Thursday, September 3, 2009

The Dumbest Investment Observation of All Time

...may go to Hong Kong -based research house Gavekal. They write:

We have long argued that gold is actually a lousy inflation hedge...

They go on to write that gold is "a reasonable hedge against a financial meltdown." They get this wrong, also. A financial meltdown is a period of a flight to cash. Witness the climb in the dollar and Treasury securities during the recent crisis. There is generally an exit from hard assets during such a period. Gold only goes up during this period, if investors believe that the downturn will be fought with money printing, which is inflationary and brings us back to the initial Gavekal comment that gold is not an inflation hedge.

Note to Gavekal: When inflation is climbing, investors seek to protect their wealth by moving out of paper currencies into hard assets, including gold, which can not be created by the whim of government.


  1. From 1980 to 2000 gold collapsed in price.
    There was significant inflation between 1980 and 2000.
    Clearly, Gold did not "hedge" well against inflation during this time.

  2. The inflation rate for the 1980-2000 period was roughly half the rate of the inflation rate during the 1970 to 1980 period.

    Gold climbed by more than 2,500% during the 1970 to 1980 period of great inflationary fears.

    What dropped the gold price after 1980 was the major slowdown in inflation as a result of Paul Volcker's actions in his early years at the Fed. If Volcker hadn't slowed inflation, gold would have continued going up.

    The 1980 to 2000 period was nothing like the inflation threat of the late 1970's.

    If you expect major inflation, there is no hedge like gold.

    Your argument rests on cherrypicking a peak period for gold, which was followed by a deflation of commodity prices. I for one always argue that gold is not necessarily a strong performer during downturns in the economy.

    It is makes no sense to start an anlysis of gold performance based on a peak gold price that then is followed by years of declinning commodity prices.

    You should have been selling gold in 1980, as Harry Browne for one advised.

    At present, if inflation goes up, gold goes up.

  3. Wenzel,

    Wouldn't that make gold a confidence-hedge, not an inflation/deflation-hedge?

    Gold will perform during periods of monetary inflation or deflation so long as there is severe doubt about the viability of the monetary system during that period. Otherwise, if people are confident about the monetary system throughout that period, gold should underperform.

    It's a function of whether or not gold is being viewed as money relative to the monetary standard, or if the monetary standard is being viewed as money. You can have inflation and people can still trust the money-quality of the system and thus gold will not perform.

    Right? Or wrong?

  4. First, gold is not a deflation hedge. The only reason gold went up during the depression was becasue FDR propped up the price at the urging of Keynes and Baruch--who both made fortunes owning gold stocks while giving FDR "prop up gold" advice.

    In part, it is a fiat standard versus gold battle. But if you generally stay out of gold during tight money periods (as I note in my original post) That would be for example 1980 and 1987, you are going to do all right, with gold as an infltation hedge. (Annonymous really cherry picked data by starting with 1980)

    I should add I would be generally out of gold during the current Fed tightening, but the possibility of an international flight out of the dollar causes mean to hang on--recognizing that IF there is know international flight that gold could go down if Bernanke stays tight.

    It is a tricky period.

  5. Wenzel,

    I didn't say anything about the GD or the fixed price of gold back then. Regardless, I am open to understanding the situation better so I welcome your instruction.

    I argued that gold is not an inflation/deflation hedge but a confidence hedge. Regardless of whether inflation or deflation is occurring, gold is money. Gold's demand as money should rise during times where the monetary system is suffering extreme stress. A deflation could be one of these situations. In deflation, money becomes more valuable because fiduciary media is contracting, making liquidity harder to come by. It's harder to service debt and harder to support high prices because money is hard to come by. Thus, money becomes more valuable via higher demand and contracting supply. If gold is money, or viewed with confidence as money, gold should participate in this demand.

    I do remember (and I know that there was a partial gold standard at the time) that Rothbard said in America's Great Depression that the banking crisis resulted in people converting certificates and other fiduciary media for gold itself. Central banks were also scurrying for gold. I have to imagine gold did well in this period as a result, in real terms, even if in nominal terms it was fixed.

    Now, when it comes to inflation, the reason gold should do well is because if the inflation is severe, unexpected or unsupported (by the public in terms of their desire to see it), then paper money and fiduciary media should be de-monetizing while gold in response monetizes. In other words, fiduciary media and paper currency drift further away from "money" (and thus fall in value) while gold drifts closer towards "money" and appreciates.

    This, then, could explain how a period like 1980-2000, which experienced inflation, could also involve falling gold prices-- despite the inflation, paper currency and fiduciary media's role AS MONEY were not questioned, whereas gold's was, possibly because of the 'we're gonna bust this inflation!'-high interest rate policy of the CB.

    I don't know if that's right or if it makes sense it was just how I was trying to look at it.

    I'm trying to figure out if that fits with what happened in Japan. I tried to look at this chart for clues:

    But that chart would seem to support your thesis that gold doesn't do well in deflation (period of early 90's to 2000 in Japan?) if Japan was in fact in deflation. But that is a tough call to make because although the BOJ was easing rates, extending credit and printing money the entire time, it seems like deflation occured nonetheless.

    I forget your take one whether we have inflation/deflation now, whether we'll continue to get inflation/deflation or if we'll get deflation like Japan did (was it deflation? People like Mish who argue it was base their definition on credit-price based underlying supplies and so far have not convincingly quantified this amount, in aggregate terms, and shown that it is decreasing in larger volume than monetary base is increasing).

  6. Gold is a general crisis hedge be it deflationary or (hyper)inflationary. It does not even need to be a direct monetary crisis. War or a general distrust in the government is sufficient - gold is an anonymous store of wealth that unlike paper money is not in direct control of the authorities. It is no hedge against moderate inflation, at least no more than other assets.

  7. It is a great fallacy to think gold rises during a deflationary period. This belief comes about because of the performance of gold during the Great Depression. But few realize the gold market was propped up by FDR at the instigation of Baruch and Keynes.

    The Japaneese example, during their deflation, is the more common response to gold during a deflation--it falls in value.

    "Confidence" is overvalued as a long term driving force on prices. People had overwhelming "confidence " that housing prices were heading higher until there was no more money in the system to buy additional housing, a lot of good their "confidence" did them.

    It's the same during an economic downturn. Many may have "confidence" in gold but even you are laid off and need money to pay the rent, you are going to sell your gold.

    Short-term for a matter of days (or possibly a few weeks) after a crash you could get a spike up in gold but that is it. Then the selling to survive kicks in.

    The current period is tricky. The Fed isn't printing, so I would normally be bearsih on gold. But because there are so many dollars overseas, the potential for these to fly into gold is very real.

    Right now, I am short term deflationary in outlook, but fully expect the Fed to reverse engines and start printing again, once things hit a panic phase again.