A meme is now circulating that gold is the investment equivalent of a pet rock and that the smart investor should sell gold and buy stocks. That’s a ridiculous notion. In fact, if you believe in buying low and selling high, this is the time to buy gold and sell stocks.
There’s only one investment I can think of that many people either love or hate reflexively, almost without regard to market performance: gold. And, to a lesser degree, silver. It’s strange that these two metals provoke such powerful psychological reactions – especially among people who dislike them. Nobody has an instinctive hatred of iron, copper, aluminum, or cobalt. The reason, of course, is that the main use of gold has always been as money. And people have strong feelings about money.
Misinformation and Disinformation
Let’s examine some memes floating around…
“Gold is expensive.”
This objection is worth considering – for any asset. In fact, it’s critical. We can determine the price of almost anything; that’s easy. The hard part is figuring out its value. From the founding of the U.S. until 1933, the dollar was defined as 1/20th of an ounce of gold. From 1933 to 1971, it was redefined as 1/35th of an ounce. After the 1971 dollar devaluation, the official price of the metal was raised to $42.22 – but that official number is meaningless, since nobody buys or sells the metal at that price. More importantly, people have gotten into the habit of giving the price of gold in dollars rather than the value of the dollar in gold. But that’s another subject.
Here’s the crux of the argument: Before the creation of the Federal Reserve in 1913, a $20 bill was just a receipt for the deposit of one ounce of gold with the Treasury. The U.S. official money supply equated more or less with the amount of gold. Now, however, dollars are being created by the trillion, and nobody really knows how many more of them are going to be shazammed into existence.
It’s hard to determine the value of anything when the inch marks on your yardstick keep drifting closer and closer together.
“The smart money is long gone from gold.”
This is an interesting assertion that I find is based on nothing at all. Who really is the “smart money”? How do you really know that? And how do you know exactly what they own (except for, usually, many months after the fact) or what they plan on buying or selling? The fact is that very few billionaires (John Paulson perhaps being the best known of them) have declared a major position in the metal. Gold is only a tiny proportion of the financial world’s assets, both absolutely or relative to where it has been in the past.
“Gold is risky.”
Risk is largely a function of price. And, as a general rule, the higher the price, the higher the risk, simply because supply is likely to go up and demand down – leading to a lower price. So, yes, gold is riskier at $1,100 than it was at $700 or at $200. But even when it was at $35, there was a well-known financial commentator named Eliot Janeway (I always thought he was a fool and a blowhard) who was crowing that if the U.S. government didn’t support it at $35, it would fall to $8.
In any event, risk is relative. Stocks are very risky today. Bonds are ultrarisky. Real estate, at least in many major cities, is in a near mania. And the dollar, although it’s cyclically popular, is on its way to reaching its intrinsic value. In fact, stock, bonds, property, and the dollar are all in bubble territory.
Yes, gold is risky now. But it is actually much less risky than most alternatives.
“Gold costs you insurance and storage.”
This is arguably true. But it’s really a sophistic misdirection to which many people uncritically nod in agreement. You may very well want to insure and professionally store your gold. Just as you might your jewelry, your artwork, and most valuable things you own. It’s even true of the share certificates for stocks you may own. It’s true of the assets in your mutual fund (where you pay for custody, plus a management fee).
You can avoid the cost of insurance and storage by burying gold in a safe place – something that’s not a practical option with most other valuable assets. But maybe you really don’t want to store and insure your gold because the government may prove a greater threat than any common thief. And if you pay storage and insurance, they’ll definitely know how much you have and where it is.
“Interest rates are near zero; gold will fall as they rise.”
In principle, as interest rates rise, people tend to prefer holding currency deposits. So they tend to sell other assets, including gold, to own interest-earning cash. But there are other factors at work. What if the nominal interest rate is 20% but the rate of currency depreciation is 40%? Then, the real interest rate is negative 20%. This is more or less what happened in the late ’70s, when both nominal rates and gold went up together. Right now, governments all over the world are suppressing rates, even while they’re greatly increasing the amount of money outstanding; this will eventually (read: soon) result in both much higher rates and a much higher general price level. At some point, high real rates will be a factor in ending the gold bull market, but that time is many months or years in the future.
“Mining stocks are risky.”
This is absolutely true. In general, mining is a horrible business. It requires gigantic fixed capital expense to build a mine but only after numerous, expensive, and unpredictable permitting issues are handled. Then, the operation is immovable and subject to every political risk imaginable, not infrequently including nationalization. Add in continual and formidable technical issues of every description, compounded by unpredictable fluctuations in the price of the end product. Mining is a horrible business, and you’ll never find Graham-Dodd investors buying mining stocks.
All these problems (and many more that aren’t germane to this brief article), however, make mining stocks excellent speculative vehicles from time to time. Like right now.
“Mineral exploration stocks are very, very risky.”
This is very, very true. There are thousands of little public companies, and some are just a couple steps up from a prospector wandering around with a mule. Others are fairly sophisticated, high-tech operations. Exploration companies are often classed with mining companies, but they are actually very different animals. They aren’t so much running a business as engaging in a very expensive and long-odds treasure hunt.
That’s the bad news. The good news is that they are not only risky but extraordinarily volatile. The most you can lose is 100%, but the market cyclically goes up 10 to 1, with some stocks moving 1,000 to 1. That kind of volatility can be your best friend. Speculating in these issues, however, requires both expertise and a good sense of market timing. But they’re likely to be at the epicenter of the gold bubble when it arrives – even though few actually have any gold, except in their names.
So Where Are We?
So, these are some of the more egregious arguments against gold that are being brought forward today. Most of them are propounded by knaves, fools, or the uninformed.
My own view should be clear from the responses I’ve given above. But let me clarify it a bit further. Historically – actually just up until the decades after World War I, when world governments started issuing paper currency with no relation to gold – the metal was cash, and it was used as money everywhere, on a daily basis. I believe that will again be the case in the fairly near future.
The question is: At what price will that occur, relative to other things? It’s not just a question of picking a dollar price because the relative value of many things – houses, food, commodities, labor – has been distorted by a very long period of currency inflation, increased taxation, and very burdensome regulation that started at the beginning of the last depression. Especially with the fantastic leaps in technology now being made and breathtaking advances that will soon occur, it’s hard to be sure exactly how values will realign after the Greater Depression ends. And we can’t know the exact manner in which it will end. Especially when you factor in the rise of China and India.
A guess? I’ll say the equivalent of about $5,000 an ounce of today’s dollars. And I feel pretty good about that number, considering how shaky the world’s financial situation is and that we are – I believe – about to enter another gold bull market. Classic bull markets have three stages. We’re still in the “Stealth” stage – when few people even remember gold exists and those who do mock the idea of owning it. Next, we’ll enter the “Wall of Worry” stage, when people notice it and the bulls and bears battle back and forth. At some point, we’ll enter the “Mania” stage – when everybody, including governments, is buying gold out of greed and fear. But also out of prudence.
The policies of Bernanke, Yellen, and Obama – and also of almost every other central bank and government in the world – are not just wrong. These people are, perversely, doing just the opposite of what should be done to cure the problems that have built up over decades. One consequence of their actions will be to ignite numerous other bubbles in various markets and countries. I expect the biggest bubble will be in gold, and the wildest one in mining and exploration stocks.
When will I sell out of gold and gold stocks? Of course, they don’t ring a bell at either the top or the bottom of the market. But I expect to be a seller when there really is a bubble, a mania, in all things gold related. There’s a good chance that will coincide to some degree with a real bottom in conventional stocks. I don’t know what level that might be on the DJIA, but I think its average dividend yield might then be in the 6% to 8% area.
The bottom line is that gold and its friends are again cheap, and they have a long way – in both time and price – to run. Until they’re done, I suggest you be right and sit tight.
Chairman, Casey Research
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