The Case Against The Case Against Gold

October 11, 2012  In: Seeking Alpa.

 

By Dr Duru

Disclosure: I am long GLD, GG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

When the Federal Reserve promises to print money for an indefinite amount of time, it seems obvious to put trashy cash into assets that cannot be so easily manufactured. This shift allows investors to gain the advantage of relative supply differentials. Gold (GLD) should be at least one of those assets. Yet, the gold bear arguments persist, mainly because gold seems like money from the "ignorant days" when civilization had not yet figured out how to breathe value into paper out of sheer will. In all my years of writing about gold, I have rarely referenced specific gold bear articles or posts, but I found myself compelled to break with tradition after reading a recent piece from Zacks Investment Research called "The Case Against Gold In Today's Market."
Based on a quick web search, I noticed that many gold bears have written pieces with the same or similar titles. Clearly, there are common themes that embed this piece in a well-established tradition of hatred for gold. Seeking Alpha contributor Doug Eberhardt has also taken umbrage with this piece in his Instablog, and his rebuttal makes for a great read (he also posts the entire Zacks article). Eberhardt breaks things down in fine detail, point-by-point, adding lots of color. My response mainly focuses on noting how the gold bear arguments themselves demonstrate that gold is not nearly as different from other assets as the Zacks pieces suggests.
First of all, the title is a bit strange. It implies that the author thinks that markets do exist where a good case can be made for gold. In fact, the author notes that "historically, gold has been known as an effective store of value." I would have thought such a statement would end the entire debate. Instead of course there are caveats: "…but this has gone in and out of favor…The only thing that has intrinsically changed is the perception of what the future might bring." The last time I checked, bonds fall in and out of favor as well, with valuations fluctuating along with perceptions about the future. Secular and cyclical rallies, dips, and crashes are innate features of the markets we use to trade assets. Arguing that gold has a different degree of troughs and heights does not put it in a class alone. The rest of the article is full of these kinds of false differences (some repetitive). I use a problem vs. solution/comment format to highlight most of my remaining rebuttal.
Problem: "Typically, when people fear the causes of inflation, currency debasement or other potential economic downfalls, many feel it is a good time to invest in gold. Not me."
Comment: I specifically like gold as a hedge against the devaluation of the currency. The author's comments establish his position as anti-gold, but left me wondering whether this is a time when he would recommend buying gold.
Problem: "I don't see gold as a financial asset. Gold doesn't generate any income, and it doesn't pay a dividend. Thus I view it not as an investment but as a speculation."
Solution: For dividends, an investor can buy stock in a gold miner. My favorite gold miner, Goldcorp Inc. (GG), currently pays 1.2%. This may seem like trading 6 for a half dozen. However, if I look at Goldcorp's gold as simply a product that gets bought and sold according to the supplies and demands of the market, then fundamentalists can analyze it just as well as any company. Very few companies sell products that last for generations. Gold has outlasted civilizations.
Problem: "Gold's value completely depends on other people to act in a specific manner for it to go up in price."
Comment: People make markets. People must respond to bearish and bullish arguments to make any price move. Gold is no different. Stocks also depend on other people to act in a specific manner for it to go up in price. Other people must believe in the fundamentals, the technicals, and/or the theme to buy the stock. I see no difference between that and gold.
Problem: "Right now, countries around the world are trying to devalue their currency in order to improve exports and fight high unemployment. To some degree, real assets like gold should increase in price, but this idea is wholly dependent on people responding in a specific way to its inherent value, even when there's no fundamental reason to do so…The high price of gold is completely reliant on people's preferences. If those preferences change, the price of gold could fall dramatically."
Comment: This argument almost seems to contradict itself. This debasement has a potential impact on price levels throughout the economy, so it is enough of a fundamental reason to consider gold. Given gold's relatively fixed supply, its value in paper currency fundamentally increases with the amount of paper that spreads across the land. The author surprisingly admits that gold is "a real asset," but seems reluctant to accept that these debasements are a fundamental prop for price levels (including stocks!). Just like stocks, bonds, and land, people must respond in a specific way for value to get created: believe in the story of future earnings and cash flows, believe in the solvency of a company or country, believe that more and more people will find the location of your property attractive, etc. … If people's preferences for the multiples paid for earnings, for risk tolerances, or for location change, then, yes, even these assets will change in value.
Problem: "Gold is something you can hold in your hand and it looks very pretty. Buying gold is very much like buying an antique or an expensive piece of artwork."
Solution: As they say, "don't hate me because I'm beautiful." Buying gold is indeed like an antique or piece of art…except that no one uses those items as currency. The government can of course declare they have monetary value and enforce that value, but that is a flaw of any manufactured item trying to pass itself as currency, especially for pieces of paper. Gold requires no such permission. I think that gold's utility as jewelry is an added bonus to its appeal, not a detraction.
Problem: "My experience in investing has taught me that the asset class that is the hardest to own tends to perform the best. The one that's easiest, the one everyone is rushing towards, tends not to do as well."
Comment: Gold is NOT so easy to own, specifically because there are so many bears out there who are eager to see it crash. Central banks pretend to hate it even as they pile it up in reserves. The easy thing to own is paper currency. Our employers pay us with paper currency every day. With the S&P 500 at 5-year highs and bond prices at historic highs (yields at historic lows), are these assets easy to own now or hard to own? According to the logic of "anything that goes up must be too expensive," one might be tempted to dump stocks and bonds here…but of course that is not the advice given in this piece.
Problem: "The same way trees don't continually grow up into the sky, the price of gold will not continue to rise indefinitely."
Comment: This is a strange argument against gold when gold has indeed continued to rise over the long-term, generations even. I sure hope no one buys stocks and bonds because of a belief in their ability to rise indefinitely.
Problem: "Historically, when the price of gold crashes, it crashes fast."
Comment: Yes, exclude the modern day crashes in 1987, 1998, 2000, 2008, 2009, and stocks never crash fast. If gold ever crashes again, I will thank my lucky stars that I can grab it again so cheap. I sure did not buy enough back in 2008.
Problem: "In short, gold prices are being driven by 'animal spirits,' not any sort of evaluation of its intrinsic value."
Solution: If a notion of intrinsic value helps you sleep better at night, I suggest reading "Justifying Gold Prices From A Money Creation Perspective." It is a great reminder of why gold is "so high." The article also suggests, rightly so, that gold remains undervalued and under-appreciated.
Problem: "…recognize gold as something other than an investment - it is a speculation."
Response: Call it what you want, as long as gold is a store of value and a monetary unit, I am good with it.
Problem: "When everyone who has been parking their assets in gold decides it would be more productive to go into equities or other investments, the price of gold will reverse itself. Once people decide they want to stop buying the pretty rock, the price of gold will fall."
Response: This argument is a tautology. It even applies to bonds: 'When everyone who has been parking their assets in bonds decides it would more productive to go into equities or other investments, the price of bonds will reverse themselves.' Yet, even though this argument is true, no one would use it as a principle for avoiding bonds as an investment.
Problem: "What is driving the price of gold is not fundamentals, not income streams, but fluctuations and perceptions about expectations. It's essentially a speculation on mass psychology, and that, quite simply, cannot be predicted."
Response: Actually, the Federal Reserve has now made its printing rules very predictable, so I will be daring and predict gold will tend to go higher as this printing machine revs up. If the economy, GDP, stocks, and bonds were so predictable, we would all be millionaires by now.
I conclude by looking at the current setup for gold. The breakout from August 31st is well intact. While I did not interpret this year's Jackson Hole confab as a guarantee for QE3 in September, clearly a lot of people did. Gold was the first mover with stocks waiting a full week before experiencing its own breakout (to new 52-week and near 5-year highs). Just as stocks have stalled out at highs of the year, gold has stalled at its high for the year. I consider this point a rest stop for gold.
(click to enlarge)
Gold's wild ride since the last peak
Source: FreeStockCharts.com