April 10, 2017 Barbara Rockefeller
Trading Gold without Guilt and Shame Our readers know that we often dismiss gold commentary as a self-serving nonsense. It’s important to use historical fact to debunk gold myths, such as “gold is money.” No, it’s not. Money has three properties: it’s a medium of exchange, a unit of account and a store of value. Just try paying the heating oil delivery man with a gold coin—as a medium of exchange, gold fails. It also fails as a unit of account—you can’t keep your books and tax records in gold terms. As for store of wealth, that is true only if you can buy low. But did you know we have an inner gold bug? We have been buying and selling gold since 1971 when Nixon took the US off the gold standard. Over the years we have tried to buy low and sell high (after all, our core business is technical analysis) and have made a gain of over 100% over time. But the gain would have been a lot higher if we had not bought at full retail but sell below wholesale to the retail sharks. The last time we sold, it was at $1,750, only $29 under the October 2012 peak. We haven’t bought again yet, but will probably try a new methodology: one that allows buying by the dollar (or euro or other currency) in small or odd amounts instead of the full cost of a one-ounce coin. This will allow two strategies: dollar-averaging and technical analysis (buy on the dips). How can we dismiss gold as an investment but enjoy playing with it for our personal account? No not hypocrisy (just a different way of looking at gold). We view gold as a consumer item, like art. A preference for something rare and beautiful is economically acceptable, whereas a penchant for a lousy asset is economically irrational. Gold is a Lousy Asset One of the main reasons why people buy gold does not stand up to scrutiny. As a vehicle for savings, gold is awful—it has no intrinsic returns and in fact carries costs for storage and insurance. As an investment, the same no-yield argument applies, with the additional caveat that over long periods of time, the return on gold can be negative, depending on exactly when you buy and sell. According to the National Bureau of Economic Research, from 1836 to 2011, gold earned only an average 1.1% per year (treasury bonds yielded 2.9% while equities earned 7.4%). Gold loses its ‘timeless’ character when you have to spend time on timing and trading. As for gold serving as a hedge against inflation: poppycock. Once in a while we get this effect, as in the late 1970’s and early 1980’s. But from the start of the most recent financial crisis during the fall of 2008, despite central banks pumping vast amounts of liquidity into the monetary base, inflation has failed to materialize. This is not really a puzzle at all; while Milton Friedman convinced everyone that inflation is “always and everywhere a monetary phenomenon,” he failed to add that you need a commensurate rise in economic activity to turn the added money into inflation. It’s called the ‘Fisher equation’ (after Irving Fisher, another University of Chicago economist), who said money supply multiplied by the velocity of money (the number of times a bank re-uses the same deposits, less reserve requirements) equals total activity times inflation. In other words, the Fisher equation has four components and Friedman’s famous quote, the one that fuelled two generations of gold bugs, has only two. It’s true but incomplete. It’s always possible that the chronic overspending and over-indebtedness of most economies these days, including the US, will result in central banks needing to keep the monetary spigot wide open, even as inflation starts appearing. Current US monetary policy, in which the Federal Reserve buys $85 billion in Treasuries and mortgage-backed securities every month, is potentially extremely inflationary unless it’s ended, and Volcker-grade tightening instituted. But at this point, at end-October 2013, it’s premature to say this will be the outcome. The US economy can stumble along for years without recovering the robust growth that is essential for inflation to re-appear. And the power of external factors to trigger inflation is reduced considerably now that the US is less dependent on foreign oil. So if you would not buy gold as savings, an investment, or as a hedge against inflation, why should you buy gold? Some die-hards say you should buy it as a store of value in the event of collapse of governments, nuclear war, and other ultimate disasters. We guess that a better store of wealth under such conditions would be salt, as in medieval times, or food, or guns, or medicine—something actually useful. Gold as a Satisfying Hobby We say the only valid reason to buy gold is to have it for its own sake. It’s rare, it’s beautiful, it will always be in demand at some price, it has uses in industry and adornment even if not in an end-of-the-world situation, and ownership gives pure pleasure. This is not a frivolous argument. When economics was first being formed as an academic field in its own right, an economist named Jeremy Bentham postulated that people take actions and allocate resources according to the amount of utility they will get as outcomes. Utility is more than usefulness; it’s satisfaction, and money is only one of the satisfactions you may gain from engaging in an activity. School-teachers, for example, are notoriously badly paid but they make up for it by the “psychic income” of seeing children learn. Utility theory helps us define preferences among competing goods or activities. Many financial analysts go out on their own for less income, rather than working at a big institution in order to avoid soul-deadening cubicle life and working with people you wouldn’t invite home for dinner—even though the work is harder without the institution’s resources. You may drive an extra five miles to a farther-away supermarket ostensibly to save a few dollars, but really because you like the drive or the checkout line. The savings are actually secondary in your preference for one market over the other, and may not even be real. So, if you are going to buy gold, you should buy it because the ownership gives you satisfaction. You don’t need to pretend that it’s an inflation hedge or will serve as money in some end-of-the-world scenario. It is sufficient to express a preference for holding gold for its own sake. A great virtue of acknowledging that gold is consumption good rather than a savings or investment vehicle is that nobody can argue with you about your preferences. Just as nobody will argue with you over a preference for a golden retriever over a black Labrador, you are entitled to choose to spend your consumption dollars on gold instead of some other consumer good, say a new washer and dryer. According to Bullion Vault CEO Paul Tustain, gold investors already know this by heart, “(people) understand that gold’s geological rarity and industrial uselessness combine to produce an incredibly stable stock quantity – the exact utility savers demand from sound money, and something they’ll not be getting any time soon from a major currency.” In the longer run, unless the US cleans up its act politically and eschews default in a convincing way, gold must be the beneficiary of fear-buying—on top of accumulation by reserve holders who now see the dollar in a dimmer light after the US government flirted with default in October 2013. Whether gold bottoms here or at some lower level, at some point we can count on gold to behave as conventional analysis says it should—as a safe-haven in a world where government debt is too darn high. So far, extreme high government indebtedness has not had the usual effect and the gold bugs are waiting for inflation to rear its ugly head, too. The combination will be toxic to most assets, but gold will benefit. Still, when we own gold, it is because it yields a sense of well-being and satisfaction, plus the suggestion that we will earn a speculative gain through timing buys. It’s a harmless hobby, not an investment strategy. Start thinking about the utility of owning gold instead of focusing entirely on the invalid financial reasons for doing it, not to mention the cost, and guilt and shame vanish in a puff of smoke. And watch our daily gold price chart. It has served us well.
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