Friday 4 December 2009
Gold in Terms of the S+P
The chart[1] shows the value of Gold in terms of the S+P index (Gold / S+P) and the long term perspective shows clearly that Gold was at its most valuable(relative to the stock market) both in the deflationary 1930s and inflationary 1970s . Gold is not just a hedge against inflation; it’s a store of value in many difficult periods. Looking at Gold versus the dollar is only part of the story. If the dollar is weak then a strong Gold may simply represent that phenomenon and so comparing Gold to a basket of currencies is more illuminating. Gold relative to the S+P is a way of judging how well Gold compares to other paper assets (It would be better to look at Gold versus a world stock market index , denominated in a basket of currencies, and that may be studied later.)
When Gold was at its strongest , it was roughly 4-6 xs greater than the S+P.
1932 S+P 4.5 Gold 20.67
1938 S+P 8.5 Gold 35
1980 S+P 110 Gold 800
When Gold was at its weakest, it was 1/3 or 1/6 of Gold
1966 S+P 110 Gold 35
2000 S+P 1500 Gold 250
We are at the half way point, roughly at 1:1 i.e. Gold 1200 S+P 1100
If you believe that the crisis has further to go, irrespective of it being a deflationary or inflationary environment, Gold does have the potential to climb considerably higher relative to stocks. Whether that means Gold at 3000 and Stocks at 700 or Gold at 700 and S+P at 175 I have no idea, but in historical terms Gold is merely at an average valuation.
Deflationary Scenario
This is not so problematic. You simply hold gold and cash pay down debt and wait it out .Jonathan[2] Wilmot has written an excellent piece arguing that the fears of a large monetary overhang are greatly exaggerated. It can take many years for this to play out but the motto is simply stay out of the market
Inflationary Scenario
In principal this is much tougher for several reasons. Everything is going up and Gold will outperform stocks but of course the gains will be subject to taxation. It will be hard to have an after- tax real gain. More importantly, if we were to move into hyper inflation then the exit strategy from holding gold is far more complicated. The hyper inflation in Germany ended in 1925 when Germany rejoined the Gold Standard with a new currency of 4.2 Reichsmarks to the dollar. It had left the Gold Standard in 1914 with the same exchange rate of 4.2 Deutschmarks. If you had held gold, you would have had huge profits in local currency but if you hadn’t exchanged the gold for hard assets before the new currency, all you would have been left with is a lump of gold. This is the key point. In the unlikely, but still frightening scenario, of wild money-printing , Gold only acts as a stepping-stone. At some point it will be necessary to sell the Gold and buy property or land, otherwise when a new currency is introduced all you will be left with is Gold valued at an exchange rate commensurate with several years earlier. In that environment, as in Germany 1925, there was a great shortage of the new currency and so Gold was not nearly as valuable as rent – producing assets. It was the industrialists and “insiders” who survived the inflation, because they owned land , property and factories and borrowed at artificially low interest rates from the central bank.
Simon GILLIS 4 xii 2009
Other references.
T.J. Sargent, The end of four big inflations’, 1986
C.P.Kindleberger, A financial History of Western Europe 1993
[1] Bloomberg
[2] CSFB Market Focus-Long Shadows ; The Sequel Nov 30, 2009
The chart[1] shows the value of Gold in terms of the S+P index (Gold / S+P) and the long term perspective shows clearly that Gold was at its most valuable(relative to the stock market) both in the deflationary 1930s and inflationary 1970s . Gold is not just a hedge against inflation; it’s a store of value in many difficult periods. Looking at Gold versus the dollar is only part of the story. If the dollar is weak then a strong Gold may simply represent that phenomenon and so comparing Gold to a basket of currencies is more illuminating. Gold relative to the S+P is a way of judging how well Gold compares to other paper assets (It would be better to look at Gold versus a world stock market index , denominated in a basket of currencies, and that may be studied later.)
When Gold was at its strongest , it was roughly 4-6 xs greater than the S+P.
1932 S+P 4.5 Gold 20.67
1938 S+P 8.5 Gold 35
1980 S+P 110 Gold 800
When Gold was at its weakest, it was 1/3 or 1/6 of Gold
1966 S+P 110 Gold 35
2000 S+P 1500 Gold 250
We are at the half way point, roughly at 1:1 i.e. Gold 1200 S+P 1100
If you believe that the crisis has further to go, irrespective of it being a deflationary or inflationary environment, Gold does have the potential to climb considerably higher relative to stocks. Whether that means Gold at 3000 and Stocks at 700 or Gold at 700 and S+P at 175 I have no idea, but in historical terms Gold is merely at an average valuation.
Deflationary Scenario
This is not so problematic. You simply hold gold and cash pay down debt and wait it out .Jonathan[2] Wilmot has written an excellent piece arguing that the fears of a large monetary overhang are greatly exaggerated. It can take many years for this to play out but the motto is simply stay out of the market
Inflationary Scenario
In principal this is much tougher for several reasons. Everything is going up and Gold will outperform stocks but of course the gains will be subject to taxation. It will be hard to have an after- tax real gain. More importantly, if we were to move into hyper inflation then the exit strategy from holding gold is far more complicated. The hyper inflation in Germany ended in 1925 when Germany rejoined the Gold Standard with a new currency of 4.2 Reichsmarks to the dollar. It had left the Gold Standard in 1914 with the same exchange rate of 4.2 Deutschmarks. If you had held gold, you would have had huge profits in local currency but if you hadn’t exchanged the gold for hard assets before the new currency, all you would have been left with is a lump of gold. This is the key point. In the unlikely, but still frightening scenario, of wild money-printing , Gold only acts as a stepping-stone. At some point it will be necessary to sell the Gold and buy property or land, otherwise when a new currency is introduced all you will be left with is Gold valued at an exchange rate commensurate with several years earlier. In that environment, as in Germany 1925, there was a great shortage of the new currency and so Gold was not nearly as valuable as rent – producing assets. It was the industrialists and “insiders” who survived the inflation, because they owned land , property and factories and borrowed at artificially low interest rates from the central bank.
Simon GILLIS 4 xii 2009
Other references.
T.J. Sargent, The end of four big inflations’, 1986
C.P.Kindleberger, A financial History of Western Europe 1993
[1] Bloomberg
[2] CSFB Market Focus-Long Shadows ; The Sequel Nov 30, 2009
Wednesday 2 December 2009
The Problem of buying Gold
The Problem of buying Gold
As many friends and colleagues know , I have been interested in Gold as an investment for some time. Gold double- bottomed in US dollars in August 1999 and then again in February 2001 at around $252.I expect it will go considerably higher (currently $1210)
The problem about buying Gold is that individuals and traders often make the mistake of viewing it as a trade. “Making money in Gold is a good thing”; don’t be so sure. A rise in gold usually accompanies either much higher inflation or a deflationary bust as under the Gold Standard in the 1930s. In today’s environment a much higher gold price may even reflect the possibility of governments defaulting on their bonds. It is perhaps better to regard Gold as an insurance policy.
Imagine a friend boasting that they just received a payout of $100.000 on their health insurance. Is that a good thing? Of course not, their health must have been seriously in danger for such an award. Equally house insurance for fire or car insurance. You don’t want the pay-out. If Gold rises to $5.000 the profit itself will be a good thing but most investors will have more serious problems to worry about like social unrest, banking failures, the safety of their families, fuel shortages etc.
This would suggest that Gold is best held as a hedge against crisis. Jim Sinclair[1] is clear about this. The leveraged trader will be lucky to make money in the bull market because the volatility will be so huge that just one mistake could wipe out years of gains. The day after Gold peaked in New York at over $850 in Jan 1980, it opened in Hong Kong at $750 and kept falling That was a remarkable $100 “gap down “.
The most important aspect of holding gold is knowing why you hold it. This might seem a ridiculous comment but as this bull market accelerates many people seem to be buying because “its going up “ . Are you buying it on inflationary fears or general fears? Gold has done well in both environments and Martin Armstrong[2] shrewdly points out that a rising gold price under the gold standard reflected a deflationary crisis but after Bretton Woods collapsed , a rising gold price was symptomatic of ensuing inflation. I don’t want to enter the inflation / deflation debate on this blog, however it is clear that in a certain way it’s irrelevant. Mervyn King was extremely candid when he simply said to the British public in 2008.”Your standard of living will drop”. That’s the point. Inflation-deflation is an argument worth discussing but secondary to whether you view the world as safe enough not to own gold. The inflation / deflation debate is less important than the hard-to-accept fact that either way your standard of living is going to drop to pay for the current mess. Like Fascism and Communism in extremis, the spectrum bends round and inflation and deflation become extremely close in practical terms. You are probably going to get poorer.
Simon GILLIS 1 xii 2009
[1] Jim Sinclair’s Mineset
[2] MartinArmstrong.org
As many friends and colleagues know , I have been interested in Gold as an investment for some time. Gold double- bottomed in US dollars in August 1999 and then again in February 2001 at around $252.I expect it will go considerably higher (currently $1210)
The problem about buying Gold is that individuals and traders often make the mistake of viewing it as a trade. “Making money in Gold is a good thing”; don’t be so sure. A rise in gold usually accompanies either much higher inflation or a deflationary bust as under the Gold Standard in the 1930s. In today’s environment a much higher gold price may even reflect the possibility of governments defaulting on their bonds. It is perhaps better to regard Gold as an insurance policy.
Imagine a friend boasting that they just received a payout of $100.000 on their health insurance. Is that a good thing? Of course not, their health must have been seriously in danger for such an award. Equally house insurance for fire or car insurance. You don’t want the pay-out. If Gold rises to $5.000 the profit itself will be a good thing but most investors will have more serious problems to worry about like social unrest, banking failures, the safety of their families, fuel shortages etc.
This would suggest that Gold is best held as a hedge against crisis. Jim Sinclair[1] is clear about this. The leveraged trader will be lucky to make money in the bull market because the volatility will be so huge that just one mistake could wipe out years of gains. The day after Gold peaked in New York at over $850 in Jan 1980, it opened in Hong Kong at $750 and kept falling That was a remarkable $100 “gap down “.
The most important aspect of holding gold is knowing why you hold it. This might seem a ridiculous comment but as this bull market accelerates many people seem to be buying because “its going up “ . Are you buying it on inflationary fears or general fears? Gold has done well in both environments and Martin Armstrong[2] shrewdly points out that a rising gold price under the gold standard reflected a deflationary crisis but after Bretton Woods collapsed , a rising gold price was symptomatic of ensuing inflation. I don’t want to enter the inflation / deflation debate on this blog, however it is clear that in a certain way it’s irrelevant. Mervyn King was extremely candid when he simply said to the British public in 2008.”Your standard of living will drop”. That’s the point. Inflation-deflation is an argument worth discussing but secondary to whether you view the world as safe enough not to own gold. The inflation / deflation debate is less important than the hard-to-accept fact that either way your standard of living is going to drop to pay for the current mess. Like Fascism and Communism in extremis, the spectrum bends round and inflation and deflation become extremely close in practical terms. You are probably going to get poorer.
Simon GILLIS 1 xii 2009
[1] Jim Sinclair’s Mineset
[2] MartinArmstrong.org
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