While my recent articles may give the impression that I am a perma-bear when it comes to gold, that isn’t the case. I turned bullish on gold back in the early 2000’s after reading a headline that central banks were ending their gold liquidations. That event pretty much signaled the end of the gold bear market that had been in place since the late 1970s. While working as a portfolio manager I had precious metals as a holding in my portfolios. I was bullish on gold for all the right reasons, and the price action was supportive of my decision. I am now bearish on gold because the bulls are bullish for all the wrong reasons, and the price action is supporting my position. In my opinion, gold is being supported by pillars of sand, and the tide is coming in.
Pillar #1: Printing money causes inflation. That is the #1 myth perpetuated by the gold bulls. Even after QEfinity in the US and 20+ years of Japan printing money and not experiencing inflation, the diehards still cling to this outdated monetary theory. There simply is no truth to it, and the very fact that every market measure of inflation proves thatshould be enough to put that theory to bed. Yes, printing money can cause inflation under the right conditions, but printing money during a financial crisis to prevent a banking collapse and to avoid a deflationary spiral aren’t the right conditions. Baring a supply shock of an economically critical commodity like oil, it is highly unlikely inflation will take root until there is a tight labor market and excessive spending. We are a long long long way away from those economic conditions.
Pillar #2: The US dollar isn’t going to collapse and go to zero as many gold bulls claim. In fact the US dollar has been strengthening since the 2008 crisis, and is about in the middle of its usual trading range. The US dollar going to zero is the political objective of Ron “End the Fed” Paul and his followers, it isn’t a legitimate economic theory. Gold is more likely to “go to the moon” than the US dollar going to zero, but neither are going to happen in our lifetime.
Pillar #3: The debt will force the US government to print money. The debt and printing money have absolutely no relationship what so ever. The debt is the result of congress spending money, printing money is the result of the Federal Reserve implementing monetary policy. Our Federal Reserve System was designed in a manner to specifically prevent congress from dictating monetary policy. The Federal Reserve is an independent body deliberately shielded from political influence. Ironically Ron Paul’s “Audit the Fed” would eliminate the Fed’s independence andpoliticize monetary policy, effectively becoming a self fulfilling prophecy and creating the very inflation collapse of the US dollar Ron Paul purports to be trying to avoid.
Pillar #4: Gold is better than paper money. Maybe in ancient Rome, during the Waimar Republic or modern day Zimbabwe but certainly not for any modern developed economy. The world abandoned the gold standard for very very good reasons. A gold standard is an inelastic currency that requires fixed exchange rates to function, neither of which are good for a modern economy. A fiat currency is highly elastic and functions with floating exchange rates, both of which are critical for modern economies to function. Had we been under a ridged gold standard in 2008, it is highly likely we would have had a catastrophic global banking system collapse, and the world would be deep in depression.
Pillar #5: Central banks, India and China buying gold will drive gold higher. No it won’t and no it didn’t, if anything inventories of gold that are now becoming financial liabilities are likely to be sold on the market as gold continues to fall. Inventories of gold during a bear market simply represent more future selling. Central banks that rely on gold to manage their monetary policy will be forced to sell their gold or risk inflation. Central banks that bought gold at its peak injected $1,902 new dollars per ounce into their economy, now that same ounce can only bring $1,232 back out of the economy. If gold continues to fall, central banks can lose control of their monetary system and have difficulty containing inflation. By the way, central banks that diversified away from using the US dollar and substituted gold are now discovering the hard way that credible stable paper money is far superior to volatile gold.
Pillar #6: Printing money is inflationary, gold is not. That is partially true but misses the point. Under a gold standard the value of a currency is fixed, and the economy adjusts to the relatively fixed supply of currency. Basically under a gold standard the tail wags the dog, and is why the US experienced such vicious business cycles in the pre-Fed era of the mid to late 1900s. Where there are ample supplies coming to market, the economy experiences deflation, where there are shortages, there is inflation, and there are almost constant bank runs and financial panics. Sure the average price under a gold standard may be zero inflation, but the price volatility is extreme. One year of 25% inflation may be followed by 20% deflation for a 0% compounded rate of inflation over those two years, but that is a rough way to get 0% inflation. A gold standard simply isn’t a superior system for a modern economy, and therefore the gold demand based upon its currency value is unjustified.
Pillar #7: Black swan events are no longer supportive of gold. Gold is no longer acting as a safe haven investment. Unlike the past, people are using crisis as an opportunity to sell their gold not buy it. Panics are being used as opportunities to exit, not accumulate gold.
Pillar #8: Gold always holds its value, in “roman times and ounce of gold bought a nice suit, and today an ounce of gold buys a nice suit.” It that were true, it would imply that there have been no efficiencies built into making a good suit since roman times. While I can’t prove this, I’m pretty sure the man-hours needed to produce a good suit, or toga, in roman times is astronomically higher than it is today, so if a suit costs the same in roman times as it does today, it proves gold has lost an huge amount of value since roman times, and is therefore an inflationary currency like the US dollar. It also would mean that a good suit would cost the exact same every single year an economy is under a gold standard because the price of an ounce of gold is fixed implying once again inflation in the suit market and the costs of production fall but the price doesn’t. Lastly, it would mean a good suit went for $50 in 1974, $800 in 1979, $250 in 2002, $1,900 in 2011 and $1,220 today. Clearly there is something missing in this roman suit theory of gold’s value.
Pillar #9: The end is near, the old world order is going to collapse, paper will be worthless. I call these theories the Armageddon theories of gold, and they represent the extreme tail risk of the lowest probability. Sure a global melt-down is possible, but highly improbable, and if we do experience a global melt-down, I would invest is lead, gun powder, guns and seeds before I invested in gold. I’m pretty sure that if a man meets another man in post-Apocalypse world, and the one man has a loaded gun and the other man has gold, the man with the loaded gun will walk away with the gun and gold but with one less bullet.
Pillar #10: Gold is the investment for every economic condition. Not so and investors are now discovering that as those that bought gold in 1979 also learned. In reality the inelastic nature of gold makes if ideal for occasional bubbles, one of which looks to have just popped back in 2011. Gold does well during periods of inflation when used as a hedge. Recently gold has done well not because of inflation, but because of the fear of inflation. The realization that that fear is unfounded is slowly sinking into the markets, and is why gold is falling in price. Gold can also do well during periods of deflation as long as interest rates provide a negative real return. Until recently treasury bonds were providing a negative real return, meaning that people that bought them were basically being guaranteed a loss on them. In that situation gold provided a better alternative than a sure loss. Today however interest rates are headed higher, and higher interest rates act like kryptonite to gold prices, and people will substitute higher yielding assets for their gold. Gold does well when there are no viable substitutes, that condition no longer exists.
Pillar #11: The bullish arguments for gold aren’t even bullish. In this video a gold bull can’t even really formulate a defense. I’ve watched this video multiple times and still can’t figure out why deflation will be good for gold, why we should price US dollars in gold and why more QE would be good for gold when it hasn’t been supportive in the past or is now. If the bullish case for gold is that deflation will develop as the economy recovers and interest rates head higher is a long shot at best. His analysis also seems to imply that gold falling in price is proof of deflation in the economy. Gold is one commodity that is basically insignificant to the economy as a whole, and its price trend is irrelevant to inflation. This is clearly a confusion of a dependent and independent variable model. Inflation will drive the price of gold, gold will not drive inflation. The analyst confuses the cause and effect relationship of inflation and gold.
Pillar #12: Gold has been a retail phenomenon and is largely held in “weak hands.” ETFs and other new market products represent large amount of future selling if gold continues lower.
Pillar #13: The technical view and trend of gold is awful. There is a very strong argument that we are on the backside of a bubble. As I write this, gold is just breaking $1,200 an ounce.
Pillar #14: When not being used as an inflation hedge, gold is basically a worthless piece of shiny metal.
Pillar #15: Buying gold in this environment is a bet against the Fed. Rarely is it a good thing to fight the Fed.
Pillar #16: Silver broke below its pre-QE peak cracking the myth that QE drove the precious metals higher. If gold follow suit and cracks its pre-QE peak of around $1,000 the last major theory supporting gold will be disproven, and likely result in gold going much lower to levels more appropriate for a low inflation economy.
Pillar #17: Many of the most vocal and high profile promoters of gold stand to gain personally from a higher gold price and collapse of the US dollar. Peter Schiff, Ron Paul and gold brokers all personally benefit from a higher gold price. Recently, during this gold collapse, Ron Paul recently claimed gold could go to infinity and Peter Schiff claimed gold was going to the moon. Their idiology is so blinding they seem unable to accept reality.
Pillar #18: Identifying a bubble is easy, getting out of it in time is the difficult part. Gold bugs just love to point out how Peter Schiff called the crash and predicted the gold rally. So what, so did I and many others. Peter Schiff and Ron Paul however are continuing to ride gold down negating the benefit of seeing the coming collapse. What good does it do to predict coming financial doom if all you do is make a short term gain, only to lose it all back? The gold trade is over, following people like Peter Schiff and Ron Paul will only result is giving back all the hard earned gains.
Pillar #19: End of quarter gold selling is likely to continue through 6/30/2013 as embarrassed portfolio managers try to cover their tracks and eliminate gold from their quarterly statements. Few portfolio managers are going to want to explain why gold remains in their portfolios.
In conclusion, as one of the above linked videos highlight, “the investing thesis has proven wrong.” Gold has gone up for all the wrong reasons, and that reality is beginning to settle into the markets. Hype, fear and outdated monetary theories simply aren’t enough to support the price of gold. Every finance and economics text book teaches that gold is basically an inflation hedge, and without inflation gold is simply a useless piece of yellow metal. Either the gold bugs are right or the Fed is right, and my money is on the Fed.