Gold Is A Lousy Investment
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.
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November 16th, 2009 at 1:38 pm
Hey Nirav,
What gold mining stocks do you like right now? Or better yet, can I ask what you are holding?
Thanks,
James
P.s. we have about 2.5 oz of gold, and about 150 ozs of silver. I’ve been wanting to get more exposure to gold, but think the prices are awfully high right now.
November 16th, 2009 at 2:45 pm
personally, i think silver might be a better valuation than gold right now. I own AUY, CDE & GDX.
December 1st, 2009 at 2:06 pm
The issue about the US unable to pay back its debt is irrelevant as it can simply produce more US dollars to pay back the debt as the US treasury contract requires.
The 3rd party cannot ask the US Government for anything else specified according to the agreement in the details of the US Treasury.
That said, 3rd parties can stop buying debt which would cause problems. However, if you haven’t looked at the numbers… China is not the highest owner of US debt. Strangely enough it is the Federal Reserve itself. Also if the numbers are to believed, the US government and fed has more gold stored away than anyone and if gold goes up… They still have control over it.
The truth of the matter though is not that the US dollar is backed by gold, but rather its bureaucracy and military might.
The USD is backed by IRS, the world’s largest ratio of inmate to citizen population, and nuclear weapons.
December 1st, 2009 at 2:25 pm
at some point all of the revenue the IRS takes in will go towards servicing debt. We currently have nearly $100 Trillion worth of unfunded debt obligations – the only way we can get out of this is printing massive amounts of money – which has to lead to very high levels of inflation. If you think its irrelevant, then continue to hold dollars and invest in treasuries. 30 years of bretton woods might turn out better than 5,000 years of using gold as currency. good luck!
December 2nd, 2009 at 12:02 pm
As WWII Germany has proven… Its not about wealth or storage of value. Its about utility. Who cares if your money is worth nothing as long as you got a labor force willing to work for you (free or forced).
Every single income transaction feeds power back into the USD through the use of income tax (the natural anti-inflation). Even if your income is paid in gold or you trade in gold with other persons, that transaction is taxed (or is supposed to be) and if you do not pay it, then you go to jail.
This forces people to believe the USD is valuable. After all they are forced to pay taxes in it and if they don’t have it… Then they go to jail.
Even your overseas income is taxed even if no longer live USA. You basically have to renounce your US citizenship.
The difference between the USA and Zimbabwe is its force of power over its citizens. You can just print more money and make people value the currency… You have to make them fear it and that is my point.
Millions of people go into work everyday and expect to be paid in dollars. As long as people still work and are productive it doesn’t really matter. Even wealth in gold is subjective and as an opinion.
Investment-wise, treasuries have always been a horrid investment and I have never a single dollar in one. I won’t invest in precious metals simply because of their supposed value. It only takes $80 an ounce to get gold out of the ground so until gold gets $1000 worth of usage in industry, electronics, or science then I’m not investing in it.
All it does it go into vaults and sits there…. Not really useful IMO.
February 17th, 2010 at 2:58 am
[...] price rise four-fold over the past decade and with substantial gains in all currencies (while outperforming every other major asset class), gold is resuming its historical monetary [...]