A friend of mine and I are having a bit of a debate as to why it is a good idea to possess at least some gold, and more importantly, why and how gold has an important relationship with the overall status of the economy. This is the e-mail he sent me recently. I was hoping someone could address his arguments within these forums. Also, he is a personal finance advisor (or whatever one calls it; he manages people’s investments, in other words), so he is in some ways speaking from that perspective. Thanks.
The e-mail starts here:
"“A gold mine is a hole in the ground with a liar on top” - Mark Twain
I am excited to hear your perspective on this matter.
Here is mine.
Consider the gold rush of the late 1970s and early 1980 when inflation was rising rapidly. On the New York Mercantile Exchange, gold prices reached a then-record $850/ounce, and by the time prices peaked in January 1980, the commodity seemed like a can’t-miss investment. But gold prices then dropped for 235 months -that’s almost 20 years - finally bottoming out at $235/ounce in July 1999. It took another 71/2 years for prices to return to their January 1980 high.
Can you imagine waiting 27 years to recoup your initial investment? Worse yet, gold doesn’t pay dividends or interest. And although stocks can split, gold can’t. As for rising inflation, gold is no guarantee. There is a PPT I need to give to show you. Please remind me. It examines Brazil and other high inflationary economies over a long period and shows that the stock market is a much better hedge for inflation and a weak currency by far far far. Anyways, if gold were a guarantee of protection then gold and interest rates would rise at the same time (positive correlation). But the two are correlated only some of the time. If you like at the cahrt pasted in the email you see that gold is hardly a hedge against inflation. In January 1979 through December 1984 the CPI rose 7.5% annually. Gold only rose 3.7% each year.
Gold will not necessarily protect you from a weak dollar, either. A weak dollar occurs when the value of the U.S. dollar declines in value when compared to a foreign currency. When this happens some stock up on gold because they “believe” gold and the dollar are inversely correlated. But that is not the case. Over the past 40 years gold moved in the opposite direction of the dollar only 20% of the time, according to Bloomberg. That’s hardly a sure bet. This is not to say never own gold, but a low cost diversified portfolio is much better.
Please hold me to the other talking points related to Austrian Economics and why the US Gov. confiscated gold."
Anyway, that’s the e-mail. I would appreciate any imput/counter arguments to this.
Your friend’s email is typical. I’ll address it piece by piece.
a) What is the relevance of any of this? Why is this 20 year span of time the one we’re looking at? Why not 1990 to 2010? Why not 1796 to 1816? Could it be that he’s just choosing to focus on a timeframe that agrees with his conjecture? (Sharpshooter fallacy)
c) He doesn’t seem to offer any reasoning as to why the price changed as it did. I wonder why.
This is true. That is why gold is not really (nor should it be considered) an “investment.” Gold bullion is a store of value. I went into this here.
Well hell, if you want to go that far, there’s no guarantees for virtually anything. Funny he would include a quote from a prominant quotable figure of a past century…isn’t there another one who said something about only two things being certain?
Sure there’s no guarantees. But I’m quite interested in hearing this know-it-all’s alternative. A gram of gold says it’s the stock market.
Wow I’m good.
“high inflationary economies”…you mean like Zimbabwe? Gold seems to be pretty important for those people. I’d be interested to see this powerpoint he speaks of. My guess is it’s filled with more of the same fallacies, of cherry-picking data and ignoring overall reality.
a) Again, no one said anything about “guarantee”. This is what you call a “straw man” argument. (Yet another logical fallacy.)
b) What? That doesn’t even make sense. Think about it. If interest rates rise, people are more likely to not borrow or spend their money. It pays them more to save or invest it…money is getting more valuable. If the value of the dollar goes up, why would the price of gold (measured in those dollars) also go up? As the dollar becomes more valuable, it would take less of those dollars to buy the same amount of gold as before…that is, the price of gold (in dollars) would go down. …Which is the exact opposite of what he’s claiming should happen.
It’s funny he doesn’t bother to look at the data for the years he’s even using. How did the Fed purport to break the back of the inflation of the 1970s? Paul Volker raised interest rates to 20%. Why? Because it is the Fed’s way of doing the opposite of inflating (i.e. devaluing) the currency. And sure enough, what did we see happen? Did inflation rates persist at double digits? Or did they drop precipitously?
I’d like to see this chart. Going by the numbers here and here, if you take the percentage increase from the annual average of CPI, year to year from 1979 through 1984, and average them, the result is 7.5. However, if you do the same thing with the annual average gold price from each of those years and average out those percentage deltas, the result is 10.88%…as in CPI rose an average of 7.5% annually and gold rose an average of 10.88%…meaning in fact the exact opposite of what he’s saying is supported by the data.
I’d be interested to see what kind of math tomfoolery was done to achieve his false result that just so happens to go along with his premise.
Um. Kind of. A weak dollar is literally one that doesn’t buy very much…of anything…not just other currencies. So in reality, a dollar is weaker when it takes more dollars to buy the same thing as yesterday. If you’re trying to buy another currency, fine. But other currencies are not the only thing that a dollar is measured in terms of (or that it is used to buy).
You have to remember that a price is nothing more than a ratio…the value of commodity x versus the value of commodity y. We just have a habit of measuring things in terms of currencies because it’s a hell of a lot easier than anything else. But that doesn’t mean that a loaf of bread doesn’t have a market price in terms of apples. Just because we say a certain watch costs $20, that doesn’t mean you couldn’t buy the same watch by trading something other than dollars.
Something declines in value when there is either a net increase in the quantity supplied or a net decrease in the quantity demanded.
Think about it. If what he is saying were actually true, that would mean that even if prices for the goods you buy continued to go down every single day — meaning you could buy more and more stuff with the same amount of money…i.e. your dollar was getting stronger — according to him your dollar would actually be “getting weaker” just because a random basket of other currencies happened to be getting stronger at a faster rate.
Sure, the dollar may be weaker in terms of those currencies…but it’s stronger in terms of everything else. And what’s more, what are you more interested in buying with your dollars? Bread, heat, entertainment…goods and services? Or other currencies?
Again, the point is, a commodity (yes, this includes money itself) has a price in terms of all other commodities (i.e. goods and services)…not just other commodities of like kind. Just because a price in terms of one thing goes up or down, it doesn’t automatically mean the overall value of one or the other has gone down.
Whether people believe this or not is irrelevant. The fact of the matter is gold has a 5000 year historical track record of being universally recognizable, useful, and valuable. It has maintained its value better than virtually any other substance (of course for purposes here, you can throw silver in as well). It’s not about being inversely correlated with anything. It’s about gold being a better store of value than virtually anything else…especially fiat currency. People buy gold typically when they are fearful of their fiat currency losing its value. And in the long run, they’re always right.
Again, what’s the significance of this timeframe? Why not over the past 50 years? Or 100? Why not over the life of the U.S. currency? Or at least the current Federal Reserve Note?
That’s like saying: “This is not to say never to ride in a car, but a 777 jet airliner is much better.” It depends on what your goals are.
OK, Thank you for sending me the e-mail with a link to all of those resources, but I am still wondering about my friend’s statements. For instance, he talks about how Gold as an investment is rather horrible because based on what he said, gold has not really even beaten inflation, etc. Could you address his talking points a little bit more specifically?
Thank you so much for such a comprehensive (yet amazingly concise) answer. I appreciate you taking the time to tackle this. I think one thing should definitely be stated about my friend: He is speaking from the perspective of someone who is focused on trying to help other people (mostly upper middle class professionals) achieve a healthy retirement, so in that context I just want to stress that he isn’t a “know-it-all”, but rather someone who is…very unaccustomed to Austrian Economics and its perspective on gold. Also, because of that, I think he makes very good choices for people’s wealth WITHIN the framework that he, up to this point, has had.
It’s getting a bit late for me to write any more on this, but I will definitely be back this weekend to bounce some more ideas off of you.
-Gold is not purely a hedge against inflation, it has performed quite well in times of deflation as well. Gold is a hedge against political and Central bank mismanagement, gold does well in times of distress, regardless if there is inflation or deflation. See Mish’s blog for more info(use the search engine): http://globaleconomicanalysis.blogspot.com/
Understand were your friend is coming from. If he’s an investment manager his whole self worth and occupation, is trapped in the idea that he can produce returns on investment for a nominal fee(~3%). Gold has kicked the ever living shit out of these clowns over the last 10 years, of course they are going to continue to try and propagate the lie that investing in markets is the best way to way to get a return on your investment. When things are going well and credit is loose, its easy to dabble in the market, but we are in a different paradigm now. A paradigm that demands an investor be more cautious and defensive. It demands that gold be taken seriously as a hedge against major tailwind events
In nominal terms the market always beats inflation, in the Weimer Republic, their stock market skyrocketed during the hyper inflationary period. In nominal terms the stock market rose some 20,000%, but in relation to the price of gold it was at 1/10 its pre war value. It’s about value and purchasing power not nominal returns in relation to monetary devaluation.
