The media is on fire with pundits and purveyors of gold hawking the yellow stuff at every opportunity.
Jim Rogers, long-time commodities guru, has been pushing gold for some time now. Monex, Blanchard, Superior Gold Group and other gold brokers have been preaching the gospel of gold for quite awhile as well. Perhaps strangely, I remain unmoved. Despite one of the strongest bull markets in gold of the last century, I am content to leave the gold to the electricians, dentists, and jewelers as well as the speculators.
My antipathy for gold arises from several sources, starting with the fact that gold is non-interest bearing, pays no coupon or dividend, and has no maturity. Gold has few practical uses (electronics, aerospace, glassmaking) and those have been declining over the years as other technologies have become available.
Out of curiosity, I printed a chart of gold prices over the last 35 years. The chart shows that during the last 30 years there have been only two major opportunities to profit from gold ownership.
The first was the run-up of gold prices in the late 1970s that resulted from the inflation aftermath of the oil embargo, the financing of the Vietnam War in the 1960s, and aggressive fiscal stimulus from Presidents Johnson and Nixon.
President Ford gave us the “Whip Inflation Now” button, not a terribly effective antidote to inflationary pressures. President Carter brought in Paul Volcker to be Federal Reserve chairman late in his term when the inflation genie was long since out of the bottle. Gold “went vertical” in late 1979 and peaked at around $840 per ounce.
The price of gold peaked with my account agreements from one of the large gold brokers from television still unfinished on my desk. There were other distractions at the time and by the time I took another look at gold, prices were falling. Lucky break.
Between the two bull markets, from early 1980 until 2001, there were about 20 years of sideways drift. In early 1983 gold prices were around $500 per ounce and at the beginning of 2006 the price of gold was, again, around $500.
For over 20 years gold prices were a sideways “chop” with prices running between the high $200s on the low side and around $500 on the high side.
Furthermore, during the periods from 1990 to 1996 and 1998 to 2002, about one third of the intervening time period, prices were flat. The real price of gold, after taking account of inflation, fell during this time period.
For more than three decades gold has provided only two reasonable opportunities for significant appreciation.
In theory, money was there for the taking by playing the small price movements during the mid-1980s and mid-1990s. However, the range of the price action was relatively constrained and the time period was sufficiently short that the likelihood of the occasional gold trader profiting from the price movements was relatively low. Naturally, someone trading gold over this period could have lost money just as easily.
I am disturbed that otherwise knowledgeable investment pundits, advisers, and counselors would suggest that a twice-in-30-year’s opportunity should merit the attention of the individual investor. The essential problem with investments like gold is that they draw the attention of the investor from the remaining 95% of their portfolio.
Instead of focusing on prudently taking tax losses and reinvesting, upgrading in bond quality, improving call protection, and all of the myriad of mundane but productive activities of the well-informed investor, the introduction of gold in to a portfolio sucks the investor’s attention away from all else and towards the yellow stuff.
Focusing on gold detracts from sound management of your other investments and is a distraction to other, more assured, opportunities. It is this opportunity cost of gold that makes investing in gold so costly on a daily basis, while the threat of a quick 50% drop in price — like in 1980 — provides a potentially painful lesson of the grandest magnitude.
An example of the high opportunity cost of gold comes from the first of the two gold rallies of this lengthy time period. In the 1980s, many investors continued to try to find entry points to the gold market after the peak in prices in 1980, while the opportunity to buy a tax-exempt noncallable municipal with double-digit yields presented itself for a couple of years.
As investors clung to gold while its price was declining, municipal bond yields also fell, closing the window on one of the greatest opportunities to lock in astronomical long-term tax-exempt yields that could have been a source of ready cash flow for years and years.
In addition to occasionally savvy institutional speculators, gold also attracts a fringe that carries an apocalyptic view of the future. The anxiety these people share about the future of the economy, the country, and the world results in their elevation of gold to a status beyond a useful investment opportunity.
In any case, if the apocalypse comes, people will be bartering with things of true survival value like gasoline, canned food, water, and cigarettes; not something that you can’t eat, use practically, or tote around conveniently. How do I know? Just recall the Mad Max films.
Like recent oil discoveries, new gold discoveries could make gold appear a lot more abundant and a lot less precious in a hurry.
Gold strikes may be relatively rare, but, like oil, they cannot be assumed away. Improvements in technology that lower the cost of extracting gold can shift the price down very quickly as well. Additionally, the price of gold is self-correcting in that higher prices bring selling pressure.
That is equally true of stocks and bonds, except for one important distinction: the dividend-bearing stock and bond investor can ride out short periods of adverse price movement because these securities provide cash flow.
The arena of stock and bond holders is much larger and much less dominated by short-term speculators. The market environment of stocks and bonds, unlike gold, is much more aligned towards a philosophy of long-term investment, rather than short-term speculation and panic buying.
If the investor is looking for inflation protection, there are other, more reliable, investments offering inflation protection than gold. Treasury Inflation Protected securities provide cash flow and a transparent connection to inflation protection in that principal goes up step for step with CPI inflation in a mechanically transparent way (in other words you can model it). With TIPs, the investor is not held hostage to the whims of a cabal of covetous profit-seekers, but rather can offset inflation risk in a measured, diligent, way.
From an asset allocation standpoint, a small gold position, 1% to 5%, would provide a huge distraction and yet little potential favorable impact. Taking a larger exposure in gold, 5% to 20%, represents too much risk for most investors.
I do not begrudge other investors their opportunity for potential profits from the trading of gold. As for myself, I would rather spend my time chipping away at dividend-paying stocks, investment-grade municipal bonds, certificates of deposit, and other “boring” investments.
These have very low default probabilities, provide cash flow that can be used to buy food and gas, and can be modeled simply in Excel so that I have a very accurate idea of what my monthly cash flow will be. A conservative strategy may leave some money on the table, but you will know with near certainty that there will still be food on the table!
I am an agnostic on the direction of gold prices. I don’t know — and I don’t want to know — where it’s going. Ignorance, in my view, is not only bliss in this case, but it is also self-protective for my portfolio. There is one thing for certain in investment markets: Going vertical (the current price action on gold) works in both directions.
Investing in gold is not wrong; it’s just not my style.
Chris Mier is a strategist at Loop Capital Markets LLC.
