Interesting Gold Analysis From Some Respected Pros
Let me preface this article by stating that I am not a gold bug, or a conspiracy theorist, doomsday prepper, or anything of the sort. Rather than making investment decisions based on fearmongering, I try my best to gather all pertinent and logical information, from credible sources. Gold is starting to look interesting again, and this article will share some of the reasons why.
(for reference, the spot price of gold today, according to GoldPrice.org, is between $1230 and $1235 per ounce)
This summer I read a fascinating book by John Mauldin called Code Red. John has been writing about the global economy, and investment opportunities that arise, for at least the past 15 years. In Code Red John breaks down what is really going on in the world, the potential effects of central bank policies, and how an individual can position their portfolio to take advantage of opportunities. In a section of the book entitled What Really Moves Gold Prices John lays out a plausible explanation for the direction of gold. I will paraphrase his main points below:
“The World is Divided Into Two Kinds of People: On one side you have gold bugs, who think that money can only be honest and pure if it is backed by gold. They will pine for the days of the gold standard. They think that one of the greatest tragedies ever was the move to paper money that is backed by a government’s good faith and credit.
On the other side you have people who scorn gold bugs and cannot see any use for this “barbarous relic”. Neither side likes the other at all.”
John quotes world famous investor Warren Buffett as once saying “Gold gets dug up out of the ground, in Africa or someplace. Then we melt it down, dig another hole, bury it again, and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”
Although this is a clever comment, John notes that the same could be said about money: “trees get cut down in Oregon, or someplace. Then we pulp them, turn them into dollar bills, put them in ATMs, and trade them. They have no utility.” He explains that money simply functions as a means of exchange, a store of value, and a unit of account. In that way both money and gold are similar. Gold has been, for centuries, used as a means of exchange.
Gold as Central Bank Insurance
Mr. Mauldin has a very interesting take on how to view gold. He explains that in today’s crazy world of Code Red policies and currency wars, one can look at gold as a form of “central bank insurance”. We have health insurance, fire insurance, and so on, and hope that we never have to use them. But we keep buying insurance because we cannot predict the future. Since gold rises and falls in relation to any given currency, and a central bank’s ability to meet debt obligations, you could own gold in relation to how strong you view your country’s currency.
What Drives the Price of Gold?
Code Red explains that the best predictor of the price of gold is the change in the real interest rate you can earn on your savings. As an investor you can either choose to keep your money in the bank or buy gold. If you are getting a real return on your savings, you are less likely to buy gold, because it does not pay a yield. However, in today’s world, inflation is higher than the return we get on our savings. You are essentially earning a negative real rate of return when your money is in the bank. That makes gold a better investment than cash.
John also describes a simple rule of thumb, to see if gold will move up or down, called Gibson’s Paradox. The rule goes like this:
- Investors expect a real return on their cash of 2%
- For every percentage point the real interest is below 2%, gold returns 8% year-on-year times that multiple.
- For example, if real returns were 4%, you could expect gold to decline by 16%
- If real returns were zero, you could expect gold to rise by 16%
John states that this rule has held true for over 40 years. He explains:
“The bottom line is that as long as real interest rates are negative, gold will continue to go up. If we had to bet, we would say that it is highly likely gold will keep appreciating. Central bankers have already told us that they plan to keep real interest rates negative for the foreseeable future.” He cites a friend and highly respected analyst, Christopher Wood of CLSA, as placing a target for gold of $3500 in a few years.
Although the value and direction of gold prices does seem to be a mystery, in my opinion you don’t have to be a gold bug, or conspiracy theorist, to make investment decisions based on sound reasoning. Examining the world from a macro viewpoint, and developing a reasonable thesis for a portion of your investment portfolio, is one of the key ingredients to making successful investment decisions. In short:
- Although it appears that there is are very sound fundamental reasons why gold may rise, please be clear that I am not recommending that you rush out and buy gold
- Gold may form a reasonable part of a well-diversified investment plan. However, concentrating your assets into any single investment category could result in very negative consequences
- There are risks involved in any investment. Economic conditions change, and you must be ready to adjust a strategy, when fundamentals are different
- Gold as central bank insurance is, in my opinion, a very interesting investing concept
- Make sure you seek advice from a professional who can provide an informed opinion
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