This Gold ‘Truism’ Is Dangerous to Your Wealth

This Gold ‘Truism’ Is Dangerous to Your Wealth

Today we begin with a thought experiment.

Imagine you flip a coin 10 times in a row.

How many heads and tails do you roll?

Five and five?

Seven and three?

Nine and one?

All combinations are as equally possible as the others.

In terms of probability, the longer you flip a coin, the likelier it is that the amount of heads and tails you land on will be split down the line 50/50.

But there’s an uncomfortable truth in this simple math.

If you flip a coin a thousand times, the first hundred attempts could easily land on heads.

The more times you flip a coin, the greater the likelihood that you can get a seemingly impossible chain of outcomes.

It’s the same in the real world.

It’s a big place. In which you’ll find some seven billion opinions.

Poll five economists and you may find a broad range of opinions on a variety of subjects. Yet, as unlikely as it may be, you could also find yourself polling the five economists in this world who think, talk and dress the same way.

That could be a problem if you’re in the business of making money.

You’ll have heard the saying ‘a fool and his money are soon parted’ before.

It makes sense, doesn’t it? Someone who’s foolish and misinformed is more likely to see their wealth go up in smoke.

But how true is that?

Take Bernie Madoff, one of history’s biggest conmen, as an example.

Did a billionaire like Madoff lose his fortune and freedom by scamming people of their wealth through a pyramid scheme? Was he a fool?

No, he was extremely clever. Otherwise he wouldn’t have gotten away with what he did for as long as he did.

But what about the countless people that were scammed by Madoff into giving away their wealth? Were they fools?

Again, we’d argue they weren’t.

Like Madoff, they wanted to get rich. People lose money through investments that don’t work out, yes. But they’re not fools. Their motivation is to make money, not squander it.

That people lose money doesn’t make them chumps. It’s through risk-taking that most people build their wealth in the first place.

When you’re seeking the opinion of others on financial matters, you always run the risk of not getting the full picture, and of parting with money despite your best intentions.

But it’s important to always keep in mind that there are many ideas in today’s market that start and end with mistaken beliefs.

And that’s exactly the case with gold today.

The great misconception about gold

In the midst of an impending global trade war and volatility, how is it that stock markets continue to march on while gold goes sideways?
The answer to that brings us to one of the most distorted truisms in finance.

It’s the one that says gold’s image problem among investors is that it doesn’t bear any interest.

Blu Plutnam, chief economist at CME Group, a firm operating in options and futures, cites rising inflation as a reason for gold’s woes:

The problem for gold is that it does not bear any interest, and the Federal Reserve is pushing short-term rates higher. If core inflation was to move well above the Fed’s 2 percent target, the Fed would push rates even higher to stay abreast of rising inflation.

In other words, for gold to move higher, Plutnam believes the market would need to see lower inflation, removing the need for the Fed to lift interest rates.

Of course, this truism about gold and interest, like those above, is not as clear-cut as it seems.

For one, in what world is inflation bad for gold? The gold price reflects the inflationary state of currencies, in this case the US dollar.

When gold goes up, it simply means the dollar has been devalued through expansion of supply. Gold itself doesn’t rise or fall in value. It’s just a measuring stick by which to value other assets.

As for not bearing any interest, no tangible asset pays interest. Your house doesn’t pay interest. Its value merely rises and falls based on demand from buyers and the amount of currency in circulation.

Does that make it a bad investment? Of course not.

That investors flock to the US dollar when core inflation rises and not gold says much about the mindset of investors today.

But it doesn’t make them fools.

They’ve just bought into the so-called truism that rising inflation, and thereby rising rates, makes the US dollar a good investment. In the short term, that may be so.

But if they’re loading up on interest-bearing assets like cash at the expense of gold, they’re setting themselves up for a mighty fall when currencies, without exception in history, meet their timely demise.


Mat Spasic,
For The Daily Reckoning Australia