Gold: Of Bogeymen and Bunker Monkeys

14 Apr

Joe Weisenthal captures an important point. The recovery drop off in gold – especially relative to more conventional investments – reflects something pretty fundamental.

On one hand you have established economists, who believe the government has tools at its disposal to address a crisis. These tools include deficit spending and a violent expansion of the Fed’s balance sheet.

Conversely you have critics who slam the arrogance of economists and central planners, and who have predicted that all of this economic acrobatics would result in an economic collapse, hyperinflation, and an explosion in the price of gold. Gold is important to their worldview, because it represents a quasi-money that’s not tied to any government or central bank.

Investing in gold is a rejection of government money and finance. Money flowing into gold-related assets represents a belief that rocks (however shiny they are) are a better place to invest than human endeavors (like stocks).

Joe points to this chart – the ratio of the S&P to gold, which is slowly moving off recent lows, but is still at around 20% of its peak.
stocksvsgold
(Note, while using the S&P price index is an ok approach for valuation, using the Total Return index makes far more sense for comparative returns).
I’m a bit less sanguine. The great peak at the end of the 90s, which culminated in (among other things) Gordon Brown’s infamous sale of the UK’s gold reserves, looks increasingly like a bubble in our faith in our leaders. Buying “The Committee to Save The World” out of Gold in 1999 looks an awful lot like a politico-economic version of Webvan or pets.com.
bubbles
Peak Bullshit

The case for gold: it has a pretty robust record of modestly outpacing inflation in the very long run. It’s pretty portable, and hence in physical form, relatively hard for the government to appropriate (or for that matter hyperinflate away).

Gold vs CPI

gold vs stocks

Data: Shiller, Measuring Worth Note:original post contained duff chart. sorry bout that.

The case against: returns are crushed in the longer term by stocks (subject to certain conditions), and it’s still pretty easy to steal or confiscate (hence the appeal of Bitcoin ohlordI’mlosingthewilltolive). Hence the vehemence with which goldbugs* enthusiasts emphasise the need to hold physical gold (ideally melted down and poured into your bones**) less subject to administrative fiat or confiscation.

So how much sense does gold make?

Ordinary Inflation? Bit crap really. Yes, gold handily outpaces the CPI over long periods, but equities do far, far better. Pages 7-20 of this (excellent) presentation make the point pretty clearly. In short bursts of inflation, gold doesn’t protect particularly reliably. In the longer-term you’re better off being involved in the real economy.

inflation hedge

So this takes us to the real point: Gold – unlike bank deposits, equity or bonds, or even banknotes – it’s separate from the real economy; it’s what you invest in when you want to take a breather from what’s happening in the real economy. That’s actually only a sensible thing to do in pretty extreme circumstances. Gold returns are utterly crushed by equity markets in the long term – to a really astonishing degree for those economies where we have continuous equity markets. Compared with shares in pre-revolutionary China or pre-war Poland, gold returns look pretty good. Gold is less an index of how confident we are that our leaders a) want to b) know how to do the right thing as it is an index of how sure we are that they won’t completely and utterly screw the pooch.

So what can go wrong?

I’m sick of hearing about hyperinflation. The case for gold often starts off with a chart of narrow money or the Central Bank balance sheet, and skips over the (dead-in-the-water) dynamics of broad money. Economists like to use the parable of “helicopter money” (banknotes thrown from a helicopter), and sadly some people appear to be scanning the skies for scrip-dispensing helicopters. What’s actually happened is that the helicopter pilot suffered some nasty losses on US subprime debt and Greek Government bonds and is hoarding the new money, so it’s not having a lot of inflationary impact.

If inflation is always and everywhere a monetary phenomenon, hyperinflation is a political one. Without the political conditions – usually an-even-more-than-normally unpopular and illegitimate government – usually the harder choices do in fact get taken. Argentina and Russia (and Jamaica for that matter) defaulted on debt in local currency debt that they could print rather than face hyperinflationary consequences. Argentina and Iceland both imposed capital controls for similar reasons.

I’d draw a lesson from a beer ad here in the UK, where a father reassures his 4-year-old daughter that she shouldn’t be afraid of the Wardrobe Monster, “It’s burglars coming through the window you want to be afraid of”. Hyperinflation is a bogeyman. But there are real threats out there, and gold is likely to be seen by some as an answer.

I personally find it highly unlikely that the Dijsselbloem dream of a queue by every peripheral ATM will come to fruition, but it’s harder to argue that the risk of depositor – and especially bank bondholder losses is “unimaginable” – not worth hedging. The head of the council of EU finance ministers is still on a victory lap, and the documents the EU have published about the Cyprus adventure do not indicate that they regard this as the colossal failure that the casual observer might. I haven’t seen any polls (please tell me if you do), but the impression I get from Comments on here and Twitter, is that politically, hammering peripheral depositors rather than bailouts is the Northern European equivalent of Motherhood and apple pie. But let’s recognise the logic…if still-wobbly banking systems are going to be fixed, someone has to pay. The Germans seem pretty emphatic it’s not going to be them, there’s neither the economics nor the politics in line for a major burst of inflation, so there’s likely to be – at least – a bid for safety for some time ahead. The bulk of such a bid is likely to find its way to the Core, but it’s likely to support gold too. The equities-to-gold ratios for the Eurozone (or for that matter the UK) have fallen futher and retraced a lot less than their American equivalents.

stocksgoldEMU

Overall then, the drop in the gold price does look like a welcome sign of greater confidence in the economy and the people who run them. But the levels of 1999 were bubbly, and we’re not heading back there any time soon, even if the discredited likes of Greenspan and Rubin (and King, and Brown and Duisenberg and Trichet) have, with maybe one exception been replaced with better. There are still some hard questions to be asked about market economies and the people who run them, and the gold price remains a pretty good indicator that a lot of people are unconvinced.

————————————————————–

This post is concerned with gold as an investment, and especially what conclusions we can draw from recent price action. I have nothing to say about the Gold Standard other than it’s the obvious solution for those who feel the main problems with the euro are that it’s too flexible and covers too few countries. I have relaxed my usual comments policy to facilitate further discussion by certain members of the gold fraternity.

* Researching gold is not for the faint-hearted. A couple of hours looking into this stuff reminded me strongly of the American Fundamentalist – gloating at the non-Elect, with a sort of anxious fervour.I do think that a lot of the fervour with which “paperbugs” have victory danced over the (pretty modest) recent falls in gold is just a response to irritation at being bombarded with innumerate diatribes from smug yahoos. Seriously, try reading Jack Chick and ZeroHedge side by side for a bit and see how long it takes the two to blur together.
update sorry I may have accidentally given the impression that I regard all gold enthusiasts as unhygienic ‘bugs’. Not at all the case, there are some very thoughtful ones. I’d start with Tim Price.
“The Grab”

** – Not my quote. I thought it was Josh Brown, but he denies all knowledge. Happy to attribute accurately.

9 Responses to “Gold: Of Bogeymen and Bunker Monkeys”

  1. dsquared April 15, 2013 at 6:01 am #

    Gold is surely dominated by land in any situation other than political collapse – I think you are better off in gold in a pre-revolutionary China situation but still better off in land even in pre-war Poland. I think this is why goldbug-ism is more of a US thing – British sceptics about politicians tend to go for our national household god of bricks and mortar.

    • pawelmorski April 15, 2013 at 6:54 am #

      Actually in hyperinflation stocks>gold>housing. Housing tends not to be internationally traded and it’s access to hard currency that matters. gold’s value is that you can swap it for proper fiat currencies.

  2. E.L. Wisty April 15, 2013 at 1:52 pm #

    Reblogged this on Pink Iguana.

Trackbacks/Pingbacks

  1. GOLDENFREUDE: Here’s Why People Are So Glad That Gold Is Crashing | cumulusreport.com / nimbusreport.com - April 15, 2013

    [...] pseudonymous trader @pawelmorski (who wrote a great post on the gold decline) explained that part of it is a reaction to the constant goldbug religious hectoring while others [...]

  2. GOLDENFREUDE: Here’s Why People Are So Glad To See That Gold Is Crashing | LiMiT - April 15, 2013

    [...] pseudonymous trader @pawelmorski (who wrote a great post on the gold decline) explained that part of it is a reaction to the constant goldbug religious hectoring while others [...]

  3. Why the Gold Crash? The Failure of Inflation to Take Off | azizonomics - April 15, 2013

    [...] calls, but in the long run may result in renewed inflows into gold and a price trend reversal. Gold is very much a barometer of distrust in the financial, governmental and corporate establishment, and as middle class incomes continue to [...]

  4. GOLDENFREUDE: Here’s Why People Are So Glad That Gold Is Crashing - April 15, 2013

    [...] pseudonymous trader @pawelmorski (who wrote a great post on the gold decline) explained that part of it is a reaction to the constant goldbug religious hectoring while others [...]

  5. Why the Gold Crash? The Failure of Inflation to Take Off | My Blog - April 16, 2013

    [...] calls, but in the long run may result in renewed inflows into gold and a price trend reversal. Gold is very much a barometer of distrust in the financial, governmental and corporate establishment, and as middle class incomes continue to [...]

  6. Eurozone crisis as it happened: Gold slumps to a two-year low as China data disappoints | Parmafey Blog - October 22, 2013

    […] Sticking with gold, Pawelmorski has written an excellent blog post on the precious metal. […]

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