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| Worthy Notions: From the Editor |
Gold Bugs
By Dwight Cass
02/01/2005
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The list of ports in which to ride out the current economic storm grows ever shorter. The dollar has surrendered its status as the world’s most stable currency. The Treasury market remains seriously overvalued, and promises to inflict significant pain when interest rates finally rise. With cash and T-bonds under dark clouds, where can one fly when the time comes for a flight to quality?
The chic answer now is: “To gold!” With the yellow metal’s price ascending to near-20-year highs, investors who despair when reading their monthly financial statements are taking a closer look at the commodity once only embraced by survivalists and central bankers.
 This requires those individuals born before, say, 1970 to overcome the psychological resistance that comes from living through a 20-year bear market in gold. It also requires one to get comfortable operating in a commodity market in which the annual demand (about 4,000 tons per year) is so far outstripped by the available supply (147,000-plus tons) that only an agreement among large holders (the central banks) not to flood the market keeps it from tanking. Finally, it requires investors to unlearn all they have learned about the benefits of investing in productive assets, like companies.
Gold industry lobbyists and financiers are more than willing to help investors retool their outlook on gold while they busily devise new gold-based vehicles. The press is full of articles these days about how gold mutual funds have outperformed other assets in the past three years. More recently, an exchange-traded fund linked to gold debuted on the New York Stock Exchange; others are in the wings.
Of course, those who now tout gold as an investment usually do so with dramatically upward sloping graphs that show its performance since 2001, when it began to claw its way above the $250 to $260 level, rather than since 1980, when it cost $800 per ounce. A graph originating in 1980 would show a long, slow, painful slide downward in value over 20 years, followed by a small bounce at the end. One of the fundamental problems with gold is its habit of just lying there. It is inert. Unlike a commercial entity, it does not produce any value. The World Gold Council, a lobbying group, in a paper extolling gold as a tool to preserve wealth, writes, “Gold has consistently reverted to its historic purchasing power parity.” The council presumably means to portray this as an advantage. But of course it really means an ounce of gold in the distant past and an ounce today are equivalent in value.
The gold bugs also seek to position the metal as a hedge against a declining dollar, noting that it rises in value as the dollar declines (see graph). This is a grossly misleading tautology—anything that you use dollars to purchase will require more of them when the dollar falls. The price of gold, by this standard, is only a measure of the incompetence of U.S. fiscal policy, not of the metal’s growing value.For example, say you bought a Christmas fruitcake in Knightsbridge four years ago for £10, or about $16. (It’s not easy to find an example of a commodity as durable as gold.) You gave it to your parents that year; they gave it to your sister the next. It circulated among your cousins for two more seasons. Now it has landed back under your own tree. On your next trip to London, you return it to the store and get your £10 back—only now, you can convert that amount to $19. “An excellent investment!” cry the fruitcake boosters. “An obvious dollar hedge!”
(Those who object that, in fact, gold has risen in price in the past four years, while Christmas desserts have languished at £10, can replay the scenario between 1980 and 1984, when gold bears and fruitcake bulls ruled their respective markets.)
An investment in gold is really nothing more than a bet on supply and demand conditions, which, given the enormous overhang of supply controlled by producers and the whims of central bankers, is an extremely risky proposition. This commodity is no safe haven, it is merely a sandy hole in which to stick your head.
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