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Unlike most anything else
out there that one could invest or speculate in, gold does not have a
valuation. It is never expensive or cheap. It might be overbought or
oversold, or some such thing, which is really a way of saying that a floating
currency compared to gold is oversold or overbought. Gold is money. It is
money because its value is stable.
Thus, there can never be
a "bubble" in gold. A "bubble", at the very least, must
be a period when people pay far more for an asset than it is worth. What's
gold worth? One ounce of gold is worth....one ounce of gold. It's money. It's
also true that there are times when it is extremely beneficial to speculate
in gold (1971-1980) and times when it is extremely unrewarding (1980-2002).
But you could say the same thing about dollar bills in a coffee can (a
wonderful investment in 1929-1932, a terrible one in 1970-1980). That's
really just the paper equivalent of stuffing gold in a vault in Zurich. In
1923, during the German hyperinflation, it is said that a hotel was purchased
for one ounce of gold. The price of one ounce of gold, in Germany, reached
about 84 trillion marks. Yet, in 1923 one ounce of gold was $20 in the US, as
had been the case for the past 134 years. Was there a bubble in Germany but
not in the US, for the same easily transported, easily traded item?
Most all investible
assets can be valued on some cashflow basis. This
is true of stocks and bonds, of course, and real estate, which constitute
among them the vast majority of assets worldwide. Gold has no cashflow. Other commodities can be valued ultimately on
their usefulness. This translates into a demand, which is balanced by a
supply, which is closely related to production cost. Gold's value is
ultimately related to production cost as well, but because annual production
is a tiny fraction of available holdings (less than 2% these days), changes
in production have little effect on gold. If all gold production ceased for
the next ten years, nothing in particular would happen. There would never be
a shortage of gold, because it is never "consumed." On the demand
side, nobody needs to buy gold either, for industrial purposes. (A tiny
amount is used in electronics.) Gold is useful, of course. It is useful as
money. One of the requirements of money is that it is
not useful (at least at its present value) for anything but money. You can
see this is true of dollar bills as well. Nobody uses them as anything but
money.
Thus, all the attempts to
value gold in terms of oil, or the CPI ("inflation adjusted gold
price"), or some such thing, are essentially meaningless. This is
reflected in the futures curve for gold. It trades like a currency -- on an
implied interest rate differential -- rather than an industrial commodity.
This makes some people
nervous, because investment ideas are typically based on the proposal that
something is "cheap," or, at the very least, that there is a
"supply/demand imbalance," which is to say, a shortage or glut.
Neither is ever the case for gold. To the typical stock investor, looking for
value or growth (gold has neither), or even the passive index investor
content to add a little to their ownership of US industry every month at the
going rate, this is counterintuitive behavior. To the bond investor looking
for a balance between yield and risk, gold is equally puzzling, as there is
no yield (or slightly negative) and the "risk" is hazy at best. And
when you have an investment that is "rising in price," but there
isn't a decent argument that it is "cheap" or there's a
"shortage," then it sort of looks like a bubble, no?
You have to use some
different techniques to invest/speculate in gold effectively. As I argued
some time ago, gold is not an investment. It's money. There's no
return on capital. But, if you're interested in return OF capital, it is the
King of Kings. Gold is an interesting speculation at only one time: when
currencies are losing value. And not only that: if one currency, like the
Indonesian rupiah in 1998, is losing value, then you can go to a currency
that is not losing value, like the US dollar in 1998. That would be more
profitable than gold, as it pays some interest. So, the only period in which
gold is an attractive speculation is when all currencies are losing value,
which typically takes place when the major international currencies lose
value. Thus, we need to look toward the currency managers, central banks, to
manage our gold speculation effectively. Today, especially in the US, it
appears that central banks are not only complacent regarding the worsening
inflation, they are outright negligent. Ben Bernanke built his career on the
notion that the Great Depression could have been averted by a brisk inflation
in the early years of the 1930s. It's false, and Ben Bernanke is going to
prove it today.
Even I am rather
surprised at the degree of Fed negligence. I thought there would be a
tightening bias, and that Wall Street's Big Surprise would be Fed rates
climbing above 6%. That will happen eventually, but not right away. (Good
thing I don't try to trade this stuff.) Even Arthur Burns, the inflationist
of the early 1970s, was tightening aggressively at this point, taking the Fed
funds rate to 8% and higher. The kind of total abandonment suggested by
today's Fed raises the possibility not only of a relatively gentle currency
slide, like the 1970s, but a collapse.
People don't have much
appreciation for how destructive inflation can be. We are stuck in the Great
Depression image of economic hardship -- bankruptcy and unemployment, and
falling prices. Neither tends to happen in inflation (although it is
happening now, something of an exception). What happens instead, is that
everyone gets poorer together. Some time ago, I showed what the US stock
market, per capita GDP and weekly wages looked like if you adjusted for the
dollar's decline in value against gold since 1970. It's not a pretty picture.
Click Here for Graphs of the
Disaster of 1970s Inflation
It took about thirty
years for the US stock market to return to its highs of 1965, measured in
gold terms. Per capita income never really reached the highs of the late
1960s (this series is inflated by the temporary rise in the dollar vs. gold
in the late 1990s). And weekly wages, measured in gold oz., have been a total
disaster. Let me say that again: for the great majority of Americans, even after
thirty years their situation did not recover to the level of the 1960s.
And it is going to deteriorate again. Maybe thirty years from now, we will
say that "even after seventy years, their situation did not recover to
the level of the 1960s." You can see from the graphs that the recovery
from the Great Depression was much briefer. Even with World War II
intervening, by 1949, or 20 years after the peak of 1929, people managed to
recover what they had lost. Life for most in the US will probably take the
funny character of a Country That Used To Be Rich, like Argentina (doing
better today actually) or the UK in the 1950s, or Italy in the 1980s.
In 1929, the DJIA hit a
high of 381, or about 19 ounces of gold when the dollar was worth 1/20th of
an ounce of gold. The DJIA had a trailing P/E of 20 at that time, so it was
not really a "bubble." (Perhaps there was a "bubble" in
corporate earnings, sort of like today.) Today, the DJIA is at 12,606, with
the dollar at $895/oz. You can buy the DJIA for 14 ounces of gold. The
DJIA is below its 1929 peak! I'm serious. It's just the same as
the German hotel. Was it worth one ounce of gold (hyper cheap) or was it
worth 84 trillion marks ("hyper expensive")? Maybe the DJIA will
rise from today's 12,606 to 84,000,000,000,000 in the future, and be worth
one ounce of gold.
There is sometimes
confusion here, because people mistake technological development for
prosperity. "But...but...in 1965 people used vacuum tube electronics,
and now you can buy a DVD player for $30!" That's true. But, you can
also buy a DVD player for $30 in Burkina Faso, or Zimbabwe. Africans are
still poor, poorer than they were forty years ago. Dying of starvation! With
$30 DVD players!
Nathan
Lewis
Nathan Lewis was formerly the chief international
economist of a leading economic forecasting firm. He now works in asset
management. Lewis has written for the Financial Times, the Wall Street Journal
Asia, the Japan Times, Pravda, and other publications. He has appeared on
financial television in the United States,
Japan, and the Middle East. About the Book: Gold: The Once and Future
Money (Wiley, 2007, ISBN: 978-0-470-04766-8, $27.95) is available at
bookstores nationwide, from all major online booksellers, and direct from the
publisher at www.wileyfinance.com or 800-225-5945. In Canada,
call 800-567-4797.
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