asset to Gold from a collateral standpoint (US treasuries) are in a bubble. How can one asset and its inverse can be both in a bubble at the same time? Check the portfolio % of Gold worldwide, it is very small. The bubble is Treasuries, very very widely held, horribly overvalued, yet noone wants to short it or is concerned about holding some, like 1999 Nasdaq.
+2
Everybody is buying gold right now.
Really? I suppose that explains why about 1% of institutions hold it as an asset and even less of the population at large.
Everybody is buying gold right now.
Really? I suppose that explains why about 1% of institutions hold it as an asset and even less of the population at large.
Everybody is also buying guns and ammo in 3D too. During the last gold boom ala Jimmy Carter - how many people were going crazy for firearms and bullets?
We were too busy waiting in gas lines.
Good luck. Maybe ilene will take you in.
Yeah, but you can't stick a house in your pocket.
hahaha +1
Fiddy simple little coins buys a damned nice house & land in many areas of the world and no bank payments. I see three little Benny Fiatzies don't agree...lol.
Fiatzies...Nazis...hmmm...I think I like the "ting" of that one ;-)
The govt. of South Korea bought 17 tonnes of Gold in Nov.
Along w/other govts. worldwide buying what do they know that we don't?
Two obvious points to anyone who is a student of investment history
Conclusion: This gold bull market is far from over. The author of this article needs to do a bit more market research.
Actually one SLIGHTLY forgotten point of the 1980 peak is that by 1981 overnight rates would be at 20% with the thirty year yield a SVELT 12%! that seems lime an important...and "classic Phil oversight." the irony that it is no less than Goldman Sachs that says "sell your gold to us...interest rates are sure to rise next" should be lost on no one. That's THEIR MAN at the Fed "pegging rates at or near zero until 2015." a discussion of PRICE however is a legitimate point of discussion...yet another meaningful discussion we will not have in "Phil's world" as well. Not true at ZH of course (mythical "price fixing scheme to devalue gold.") still...at least it's a start.
Hoarding is due the level of real interest rates, period. As long as it is very negative Gold in dolalr would rise.
HOWEVER, one should watch what happens in China because the currency appreciating and the rates being up means that their demand for gold might abate.
In other words, if their new policy of liberalizing interest rates and internationalizing their currency continues the local Chinese might be happy with a currency appreciating AND positive interest rates, that would dampen their demand... Gold might keep going down in USD, but Yuan is a good diversification.
I appreciate your comments WK.
One reason why I am not bullish on the Yuan is low real interest rates, plus the political risk that I think is always present (even now right after transition to a new generation of "leaders").
If their interest rates go up, what are the manufacturers going to do?
If the government attempts to liberalize it will take them years - 5 at least, if not more. I think they will proceed slowly and carefully but that's just my feeling... You may very well be right.
Here is the Key Non Passaran. I happen to be invested in a citrus plantation in China, the company pays no land lease, no taxes, and the toll rOad is free for all farming entreprises. China represses the cost of food downward. China history is of hyperinflation in 1948 which brought the communists in power, in 1987 inflation started to rise and you started to see panic buying leadingbup to Tian An Men with inflation at 13%. For those reasons and the fact that food and energy is 30% of consumption basket, there is a very paranoid position of the communist leadership about inflation, actually more paranoid than the Germans and hence the encouragement for the masses to buy precious metals by leadership. Now in the US corporations own the goverment, but in China the government own the corporations, meaning that SOEs are a mean to an end which is to stay in power. If the choice is between massive inflation riots and sacrificing some SOEs and exporters, so be it. Besides a strong currency would help stimulate the consumption sector which still to grow as % of GDP.
. The author of this article needs to do a bit more market research.
Sorry, boyZ and girlZ, but Tyler must've bumped my post all the way to the top of the thread...
The usual Ilene: Sell Gold and Buy APPL. BTFD YFI!!!
I can't finger out (pardon my spelling) how she (Ilene) gets to be printed next to Tyler, Reggie Middleton, Testosteron Richter, Mark Grant, and many other delightful ZeroDudes and ZeroDudettes. BUT... if the price of the ZeroAdmission is an occasional Ilene's "Sell PMs and buy AAPL, BTFD YFI!", I'll take it...
Looney
P.S. For those who's missed the last 4 years: BTFD YFI = Buy The Fucking Dip, You Fucking Idiot! ;-)
I'd again argue that using Minsky's bubble checklist this thing is anything but a bubble. On volume, getting physical, gold accounts for 1 percent of global investments. There is not enough fucking gold to give HNW's 5 percent of their portfolio in gold.
Conclusion: The author is a fucking moron.
Excellent points, Dangertime!
Your first point is especially pertinent, and one not often heard. I always bristle in outrage when gold naysayers cherry-pick the extreme (and brief) 1980 spike high as a baseline from which to measure gold's subsequent 20 price history, which is as dishonest as it is intellectually insulting (which certainly does not stop Kitco's Jon Nadler from doing exactly that on a regular basis).
Too many people pick one data-point and think it tells a story. A story requires a time-line. Anyone who points to one specific value as proof of something is either an idiot, or they have an agenda and are trying to lead others astray.
The gold bull likely has about 5 years left by my current analysis. Subject to change of course as economic conditions unfold.
We "ain't" in 1980. I wish we were. Reagan helped improve things for a while. Now we are looking into the abyss. In 1980, I doubt anyone expected the fiat globally to fail and the country to go broke and other really bad things.
No, and yet we aren't in 1929 either.
There is no end in sight to the printing of money, the election of Obama should be proof enough of that.
Regular stocks at best have reached an average PE of 14 for a very short period of time, usually these secular bears end with an extended time frame where PE's hover in the 7 range.
The Dow/Gold ratio is still in the 6-7 range, not having reached 1:1 as of yet, which also historically has shown that the commodity bull will continue.
There are a plethora of indicators to use that show stocks are still overvalued, commodities are undervalued, and that our monetary woes will continue. If the only evidence someone has to suggest gold has topped is a visualization of the gold chart without the commensurate numbers behind it (including more than doubling within three months), then there really is no argument for the gold bull to be over.
History doesn't repeat, but often it rhymes ~Mark Twain.
One data point is not enough, but many are better, still not a proof.
Hmmm, if we must use this two dimensional 1970-2008 chart as a metaphor, my guess would be that it's 1977 and we're about to blast off.
On the other hand, I don't give a flying fuck if the gold:$us drops to $1000 before it stops trading and becomes reserve currency.
'Stupid is as stupid does.'
The only thing I agree with is the caution on foreign mines.
If you live in the US, why would you buy Home Insurance from a company in a country with a name you can't pronounce (or find on a map). Likewise with Gold.
If something bad happens and Gold does go parabolic, that hole in the ground will be worth a LOT more. And the local Government will likely decide to increase their percentage of profits. You can take it or leave it, literally.
Alternatively, one day 50 guys with AK47s could just show up and say "thanks for the Gold, Stupid!".
I think if you want a mine and live in the US, buy a mine in the US or Canada, maybe Mexico, possibly Panama.
I've read enough reports on Gold / Inflation over time that I wouldn't necessarily say Gold is a perfect hedge.
Gold seems to better as a "WTF-hedge". If the investment world is totally messed up, then Gold is attractive as a store of value.
If we get a deflationary environment where global growth prospects evaporate, and countries resort to currency wars, then Gold would do well. So how does it make sense that the perfect inflation hedge works in deflation?
If the investment "rule of law" breaks down, as with dead banks allowed to remain operating, shouldn't that help Gold?
I think Egon von Greyerz has well articulated what you are looking for. KWN runs some super and 5-10 minute podcast interviews with him. I'd highly reccomend them and offer that info to you.
If you are slammed, the gist of it is get the fuck away from the banking system, the banks are walking dead men, changing FASB didn't fix shit.
The other take is that this is the first time in history that all currencies are circling the drain at the same fucking time. That is the big one. First it hides the fact that the dollar is getting weaker because the metric, other currencies are doing the same. Gold is a currency and it becomes the game of spot the odd one out. For those who don't get this, well they will, sadly the hard way when they get financially ass raped with financial repression.
You know, Phil, I'm getting embarrassed that you went to Penn.
On the uber-bright side: Jim fucking Quinn of the Burning Platform who contributes almost weekly to Zerohedge is now their fucking controller. And I have a good Penn friend who took a company public and dumped part of that IPO into gold.
Easy does it, Davos ;-)
LOL, the 0Hedge leashes are longer than CM's.
The most obvious long term correlations of gold are:
- with the US debt ceiling/debt level http://www.pmbug.com/forum/f13/strong-correlation-between-us-debt-ceilin...
- with real interest rates (Gibson's paradox): http://www.pmbug.com/forum/f2/golds-inverse-correlation-interest-rates-g...
So if you believe one of the two indicators has changed trends, sell your shiny stuff immediately.
Good short term indicators are:
- COT reports. The commercials are way better "traders" than the speculators. http://www.pmbug.com/forum/f13/open-interest-futures-options-watch-gold-...
- LBMA forward rates. Unsurprisingly, the LBMA has stopped publishing silver forward rates (SIFO) when silver suddenly went into backwardation in early November 2012. GOFO is still beeing published, though. http://www.pmbug.com/forum/f2/negative-lease-rates-gold-silver-341/
- recurring manipulation days (NFP, CRIMEX op/ex, ECB/FED meetings). http://www.pmbug.com/forum/f2/options-expiry-manipulation-gold-price-one...
I've seen this inflation argument before as means to knock holding gold. But as you say the authors always totally ignore Gibson's Paradox. When REAL interest rates are less than 2%, the price of gold always increases. In fact it increases 8% per percentage point under 2%. So all you need to know is the REAL interest rate and you can forget inflation. Real interest rates are currently negative so gold should appreciate by at least 16% per annum.
I guess what Gibson was saying is that when government impliments financial repression, gold price is going to rise.
ilene your full of copy and paste bull shit.
What the blazes are yiou doing just setting around with nothing do so you pull up bull crap..
your post usually are worthless.. so little in so much noise text
Analyzing gold using the dollar as a benchmark seems.... ummm... wrong.
Use tobacco, it is a better benchmark. In tobacco terms Gold is not cheap but three times cheaper than in 1981.
Ding!...one ounce of gold now equals 486 loaves of bread.
Now, if all other money appreciated at the same rate, why world hunger could be a thing of the past...lol...but they can't, the other is nothing but credit/debt ;-)
Agreed. It would be like analyzing one's vehicular gas mileage using a constantly shrinking "gallon". In no other sphere of life is the very metric of calculation considered, or tolerated, as a variable.
Treating gold as a commodity is a mistake, it is more of a collectible like early 1960s Fender Stratocasters.
Pre-CBS Strats have been a great investment, a good one in 1990 would have cost $800 in a pawnshop. The same Strat today would sell for + $30k. BTW: neither Chinese nor Indians are buying vintage guitars.
Some collectibles are worth more than others. Trading collectibles is not a business for amateurs. For instance, a person with experience will pick out counterfeit coins instantly by sight and 'feel', ditto antique furniture (which is expertly counterfeited by the Chinese in container- quantities).
In an environment where are there are few non-financial returns and expanding risks, collectibles are ... worth their weight in gold!
Can collectible prices decline? Of course, but ... if collectibles become completely worthless it is because there is no economy to speak of. Ironically, at that point small amounts of gold would likely be worth a great deal: one could trade a few coins for a house, for instance: a 'like-kind' exchange.
I agree except that what is more important in Fender guitars is authenticity. Like any collectable provenance is everything. CBS era instruments are collectable as well and they suffer far less from the market confusion caused by very high quality fakes. See this.
Art and other raritys can be good as gold for inflation matching, no ownwership tax (ala real estate), condensed value/portability etc. but in this market the bottom line is provenance, provenance, provenance. One wants to see a credible, unbroken chain of ownwership; one owner instuments are the holy grail. BTW pre CBS jazzmaster is growing in desireabilty and suffers less from the proliferation of fakes (Strat and Tele) as well.
:-)
Edit: Chinese may not be buying vintage instruments, but they sure as hell are building them.
George Washington, who unlike ilene I respect George, had an interesting piece I think on OH as well as his blog about fake art and people bribed to appaise it. I can't recall exactly but the take of it was that there are a lot of fakes hanging in muesems.
But I agree with art and what you are saying.
I have a good friend who is a CRE developer and he kids that when they get robbed they'll leave the art because they don't know what it is. He once ran an art studio.
If gold truly does NOT maintain a good or even reasonable correlation with "inflation" (read: currency debasement), then the purchasing power of one ounce of gold should be either significantly more, or significantly less, than it was one hundred or two hundred years ago. That happens to NOT be the case, however.
And for the last time, you disingenuous and dishonest bastards, stop cherry-picking the top of the extreme (and very brief) 1980 price spike in gold as a baseline from which to attempt to argue the purported bad correlation between inflation and gold. You only discredit yourself by so doing.
It is true, however, that inflation (currency debasement) is not the ONLY factor responsible for the rising price of gold in the last ten years --- both depletion of formerly high-grade ore deposits, insufficient mineral exploration work in the later 1990s and 2000s, and the rising cost of petroleum (mining and refining gold is a TREMENDOUSLY energy-intensive process) have all played their roles as well. The collapsing (fraudulent) world financial system hasn't hurt it, either.
Agreed but 1981 is not the baseline, it is the extreme from which every gold bug is trying to assess whether we are far wawy from or close, as none of of us would be comfortable holding gold if we were in the same extreme. Adusted monetary base has increased 18.9 times since the peak of 1981 versus 2 times for Gold price roughly, we are almost 1 order of magnitude away, we are ok still.
With respect to your last paragraph, I think taking into consideration Sprott's work on CB leases that went out the door (documented here on ZH during the 1970s if I recall with FOIA) should be considered. In other words, the CB's cubbards are bare and have pressured gold prices lower. Sprotts math is impecable.
DavosSherman, of couse I would concede your argument here as well --- I was merely trying to point out some factors in the rising price of gold which are inarguable and irrefutable (well, except to Jon Nadler).
I was merely trying to point out some factors in the rising price of gold which are inarguable and irrefutable (well, except to Jon Nadler).
+1 !!
akak: "And for the last time, you disingenuous and dishonest bastards, stop cherry-picking the top of the extreme (and very brief) 1980 price spike in gold as a baseline from which to attempt to argue the purported bad correlation between inflation and gold."
+the giant cube of all the gold in the world
I appreciate having my positions argued against. Cause maybe I'm wrong. The arguments here weren't persuasive though. Technicals, ok, counterfeit, ok, counterparty risk (lol), ok. What he doesn't touch is where we are today, where we are going, and the end game. ZH convinced me on that score some time back and I've acted accordingly.