Tuesday, June 11, 2013

8 Reasons Why Nouriel Roubini Is Wrong About There Being 6 Reasons for Gold to Drop in Price

Nouriel Roubini recently penned an essay, After the Gold Rush. In the piece, he details six reasons why he expects gold to drop in price. Here are eight reasons he is wrong.

1. First, he writes:
The run-up in gold prices in recent years – from $800 per ounce in early 2009 to above $1,900 in the fall of 2011 – had all the features of a bubble. And now, like all asset-price surges that are divorced from the fundamentals of supply and demand, the gold bubble is deflating.
 Gold has had a spectacular run for decades, with only short-term downturns. The downturns , with the perspective of time, being nothing but minor blips. Here is the price of gold when looked at from a much longer perspective than Roubini's 4 year look.

Since gold is a counter to Federal Reserve notes as a type of money, as long as the Federal Reserve  continues to increase the money supply, gold will climb. Here is the growth of money supply for the same period as the gold chart:

If anything, these charts show that gold rather than being in a bubble is lagging relative to money growth.

2. Roubini writes:
First, gold prices tend to spike when there are serious economic, financial, and geopolitical risks in the global economy. During the global financial crisis, even the safety of bank deposits and government bonds was in doubt for some investors. If you worry about financial Armageddon, it is indeed metaphorically the time to stock your bunker with guns, ammunition, canned food, and gold bars.
But, even in that dire scenario, gold might be a poor investment. Indeed, at the peak of the global financial crisis in 2008 and 2009, gold prices fell sharply a few times. In an extreme credit crunch, leveraged purchases of gold cause forced sales, because any price correction triggers margin calls. As a result, gold can be very volatile – upward and downward – at the peak of a crisis.

But, if anything, we are in a lull between financial crises AND gold has been moving from the hands of leveraged buyers of gold to those holding gold in an unleveraged physical possession manner. Thus, gold is moving into stronger hands.

3. Roubini writes:
 Second, gold performs best when there is a risk of high inflation, as its popularity as a store of value increases. But, despite very aggressive monetary policy by many central banks – successive rounds of “quantitative easing” have doubled, or even tripled, the money supply in most advanced economies – global inflation is actually low and falling further.
This is simply not true, while the monetary base is climbing, as I report regularly in the EPJ Daily Alert, most of the high-powered money the Fed is printing is ending up back at the Fed as excess reserves and not in the system. Indeed, as I have pointed out in the ALERT, the EPJ Money Supply calculation has shown money supply growth dropping in recent months from a high of 11.4% annualized to a current growth rate of 3.7% annualized. Thus, money growth has not been as strong as policy would indicate. However, a more important factor, the desire to hold cash balances has been declining, which will have the same impact on prices as money growth, that is, higher prices in the second half of 2013. A price inflation that is going to fool Roubini, who writes:
With little wage inflation, high goods inflation is unlikely. 
4. Roubini writes:
Third, unlike other assets, gold does not provide any income. Whereas equities have dividends, bonds have coupons, and homes provide rents, gold is solely a play on capital appreciation. Now that the global economy is recovering, other assets – equities or even revived real estate – thus provide higher returns. Indeed, US and global equities have vastly outperformed gold since the sharp rise in gold prices in early 2009.
Gold is a medium of exchanging not an earning asset. It should be compared only relative to other mediums of exchange, such as the dollar. Comparing, gold to earning assets is like comparing Albert Einstein to Michael Jordan  and bitching Einstein didn't have a great vertical leap or that Jordan, when he was with the Chicago Bulls, didn't understand multi-variable calculus.

5. Roubini writes:
Fourth, gold prices rose sharply when real (inflation-adjusted) interest rates became increasingly negative after successive rounds of quantitative easing. The time to buy gold is when the real returns on cash and bonds are negative and falling. But the more positive outlook about the US and the global economy implies that over time the Federal Reserve and other central banks will exit from quantitative easing and zero policy rates, which means that real rates will rise, rather than fall.
It is true that if the real rate climbs dramatically that gold will fall, but it is very, very unlikely that the Fed will allow rates to move into real territory. Rates will climb, but my suspicion is that they will way behind where rates would be without Fed intervention. Indeed, if the Fed is intervening in the markets, it is by definition not where rates would be without such intervention.  Rates at some point may climb to, say, 7%, but if they do while the Fed is still manipulating the rate, the unmolested market rate may require a market interest rate of 10%.

6. Roubini writes:
 Fifth, some argued that highly indebted sovereigns would push investors into gold as government bonds became more risky. But the opposite is happening now. Many of these highly indebted governments have large stocks of gold, which they may decide to dump to reduce their debts. Indeed, a report that Cyprus might sell a small fraction – some €400 million ($520 million) – of its gold reserves triggered a 13% fall in gold prices in April. Countries like Italy, which has massive gold reserves (above $130 billion), could be similarly tempted, driving down prices further.
Yes, sales buy Italy and Cyprus would have a short-term downward impact on the gold price, but Roubini is ignoring the fact that this would cause greater fear among individuals that governments can't handle their finances. And while the threat of these gold sales looms, we see gold flowing into the hands of not only individuals, but aggressive sovereign stockpilers of gold, such as China and Russia. It's long-term bullish for gold.

7. Roubini writes:
Sixth, some extreme political conservatives, especially in the United States, hyped gold in ways that ended up being counterproductive. For this far-right fringe, gold is the only hedge against the risk posed by the government’s conspiracy to expropriate private wealth. These fanatics also believe that a return to the gold standard is inevitable as hyperinflation ensues from central banks’ “debasement” of paper money. But, given the absence of any conspiracy, falling inflation, and the inability to use gold as a currency, such arguments cannot be sustained.
First of all gold, has been around a lot longer than the United States or the "far-right fringe." Gold would have been around even if the Brits had beaten the American fringe of the 1700s. Second, it  is being hailed, by not only the "far right fringe," but even those who have been inside the headquarters of the belly of US government gold manipulation.

8. Finally, I must note that Roubini seems to fear gold. He may diss it, but among his closing remarks he does write:
Yes, all investors should have a very modest share of gold in their portfolios as a hedge against extreme tail risks.
[...]gold prices may temporarily move higher in the next few years[...]

For a gold hater that is a very strong endorsement.

1 comment:

  1. "And now, like all asset-price surges that are divorced from the fundamentals of supply and demand, the gold bubble is deflating."

    Can someone please tell me what he considers to be gold's fundamentals? Can he put a number on gold supply and gold demand?

    I'd really love to know.