From my friend Vitaliy Katsenelson, CFA--- pretty much sums up the truth about gold. got a call today from a financial journalist asking me if gold is âtheâ asset for the doomsday portfolio. I took this question very seriously after all if you are reading the news we are on the brink of one. I weighted my words very carefully. And answered: No! You need to diversify into canned food and guns. I added, as I learned by watching the TV-show Jericho - salt is the ultimate commodity you should own: âSalt has more applications than virtually any other mineral. Besides being a dietary necessity, salt can be used as a preservative, an antiseptic, a dentifrice, a cleanser, an abrasive, a fire-retardant, a defroster and a deodorizer. The list goes on and on.â The problem with gold is that it is very hard to determine its worth. It is only worth something if market participants perceive it is worth something. Unlike bonds or stocks, it is not a cash flow producing asset thus traditional valuation metrics cannot tell you if it is cheap or expensive. You look at Microsoft, you may disagree on the assumptions that you put into the discounted cash flow model, but it is worth somewhere between $20 and $50. It is analyzable. Gold is only worth something if people consider it to be a store of value â the doomsday currency. But if it lets people down even once, it is done! Here is what I wrote about gold in my book: Will Gold Shine Again Gold is an important but very different asset class that competes with stocks and bonds. Unlike stocks and bonds, its main attractions are scarcity, durability and resistance to oxidation - it simply never stops shining. In fact, most of the gold ever mined is around today. It is exhibited in museums, worn as jewelry and buried deep in the vaults of the central banks. Peter Bernstein, in The Power of Gold, wrote: "Despite the complex obsession it created, gold is wonderfully simple in essence. Its chemical symbol AU derives from aurora, which means "shining dawn," but despite the glamorous suggestion of AU, gold is chemically inert. That explains why the radiance is forever. In Cairo, you'll find a tooth bridge made of gold for an Egyptian 4,500 years ago; its condition is good enough to go into your mouth today. . . . Stubborn resistance to oxidation, unusual density, and ready malleability-these simple natural attributes explain all there is to the romance of gold." Despite its unique properties, gold has not been a good investment. Over the past 200 years, its returns have barely kept up with inflation. Its value has a low correlation with stocks (prices of gold and stocks move independently of each other most of the time), which is a big positive from the portfolio construction perspective; diversifying with gold can reduce a portfolio's fluctuations(volatility). But the diversification benefit comes at a large cost: Once added to the portfolio, gold substantially reduces that portfolio's risk-adjusted returns. Its dismal returns negate any benefit the portfolio receives from reduced volatility. One thing about gold, however - it is real! You can hold it and touch it and see its shine. This tangibility makes it seem impervious to the whims of politics, nature and time, as opposed to paper assets such as stocks and bonds. Gold's physical attributes attract investors during times of economic uncertainty, and so it serves a purpose in the markets and society - it is a stabilizing influence. It feels safe. Doomsday currency The thinking of the so-called gold bug (a believer in gold's supremacy, a gold aficionado) often takes on a variation of this form: While in the bunker (or any other variance of the "world-falling-apart" scenario), you cannot pay for food with paper money or a stock or bond certificate. You may do so with real tangible assets, such as gold. If this scenario played out (God forbid), it is conceivable that gold could become the de facto currency. In that event, you need to have real gold in a safe or buried in your backyard. The wise gold bug would have managed portfolio risk by also investing in a good arsenal of guns, as the demise of government bonds would likely lead to the end of the rule of law as well. Gold held by your broker or through ownership of gold stocks or exchange-traded funds will not come to the rescue; these bytes and bits are not superior to default-free bytes and bits, for example, U.S. Treasuries. Canned food may actually be a better store of value in this "world coming to an end" scenario. The ever-increasing complexity and globalization of the financial system, rapid spread of international trade and the availability of risk-free investment instruments that were not available to investors in previous economic crises may have changed investor behavior during economic doomsday times. Financial instruments such as Federal Deposit Insurance Corp.-insured checking and savings accounts, U.S. Treasury bills and Treasury inflation-protected securities may challenge gold's status as the safest haven in times of inflationary crisis. Treasury inflation-protected securities may turn out to be the key challenger to gold's store-of-value supremacy status in the future. Aside from being issued by the U.S. Treasury and therefore backed by the full faith of the U.S. government, they also protect investors from inflation - one of gold's most-valued qualities. TIPS' principal is tied to the CPI: The principal value increases with inflation and falls with deflation. When the security matures, the original or adjusted principal is repaid, whichever is greater. Though TIPS appear to have superior financial properties to gold, they still lack one of gold's main attractions - tangibility. After all, they are still just bytes and bits on a brokerage firm's or bank's mainframe, or pieces of flammable paper stored in a safe. Holding gold has costs Any cash flow-generating asset, like a stock or a bond, can be valued on the future cash flows that it is expected to generate. Predicting gold prices is extremely difficult because gold is not a cash-generating asset. In fact, it is important to note that gold actually has a negative yield. Gold is a cash-consuming asset; its safekeeping and transportation cost money. TIPS, as well as any bonds and dividend-paying stocks, have a positive yield; they pay investors for holding them. Gold is also considered a good currency hedge, especially for the U.S. investors who are concerned about the declining dollar. Again, our financial ingenuity is stealing gold's long-held exclusivity on that trade, providing options that were not available a few decades ago. To protect themselves against the declining dollar, U.S. investors can use currency futures and options, foreign-currency-denominated mutual funds and certificates of deposit; they can buy foreign stocks on foreign exchanges or through American depositary receipts; and, of course there is a most recent development - currency exchange-traded funds. In both the long run and the short run, gold prices are driven by fear of the world coming to an end and investors' expectations of future inflation. Although gold has some industrial applications - in jewelry, dentistry, computers, jet engines, electronics, as a superconductor, etc. - linking its intrinsic value directly to its price is difficult. Perception of its ability to store and preserve real value, especially in an inflationary environment, is the key driver of gold's price. As long as investors perceive gold to be a refuge in times of uncertainty, gold will act as such. It is important to note that gold's monopoly as an instrument of choice at the time of fear and uncertainty has been undermined by other very capable and often superior financial instruments.
Surf, that is an excellent dissertation on gold. I think it accurately reflects current reality. Let be bring some ideas to think about though. Like gold, there is no intrinsic value in a federal reserve note. It's just a piece of paper printed by some bank that is deemed legal tender for trade. The confidence in the dollar is what has made it worth anything. Nothing but confidence, a human psychological emotion. Now what if that confidence is lost? Nothing that pays in dollars is worth anything. I like the canned goods, guns, ammo, and fresh water store idea. Certainly that'll keep you alive for a while, then trade will still have to take place. I'm not talking doomsday, each man for himself necessarily, just that the confidence in the dollar is gone and nobody regards it as having any value. What might make a suitable currency? The euro? Maybe we barter our talents and labor. Maybe something else that physical in nature. I don't know, but it's worth thinking about what it is that people will feel comfortable in placing a new sense of confidence in. That's really the bottom line, the direction of a human emotion. I don't know if it's gold or silver or something altogether different. The only clue we have is to look at the past. What was it that people had that confidence in throughout history and might that history repeat itself? I'm not a gold bug, but I do contemplate things like this and try and get a sense of how this scenario might play out. After all, as far as I know, every fiat currency has been devalued to the point of failure throughout history. Why should the dollar be any different, especially given that you can see it happening on the monumental scale, orders of magnitude greater than ever right now. It just seems that along with the self sustaining gear, there would still need to be a trading replacement for a failed confidence. But what?
Thanks for posting this surf - it's a good read. I agree that US Dollars and gold are both only worth what someone is willing to pay for them. So in that respect, canned food and ammo are probably better stores of value. However I do not the following: * Investing in gold is not necessarily a black or white proposition. i.e., it's not either "doomsday scenario" or "everything is OK". There can be an in between. For example, gold proved to be an excellent store of value in the US 1970s. It proved to be an excellent store of value to countries outside of the US that experienced currency crises. If the world does move toward a doomsday scenario, then it is likely that there will be time for holders of gold to sell the metal, and buy canned food. * While I agree that canned food has utility (edible) that gold does not have, gold and silver have a long successful history as money. Judas did not betray Jesus for 30 cans of tuna. He betrayed Jesus for 30 silver coins. * Gold has a much smaller bid-ask spread than a can of tuna. There are financial markets and coin shops that deal in gold. Supermarkets sell tuna but they are reluctant to buy it from the general public who don't have a receipt, and/or want to exchange a large amount. * There are difficulties associated with storing large quantities of canned food and ammo. At a value above 300 "US Dollars" per ounce, gold has a much larger value to size ratio than a can of tuna.
CFA= unable to think outside the box. Gold will always hold its value. What happens if confidence in this entire system totally collapses.
If confidence in the system totally collapses, then it is possible that food is considered a better store of value than gold. I believe that this is Katsenelson's strongest point. For what it's worth, I disagree. Gold has many hundreds of years of history as money.
gold is slipping on bailout plan--reuters http://www.reuters.com/article/hotStocksNews/idUSTRE48P85J20080928?rpc=401& http://www.reuters.com/article/goldMktRpt/idUST29152220080928
It makes sense that gold was going to slip on a bailout announcement. Typical knee-jerk reaction. Let time pass to see if this is just the beginning of a snowball rolling down the hill. What happens when the next request comes in for another $700 billion. If the 62 trillion in credit-default swaps is placed on the backs of taxpayers, it's all over.
In about 6 months they'll need another $700 billion if my guess is correct. So, if you say that gold has performed poorly as a store of value, how has the paper dollar fared by comparison? And what makes you think the paper dollar will always fare so well? It no different than expecting housing prices to always rise to expect the dollar to always be accepted for real goods on a global basis. Stranger things have happened, and the combined effect of those deficit twins and the debt keeps getting larger...
Gold has now made a new all time high in all major currencies except for the dollar and the yen. http://www.galmarley.com/framesets/fs_currency_charts.htm The huge rally in the dollar has temporarily masked the strength of gold, but I doubt that will be sustainable. I wish gold would go down as its strength is a sign of the destabilization of the global financial system. But I don't argue with facts and I'm long futures and have been buying some physical as well.