When Do You Skip Gold?

The Silent Sentinel

“All the perplexities, confusion, and distress in America arise not from defects in the Constitution or Confederation, nor from want of honor or virtue, so much as the downright ignorance of the nature of coin, credit, and circulation.”

-John Adams

“Gold has worked down from Alexander’s time…when something holds good for over 2,000 years I do not believe it can be so because of prejustice or mistaken theory.”

-legendary investor Bernard Baruch

I first wrote about gold back HERE.  In fact, it was the second post ever on the blog, which was written over 3 years and just over 300 posts ago.  I think it stands up well since it was first written.  Since 2000, gold has gone from roughly $250/oz to over $1,000/oz while the stock market is down nearly 20% over that same time period.

It is amazing to me how few American’s really understand the idea and difference between money and wealth, and nominal and real returns.  The authorities in charge know this ignorance well, and thus it is preyed upon and exploited in order to reach desired ends.

Most view gold as a hedge on inflation.  I do not.  Gold does well when people no longer have faith in the statists in charge of fiscal (ie. Congress and the White House) and monetary (Federal Reserve) policy.  Simply put, gold is an alternative currency that people use to protect their wealth when they do not trust those in charge.  Gold calls “bullsh%t” on the economic and monetary policies being put in place.  Most American’s look at the stock market to gauge the health and outlook for the economy, but history says this is unwise.  First and foremost, the authorities know this tendency, and thus policies are put in place specifically to boost the stock market, even if temporary.  And if you think the stock market tells all, I suggest you look up a chart of the Zimbabwean stock market during the last 5 years while hyperinflation ravaged the population, causing massive food shortages, and drove unemployment into the stratosphere (it when absolutely vertical as people fled their currency for anything to keep up with devastatingly errant economic and monetary policy).

We have gone more than 10 years with the stock market going nowhere in nominal terms and down more than 30% in inflation-adjusted terms while gold has gone from $250 to over $1,000 per oz.  But don’t ask “what”, ask “why”.  Despite claims from Washington and Wall Street that things are on the mend, the “silent sentinel” has been screaming things are not well.  I remain amazed and puzzled at what the American people will allow their government to do as long as the stock market is in the process of going up.

I am not necessarily saying buy gold now -- that depends on your own risk tolerance, current portfolio allocation, etc.  This call was very easy for me when gold was $250-$500/oz.  Over $1,000 is a large price to swallow, no question, and I wouldn’t be shocked to see a large pullback at some point.  There is a vocal cadre of “goldbugs” who see gold going to $2,000, $5,000, even $10,000/oz. before this chapter plays itself out.  To be honest, I don’t know whether gold should be $500 or $5,000, but I do know gold has been one of the few assets that has held it’s real value over the centuries.  Take a million dollars, euros, or yen back centuries in time and I say to you, “Good Luck with that”.  Take them far enough into the future and my sentiments are the same.  But in today’s day and age of historic monetary and fiscal intervention, I think people are crazy for not having some gold in their portfolio. 

For the more initiated, below are a few recent links from some trusted commentators (at least from my viewpoint) on gold.  If there is one thing that is certain, there are going to be more crisis and dislocations as our financial engineers try to paper over all their mistakes with rampant money printing and debt and deficit accumulation.  It may look benign in the very short-term, but these policies are setting up a very dangerous situation for the future, and I fear the consequences.  And the authorities are only going to get more and more involved in attempting to solve the very problems they are causing.  Trust me on that one.  

First, from “Jesse's Cafe Americain” (click on any link for more details): 

Gold is where people put their wealth when they are confronted with uncertainty, with asymmetric information, when they are afraid; when the statists and the crony capitalists are preying on the savings of the people. Gold is a refuge, a safe haven, when there is good reason to be concerned about your currency, your wealth, and your future; when lies are in the ascendancy and truth and justice are scarce commodities.

This is because gold is one of the few stores of value that is compact, universal, portable, and contingent upon the full faith and credit of nothing but itself.

From “The Cunning Realist":

There's no doubt that Obama's spending is causing international concern about the dollar. But just as important is the new status quo of "too big to fail" for the financial sector and what that means for various aspects of Federal Reserve policy. The implicit government guarantee of a few GSEs was an important factor in the financial crisis. There's now an explicit government guarantee of every large financial institution on Wall Street. Almost two years after the Bear Stearns debacle, there are still no plans by the government to unwind or repudiate that guarantee -- indeed, some believe it should be codified -- so apparently it's permanent. And remember, the guarantee encompasses more than just occasional hundred billion dollar bailouts. It means unlimited liquidity, as well as artificially low interest rates that let banks "repair their balance sheets" by borrowing for almost nothing and lending to the public at 20%. The rest of the world sees this. As the currency markets and gold get more attention, the main challenge to honest discourse will come from those who focus solely (and predictably) on Obama's spending while ignoring the importance of Wall Street's perpetual blank check.

Again from “The Cunning Realist”:

Former Federal Reserve Governor Wayne Angell once said that a Fed chairman's performance can be measured by whether the price of gold is higher or lower than when he took office. This is what gold has done since October 24, 2005, the day Bush nominated Bernanke :

 

From one of the most respected market historians, Jim Grant:

"What manner of incompetence - both at the public policy level and at the so-called financial professional level - led to this mess?"

It is really something.

And the people who are paying are the savers, among others. Savers have taken a pay cut as the Federal Funds rate is chopped to accommodate the speculators who need more and more leverage at lower prices. They need a steeper yield curve, that is to say, a more favorable alignment of interest rates over time to facilitate the growth in bank earnings.

Gold is the value investor's gilded (guilty?) pleasure - it yields nothing, it has no stream of dividends, you can't value it on a key ratio of management, but it is a hedge against the depredation of our masters at the Treasury and the Fed. Therefore, I hold it, not knowing what it's going to return, not having any sense of how to value it. It's price is the reciprocal of the world's stock of faith in the person Ben S. Bernanke and others like him.

So, I say, the Fed is worthy of less credit and confidence, ergo the price of gold, all else being the same, ought to go higher.

A second one from Jesse:

The utility of gold is that it resists the manipulation of the statists, which is why they hate it. It provides a store of wealth that is difficult for the state to confiscate through debasement. Gold and silver have represented the instruments of freedom and safety, a secure store of wealth, for individuals faced with adversity and uncertainty over thousands of years.

Jim Grant again:

"Gold has two interesting properties. It is cherished and it is indestructible. It is never cast away and it never diminishes, except by outright loss. It can be melted down, but it never changes its chemistry or weight in the process. Its price has been remarkably similar for centuries at a time. Its purchasing power in the middle of the twentieth century was very nearly the same as in the midst of the seventeenth century."

So how does gold, which many argue is the only true store of value, stack up when represented not merely on its day-to-day price fluctuations, but looked at through the filter of a true long-term perspective?

Let us say that an ounce of gold bought the same proverbial "good man's suit" in 650 A.D. as it does today…

The truth about the long term, then, is that it consists of a sequence of short terms and these short terms are full of episodes we call history: war, peace, pestilence, progress, revolution, invention, discovery, depression, enterprise, bankruptcy, birth, death, taxes and such. Kingdoms rise and fall, debts are incurred and repaid, or - as often as not - not repaid, or repaid in money unrecognizable to the poor creditor. Interest runs for years at a time, but rarely even for decades, politics or central banks intervening to disrupt the piling up of what would otherwise be wealth too vast to be stored on the planet Earth. Through it all, just as Hall and Jastram have separately noted, gold endures, holding its value but returning no income. Well, you can't have everything.

And from highly-respected hedge fund manager and author of “Fooling Some People All the Time”, David Einhorn of Greenlight Capital:

I have seen many people debate whether gold is a bet on inflation or deflation. As I see it, it is neither. Gold does well when monetary and fiscal policies are poor and does poorly when they appear sensible. Gold did very well during the Great Depression when FDR debased the currency. It did well again in the money printing 1970s, but collapsed in response to Paul Volcker’s austerity. It ultimately made a bottom around 2001 when the excitement about our future budget surpluses peaked.

Prospectively, gold should do fine unless our leaders implement much greater fiscal and monetary restraint than appears likely… When I watch Chairman Bernanke, Secretary Geithner and Mr. Summers on TV, read speeches written by the Fed Governors, observe the “stimulus” black hole, and think about our short-termism and lack of fiscal discipline and political will, my instinct is to want to short the dollar. But then I look at the other major currencies. The Euro, the Yen, and the British Pound might be worse. So, I conclude that picking one these currencies is like choosing my favorite dental procedure. And I decide holding gold is better than holding cash, especially now, where both earn no yield…

Yes, gold has indeed been on more radars lately, and I have heard many more radio and TV ads espousing gold as an investment.  Naturally it makes me a little more nervous once some investment vehicle gains wide acceptance.  But I ask you: how many people do you know that own even a single American Eagle coin?  Or even seen one and felt its weight in their hand?  My guess is for those under 70 years old, the answer is "not many".

India's central bank announced this week it is going to buy 1/2 of the IMF's gold stash in what will be the single largest gold purchase in 30 years.  What's perhaps more amazing is that even a purchase that large brought India's total foreign exchange reserves backed by gold up to 6% from 4%.  That is still way down from a more typical 20% backing.  And China?  Less than 2% of it $2.2 trillion foreign exchange treasure chest is gold.

Gold's rise is mostly due to a loss of confidence in the world's central bankers and politicians that they will stop at nothing to arrest any decline in the global economy.  The price of gold will go up and down, but for thousands of years, gold has been the single safest store of wealth, period.  That's why it's performing so much better than nearly all other asset classes over this historic period of time.

Who do you trust?  Got Gold?

How the Federal Government Causes Skyrocketing College Tuition

According to Wikipedia, "Stockholm Syndrome" is a psychological response sometimes seen in hostages, in which the hostage shows signs of loyalty to the hostage-taker, regardless of the danger or risk in which they have been placed.  I think many American's suffer from a similar condition when they view their "benevolent" government's programs as being beneficial for them, but the actual result is something far less benign.  Consider the following:  what two industries have witnessed the most cost inflation over the last few decades?  I think you would be hard-pressed to find any major part of the economy that has had costs rise faster than healthcare and higher education (my grad school program tuition nearly doubled from ~$27k to well over $50k since 2002!).  Coincidence or not that no two sectors of our economy have more government programs, funding, and influence than healthcare and education?  I think there is absolutely NO coincidence.

Peter Schiff, head of Euro Pacific Capital and Senatorial hopeful in the state of Connecticut, gives a must-watch video blog on how the government has been the major reason why college tuition has skyrocketed.  You may or may not agree, but hopefully it gives you something to think about even when it comes to the supposed "good" government programs.

The Upside of Down

Great speech by well-respected hedge fund manager Paul Tudor Jones to a 9th grade graduating class.  In it he details some of his life's biggest failures (the agony of sports defeats, getting fired, stood up at the altar) and how they led him to achieve extraordinary things and be of service to many people.  I really enjoyed it's message and included an excerpt below. If you're so inclined, check out the whole thing HERE:

Today, I want to talk to you about the dirtiest word that any of you 9th graders know. It’s a word that is so terrible that your parents won’t talk about it; your teachers won’t talk about it; and you certainly don’t ever want to dwell on it. But this is a preparatory school, and you need to be prepared to deal with this phenomenon because you will experience it. That is a guarantee.

Every single one of you will experience it not once but multiple times, and every adult in this room has had to deal with this in its many forms and manifestations. It’s the “F” word. FAILURE…
 
So here is the point: you are going to meet the dragon of failure in your life. You may not get into the school you want or you may get kicked out of the school you are in. You may get your heart broken by the girl of your dreams or God forbid, get into an accident beyond your control. But the point is that everything happens for a reason. At the time it may not be clear. And certainly the pain and the shame are going to be overwhelming and devastating. But just as sure as the sun comes up, there will come a time on the next day or the next week or the next year, when you will grab that sword and point it at that dragon and tell him, “Be gone, dragon. Tarry with me and I will cut your head off. For I must find the destination God and life hold in store for me!”

A Banking Primer

"And I sincerely believe, with you, that banking establishments are more dangerous than standing armies; and that the principle of spending money to be paid by posterity, under the name of funding, is but swindling futurity on a grand scale." 
-Thomas Jefferson, May 28, 1816, in a letter to John Taylor 

Well, it's a little late for that, since that is exactly what we've been doing for the last 15 months.  But worth keeping in mind given the rules of expediency today.  Upward and onward, hopefully. 

There seems to be a lot of confusion about the banks, their liquidity and solvency, and their capital structures.  Calculated Risk has a short primer called "Bank Balance Sheet: Liquidity and Solvency".  It's very well done, concise, and simplifies what I think the financial media muddies.  Here is PART 1.  Here is PART 2.

Congress is not likely to approve further TARP funds for more Wall Street bank bailouts, at least I hope not.  But the Treasury Department says that's okay because it will convert it's preferred stock into common stock.  Somehow, that is supposed to make banks adequately capitalized.  If you read Calculated Risk's primer above, you will easily see what Paul Kasriel of Northern Trust sees: this is accounting alchemy, and banks are no better capitalized than they would be before the conversion.  It's a little like saying you are in better financial shape if you convert all your dollar bills to quarters.

Loving Your Enemies and the Next 100 Years

For a small break from economic and market commentary, I read two pieces this weekend that I think are well worth the time:

-If everyone read "Loving Your Enemies" by Rev. Martin Luther King, Jr. each year on the day we celebrate him, I think the world would be a better place.  It's the kind of speech that changes attitudes.

-George Freidman heads up Stratfor, a leader in global intelligence information.  In this fascinating article, we get an introduction to his upcoming book, "The Next 100 Years", where he discusses his thought-provoking outlook for the world in the 21st Century.  His outlook on China, in particular, might surprise you.