All That Glitters...

December 3, 2009

Gold is supposed to be the great hedge against inflation, so economists are at a bit of a loss to explain why its value has risen so high recently with deflation being the most recent concern.

I like gold. It's pretty, heavy, and it makes wonderful jewelry (just ask my wife). For adornment and certain industrial applications, it can't be beat. But as an investment, it leaves much to be desired and the current speculative mania driving the price to a record $1150 an ounce (up 32% this year, as of this writing), just begs to be analyzed.

Much of history has been driven by man's almost universal and obsessive desire for this metal. You might read Peter Bernstein's excellent The Power of Gold to get an economist's view of the swath that gold has cut through man's recorded history.

Now I have no idea when the value of gold expressed in dollars is going to go up or down, how high or low, any more than anyone else. But I can say, without fear of contradiction, that it has and will go up and down….because everything in man's economy does. And so far gravity has not been nullified, at least not permanently. We're just not smart enough (yet?) to predict these cycles, so we diversify and hedge and keep our powder dry.

Gold is supposed to be the great hedge against inflation, so economists are at a bit of a loss to explain why it has risen so high recently with deflation being the most recent concern. Are speculators looking forward to the time when the world economy rights itself and the trillions with which governments around the world have stimulated the economy catches hold for a round of inflation?

Or is it the rising economies of China and especially India that are driving this train? Indian women have worn their personal assets in gold jewelry for generations and now they can afford to buy more…a lot more.

Many economists think it is the weakness of the dollar that lies at the heart of the phenomena. Too much government debt causes debt holders to get nervous and start looking for safer harbors; for example, the Chinese, our number one creditors. They pressed President Obama to reverse our deficit trend on his recent Asian tour, so he is beholden to try as he might.

If we rise above emotion ("Good as gold!"), gold has little intrinsic value. In a pinch, you can't eat it or drink it. It does not create wealth, and so hoarding as an end is meaningless. Its value is psychological and we are playing an expensive game of chicken with other speculators when we buy or sell it or its surrogates, like gold mining shares. So who will blink first?

Because gold prices have gotten so high, a lot of mothballed gold mines have been brought back into production and we will be seeing the effect of a growing supply increase the downward pressure on gold as the world economy recovers and then starts to grow. And a healthy economy is Kryptonite for gold value.

But being the lemming-like folks we are, when something starts jumping in value, that's when we buy, only to become disillusioned later and sell, also at the wrong time, for a loss. We buy high and sell low. Does anyone else see Warren Buffet jumping in now? I think not.

There is some justification for speculating in some commodities other than for sheer foolishness. If you are a farmer, it is prudent to try to offset nature's vicissitudes, and the subsequent instability of crop prices with commodity hedges. It can have a business purpose if done carefully without getting emotional. For example, Southwest airlines almost alone made a profit last year because they hedged the price of oil in advance, softening the pain as oil temporarily bumped to $140 per barrel. This play is something on to which the other airlines are now just catching.

Also consider that gold in lieu of money, or even as a backing for money, is an anachronism because it is physically unwieldy and there is just not enough of it to allow any economy to grow. Only the liquidity of paper, or numbers in a computer, can allow rapid growth. Of course, as we have recently learned to our chagrin, that process has to be watched and tended or “Burn on us,” as my kids used to say.

There is a need for a universal, stable money system. Serially, all so far have failed and we're struggling to protect the current standard, the Almighty Dollar. But historically gold has only led those who chased it into a ditch. In the 19th century, Sir Benjamin Disraeli, the then Prime Minister of Great Britain said, "Gold is a consequence, not a cause." And that's about right. This is the reason that experts recommend putting maybe 5% of your assets into it, when this particular bubble bursts.

And in the meantime, if you can afford it, Christmas is coming up and I bet someone in your life would love a shiny, fun new bauble. Happy shopping.