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The establishment argument against gold comes down to the statement
that it is a collectable that earns no yield. Art, rare coins, stamps and gold and
silver bullion do not earn a yield.
Stocks, bonds and real estate earn yields, so the prudent investor
should focus on these assets rather than gold or precious metals.
First,
let us examine a hole in this argument.
Let us look at bonds and other fixed income investments. The best instrument here is T-bills
because they are virtually risk-free (not counting the risk from the
depreciation of the currency). A
study of the yield on T-bills going back to 1933 (which is the beginning of
the modern monetary system) shows that the yield paid on T-bills bought at
almost any time over the past 75 years has been completely eaten up by the
depreciation of the currency. For
example, right now you can buy a T-bill yielding 1%. But the (official) Consumer Price
Index is rising by 4% per year.
So at the end of 12 months time, you receive $1,010 (from your
original $1,000 investment) and can buy goods which at the start of the 12
month period had cost $970. In
reality, your money has shrunk in value and you have received negative
interest. It hasn’t been
this bad all the time, but the average over the past 75 years shows a return
of (very close to) 0% real interest.
This
eliminates T-bills as an establishment investment, and it pretty much
eliminates any riskier fixed income investment as well. Because all you are receiving beyond
the T-bill rate is a small risk premium.
Yes, you get some extra return, but you have to take extra risk. The game is not worth the candle. And if you try so-called inflation
protected Treasury securities, they are only protected against the
“inflation” reported in the official Consumer Price Index. Interestingly, it was right at the
time that these were introduced that the Bureau of Labor Statistics began to
introduce fraudulent statistics into the CPI so that it no longer truly
measures the rate of price increase in our society.
What
is needed during this period when the U.S.
currency is depreciating (as measured against goods) is an economic good
which protects you against currency depreciation and which also has a
yield. Stocks have yields because
(most of) the companies have earnings.
Real estate usually has a yield (unless it is raw land). In both of these cases, it is possible
to protect yourself against the depreciation of the currency and still earn a
return on your capital.
So
far the establishment argument is looking good. Both stocks and real estate, like
gold, can protect you against the depreciation of the currency. But unlike gold they pay a yield. The problem with this argument,
however, is that it is true only for the long term.
Starting
with the Kennedy tax cut of 1963, budget deficits and the creation of money
became the operating policy for both political parties. Indeed, the (official) Consumer Price
Index has risen every year since that date. However, different goods react differently
to the easing of credit and the printing of money. The result of this has been the
development of what I call the commodity pendulum. First, commodities lag behind the rise
in other prices and become undervalued.
Then they play catch up and rise rapidly. When they go too high the cycle starts
again. For example, commodities
were undervalued in 1971 and dramatically outperformed stocks through the
decade of the ‘70s. In the
‘80s and ‘90s, the situation was reversed; commodities declined,
and stocks rose. Starting early
in the new century commodities were once again undervalued and began another
rise, and this will soon lead to large scale declines in bonds and stocks. That is, the first part of this
century will be a repeat of the 1970s.
So
although the establishment point is correct for the very long term, it is too
long for practical trading. Yes,
stocks can give you protection against the depreciation of the currency as
well as yield. But that did not
help the stock investor from 1966 to 1982 because he lost 70% of his capital
in real terms.
The
argument for gold now is the same as it was in the early 1970s. Gold, and other commodities, are
coming off a giant oversold condition.
Over the ‘70s, gold multiplied by a factor of 25 times. What will happen during this swing of
the pendulum cannot, as yet, be predicted. But
it is likely
to be quite similar.
Take
the establishment supporter who bought stocks in 1966. It was the recognized
“wisdom” of that day to buy “good, sound stocks for the
long pull.” They laughed at
the foolish gold bugs buying gold stocks with the price of the metal at
$35/oz. Gold, after all, was a
collectable. This situation is
repeating in our day. The same
forces which pushed gold upward then are pushing it upward now. The ethanol bill plays the role of the
Russian wheat deal. The
establishment type who buys “good, sound stocks for the long
pull” today is quite likely to sit through a 70% decline in real terms
over the next dozen or so years.
We
all know what the establishment did in the 1970s. When gold raced over $800 in January
1980, they said, “We will pretend that this whole affair never
happened. It is too embarrassing
to admit that we were wrong and the gold bugs were right.” Those who do not learn from history
are condemned to repeat it. And
repeat it (the seventies) they are.
But
when the commodity pendulum is finally over (and that will be quite some time
in the future), and the cycle is ready to switch back in the other direction,
when the day comes that gold is overvalued and stocks undervalued (similar to
1980-1982), I will be perfectly happy to get out of gold and buy stocks again.
But
as I remember the advice of the economic establishment over the past
generation, they were as bullish as they could possibly be on stocks in
1966. And then they turned as
bearish as the gloom of night in 1982.
I am confident that they will do the same thing on this second swing
of the commodity pendulum.
Is
gold the true store of value in uncertain times? Will the impending flood of
inflation destroy my financial house? How can I protect my wealth with gold
and precious metals? These are the type of questions addressed in issues of The One-handed Economist.
Subscriptions are available for $300/year online at www.thegoldspeculator.com, or for $290 ($10 cash discount) by sending your
check to The One-handed Economist, 614
Nashua St. #142,
Milford, NH
03055.
Thank you for your interest.
Thank you for your interest.
Howard Katz
The Gold Speculator
Howard
S. Katz is the editor/publisher of the One-handed Economist, a financial
letter which combines fundamental and technical analysis. He was a bug on gold
in the 1970s and became a bug on gold again in late 2002.
Subscribe to the
Gold Speculator (the One Handed Economist)
You
can subscribe to Howard Katz’s thoughts on commodities, stocks, bonds
and real estate are available in a letter entitled The One-handed Economist
and published every two weeks giving specific advice on trades in stocks and
futures. This letter is available (both electronic and paper copy) for
$300/year with a 3-month trial for $100. Send to: The One-handed Economist,
614 Nashua St. #122, Milford, N.H. 03055.(Include
both electronic and mailing address.)
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