During a week when almost everything went wrong, the gold market went very right. In fact, gold has been going very right for more than a decade. The gold price has more than quadrupled during the last 10 years. So is it too late to buy the stuff?
My short answer is, "No."
Admittedly, gold is not like any other investment. It is not merely a financial asset; it is the ultimate form of money. But that doesn't mean it is always a good investment. Many investors make a case for gold laden with ideological fury over the government's printing press. These investors are always saying buy gold. Their arguments are timeless, but not always timely.
If you bought gold in the 1980s and 1990s, your return was abysmal. So, as with all assets, there are times when gold is a really good buy and there are times when it is not. Sounds obvious, but many people seem to want to think that gold is an exception to the order of things. It isn't.
But how do you know if gold is cheap? Well, intelligent people usually advance a couple of arguments:
1) On an inflation-adjusted basis, gold is 30% less than its all-time high in 1980. Okay, that's true, but it's not particularly timely because by that measure gold has been cheap for three decades. And who's to say that the 1980 gold price is a benchmark we should pay attention to anyway? By that way of thinking, the NASDAQ is a bargain, too, because it trades at a big gap from its 2000 high. But is it? I think not.
2) The other point often advanced by the "gold is cheap" crowd is the old monetary base argument - that gold's price tends to track the monetary base over long periods. The monetary base is essentially bank deposits and currency. It's like the seedlings of inflation.
This second argument is a little more interesting. Yet, as the government has added huge piles to the monetary base in the last year or so, the gold price has responded in a muted way.
The hedge fund QB Partners really likes this argument. QB writes:
"True capital has already begun to flow where it is being treated best - to capital-producing economies and to global stores of wealth, from paper money and financial assets to hard money and hard assets...We think gold is cheap by a factor of almost 7 times."
If a gold price of $7,000 an ounce doesn't strike you as implausible or absurd, QB's next comment might. QB says, "The gold price could move higher than [$7,000 an ounce] if it experiences a blow off top, like all other bull markets tend to do before exhausting themselves." So, $7,000 an ounce, you see, is just some kind of base case.
Maybe it's not so implausible. Strange stuff happens all the time in markets. If I had told you on May 6 that Accenture - a $40 stock with a $29 billion market cap - would trade for a penny a share the next day, you would have thought I was nuts. Yet, on May 7 it did just that, if only for a second.
As investors, we tend to think too narrowly within the confines of what seems probable. Yet, the really big money lies in the outlying events. As QB puts it:
Most investors allocate to the markets by playing the odds, which by definition gravitates capital to the middle of a bell curve of possible outcomes. This fools the investor into thinking that the probability of future events is somewhat predictable. Of course, history is rife with startling social, economic and political "tail" events. Stuff happens - things like earthquakes, the bombing of Pearl Harbor, the 1980 US Olympic hockey team, the demotion of Pluto, dotcom bubbles, liar loans and even periodic global economic failures and the re-assertion of gold as money.
This is essentially the familiar "black swan" argument made popular by Nassim Taleb. This is really the best argument for gold in my view. It is a hedge against really bad stuff happening. And when really bad stuff happens, gold holds up.
Of course, over the last decade, it has more than held up. Gold has been the best-performing asset class from December 1999 to December 2010.
People often invest by looking in the rearview mirror. They feel better investing in stuff that has done well. Even professionals feel this way. Money follows performance, which is why so many investors get mediocre results. They hop into the hot fund or sign up for the hot newsletter just as it is about to go cold. They abandon apparent losing strategies and sell poor-performing stocks just as they are about to turn up.
But the gold market is different because it's so small. Even a small amount of interest in gold will send it up a lot. Just imagine if people decide a small sliver of that tall bar of financial assets should be in gold. We're talking about some serious pressure on the gold price.
Frankly, the gold market is set up perfectly these days. You couldn't design it better. Bad stuff is happening - see the crisis in Europe. And you can surely bet more bad stuff will happen, given all the debt and leverage that still remains in the system. Even if you don't know exactly what will happen or when it will happen, you know a monetary crisis is good for gold.
As an added bonus, gold has a track record, which will attract fans soon enough. And when it does, it can't really accommodate many buyers because the market is small. This means the chance of the gold price spiking upwards are pretty good. It's like being in the lifeboat business on the Titanic. No price will seem too high!
Chris Mayer
for The Daily Reckoning Australia
P.S. to get The Daily Reckoning direct to your inbox sign up to our free e-mail newsletter or if you prefer to use RSS, subscribe to the Daily Reckoning RSS feed.
Related Articles:
- A Bull Market in Gold and Gold Alone
- Gold Ratios: Bearish for Gold Prices, Bullish for Gold Shares
- A Gold Standard, Without Gold
- Gold: The Ultimate Unlevered Hard Asset
- We are Confident the Bull Market in Gold is Not Over
About the Author
Chris Mayer is a veteran of the banking industry, specifically in the area of corporate lending. A financial writer since 1998, Mr. Mayer's essays have appeared in a wide variety of publications, from the Mises.org Daily Article series to here in The Daily Reckoning. He is the editor of Mayer's Special Situations and Capital and Crisis - formerly the Fleet Street Letter.
Comment by Neo Sin Huat on 8 June 2010:
You are right.
Comment by prozak on 10 June 2010:
Even without the recent corrections gold would still be outperforming every other asset class.
We are told all the time how all these other assets are or were in a bubble......
But not gold right? Gold is "different".
Oh but gold isn't leveraged right?..... err.... as long as we pretend the largest gold market, you know the one its big enough to drive spot prices - gold futures - doesn't exist....
But this is the DR. So buy gold, its dead cheap.... soon no price will be too high
Comment by Stillgotshoeson on 10 June 2010:
Without a doubt Gold can (and will ) correct.. and most likely in a big way when it does. I don't htink it is time for that yet. Still more bad news than good with the economy.
I have a sell point for gold, same as I do for stocks.. Sell out at my target, if it keeps going higher, all good for the ones that stay longer... I figure you never lose taking a profit..
Comment by Lachlan on 10 June 2010:
Although Im a "too da moon" man on gold I can see that that paper can/is/ has been used to suppress the price especially during peak demand times such as recently with a new record short interest.. granted the long leverage there too. I doubt this is about to change. The banks are in control, no man is likely about to change that. Im sure they have the power to drive the price down to wherever they like apart from the social fallout it may cause. But then price and purchasing power arent the same. The end game may be gold at $500 but other assetts repriced lower by greater multiples. And thanks for the pullbacks fellas. We shouldn't carry on about the banks. It wouldn't be a game without em.
Comment by prozak on 11 June 2010:
" to da moon" priced in government paper?
Inevitable eventually... timeframe is between 5 and 1000 years.
To da moon priced against other hard assets?
Never.
Comment by Davo on 11 June 2010:
"What if scenario on gold."
What if Governments legislate to restrict the gold market (both physical market and transactional market), as it competes unfairly (in their mind) with use of paper currencies.
They would prefer people to put their funds into bonds, rather than buying bullion.
Safe haven status goes out the window, and people are stuck with a physical asset or piece of paper that nobody will be able to buy, except within Government guidelines.
Desperate times ahead could lead to desperate actions by politicians to collectively protect themselves.
"Excuse" given for this measure could be people avoiding GST on something purchased with gold.
Personally, I wouldn't rule any action out by these morons running our country and others.
Comment by Justin on 11 June 2010:
"Desperate times ahead could lead to desperate actions by politicians to collectively protect themselves." Undoubtedly
"Safe haven status goes out the window, and people are stuck with a physical asset or piece of paper that nobody will be able to buy, except within Government guidelines." Hardly, gold is the most marketable of all commodities, ultimately the government cannot control it. Look at Zimbabwe.
Comment by prozak on 11 June 2010:
"Hardly, gold is the most marketable of all commodities, ultimately the government cannot control it"
Right. Sure they can't.
Know much about the history of gold?
Comment by Lachlan on 12 June 2010:
"ultimately the government cannot control it"
Thats correct in the sencse that since no government yet has found it possible to control gold or people or anything else continuously or indefinately. Regimes persist longer than successive generations usually hope for though.
The GFC/currency collapse tells me that power balances will change soon. Either towards tighter gov control eg nationalisations, higher policing or towards greater individual liberty such as lesser taxation, regulation. Its anyones guess. The world is inherently chaotic. I dont see a human solution ever possible. So the tools of the free market (such as gold) will have a use from time to time.
Comment by Lachlan on 16 June 2010:
fasten seat belts yea men of free market money
Comment by Stillgotshoeson on 18 June 2010:
http://www.kitco.com/ind/Wilson/jun162010.html