Gold And Unrealistic Expectations

Gold has been characterized as insurance, a hedge against inflation/social unrest/instability, or, more simply, just a commodity.  But it is treated most of the time, by most people, as an investment.  

This is true even by those who are more negative in their attitude towards gold. “Stocks are a better investment.”  In most cases, the logic used and the performance results justify the statement. But the premise is wrong. Gold is not an investment.  And, yet, there have also been extended periods of time when gold outperformed stocks.  (To read more about gold’s performance versus stocks see:  Gold: Warren Buffet Is Absolutely Right – And Wrong)

When gold is analyzed as an investment, it gets compared to all kinds of other investments. And then the technicians start looking for correlations.  Some say that an ‘investment’ in gold is correlated inversely to stocks. But there have been periods of time when both stocks and gold went up or down simultaneously.

One of the commonly voiced ‘negative’ characteristics about gold is that it does not pay dividends. This is often cited by financial advisors and investors as a reason not to own gold.  But then…

1) Growth stocks don’t pay dividends.  When was the last time your broker advised you to stay away from any stock because it didn’t pay a dividend.  2) A dividend is NOT extra income.  It is a fractional liquidation and payout of a portion of the value of your stock based on the specific price at the time.  The price of your stock is then adjusted downwards by the exact amount of your dividend.  3) If you need income, you can sell some of your gold periodically, or your stock shares.  In either case, the procedure is called ‘systematic withdrawals’.

The (il)logic continues… “Since gold doesn’t pay interest or dividends, it struggles to compete with other investments that do.”  In essence, higher interest rates lead to lower gold prices.  And inversely, lower interest rates correlate to higher gold prices.

The above statement, or some variation of it, shows up daily (almost) in the financial press.  This includes respected publications like the Wall Street Journal. Since the US elections last November, it has appeared in some context or other multiple times.

The statement – and any variation of it that implies a correlation between gold and interest rates – is false.  There is no correlation (inversely or otherwise) between gold and interest rates.

We know that if interest rates are rising, then bond prices are declining.  So another way of saying that gold will suffer as interest rates rise is that as bond prices decline, so will gold.  In other words, gold and bond prices are positively correlated; gold and interest rates are inversely correlated.

Except that all during the 1970’s – when interest rates were rising rapidly and bond prices were declining – gold went from $42 per ounce to $850 per ounce in 1980. This is exactly the opposite of what we might expect according to the correlation theory cited earlier and written about often by those who are supposed to know.

During 2000-11 gold increased from $260 per ounce to a high of $1900 per ounce while interest rates declined from historically low levels to even lower levels.

Two separate decades of considerably higher gold prices which contradict each other when viewed according to interest rate correlation theory.

And the conflictions continue when we see what happened after gold peaked  in each case.  Interest rates continued upwards for several years after gold peaked in 1980. And interest rates have continued their long-term decline, and have even breached negative integers recently, six years after gold peaked in 2011.

People also talk about gold the way they talk about stocks and other investments…  “Are you bullish or bearish?”  “Gold will explode higher if/when…” “Gold collapsed today as…” “If things are so bad, why isn’t gold reacting?” “Gold is marking time, consolidating its recent gains…”  “We are fully invested in gold.”

When gold is characterized as an investment, the incorrect assumption leads to unexpected results regardless of the logic. If the basic premise is incorrect, even the best, most technically perfect logic will not lead to results that are consistent.

And, invariably, the expectations (unrealistic though they may be) associated with gold, as with everything else today, are incessantly short-term.  “Don’t confuse me with the facts, man.  Just tell me how soon I can double my money.”

People want to own things because they expect/want the price of those things to go up. That is reasonable. But the higher prices for stocks that we expect, or have seen in the past, represent valuations of an increased amount of goods and services and productive contributions to quality of life in general.  And that takes time.

Time is of the essence for most of us.  And it seems to overshadow everything else to an ever greater degree.   We don’t take the time to understand basic fundamentals.  Just cut to the chase.

Time is just as important in understanding gold.  In addition to understanding the basic fundamentals of gold, we need know how time affects gold.  More specifically, and to be technically correct, we need to understand what has happened to the US dollar over time (the past one hundred years).

Lots of things have been used as money during five thousand years of recorded history. Only one has stood the test of time – GOLD. And its role as money was brought about by its practical and convenient use over time.

Gold is original money.  Paper currencies are substitutes for real money.  The US dollar has lost 98 percent of its value (purchasing power) over the past century.  That decline in value coincides time wise with the existence of the US Federal Reserve Bank (est. 1913) and is the direct result of Federal Reserve policy.

Gold’s price in US dollars is a direct reflection of the deterioration of the US dollar. Nothing more. Nothing less.

Gold is stable. It is constant. And it is real money. Since gold is priced in US dollars and since the US dollar is in a state of perpetual decline, the US dollar price of gold will continue to rise over time. There are ongoing subjective, changing valuations of the US dollar from time-to-time and these changing valuations show up in the constantly fluctuating value of gold in US dollars. But in the end, what really matters is what you can buy with your dollars which, over time, is less and less.  What you can buy with an ounce of gold remains stable, or better. (see A Loaf Of Bread, A Gallon Of Gas, An Ounce Of Gold)

When gold is characterized as an investment, people buy it (‘invest’ in it) with expectations that it will “do something”.  But they are likely to be disappointed.

In late 1990, there was a good deal of speculation regarding the potential effects on gold of the impending Gulf War. There were some spurts upward in price and the anxiety increased as the target date for ‘action’ grew near. Almost simultaneously with the onset of bombing by US forces, gold backed off sharply, giving up its formerly accumulated price gains and actually moving lower.

Most observers describe this turnabout as somewhat of a surprise. They attribute it to the quick and decisive action of our forces and the results achieved. That is a convenient explanation but not necessarily an accurate one.

What mattered most for gold was the war’s impact on the value of the US dollar. Even a prolonged involvement would not necessarily have undermined the relative strength of the US dollar.

Gold’s value is not determined by world events, political turmoil, or industrial demand. The only thing that you need to know in order to understand and appreciate gold for what it is, is to know and understand what is happening to the US dollar.









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