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Is Gold A Sucker's Bet?

by: Alan Brochstein October 11, 2008 | about stocks: GLD    

Alan Brochstein

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World stock markets seem to indicate the coming collapse of the global economy.  Credit is unavailable to individuals, companies and nations.  Commodities of all types are plunging.  Deflation appears to be inevitable, yet gold prices remain near their all-time highs from earlier this year. 

Why does gold trade at $850-$900 when it should trade below $600?  Old-school economic thinking.

Gold participated in the overall commodity bubble.  There were all sorts of rationale for the surging prices of oil, copper, agricultural products (mostly related to the emerging world's economic elevation), but I think gold just went along for the ride. 

As the dollar depreciated so significantly, especially early in the year, demand for gold went up as an inflation hedge.  I grew up reading about the long-term "store of value" argument for gold, but I realized years ago that gold isn't what it used to be. 

I wasn't surprised when gold stopped going up earlier this year despite the continued decline in the dollar.  People around the world began melting their gold in response and selling it for scrap.  With so much fear in the market and a historical tendency for gold to serve as a safe haven, I am not that surprised that gold has failed to follow other commodities down (still up in 2008).  Stay tuned, though, because in a world where every asset seems to be worth less today than it was yesterday, gold too should crumble soon.

I don't mean to pick on gold, as I could make similar statements about art, stamps, fine wines, antiques or any other "collectible".  We already know stocks, non-government bonds, and commercial and residential real estate are under intense pressure. 

As one can see in the chart below, commodities have done a complete 180 and have wiped out all of the gains of the past four years in just three months (similar to stocks).  I understand that unlike many of these commodities that tend to correlate to levels of economic activity, gold is not as "industrial" as other metals. 

Well, gold sure seems to correlate well with the CRB.  Maybe it doesn't get to the $400 it saw four years ago, but I will be surprised if it doesn't drop significantly soon.  It rose as inflation fears went up, and it has been sustained by investors who apparently don't look forward or who mistakenly assume that it serves the same role in today's world as it always has without examining that notion.  If anything should be the ultimate store of value, it seems like perhaps it should be a barrel of oil (though it is harder to store!).

(click to enlarge)

Gold101008 

While it is down just 15% from its peak, it has indeed begun to roll over.  Gold fans blame the move primarily on the strengthening of the dollar. 

Looking forward, I expect to see a lot of sources of selling, whether it is individuals that need cash or central banks.  As I review the articles on Seeking Alpha, there seems to be a unanimity in the optimistic views. 

The most "bearish" view I found was that silver is a lot cheaper.  I question the whole economic notion.  If it were just the United States alone and not the entire world wrapped up in this deflationary spiral of deleveraging, I might not question the sustainability of this high price, but this is a global problem. 

If gold really still were the safe haven that it has traditionally been, it sure seems like it would be a lot higher (as many have shared in comments on articles contributed to Seeking Alpha).  I have learned when something doesn't act the way one expects, one is usually wrong. 

Maybe I underestimate the amount of thought that gold bulls have put into their investment thesis, but individuals with whom I have spoken seem to fall into the camp of blind faith.  I majored in economics and am quite familiar with the theories surrounding gold, currencies, etc., and I also realize that many of the principles we were taught don't necessarily work in the real world. 

If you are investing in gold as a safe haven or inflation protection vehicle, I suggest that you reexamine your reasons. Silver, palladium and platinum are all plunging.  Why shouldn't gold?

Disclosure:  No current position, but considering shorting an ETF

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This article has 152 comments:

  •  
    Oct 11 02:57 PM
    I think I'll trust the Mogambo Guru. Plus he is a lot funnier!
    Reply
  •  
    Oct 11 03:25 PM
    Alan ---You are totally right. I have been shorting gold since July. It went up again in Oct. even though the dollar is soaring. This rise was caused by irrational panic in the stock market. Gold is clung to for no reason unless real money is going down. Gold should continue its trip down to $400-500.

    Remember gold is not money (nor is oil). As real money becomes more valuable gold and oil will be sold. Gold cant even be used to power your car. Its useless except to gaze at.
    Reply
  •  
    Oct 11 03:25 PM
    The real estate bubble burst, the financial market bubble burst, the credit market bubble burst, the energy bubble burst, the commodity bubble burst, the stock market bubble burst. Money moved from asset class to asset class along the way.
    The next and final bubble to burst will be gold. History says it will. Gold is neat but you can't do anything with it except cash it in for money to do something else with. When people start to head for the cash register, the price will plummet as viciously as the stock market . It always has. It always will. The slower ones will be left holding the losses and the gold bug rhetoric. I'd rather take my chances with inflation.
    Reply
  •  
    Oct 11 03:32 PM
    I believe that all the hedge fund redemptions are behind many commodities being sold out and exacerbated by retail investors panicking with their September statements and margin clercks selling out anything with a pulse.
    This is why the USD held up but it is it's last hurrah. Within the next 4 weeks there will be a run out of the USD, the British pound and I am not sure there are enough Yen and Euros buyers to make a case for gold bears. What you do not want to do though is buy gold futures or stocks as they will have distortions caused by still unwinding positions. My advice is to buy a gold bullion fund with a very low MER (management expense ratio). I use the canadian CEF.A. (Central Fund of Canada). I play it 6 times in the last 24 months buying below 12 and selling above 14.55. I do believe that this time gold will reach 1500 dollars as the US system is about to crumble.
    Reply
  •  
    Oct 11 04:02 PM
    This is from someone who wrote, on September 28th " I believe that if you were to sell the market now, it would be analogous to taking a hit in blackjack on 16" (seekingalpha.com/artic...). Since that article was written the S&P has dropped exactly 25% in 13 days.

    Perhaps your credibility needs to increase a little before much faith can be put in your predictions.
    Reply
  •  
    Oct 11 04:07 PM
    I believe that with trillions of dollars of FIAT currency in the game. The money changers will play any game and tell any lie to prop up their system. Figures don't lie, but liars figure. Right now G7 is plotting a world central bank.
    The Bailout is a tool for the mass reallocation and consoldation of wealth to buy everything up after the fall.
    If you want to know the truth of things study austrain free market economics and Ron Paul. www.campaignforliberty.../
    Reply
  •  
    Oct 11 04:11 PM
    Just keep doing the opposite of whatever CLH does and you should be fine. He is correct that, unlike oil, gold is almost entirely useless. However, he fails to capture the one thing gold is good for: as a store of value, nothing else comes close. In particular, oil is not a store of value because its entire purpose is to be consumed. To even involve the US dollar in the conversation would be a joke.
    Reply
  •  
    Oct 11 04:26 PM
    Alan Brochstein looks like a typical wall street banker...
    Reply
  •  
    Oct 11 04:47 PM
    Alan and CLH, The last I checked my US dollar bill wasn't backed by anything. Sort of looks like you forgot about the $100"s of Billions being given out to financial begging community which is quickly turning into Trillions of $$. AND, where do you think all those dollars are coming from. Yep, your are right, gold has no industrial value and at least at some time in the future you can burn your dollars in the fire place to help keep you warm. Seriously, as the printing presses are working overtime cranking out dollars, their value has to drop. Keep in mind that the purchasing value of the dollar has already dropped somewhere around 90% in the last 50 years.
    So if everything is dropping in value including a barrel of oil which is now almost 50% below its high from just a few month ago, where do folks stash their savings/wealth to protect themselves? It may well be a question of what drops the least but for sure, there is not a single person on the face of this planet that knows the answer. At some point in the future when a dollar is valued far less than it is today, gold may be down or may be up from where it is today but since the alchemists still haven't figured out how to make gold out of something of little value, (ie: paper) , I tend to "feel" that 10,000 years of human history that has always valued this precious metal is a better bet than paper.

    The other alternative is to go to Vegas and gamble all your dollars there in hopes of maybe a 100 to 1 winning record so that you have enough dollars to weather out any storm. Probably about them same probability as guessing what will happen to the market in the next few years.
    Reply
  •  
    Oct 11 04:55 PM
    Gold has two values: the actual use value in industry, and speculative value. As the former is less than 1/10th of the latter, it's a pretty poor investment, relying on the greater fool theory.

    If things go really bad gold will have no use because gold coins are easily counterfeited, the trust issue will prohibit gold use. You can't eat it, it won't keep you warm on cold nights, it won't guard your safety, but every moron in the world will want to rob you of it without regard to your life.

    Gold coins can be a reasonable investment if you derive value of your collection and have the means to display and examine them properly, bringing you pirate lord's joy. Just don't ever expect to make an actual profit from them because most probably you were the greatest fool.
    Reply
  •  
    Oct 11 05:05 PM
    "If things go really bad gold will have no use because gold coins are easily counterfeited" Wefwef

    I suspect a fool proof coin analyzer exists or soon will. But keep talking, I haven't stocked up yet.
    Reply
  •  
    Oct 11 05:06 PM
    China said last month that it intends to diversify its foreign exchange holding, adding to Gold. Among the areas forecast for the greatest growth in are the Middle East and India, both areas that have an historic affinity for Gold.

    Gold is whack and it's never going back.
    Reply
  •  
    Oct 11 05:15 PM
    If gold is so useless why does the US have 262 million ounces in their vaults? Why does the Federal Reserve keep other countries gold stores in their vault in NY? Gold is a type of currency onto itself, it's a fallback. Right now China, India and Russia barely have any gold reserves. You will soon be seeing Gold buying by these countries as a shore to their currency.
    I think you have the wrong concept on gold, it's not a commodity, it's an alternate currency. Just like the dollar value, it fluctuates on demand.
    Reply
  •  
    Oct 11 05:26 PM
    Since 1972 the DOW is up 8.5 times and Gold is up 25 times. Gold quietly preserves wealth through time. 'Nuf said!
    Reply
  •  
    Oct 11 05:27 PM
    If things get really bad, I will trade all my gold coins in for a shotgun and all the slugs I can get. I know that is nonsense to even think of but what isn't nonsense and everybody isn't addressing is that the credit party is over. Once all this toxic paper has been cleared up and the housing and credit card businesses stabilize, there is going to changes. The USA is putting a lot of hurt on the entire globe and we no longer have the resources to jam it down their throats. Just look at us. Our military is spending Billions per week and unable to make much progress in the 21st century warfare game. We are at the mercy of of foreign energy suppliers and it doesn't look like we will ever become self sufficient. GM, Ford, GE; they peaked many years ago and are in a slow death spiral. Etc. Etc. So, what do we manufacture to sell the the world - - toxic debt paper. I think a trip to the wood shed is already in the making and it won't feel good for the average US citizen. GOD help us.
    Reply
  •  
    Oct 11 05:32 PM
    Central Banks are not selling their gold reserves any longer. Why? The same reason that gold, silver and energy plummeted at 2pm EST on Friday, when the margin clerks forced the sell. This is the last thing a hedge fund or broker would sell under pressure. They sold everything else first, and these items last. How do we know? If Friday was not the "final capitulation", then I am wrong. As a clarification, I am not including market indexes (filled with about-to-be slaughtered financial stocks) as the reference. I'm using the various collection of commodity indexes found on Bloomberg.

    www.bloomberg.com/mark...

    Even oil sold off before gold. Strange, no?
    Reply
  •  
    Oct 11 05:32 PM
    Forgot my conclusion. I agree, the foreign countries will love our gold and tell us where to stick our paper dollars.
    Reply
  •  
    Oct 11 05:39 PM
    Some of Alan's past articles from this year include:
    1)Chevron: Good Choice for Conservative Growth Investor, on Jul 23;
    2)A Perfect Storm: Retail Is a Buy, on Sep 02;
    3)Will the Energy Exodus Fuel a Consumer Stock Frenzy? on Sep 11;
    4)Time to Look At Conservative Growth Stocks, on Sep 22;
    and my personal favorite!
    5)9 Reasons Why We Are Close to, If Not Past, the Bottom, on Sep 28.
    Note that in one of his articles he admits to owning Fannie Mae (FMN) as it fell under conservatorship. I'm not sure about this guy.
    Reply
  •  
    Oct 11 06:00 PM
    Bankers hate gold Governments hate gold. They hate it because it is and always has been money. In good times, it's the rich mans idolatry. But in times of insecurity, it's everymans agreed form of real money, for one simple reason. Unlike FIAT currency, it can't be printed, it has to be mined, at considerable cost. It has been money culturally for thousands of years. The only difference is how many pieces of paper you're willing to trade it for.

    You predict gold will fall, and it may. But your prediction is correlation to other commodities, which have industrial or consumptive value, that of course are tradeable for those pieces of paper, and in hard times, supply exceeds demand. Every governments response to such circumstance is the same. Print more paper to make people feel wealthy so they borrow and spend. But human behavior is different than that. In deflationary times, people avoid debt, consume less, and spend more time with family. Good for humanity, bad for economy.

    The problem is, over time, the public grows to mistrust governments everywhere who use the printing press as a solution to bail out the corrupt. Gold is the one thing that equalizes the equation of citizens against their government. That's why it was illegal to own in the free USA for so many years.

    Yes, governments through their central banks, because they know that as nation to nation, just as citizen to government, gold is money. It's why the Nazi's robbed very central bank in WW2. DO you think the Swiss were going to make tanks and ship them to Germany for marks?

    Nope. Only gold shines in hard times.

    There are times when I may choose not to go long gold, but I would NEVER short it. (neither would I short energy or food). Step aside if you think it is overvalued. But shorting any of these 3 is Russian roulette. It gold falls to 800, I'm bying. I'll buy more at 750. At 650, I'll gladly trade all my dollars in for gold. Because the government always responds to deflation the same way. print print print print
    Reply
  •  
    Oct 11 06:09 PM
    As "Not Sure" detailed so well, the author is a contrary indicator, and I'm looking forward to the rise in PM value. Thanks in advance, AB.
    Reply
  •  
    Oct 11 06:28 PM
    If gold isn't of value then why after the Great Depression did the US government pass the Gold Reserve Act on Jan. 30, 1934. It prohibited personal gold ownership and pegged the US currency to gold. Alan must have studied Keynesian economics. Our major economic meltdowns should be a clear indication that Keynes was wrong! And, you seem to have neglected to note that in 1932 and 1966 1 ounce of gold had a 1 to 1 ratio in value with the DOW. Hold your dollars, and I will laugh as your wealth disappears over the coming months and years.
    Reply
  •  
    Oct 11 06:32 PM
    By all means, sell off your gold and bring the price down for me. I'd love it....
    Reply
  •  
    Oct 11 06:44 PM

    Gold is definitely a safe haven, may or may not be an inflation hedge. What asset class you can invest in today’s market – not stocks, not bonds, not real estate, not copper or oil – so gold is the only thing left. Gold has withstood the test of time as a store of value and as a means of trade/currency.

    Deflation will hit a lot of asset classes – but all the “fiat’ money will have to find a home.
    In times like these gold will thrive. Author’s essence of the argument is wrong. Recent downward pressure on gold prices (including Friday) is due to redemptions – the same hedge funds etc were levered into gold.

    Gold is not a sucker’s bet it is the smart choice – diversification, risk aversion.

    Yes buy gold, most analysts suggest 5-10% of your portfolio should be gold- in these times you should actually be over weight in gold.
    Reply
  •  
    Oct 11 07:04 PM
    Sigh ... once again an economics major lets his education dull his wits:

    1970 median house in dollars $17,000
    1970 gold in dollars $38
    1970 house priced in gold: 447+ oz

    2000 median house in dollars $119,000
    2000 gold in dollars $279
    2000 house in gold: 426+ oz

    2008 median house in dollars $219,000
    2008 gold in dollars $800 (I rounded down a bit)
    2008 house in gold: 273+ oz

    Based on the above FACTS regarding the relative values of gold and the dollar anyone with a functioning brain cell left in their head would have to conclude that:
    Reply
  •  
    Oct 11 07:04 PM
    GOLD IS A STORE OF VALUE!

    (at least better than the dollar has proven to be)
    Reply
  •  
    Oct 11 07:06 PM
    If I have 450 oz of gold I bet I can exchange it for a house.

    Not so if I have $17,000
    Reply
  •  
    Oct 11 07:10 PM
    But don't let silly little things like historical facts get in the way of your debt-based theories.

    Those dollar bills in your wallet will buy just as much 10 years from now as they do today.
    Reply
  •  
    Oct 11 07:15 PM
    Yeah, sell all of your gold and bring down the gold price for me. I am ready to buy some.
    Reply
  •  
    Oct 11 07:47 PM
    Why do you start your graphs at the end of 1978? Any analysis of gold price over time should start in 1972. That was when the modern monetary system was established. The runup in gold is much more severe when you look at it like that. You look like a nice young man. If you are going to be an analyst, you need to learn to control your own biases and look at data objectively and ask the right questions.

    That being said, I just sold all my gold since I am guessing that we are in a deflationary period right now. Historically, the first thing that happens in a deflation is that money "disappears" (ie is horded). I believe that this is what is happening at the retail level with gold and at the banking level with US dollars.

    The growth in the money supply is massive right now. It is not leading to rises in consumer prices because the banks are hoarding money. If Paulson and company don't have a plan to get all that money back we could be in for a severe inflationary shock once money gets flowing again.

    If I don't see the monetary base dropping when credit starts flowing again I'll be back into gold all the way.
    Reply
  •  
    Oct 11 08:10 PM
    To all of you who pointed out that I have had some bad calls lately, I have to agree (and have done so publicly). I believe that if you were to review my entire list of contributions, though, you would see that I get it right more often than not. Click back to what I was saying from August until March. I have also highlighted several stocks that were acquired over the past year or so. Additionally, I have identified Financial longs that have increased in value substantially this year. No, I don't claim to be an oracle.

    Gary D, your accusation that I am altering the charts to fulfill my own biases is wrong. Thanks for calling me young, though, as I don't feel so young at 43. My database doesn't allow more than 30 years. Ultimately, as you say, gold could rise again, but the game plan now is indeed deflation.
    Reply
  •  
    Oct 11 08:29 PM
    Alan, does your study include the Austrian School? It appears not. The definition of inflation has to do with money not prices. prices are the symptom (consumer goods and/or asset classes). The disease is "monetary policy" once also known as "debasement"... chase
    Reply
  •  
    Oct 11 08:51 PM
    I suppose the problem with the Austrians is that if their policies were adopted, they would put themselves out of business as opposed to the Keynesians who will eventually put everyone else out of business.
    Reply
  •  
    Oct 11 08:52 PM
    Keynes said "In the long run we are all dead." Only partially correct, he is dead but we aren't.
    Reply
  •  
    Oct 11 09:01 PM
    I'm surprised that many here think that the price of Gold has increased, when in reality it's the U.S. $ that has lost it's value. Gold & Silver are real money, the U.S. $ is a fiat currency that is on it's way to collapse, Gold will hit 1200.00 in the near future, only because the U.S $ will take a dive soon.
    Reply
  •  
    Oct 11 09:28 PM
    SmartyPants, I don't believe your statement is correct. If one were to invest in T-bills every year, this is what the comparison looks like compared to gold futures:

    30Yrs: gold up 4.6%, t-bills median return 5.6%
    20Yrs: gold up 3.8%, t-bills median return 4.9%
    15 years: gold up 5.9%, t-bills median return 4.8%

    So, over a very long time-frame, riskless T-Bills have proven to be superior. If one looks at shorter time-frames, which obviously look good due to the run-up over the past several years, the difference isn't so compelling.
    Reply
  •  
    Oct 11 09:30 PM
    User 55947, I have read the works of Ludwig von Mises, if that is what you are asking. The world has changed greatly. What I think many of you fail to realize is that NO currency is linked to gold any longer - everyone prints fiat money. Someone said that the Pound and the Dollar will get hammered and the Euro and the Yen will fare poorly too. What currency then will appreciate? Maybe Iceland's?
    Reply
  •  
    Oct 11 09:44 PM
    You may be right in the short run, but in the longer term you are incorrect. The logic is much simpler than most make it out to be. In the later stage of credit bubbles all assets inflate massively. That includes stocks, bonds, real estate, and finally commodities. Gold rides up this inflationary wave. Then the credit bubble pops and all assets begin to deflate. Initially panicked investors seeking to perserve wealth flee into cash and short term treasuries. That causes the reserve currency of the world to rise. That is where we are now in the credit/debt cycle. Gold gets sold like everything else as there is a "dash for cash". The next phase is when the central banks respond by trying to reinflate by putting the printing presses in overdrive. That strategy doesn't work. In no credit bubble in history has that strategy worked, yet it doesn't stop the bankers from trying. At that point the value of the currency is destroyed and the last paper assets, cash and short term treasuries lost their ability to store value. Then the flight into gold ensues. That is how it has happened in every asset bubble in history. Make no mistake - when the flight into treasuries ends the dollar will crater and lose its status as the reserve currency of the world.
    Reply
  •  
    Oct 11 09:49 PM
    Brewtul, you make a great point. I certainly didn't mean to imply that gold is permanently impaired (though it may be). The point I was addressing is the one you concede - it is going to get hammered. I am curious how you address the notion that this is not just a U.S. issue but rather a global issue - the entire G-7 and beyond. Classical economic theory assumes that it is just one nation.