(Gold) Hoarders, Buried Alive!

April 19, 2013

I reckon we’ve been talking about this here gold bubble in them thar hills for quite some time. Thankfully, the market gods have finally deigned to demonstrate exactly why we shouldn't be worshiping this particular golden calf. As of this writing, gold is down 27% from the highs it reached in September 2011. It fell 8% on Monday alone.

Rationales abound for gold’s recent descent: rumors of a Cyprus bailout-related gold selloff seem to be the leading culprit. But the sharp drop in gold might also have something to do with stocks being up more than 30% since its peak in late 2011, a fact particularly painful to gold bugs. The last gold slide occurred during the fall of pretty much everything in 2008, so at least they could feel better about that relatively brief spell of poor performance. More importantly to the tea-leaf readers, gold didn’t fall as hard as stocks did during the financial crisis. It even eked out a small gain in 2008 – one of 12 calendar years in a row of positive gains.

Surprisingly, the bank collapse in Cyprus and talk of depositor losses is the perfect environment for gold. Yet therein lies the problem, the greatest source of fear and confusion for gold hoarders : 

What 's Supposed to Be Good for Gold Hasn’t Been:

1) The Collapse of the U.S. Dollar

Although the dollar looked pretty weak for most of the 2000s (coming off a high value following the late 1990s boom,) things have turned around. The dollar drop has stabilized and is now slowly appreciating against many currencies.

2) Massive Inflation, Any Darn Day Now…

Surely, creating money out of thin air to buy busted mortgages and government debt is the last straw! When will such central bank shenanigans trigger double-digit inflation and losses for all investors except those smart enough to hoard gold?! 

Instead, the anti-gold, longer-term U.S. Treasury bonds continue to perform well as investors all over the world snap up their paltry yields.

The important thing to know about the Fed is this: they're creating money out of thin air to offset all of the money that's been destroyed out of thin air by our economy since 2007. Fortunately, this policy shouldn't be too difficult to reverse once the private sector begins borrowing aggressively again. 

To see proof that everything's essentially in balance in the universe, simply refer to our still-low inflation rates. If either force were out of whack, we’d have either big deflation or inflation. Good job (so far,) Ben Bernanke!

3) U.S. Debt Collapse

As the world’s biggest debtor, the United States must surely be on the road to default dangers of greeklike proportions. Yet so far, countries trying to pay their way out of debt are having a rougher go of it than the good ole U.S. of A. 

Can we continue to spend more than we make? Probably. In the very long run, we’ll need increased economic growth, higher taxes, and lower spending (similar to the 1990s,) but some countries can just get away with it. Japan has more than double our debt relative to GDP (and almost double the annual budget deficit), yet investors still lap up their sub-1% yield, ten-year government bonds – and Japan's actively trying to raise inflation! 

The U.S. government has been running deficits for decades (other than a brief spell  of surpluses in the late 1990s, brought on by a stronger economy and higher taxes). But America will grow. Even modest longer-term spending cuts and tax increases will get us back to a sustainable deficit.

4) General Economic Collapse

I’m not even sure how gold is supposed to go up during an economic slide (it hasn’t, historically) – but either way, the “Great Depression Ahead” seems to be a much longer shot than another economic boom.

5) Foreign Political Risk

The only legitimate use of gold (other than pretty trinkets and fillings) is by those poor souls that live in questionable countries plagued with a) confiscation of wealth; b) rampant inflation; c) devaluations; d) true economic panic; or e) runs on banks capable of creating actual depositor losses. 

Since these unfortunate bystanders have no easy path to owning Google stock, U.S. real estate, art and antiquities, U.S. Treasury bonds or even U.S. currency, investing in gold continues to make sense (but not at any price, as they're now learning).

There's only one asset class gold might beat over very long periods, and that's currency itself. And at current gold levels, it would be tough to even beat cash,  despite the drag of inflation. 

But currency is not an asset class. You don’t put dollars under a mattress. Dollars, by design, will go down in value. If they didn’t, we’d all hoard them. We're incentivized to CONVERT our dollars by paying for goods and services or investing, including bank deposits.

There's some truth in the rationale behind investment bubbles, including the stock mania of 2000 and the fliptastic real estate economy of 2005. The global economy is not so sound and money policy is loose. But like the other big bubbles, the investment – if you dare call gold an investment – got way, way ahead of the story. 

Remember  the MAXfunds Golden RULE: Those investing in gold will Really Underperform Likely Everything.