Tuesday, December 15, 2009

Mainstream Thinking as Contrary Indicators: Unemployment and Gold

In its current above-the fold online article Poll Reveals Depth and Trauma of Joblessness in U.S., the New York Times may be ringing a bell for the (sort of) end of the jobless recovery and the (sort of) beginning of the "jobful" recovery. To date, there has been much more diminution of firings/lay-offs than there has been new hiring. Basic economic knowledge says that can only take business so far (and it takes it not very far). A year ago, the MSM was full of pictures of people in bread lines from the 1930s. Now, two years after the Great Recession began with a whimper, it is a bit late for the Times to run this sort of story and have anyone think that it has any predictive value (not that there is anything wrong with the content of the story). Let the hiring begin!

The yang to the above yin is that I believe that small business is going to "under-hire" in this expansion because of such factors as healthcare reform mandates, assuming that a bill passes, along with significant state and Federal marginal income tax increases. Having been a small business owner at one point, happily with substantial ability to earn more or less income by working harder or less hard, I can verify that the current level and trend of marginal tax rates had a real effect on my work effort, expansion plans, etc. Thus I suspect there will be a bit of a Potemkin quality to the Dow and S&P 500 indices, wherein the companies comprising those indices will tend to have better business results than average for the economy.

I personally exited the stock market at Dow 13,000, 28 months ago. I resumed stock investing in a modest way this summer at Dow 8500 or so. But my heart was with gold, as regular readers know. Strong companies that have not been directly involved with credit creation look to be sensible investments on a multi-year basis, though in the context of what I believe to be an overvalued stock market on an asset and dividend-paying basis. (Reported earnings don't matter all that much, FYI, when assessing fair value to a minority investor in a publicly-owned company.)

That brings us to gold. Randall Forsyth has a poorly-argued screed against gold in Barron's online today titled Nostalgia for the Gold Standard is Misplaced. He gets it wrong early on by saying:

The fundamental force behind the surge in gold is, of course, the economic crisis from which we may (or may not) be emerging.

Not so. Gold started rising after 9/11 and briefly quadrupled from its 2001 low in early 2008. It then stagnated/digested its gains until as late as 2 months ago, when it broke out not due to the crisis but due to the zero interest rate recovery. Too much credit chasing too few real goods and services. In other words, financial speculation is back, as the Fed and the Feds have more or less successfully reflated without an intervening general deflation of the overall price level.

Forsyth concludes:

Impassioned adherents of the gold standard gloss over the inability to counter deflation. Modern democracies simply will not tolerate the Dickensian unemployment and suffering brought on by debt deflations, however, which is why the Federal Reserve was created during the Progressive Era that also had previously brought anti-trust laws and the beginnings of other government regulation of business.

What we gold investors say is that there is nothing inherent in modern democracy that requires excessive credit creation in the first place. Without that debt creation, there cannot be a debt deflation; and let us consider all the price inflation that has occurred since indexing of tax rates for inflation brought the Federal government larger and larger deficits (inter alia) in the early Reagan years and coincided with more and more debt/income in the private sector. In other words, modern policy is to print money. Helicopter Ben, remember? Keynesians still believe in the price illusion, strange though it is for this blog's sophisticated readers to believe. Give a worker a raise of 5% and have him/her pay 5-7% more for what he/she buys is supposed to make the worker happier than providing no raise and having what he/she buys drop 2% in price. Supposedly this deflation must be "fought" by printing money. But deflation in price is good for consumers. When the MSM brings out debt deflations as a straw man, hold onto your wallets. Inflation is in the works.

There are many, many good points to be made against investing in gold. As someone who came into his first investable money in 1979, I stayed away from gold until 2001. My focus was on growth and disinflation; stocks only till 1997-8, then stocks and bonds.

Putting the Times unemployment article together with the Barron's anti-gold article as representative of an important segment of Establishment New York thinking, here's one scenario to consider:

The economy picks up speed just as it did in 1975-6. Federal and Fed policy are pro-cyclical, as they were then. The Fed does its usual thing and does not raise rates until the unemployment rate has declined a good bit. Price increases pick up steam, and the same inflationary psychology not only of the Carter years but of 1936 return. P/E ratios for stocks fall; long-term interest rates do not fall; and investors go with the inflationary hedges based on "fundamentals" and strong, self-fulfilling chart patterns.

A final bit of history. Gold went from $35/ounce to over $700/ounce in ten years, from 1969-79. It then lost almost all its value vis-a-vis cash or long-term T-bonds in the intervening 20+ years. Timing is everything with this asset.

The NASDAQ index (IXIC) went up about 15 times from its October 1990 recession low to its March 2000 high.

If gold were to have a lesser, ten-fold move from its 2001 low to an upcoming high, that would take it to about $2500. This amount happens to roughly equal its inflation-adjusted high of 1980. But in a broader sense, since gold appears to be in some rough equilibrium with other financial assets, over many years, I suspect that it will rise roughly in line with the general price level (or fall less than any unexpected general decline in the price level).

In a world where "cash is trash" in that we know that even forgetting about taxes on interest, government policy is for inflation rates to exceed bank rates on cash, one can hold gold and forgo essentially no interest income, and one knows that Establishment thinking notwithstanding, gold is likely to be a monetary metal longer than Barron's is likely to have any influence.

So for me, having adequate gold reserves, some physical but mostly in ETFs (GTU preferably), provides speculative upside with a long-term buy-and-hold comfort level that I currently lack for the general stock market, cash, Treasuries, and real estate.

Copyright (C) Long Lake LLC 2009

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