One for all you Gold bugs.

http://www.bloomberg.com/apps/news?pid= ... TPikM1zf1Y

Gold Is a Bad Hedge, Questionable Investment: Michael R. Sesit

By Michael R. Sesit

Oct. 5 (Bloomberg) -- One of the enduring dogmas of global finance holds that gold is a safe-haven asset. The precious metal is billed as a hedge against inflation, the ultimate insurance policy against geopolitical risk and protection during periods of financial-market turmoil.

With the credit crisis and the Federal Reserve's response to it -- cutting the federal funds and discount rates and injecting huge sums into the banking system -- the emphasis on gold's value has lately focused on market dislocations and inflation. Although with Iran and the Middle East, not to mention other hotspots, the specter of political risk is ever present.

Investors -- and there are many of them -- who buy into these suppositions might as well believe in the tooth fairy.

Here's why. Gold reached a record high of $850 an ounce in January 1980. If since then the spot price of bullion kept pace with U.S. inflation as measured by the consumer-price index, gold would now be selling for $2,119.84. Instead, it stood at $732.05 in London trading yesterday, only about a third of what it should be if it were truly an effective inflation hedge.

History shows that since 1988, the correlation between bullion and U.S. inflation expectations is just 36 percent, according to Goldman Sachs Group Inc. That means the price of gold rises and falls with inflation expectations 36 percent of the time. The relationship between gold and U.S. consumer-price inflation is less, at only 23 percent. And the metal's correlation with U.S. core inflation, which excludes food and energy costs, is even lower, at 7 percent.

Out of Sync

``Gold is often described as an inflation hedge, but in fact there are few instances in the past 20 years when gold has moved in sync with either core or headline inflation,'' says James Gutman, a London-based commodity economist at Goldman Sachs International. Thus, gold ``should not be used as an inflation hedge,'' he says.

Investors seeking protection from inflation would have been better off in the U.S. stock market. On Jan. 30, 1980, the Standard & Poor's 500 Index stood at 115.20. Adjusting the index to compensate for the increase in the CPI since then would put it at 287.30 today. Yet on Oct. 3, the S&P 500 closed at 1539.59, more than five times the inflation-break-even level.

As for political risk, the inflationary expectations associated with the Sept. 11 terrorist attacks on the U.S. -- arguably the most dire threat to American security since the 1962 Cuban Missile Crisis, or even World War II -- had no lasting impact on the price of gold.

Sept. 11 Effect

For instance, gold was selling at $276.25 an ounce on Aug. 31, 2001, less than two weeks before the attacks; after rising to as high as $295.10, bullion was back at $274.25 on Oct. 23.

Whatever effect inflation has on gold is transmitted through the dollar's exchange rate. Since 1988, gold has moved in tandem with a basket of currencies consisting of the Australian and Canadian dollars, South African rand, euro, yen and Indian rupee 91 percent of the time, according to Goldman Sachs. And dollar weakness is often associated with inflation.

Even so, there is little to explain movements in gold prices once the currency relationship is accounted for, Gutman says.

In any event, with the 1997 introduction of Treasury Inflation Protected Securities (TIPS) in the U.S. and similar products in other countries, there's no reason to use gold as an inflation hedge. TIPS are U.S. Treasury bonds whose principal increases at the same rate as the CPI. The interest payment is then calculated from the inflated principal and paid at maturity.

Fed Rate Cuts

What's more, inflation isn't a problem currently, even though the Fed last month cut its fed funds rate by half a percentage point to 4.75 percent, and traders are betting there's a 70 percent chance it will fall to 4.50 percent later this month. American consumers expect a U.S. inflation rate of 3.1 percent in a year, according to the Reuters/University of Michigan preliminary September index of consumer sentiment.

Still, the CPI fell to 2 percent year-over-year in August, down from 2.4 percent in July and 2.7 percent in June. ``It's far too early to expect higher inflation,'' says David Abramson, Montreal-based chief currency and commodity strategist at BCA Research Ltd.

Gold has been on a roll. It's up 15 percent so far this year, climbed to a 27-year high of $747.90 an ounce on Oct. 1 and is on course to rally for the seventh consecutive year. Behind its rise has been the abundance of global liquidity and, more recently, the Fed's relaxed monetary policy and weaker dollar.

`Right Reasons'

Bullion has also benefited from strong jewelry demand in emerging-market countries such as China and India; shrinking global mine production, especially in South Africa; reduced net central bank gold sales; and the growth of gold exchange-traded funds, which make it easy for individuals to invest in gold and which have $17.7 billion in assets, according to Morgan Stanley.

This shows that although gold may be a poor hedge, it isn't necessarily a lousy investment. ``It should be invested in for the right reasons,'' Gutman says.

Nonetheless, bullion has no direct link to economic growth as do other commodities, doesn't earn a return, offers limited hedging advantages and hasn't kept pace with inflation. Moreover, the world's biggest holders of gold, major central banks, aren't overly eager to keep owning it.

For investors who decide to hold gold, things may not be as easy as the past few years.

Ahh the experts from Goldman Sachs, a more cyncial person might wonder why they're so negative about gold considering they're rumoured to have one of the largest short positions in the gold market in the world - but then who am I to question them given that they manage to post ever increasing profits year after year.

It is true that Gold has shown a distinct lack of corrolation with US inflation readings over the past 20 years, but what about prior to the 80s and 90s? While the world inflationary pressures continued to build year after year in the 60s and finally burst onto the world stage in the 70s the pressure on gold continued to rise. Firstly at the Macro stage amongst the Governments. While retail prices continued to be set at $35 an ounce by the US government, foriegn nations desire for the yellow metal surged as a means of countering the effects of the rapidly diminishing value of the USD. Culminating in the US Government finally abandoning the defacto gold standard in the early 70s by refusing convertability and refusing to transfer any more of their gold reserves to Europe - particularily France who had grown annoyed with America's prolfiagent spending and arrogance towards the global impact "It is our Dollar, but their problem" was how one US politician succinctly put it.

Yes, new economy champions love to point out the statistics of where gold should be if it had continued to be priced from its all time high of $850/ounce.... owww I hear them say time and again "If gold was a true hedge against inflation then it should be 2,119.84 by now!" They conviniently like to leave out the part that this was the price achieved during the height of speculative gold fever and before the effects of Paul Volkers 18% interest rates had the desired impact of returning economic crediability to the USD - despite the crushing recession that resulted. Anybody wanna bet on Bernanakes resolve to raise interest rates in the face of a possible recession? I'd rather believe in the tooth fairy!

How about another comparison? Say on the reliability of investments in the equity of stocks to counter the effects of inflation? Maybe the next time Goldman Sachs issues another tome on the anti-wisdom of investing in gold they could, for the sake of balanced advice, include the results of their annualised investment advise concerning the new technology stocks that they were championing at the height of the dot com boom... some return those poor saps have achieved. Infact even I bet quite a few dot com investors would have gladly swapped Golds performance over the past 20 years for their IT returns when they entered at the height of the dotcom boom.

Oh yes James Gutman says Investors seeking protection from inflation would have been better off in the U.S. stock market. On Jan. 30, 1980, the Standard & Poor's 500 Index stood at 115.20. Adjusting the index to compensate for the increase in the CPI since then would put it at 287.30 today. Yet on Oct. 3, the S&P 500 closed at 1539.59, more than five times the inflation-break-even level.... but how convinient that he failed to examine the 10 years prior to 1980, a time when inflation when was a real concern as opposed to the past 20 years when it has been a relavent none issue. Gold went from $35 to $850 - a 2,329% return in the space of 10 years - what was equities return in this period? (my apologies have not calculated golds real post inflation return during this period, but it would have been markedly, though not considerably less)

Yes there has been a marked lack of corrolation between US inflation expectations and the price of gold over the past 20 years. But inflation has generally been in the 1% to 5% range in that time. If inflation rises from 1% to 2% that represents a 100% increase in inflation expectations - are we to expect gold to rise 50% or 100% in that same time? Obviously the "analyst" seems to expect so.

On top of this we've had recent hedge fund activity as managers have entered the gold market in leverage plays in order to make a buck. When things suddenly go pear shaped it's these same players who are forced to dump gold along with everything else in order to raise equity and reduce leverage... suprise, suprise in the short term this increases golds corrolation with risky assets.

What other issues could be influencing the gold price? Well there has been the substantial depressive effects of continued gold price sales by predominantely European central banks over the past 20 years as they "diversified" their reserves (funnily enough America has chosen not to indulge in this diversification. Not only does it hold one of the smallest amount of reseves in relation to the size of its economy, it has not sold one bar of gold since ending gold convertability in the 70s).

On top of central bank selling we have had a sustained 25 period of time where every commodity has seen it's value in real terms decline. The supposed "conqueroring of inflation" resulted in a boom of unparralled magnitued in financial assets. Debt markets, which only formed a small part of financial markets at the end of the 70s, now dwarf the $ value of equity and commodity markets around the world. Is it little wonder that gold, along with every other real asset has seen it's value diminish. (Some people will say what about housing? Aren't houses a real asets? If you look at the forces behind housing, houses are really far more like financial assets than people give them credit for - beyond supply and demand their prices are largely determined by the availabiliy of debt and lo - guess what, the availability of debt has soared over the past 20 years, just like house prices.)

"In 1997 introduction of Treasury Inflation Protected Securities (TIPS) in the U.S. and similar products in other countries, there's no reason to use gold as an inflation hedge. TIPS are U.S. Treasury bonds whose principal increases at the same rate as the CPI. The interest payment is then calculated from the inflated principal and paid at maturity."

In the same breath as he quotes these facts the reporter reports that reported inflation excludes food and energy costs - how convinient. And just how reliable are these inflation statistics? Japans greatest export over the past 15 years hasn't been Toyotas or Computers or Microwaves, most of these are made in the rest of Asia nowdays. No Japans greatest export has been liquidity - which I will come back to in a moment. Such is the policitical desire to continue with their low interest rate environment that when inflation showed some signs of life for the first time in 15 years, without accompanying and expected increases in growth what did they do? They excluded a whole swath of items from their inflation calculations whose prices were, on average rising, and added a whole swath of items whose prices, on average were falling. Well what do you know - inflation in Japan has been subdued ever since and making it easier to continue with their low interest rate policy.

And finally we come to Mr Gutman's comments: "Whatever effect inflation has on gold is transmitted through the dollar's exchange rate. Since 1988, gold has moved in tandem with a basket of currencies consisting of the Australian and Canadian dollars, South African rand, euro, yen and Indian rupee 91 percent of the time, according to Goldman Sachs. And dollar weakness is often associated with inflation."

Well guess what, all currencies are moving largely in tandem because they're all currently engaged in a race to the bottom and falling more or less at the same rate. To say the USD is falling is just like a bunch of sky divers falling out of the sky, when one of them suddenly points head down, and pulls away. To an observer in the group of skydivers it would appear as though he's falling away. To someone standing on the ground they'd all be falling, just one of them would be falling a little faster than the others. That is what gold is - it is someone standing on the ground.

Growth in money supply, the truest means by which to measure how quickly money's value is being erroded has soared in recent years. Money supply growth in China is approaching 18%, in the US, which stopped measuring and reporting the most common measure of money M3 a year or so ago, it is estimated that money supply growth is approaching 16%. Australia, the UK and near everywhere else has money supply growth in the low double digits as well. Theoretically money supply should increase at the same rate as GDP growth, but in order to avoid senarios where a slow down in growth may tip inflation into the negative most prudent economists agree that it should be 3 or 4% above GDP growth. Now while China may be experiancing GDP growth to sustain that sort of money supply expansion, is the US's GDP expanding at anything like 10% a year?? Milton Friedman said "Inflation is and always will remain a monetary phenominom." Well folks, get ready for inflation. The presure is building and when it finally bursts into the open, wishy washy reserve bank governers of the likes of Bernanake aren't going to be able to do squat about it.

People who think they're going to get rich investing in gold are mistaken, investing in gold is about wealth preservation. But wealth is a relative thing, you can become wealthy simply by staying where you are while those around you are getting poorer. Golds value has pretty much remained the same throughout history. Go back to Roman times and an ounce of gold could have purchased you a nights accommodation and meal at a fine hotel with enough left over to buy a smart toga to wear to the colloseum - today it is much the same. Tomorrow it will be much the same as well. In the long term it will be much the same. Yes there will be periods of speculative excess like in the late 70s and early 80s, and which, in my opinion will follow in the not too distant future, and on such occassions it will be possible to make real money through speculation (and lose real money). But in the long run, gold will always be what it always has been - a store of wealth.

For anyone who is still paying attention after my rant would like to read something that is a little more less emotionally charged than my rant, I would suggest that you check out the following link:

http://www.sirchartsalot.com/article.php?id=69

I personally find the discussion fasinating, but be warned it is a long article and a little dry (perhaps I am more of a nerd than I thought to enjoy such material), but to get the most out of it you have to read it all.

Good Point Disco Stu,

Although my views are probably biased towards gold, -

can anyone answer how to value paper currency , in a world where resources are limited ? , i cant find out logically how in eternity (assuming civilisation continues to exist and expand) can people avoid wasteful and foolish consumption. This China boom is obviously coming at a cost to the rest if the world, which is only fair as there nation has worked hard and saved through out the last few decades. But if currency backed with nothing can be printed endlessly and handouts are given out unfairly to anyone who has a debt problem(bail out of the banks sub prime lending) than we have a problem. What happened to the good old fashioned I want a house or a holiday than save and sacrifice and consume less of something else.

This is a bold statement but i think we are going through a period of reckless and silly economical times. In probably a 100-300 years from now people will look back in history and view todayseconomic policies as being extremely irresponsible.


let the people who make bad investment decisions suffer !

Hey muhaha,

your not the only one is is can claim to be a little bias in his views on gold, at times I get a little over enthusiastic or passionate about the subject. There are many reasons why gold will not go to the moon, but when I read an article that is dismissive of the gold as an investment choice, by using the opening lines of where gold should be in dollar terms today if it had continued on it's merry way from its all time speculative driven high of 1980, I pretty much know what the rest off the tone of the article is going to pan out.

A couple other googled links on gold and this reporter:

http://www.fullermoney.com/content/2004 ... OnGold.pdf
http://finance.thestandard.com.hk/en/mo ... ?aid=49058

For reasons to do with the need of need to be able to expand money supply as economies grow in order to avoid negatives of deflation gold really isn't a useful means of money anymore - anybody who thinks that the worlds economic problems will be solved by returning to the gold standard is indulging in wishful thinking. Sadly paper fiat currencies are really the only choice, but that doesn't mean gold is totally without purpose as a means of storing value.

Thanks to muhaha and Disco Stu for the useful links and commentary on Gold.

DS can you elaborate on why you feel Gold is still useful as a vehicle for storing value over other means? Is the consensus here that Gold is not a valid prospect as a hedge against inflation and volatility?

On a separate note, Disco Stu; is there any means of sending you a PM?

Regards,

KHKW

In immature economies and unstable regimes where people live in poverty westerners cannot even pathom , GOLD is the salvo .
Try Zimbabwe for a change with 1000% Inflation rate , or even the Indian sub continent (including of Bangaledesh , Pakistan and Sri Lanka ) where at least close to ONE BILLION human beings TRUST nothing bur GOLD .
Does this poor class of humanity has a reasonable weight in the demand / supply equilibrium of gold worldwide ? I don't know for sure but U would find it very hard to marry your daughter within that class without that shining metal ...cheers eG

Actually thanks to all posters, including Judd - I hope my rather passionate counterance to your article didn't put you off. Sometimes it takes reading an article that I don't actually agree with for me to sharpen my own views on a subject, which was probably the case here. A diversity of views is what contributes to the forums depth and usefulness.

KHKW - gone straight for the money question on why I feel gold is a useful vehicle for storing value over other means, huh? Mmm... this is the hard part, to pontificate from a pulpet of anominimity is one thing, to try and explain the practical reasons for it makes it a little harder. I should start by saying my views are my own and I'm certainly not qualified to give any investment advise, so please don't rely on any of my ramblings. I am certainly not urging anyone to go and buy gold, or gold stocks - merely to consider the wider forces that are driving the gold market and indeed the wider financial markets at the moment.

My view on gold being a useful store of value is largely historic - and when I mean historic I mean over the last 2,000 years as opposed to the last 20. It has long been used as a medium of exchange, and as opposed to paper currency will always be accepted. You can walk into a money changer anywhere in the world and chances are they'd be happy to pocket your gold for a small commission and turn it into whatever locally accepted currency is in use. As pointed out by EG, walk into any shop in a 3rd world, where their faith in their currency is more a mater of coercion and lack of alternative than a matter of trust, and chances are they'd prefer your gold to the local currency anyhow (Ever visited a country whose currency is collapsing? - I visited Venezuala a few years back and was getting one and a half times the official exchange rate, such were the locals desire to convert out of their useless Bolivars. Actually could have gotten a better rate if I'd had any Euros to convert, unfortunately all we had were USD's which even then the locals were growing weary of !!!)

But that's the third world or countries heading towards the third world - why would people in advance nations choose to invest in gold? Traditionally in the west gold is viewed as a safe haven. Now critics will say gold barely nudged when those planes flew into the twin towers or when America chose to invade Afganistan or Iraq - big deal. If anyone really thought the world was about to end because a couple buildings fell down in NY or the US finally invaded a country that they'd been telescoping their desire to invade for at least 10 years then they're probably the same people who are suprised everytime rain finally falls at the end of a drought.

When I see a global crisis I see it in terms of China invading Tawian and sinking a couple US ships along the way, I see the US invading Iran and losing an aircraft carrier to a sunburn missle, or I see Musharif being overthrown in Pakistan and replaced with an Nuclear armed Islamic Theocracy and taking the local US embassy hostage for good measure - anyone wanna bet that gold would barely shift under any of those senarios? These are worse case senarios and to make an investment decision based soley around the chances of such extremely unlikely or unfortunate events occuring is probably even more foolish than to totally ignoring the possibility of them arising in the first place.

In the west our faith in our currency stems from our faith in the economy. We believe that if someone runs up a debt to us and they're tripple A rated than chances are they'll pay it back. If we invest in triple A rated Bonds we think that our funds are safe. If we invest our funds in triple A rated bonds issued by a triple A rated nation then the promise should be as good as gold..... as the recent subprime debt fiasco has revealed there are a lot of assumptions being made about what is as good as gold.

While the US's debt levels are astronomical and few people could realistically believe that the actual fair value of these debts, at the time they were run up, will ever be repaid other than in perhaps notional terms, there are other factors at work in underlying the faith in the USD. Firstly until recently there has been no other viable alternatives in the fiat currency space, the emergence of China as a global power perhaps gives an indication as to a future alternative currency may occur, just like the emergence of the USD ultimately threatened the status of the GBP as the worlds premier reserve currency. The EUR and JPY are not as viable due to the factured political nature of the EUR and Japans preoccupation with 0% rates - they've indicated they'd rather sacrifice the value of the yen and the savings of its citizens to meet the political objectives of the ruling party.

Other reasons supporting the USD are it's overwhelming military might, accounting for 60% of global military spending. No one is going to argue with you if you can put the worlds biggest gun to their head. Thirdly there is the well documented fact that the USD is the only currency that oil is priced in and until recently accepted in payment for (there is a whole other thread devoted to this discussion). Following on from this is the fact that the USD is the main currency that lies behind the worlds current financial set up. The risk and debt markets in the US are still the largest in the world, and risk globally is swapped or hedged back to USD. The absoulute cobweb of financial links and dependancies will ensure that it will be around for many years to come. Finally, despite whatever doomsayers are saying out there the US is still an enourmous economy and likely to remain the largest economy for many years to come.

That said, things change. China's economy is rapidly growing. In purchasing power terms it is already the 2nd largest economy in the world. It's military is growing rapidly and they've recently announced their intention to develop a blue water navy. The US thinks nothing of moving an aircraft carry group to close proximity of China when they're endulging in some sabre rattling with Tawain. How would America react if China engaged in Navel exercisise with a carrier group of the coast of Calafornia. These are long term trends that are likely to errode some of the faith in the USD that I mentioned above - and there just a couple items, I won't even go into their current Middle Eastern escapades and the long term likely outcome on the USD.

But back to gold in general, as an a class of investment designed to grow your wealth, gold is terrible. It pays no interest, grows not in capital and usually comes at a price to store as well as carries a risk of being stolen. What it is good at is staying acting as a store of wealth. An ounce of gold more or less will buy a similar quantity of what it could be used to purchase at the turn of the century - can the same be said of the USD? Ah but what about the interest on that $1 over the past 100 years? Well with Australian banks and bank their charges if you started with $1 in your account I would be very suprised if you didn't owe them money come 1 years time, let alone 100. Oh and there's the fact that interest is taxable (as is any capital gain on the appreciation in your gold)

In the short term gold doesn't really act as a good hedge against inflation or volatitlity, short term events will dominate in the short term with swings either way. But in the long term and over the long term, it will do what it has always done - act as a store of value. Just don't expect to get rich off it, unless you intend to profit from any speculative frenzy that may eventuate along the way in which case realise that it is just speculation.

The question really should be less about whether or not gold is a good investment, but more about where the economic forces are going that can influece golds price. Do you feel as though we're in for much the same as the previous 20 years? Or are we getting ready for a version of 70s stagflation lite or 70s stagflation heavy?

Cheers

PS: As to being able to Private Message me, I don't think anyone has tried that before - I certainly haven't recieved one before and frankly wouldn't know how to send or recieve one. But if you'd like feel free to PM me, or you can grab my email from my member details which I just updated.

Disco Stu wrote:Actually thanks to all posters, including Judd - I hope my rather passionate counterance to your article didn't put you off.

Not in the least, Disco Stu. First because I didn't write it and, more importantly, even if I had written the article, it was only posted for the same reasons you have given.

In any event, I find this discussion on gold very interesting.

Cheers

Cheers Judd, I sometimes get a little self concious - having read some posters on other sites I am accutely aware of sounding like a blow hard and try and avoid commenting on things unless I have a definate opinion.

KHKW - found the following commentary on Kitco in relation to the volatility of the gold price and inflation, as a part of a study of the prior to US recessions, compared to the big recessions of the 70s and early 80s.

http://www.kitco.com/ind/Ip/oct012007.html

It would seem to indicate that provided inflation remains subdued a recession would see reduced volatility in the gold price in USD terms.

Couldn't google much on the reporter as most of her commentary appears to be in Mandarin, but she has a number of other articles on Kito as well.

A very positive report.....what are we waiting for??? Goldfever???

Gold At US$1400/oz Within Five Years?
FN ARENA NEWS - 11/10/2007


UniCredit, a subsidiary of the German Bayerische Hypo- und Vereinsbank AG, believes the gold spot price can surge as high as US$1400/oz over the next three to five years.
Commodity expert Jochen Hitzfeld has drawn a comparison with other commodities such as nickel, crude oil and wheat to come to this conclusion. He says prices of other commodities have exploded over the past few years while being supported by three preconditions: continuing supply deficits, low inventories and low price elasticity of demand.

With all three preconditions in place Hitzfeld says commodities such as nickel, crude oil and wheat quickly "oriented themselves" at their inflation adjusted price peaks reached during the last bull market for commodities in the 1970s.

If one were to apply the same principle to gold than spot gold should reach as high as US$1,400 per ounce. Hitzfeld suggests this should be possible on a three to five year horizon. But even if gold were to fall short of this price level, he nevertheless sees the precious metal as a "very attractive" investment and believes it should not be missed in any longer term investment portfolio.

The analyst also makes an interesting observation with regards to gold's declining production/supply over the past few years. In reference to what he describes as a "relatively new idea", Hitzfeld suggests gold may simply have reached its final production peak. By definition, this should be the case when 50% of available resources have been mined. According to the US Geological Survey the number is already at 57%, which would support this thesis.

Cheers
JP

peak gold eh !

There is ``growing concern that the rest of the world will devalue along with the dollar in a race toward global currency weakness,'' Dennis Gartman, trader and editor of the Virginia- based Gartman Letter, wrote in his daily report today. ``In that environment, gold's trend is rather secure.''

http://www.bloomberg.com/apps/news?pid= ... ommodities