LIVING OFF DIVIDENDS & PASSIVE INCOME

Gold hit another record today and is currently trading over $1,100 as I write this. However, it hasn’t prevented several news stories coming out about how gold is a lousy investment. Investment stalwarts from Warren Buffet to Monish Pabrai have all denounced gold as an investment.

And despite the decent performance of gold over the past 10 years, they’re correct. Gold is a lousy investment. It creates no income and just barely keeps up with inflation.

But do you know what the best performing asset class was during the past 10 years? No, it wasn’t your stock portfolio or your real estate. It was gold, and it returned a decent 270% over that period.

Despite its out-performance of all major asset classes, gold still gets no respect from the investment community. That’s because it is only a store of value and typically only does well in periods of currency crisis, or times of poor monetary policy.

For example, during post-WW2 Germany and in post-Mugabe-school-of-economic-policy Zimbabwe, their currencies have faced severe devaluation and gold prices sky-rocketed against those currencies. Faced with hyperinflation and an inability to buy basic necessities, people flock to gold causing the price to soar.

But that wouldn’t happen in the US right?

Economic research has shown that consumer psychology is affected by the amount of wealth people feel they have. If they’re broke and living pay-check to pay-check, but have tons of equity in their homes, they still feel wealthy. But even if they still have a job, but are upside down on the mortgage and have negative equity in their home, they feel poor and their spending decreases. Since the US is a consumer spending driven society, with spending constituting 70% of our GDP, the Federal Reserve has been trying desperately to get the consumer to start spending again.  Part of this entails propping up housing prices by keeping mortgage rates low, and another part is keeping interest rates low on non-collateralized consumer debt (that’s credit cards and student loans).

In an effort to stem the free-fall in the housing market, the Federal Reserve has been trying to keep the interest rates for mortgages as low as possible. Historically, the Fed has tried to manipulate the short-end of the yield curve by adjusting the shortest of short-term rates – the Inter Bank Overnight Rate (also called the Federal funds rate in the US. The UK has something similar called the LIBOR). This is supposed to have a trickle down affect the interest rates of long-term interest rates (such as the 10 year and 30 year Treasuries).  The rates for 3o year fixed rate mortgages are impacted by the rates on the 10 year Treasuries. So by keeping the federal funds rate at zero (or 0.2% which is close to 0%), mortgages rates should stay quite low. However, given the fact that this is not a typical economic scenario, the fed isn’t quite sure that mortgage rates would stay below 5%. So it has been buying billions of long-term Treasury bonds as well as mortgages, which is a quite a bold move away from its historic stance. When the 800 pound gorilla starts buying bonds, the prices rise and the yields go down.  When the Federal Reserve decides to buy $300 Billion dollars worth of mortgages and government bonds, something is definitely wrong with the economy.

I’m  interested to see the effect on mortgage rates once the Fed stops buying Treasuries and mortgages.

The government is increasing its deficit spending at a steady clip. If this continues, eventually we will be unable to repay the debt and barely just able to service the debt. Obviously this is not a viable long-term strategy, but it doesn’t look like there is any other back-up just in case helicopter Ben’s strategy of throwing money at the problem doesn’t pan out.

Clearly, we are currently in a crisis period in regards to fiscal policy and gold prices are likely to keep going up. During times of good fiscal policy, gold does nothing. This does not seem to be one those times.

A well-known hedge fund manager (and world poker champion) David Einhorn shares the sentiment.  And someone else who agrees with him is Liu Mingkang, chairman of the China Banking Regulatory Commission. He recently said, “Low U.S. interest rates and a weaker greenback have “seriously affected global asset prices, fuelled speculation in stock and property markets, and created new, real and insurmountable risks to the recovery of the global economy, especially emerging-market economies.”

Someone I know who works at a very well-known bond fund company recently advised me to sell my gold holdings. He advised me the same thing last year when gold was only $800/ounce. And I told him the same thing I said last year – Not yet.

Disclaimer: I’m long gold/silver bullion, gold mining stocks and short long term treasuries.

If you found this post helpful, consider donating to my coffee fund!

Related Posts

• Deleveraging Is Not Deflation! I read a very interesting article on called De-leveraging is Not Deflation. Here's a partial extract: "Inflation, as this term was always used everywhere and especially in this country, means increasing the quantity of money and bank notes in circulation and the quantity of bank deposits subject to check. But......
• Gold Play: Great Time To Invest As I've mentioned before I think the US is going to enter a period of inflation and recession brought on by the trade & budget deficit and precipitated by the devaluing dollar. Both Oil and Gold have been in a slow and quiet bull market for the past few years.......
• Gold Cracks $1000/Oz: Investing For A Recession Based on continuing weakness in the dollar, gold briefly breeched the $1000 level yesterday along with oil hitting an all time high of $111 per barrel. I had a really strong suspicion that we'd see $1000 gold by mid-March. Despite what Bernanke and Paulson said last summer, the housing......

Related Websites

• The Dangers of Long Term and Interest Only Loans There are two new trends in the banking world that may actually be very dangerous for consumers. Long term personal loans and interest only loans are gaining in popularity, especially in the wake of the housing crisis. While these may seem to be a great option at the time, there......
• Why Are Oil And Gas Going Up Again?  Ahh Memorial Day was fun huh?  We can always tell it's here without looking at the calendar by simply driving by the nearest gas station.  Is it 25% higher than it was a month ago?  If the answer is yes than we're in the season of flowers, bugs, and college......
• Different Types of Short Term Investments Short term investments are the most ideal form of investing if you want to invest over a period that is relatively short. Cash manager accounts make it possible to access your money whenever you need to. Fixed term deposit investments secure your money for the entire length of the term.......

[All content is copyright of Living Off Dividends & Passive Income]

Related Posts

• May 12, 2010 -- Gold Closes At Record High
• January 25, 2010 -- Venezuela Devalues Its Currency
• November 9, 2009 -- Gold breaks $1,100: Does It Matter?
• October 6, 2009 -- Gold Hits Record High!
• October 4, 2009 -- World Bank President: Time To Diversify Out Of The Dollar
• September 12, 2009 -- Guess Who’s Betting On Inflation!
• September 8, 2009 -- Why Is Gold At A $1000/Oz?

You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.