Wednesday, February 10, 2010

Gold Goes Nowhere. Literally

Actually, the thing about gold is that, unlike oil or even platinum, it mostly goes nowhere. It's more boring than watching grass grow, because grass actually grows. The classical reason to own gold is simply to preserve purchasing power. Gold falls out of favor when capital can reliably be used to create additional purchasing power. The easy time to do that was when Volcker made interest rates soar well above declining inflation. Who needed gold then? No one, and a huge bear market in gold ensued, with massive loss of purchasing power from peak prices even through to today's nominal higher prices. Over historical periods of time, gold prices have tracked general inflation levels.

This is the core argument for long-term buy and hold gold investing.

Now, to trading of gold.

Newcomers to gold investing/speculating are feeling glum and worried. My new most favorite precious metals technician, Clive Maund (, with interesting recent free material on the site), is quite bearish short-term on the precious metals, with gold the least bad amongst them in his view; and he makes a living recommending such things as small gold mining stocks. Optimism on the anti-gold asset (the dollar) is at a 15-month high, per reports today in a poll of its users in the Bloomberg Professional Global Confidence Index.

Meanwhile, the headlines at the WSJ and other business publications are reporting, perhaps with more than a touch of schadenfreude, that the king of the subprime shorts, John Paulson, has mistimed the gold market significantly. Here is one of several articles on the subject: John Paulson Gold Fund Said to Tumble 14% in Its First Month. Mr. Paulson has $250 million of his own money in the fund. Minimum investment duration is 3 years. The fund is, I believe, the single largest holder of the ETF known as "GLD".

I too want to be optimistic on Larry Kudlow's "King Dollar" and thus bearish on or simply uninterested in gold, which was my attitude from 1980 to 2001. Everything changed in that regard after 9/11/2001.

We learned that the bin Laden goal was economic ruin of the U. S. He has not failed.

We all want to pinch ourselves and simply choose not to believe that our rich country has created a fiscal nightmare. Out of plenty has come a California using scrip to pay its bills. Phony accounting rules in Big Finance and in D. C. We are given the Big Lie that the Federal deficit is only 60% of GDP, and won't hit a Greece-like level for 10 years or so. Ha! Why don't they try putting Fannie/Freddie on budget, plus a realistic estimate of the coming FDIC and FHA bailouts? (Plus smaller stuff such as unrealized losses on TARP etc.)

And let us recall that all workers get a Federal statement saying what their Social Security benefits will be. Where is the funding for those benefits?

Dollar optimism?

No. It's simply Euro and yen pessimism.

For now, the dollar may be less flawed than the above fiatsco currencies. But gold just sits there. It has no unfunded liabilities. Its supply cannot be gunned by a Fed that wants to reward its buddies who own the bonds of Big Finance companies. Gold rose to the level of the Dow, not the current level of the S&P 500, during the reign of the last Democratic president whose focus was jobs, jobs and jobs and who had an overtly easy-money Fed chairman (Jimmy Carter, till he was forced to install Volcker). Currently gold's price is closely tracking that of the S&P 500.

With the political imperative in the White House and Capitol Hill to retain power via money printing and pushing for economic growth, we can assume that just as in 1933-6 and 1977-79, price inflation is desired if it will bring higher employment levels (so the thinking goes, that it).

Deflationists such as Gary Shilling have great points, and Treasuries can rise in price even as inflation heads from around 1% to 3%, but until the Fed actually gets Volcker-like, I suspect that the articles about troubles in Paulson gold-fund-land are more likely than not signaling a bottoming action in gold prices. You should however worry if a year or three from now you are long gold and you start seeing headlines about what a genius Mr. Paulson has again been proven to be because his fund is up so much.

Most likely Mr. Paulson is trying to preserve his purchasing power via the anti-dollar, in the true hedgie spirit.

It is at core a conservative strategy. However, the Paulson fund buys stocks of producing companies as well as GLD. I am yet more conservative. I believe in going only for refined gold, 0.9999 fine etc., and not trusting that there is any value to gold trapped underground in ore form. That gold may go nowhere and may never be able to profitably extracted, and the company owning the mine may still have an overpriced stock even if it can remove the gold profitably.

With all the above said, gold is being advertised heavily on bubblevision, so there are clearly some cross-currents that to a skeptic raise the question of whether it is "too" popular right now.

Given a 15-month high in dollar optimism and a 15% sell-off in gold in 2 months to a level just above its 2008 highs, and a price only 25% above its prior cycle high price 30 years and one month ago, the bubblevision ads are not enough to scare me into selling. Gold stocks are not cocktail party talk, a better warning sign of a major top.

Along with John Paulson, Paul Tudor Jones and David Einhorn, I shall sit with a modest portion of my financial assets with the inert perpetually shiny metal and root for all the other assets to do so well that the gold does poorly.

Copyright (C) Long Lake LLC 2010

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