what my intuition tells me now: What About Gold Right NOW?Posted by Jason Apollo Voss on Apr 6, 2011 in Best of the Blog, Blog | 2 comments
Loyal blog reader, Clint, asked a question yesterday about my 2011 Prediction for gold prices that I feel needs to be brought into the larger forum of the blog itself. Here is what Clint asked:
I have a question about your gold prediction. With the fed printing money faster than I can say “the fed is printing money”, rising turmoil in the middle east (although not new), another war, and not too dramatic increase in job creation, do you still see a major sell of in gold within this year?
Thanks for the question and I wish that you hadn’t asked the question : ) It’s not that I feel gold is a steal at current price levels and that I made a mistake. It’s just that gold of every asset is the hardest to assess. For your edification I would go back to some of my earlier posts that are specifically about gold…
That will give you some of the background as to my thinking about gold.
Regarding gold, it seems that there are two arguments: that it has no intrinsic value, or that it is the only asset that really has any value at all. Sigh! Where do I stand? Somewhere in between. Why? How? I am going to answer this question using demand and supply fundamentals. But because supplies of gold are largely fixed, the gold discussion is only interesting from the demand side of things. Let’s get to it…
Gold Has No Intrinsic Value
I completely disagree. First of all, gold is one of nature’s best electrical conductors so some demand for gold makes complete tangible economic sense. Second of all, there are lots of goods that have no tangible value that nonetheless we would all argue are valuable. For example, our favorite album, or our good health. That gold is in demand because of its use in wedding rings or in other jewelry or in other forms of bling is legitimate demand for gold in my mind.
What kind of gold demand do I think is illegitimate? Speculative demand. As I have written about many times before on the What My Intuition Tells Me Now blog, speculators don’t really care about their absolute price entry point into an asset. What they care about is price volatility around that price point. If prices fluctuate enough they make money from their hedges. It’s my feeling that a lot of gold demand is speculative in nature. It’s demanded the same way mortgage backed securities and dot.com era stocks were in their bubble periods. The usual argument against this is that gold is the only asset class with any real value.
Gold Is The Only Asset With Any Intrinsic Value
The thinking here is that gold has always been a unit of exchange and if the world goes crazy it will be that again. Therefore, in periods of inflationary monetary policy or political upheaval (to Clint’s points) you want to be invested in gold. Now here is where the gold story always gets difficult. Here is why I dislike these arguments.
One, say that all of the upheaval does occur that gold bulls use as motivation to buy gold, what will really have value then? What will have value is what has always had value: real assets, like land and agriculture; and skills, like farming, fire-making, weaving and fighting.
Say the world goes all Mad Max and apocalyptic – the nuclear meltdown scenario – and clean water and food are very scarce. If you have the clean water and the food are you going to give it up for a shiny rock? If you have the loom, the hoe and horses, the wools bane (fire starter), or the distillery are you going to trade it for a shiny rock? I think the answer is no.
Adam Smith (yes, that Adam Smith) and I agree, gold only has value for what you can exchange it for. But wait a second, isn’t that same argument as is made for Treasury Notes? After all, in the apocalypse, who cares that this piece of paper is backed by the full faith and credit of the Untied States (yes, I meant that misspelling of United).
So this is my problem with speculation based on apocalypse. At this level gold has the same intrinsic value that cash does. Do we covet cash because it has intrinsic value in and of itself? No. We only covet it because it can be exchanged for something we need or want.
Clint’s question has reasons to demand gold, but what about those reasons?
The Federal Reserve is not my favorite institution. To my way of thinking each of the last two recessions were due to very poor Federal Reserve policy.
The Fed’s problem seems to be that they don’t include prices of assets like stocks and real estate in their inflationary calculations or targets. I think the economic history of the past 15 years demonstrates aptly that this is ignorant.
Now the Fed is engaging in Quantitative Easing – in other words, printing money to prop up the U.S. economy. I definitely do see this as inflationary. However, asset prices for stocks look fairly valued to me relative to profits. And real estate prices look slightly undervalued to me depending on the geographic region of focus. Not only that, but the Fed is easing out of Quantitative Easing and just last week the Fed intimated that interest rates will rise by the end of the year.
Lastly on this point, the Fed has acknowledged that it now looks at asset prices as a form of inflation. So demand for gold from inflationary pressure has to be considered a weak argument at best.
What about rising turmoil in the Middle East? I think that the pressures in the Middle East are going to lead to regime change, but only slowly, on balance. Not only that, but truly who cares what goes on politically in the Middle East? The only real concern is whether or not the real gold, oil, keeps flowing.
As I said recently on the blog, oil discomfort is overblown. Why? Because whomever survives politically in the Middle East will be in the business of selling oil. And the reason for that is that there is practically no other asset of value in most of those countries.
Without an economic backbone to put food in the mouths of a people there is no political backbone to sustain a nation. So regardless of the Middle East outcome, oil will flow.
To me this reason to invest in gold looks like a convenient momentum player’s excuse to buy gold futures. In fact, if I were such a large player I would be out there in the media talking about my concerns about the Middle East like crazy. Hmmm.
There was a mentioning of “another war.” I am assuming you are talking about Libya. The United States has officially stopped its overt, hot war activities in Libya and turned over the operation to the European members of NATO.
If the U.S. is going to be sucked into “another war” I think it will actually be a re-entry into an old war: Iraq. Iraq is the countervailing weight standing against Iranian domination of the Middle East. That we destroyed Saddam Hussein (not a nice guy) removed the balance of power in the entire Middle East.
Many reports about 2011′s Middle Eastern unrest have Iran behind the “revolutions.” It plays well in the New York Times and on Fox News, but the reality is that the Middle East is largely a land ruled by Medieval thugs, ruling over those who would like to be the feudal thug.
Now to the final point in the question, “weak job creation.” I think here you mean the weakness of the economy and its inability to create jobs. Without doubt this is a real concern. Now new jobs = no new monthly income = no new profit growth = more layoffs = another recession. While I think this is a legitimate concern, the recent evidence is strongly suggesting that the final vestiges of the Great Recession are now disappearing. So it would be difficult to advocate that there is demand for gold here, too.
Where is all of that gold demand coming from? I think three sources: speculators, China, and hype. Speculators have been in gold for the last three years because all of the conditions that usually lead to gold speculation have been in place: economic instability; poor monetary policy; and political upheaval. Yet, each of those is disappearing as a reason to invest in gold. What about China? Word is that the Chinese economy is experiencing a catastrophic bubble that the government there is hiding (poorly) from the rest of the world. If the Chinese economy collapses, and at some point it will, gold demand from the Chinese Nouveau Blinge (ne Riche) will dry up.
Now if you take care of these first two sources of gold speculation, the third, hype, takes care of itself. So its hard to make the bull case for gold right here.
After a nearly five year bull market in gold can you say that we are closer to the bottom in gold prices or the top in gold prices? I think you would have to say we are more near the top.
Then the question becomes what types of returns can I get in other asset classes? I think a very strong case could be made that real estate is actually an asset class nearer to the bottom in price than gold and that offers higher future returns than gold.
And lastly, not sure if you know it or not Clint, but I was quoted in Smart Money’s March cover story about gold, I said then and I will repeat it here: “I don’t like to invest in things that depend on people’s nervousness.”
But why was I reluctant to answer this question? Because you asked if my 2011 Prediction about gold still held? The timing of the unwinding of the gold bubble is the only thing I am uncertain of.
That gold is a massive speculative bubble I have no doubt. But that you can’t make money by investing in gold this year? That’s a harder question to answer because who knows what will spark speculators’ run for the exits? And that I just cannot answer.
But I can say in closing that investing in gold at this point has a lot more that can go wrong than can go right. The “wrong” things are all of the large trends I addressed above; and the right things would be those large trends reversing themselves completely – I feel that’s highly unlikely.