Money Magazine joined the ranks of gold critics recently when journalist Stephen Gandel wrote an article “Coming Down With Gold Fever.” Also recently, a CFA wrote an article for Investopedia “5 Reasons Gold Is The Next Bubble To Burst.”
As is typical of those who try and criticize gold as a necessary ingredient of a well diversified portfolio, they use flawed analysis in coming to their conclusion. This article will go into depth as to why their analysis is flawed in my continued effort to bring the truth about gold to the public.
First up: Stephen Gandel, former writer for TIME Magazine and now with Money Magazine. To understand possibly Gandel’s bias against gold, look at what grade he gave the Federal Reserve’s expansion of its balance sheet by $1.4 Trillion in 2008, including $200 billion of risky securities. He also tried to put forth the theory that China, Saudi Arabia and, yes, Canada were to blame for America’s financial crisis. In reality, it was the Fed to begin with that is to blame with their manipulation of interest rates during the Greenspan tenure. But you’ll never read about that in TIME Magazine or Money Magazine, only through Austrian Economists at Mises.org would you be able to understand the real cause of the Meltdown.
Gandel’s Flawed Gold Analysis
Gandel: But the case for gold as an investment? That’s built largely on straw. And it’s only in fairy tales that one can spin straw into gold.
My Reply: We’ll see there Rumpelstiltskin.
Gandel: In fact, the study found gold prices and inflation had very little correlation. Between January 1977 and April 1980, small-company stocks were actually the best-performing asset, outpacing gold and other commodities by 4 percentage points a year during that stretch.
And over a much longer period — since the end of 1974, when the federal government permitted U.S. households to own gold as an investment for the first time since the Great Depression — even the S&P 500 index has whipped inflation by a wider margin than the metal has.
My Reply: Notice how Gandel cherry picked the year 1974? While it is true that Executive Order 11825 allowed U.S. citizens to purchase gold again as of Dec. 31, 1974, the U.S. went off the Gold Standard in 1971. In comparing the CPI vs. Gold and the Stock Market since 1971, we see gold to be worth $912 at the end of 2008 but stocks only worth $531 (not including dividends which are discussed will be discussed below) according to Measuring Worth.
Both stocks and gold outpaced the governments flawed definition of inflation during this time.
Gandel: At least stocks give you a share of a firm’s earnings, and many pay dividends to boost your overall return. Gold is merely a commodity, and a volatile one at that. Gold prices fell in 14 out of 20 years between 1981 and 2000, and finished that two-decade run having dropped by more than half — and that’s before the effects of inflation are considered.
My Reply: Again Gandel is cherry picking years to make his analysis come out looking better. Notice he stopped his analysis at 2000, just when gold was bottoming and subsequently to rise every year of the 2000 decade while stocks spent the decade losing 23.8% in purchasing power?
While it is true that physical gold doesn’t pay dividends, most stocks don’t pay near their historical average and overall averaged under 2% in the last decade. Using the 2% dividend rate, you would still be under water with a stock investment that included dividends the last decade as DOW 10,000 2009 would be worth less than DOW 1999 even including these dividends.
Gold during this decade rose about 15% annually. But lets just conveniently leave that out of the analysis ok Mr. Gandel?
Gandel: But isn’t there a limited supply of gold around the world? And doesn’t that mean prices will have to go up? Not exactly. The truth is, no one really needs gold. Besides its use in jewelry, gold serves very few functions. In fact, industrial demand for the metal has been falling for years.
My Reply: No one needs gold? Are you kidding me? Gold is held by every Central Bank in the world. Why? Because it gives the illusion that the fiat/paper money they print out of thin air has value. The truth of the matter is, no one needs paper dollars. They depreciate over time.
It is true there is a limited supply of gold. If only our government had a limited supply of money associated with their budgets, without the Federal Reserve allowing abuse, we might just have a sound economy!
Gandel: Global central banks are expected to have bought more gold in 2009 than they sold — the first time that’s happened in 20 years.
Even with its recent purchases of gold, China still holds 20 times more of its reserves in the greenback than in gold.
My Reply: And that’s why China is buying more gold and will continue to do so (silver too). They see the future and the risk associated with holding dollarrs. You don’t. India just bought 200 tonnes of gold too. Why? Perhaps they have a better grasp on what’s going on with the U.S. economy.
Gandel: Gandel here quoted Steve Leuthold, chief investment officer for the Leuthold Group.
If you fear the dollar’s slide, there are far easier (and cheaper) ways to wager against it. “The U.S. economy is in some serious trouble down the road, but I’m not going to pay this much for insurance,” says Steve Leuthold, chief investment officer for the Leuthold Group.
Instead, Leuthold says he is buying stocks in Latin America and Asia, which are a natural hedge against the dollar’s demise. After all, if you buy assets denominated in foreign currencies, and those currencies rise in value while you hold them, you can make money simply on the exchange rates — even if the underlying assets don’t appreciate.
My Reply: How did that work out for investors in 2008 and through March of 2009? Every stock market in the world got hit hard, most down around 50%. What did gold do in 2008 and 2009? Finished it’s 9th and 10th straight year higher.
Gandel: Gold has always been a favorite of doomsayers and conspiracy theorists.
My Reply: And investors who understand how gold fits into a well diversified portfolio.
Gandel: So you’d do well to heed the warning of economist Nouriel Roubini, who was ahead of the pack in predicting the credit crisis. People who argue that there’s economic justification for gold prices continuing their rise, he wrote recently, “are just talking nonsense.”
My Reply: Roubini called a gold top in June of 2009 and has been negative on the stock market this whole bounce higher. So much for Roubini and his cries of “nonsense.”
Next up, the CFA. I don’t like naming names unless they’re an ignorant journalist or someone who is on television trying to influence the masses. On this site I’ll expose financial advisors, CFP’s, CFA’s and even PhD economic professors pointing readers to their articles and critiquing them.
CFA: Investors very well may be in the midst of a gold bubble that is gearing up to burst in the not-too-distant future.
My Reply: In my other article critiquing a different CFA, I agreed that we could have a downturn in the price of gold and we have seen this come to fruition. At the same time, buying gold in EURO’s has done well over the last 60 days. But to call this downturn a “gold bubble” is seriously flawed and shows a lack of economic understanding of what’s really going on in the economy and how gold represents truth.
CFA: Gold is a terrible long-term investment. Gold’s last high of just over $825 per ounce in 1980 is equivalent to approximately $2,300 in today’s dollars, after factoring in the inflation of this time period. Even with the recent run up, gold falls well below inflation-adjusted levels of three decades ago.
My Reply: Again, as I have written many times in my rebuttals, the people who keep choosing the all-time high of the 80’s decade in the price of gold are cherry picking a month where the price of gold doubled from the previous month. The average price of gold during January of 1980 when gold reached its high of $850 was about half that amount. But why not do the complete analysis and compare gold to 1971 when Nixon took the U.S. off the Gold Standard?
Gold has kept pace with stocks during this time, but you’re not calling stocks a “terrible long term investment” because you are biased towards them. And what about the last decade? Do you consider 10 years long term? How have stocks done in the last 10 years?
CFA: Gold does not produce income or perform like other investments. Gold does not pay a dividend like bonds, does not have an income stream like stocks and is not consumed like consumer staples or energy. As such, it only trades on what investors are willing to pay for it. And investors have a history of becoming excessively optimistic and greedy.
My Reply: Yes, gold doesn’t pay dividends, but as I addressed above, stocks aren’t paying much these days either. For that matter, neither do savings accounts, CD’s and money markets.
You say that gold trades on what “investors are willing to pay for it,” and I say gold trades inversely to the U.S. dollar and needs to be held as insurance against the portion of one’s portfolio that is subject to the decline of the U.S. Dollar. For most in the U.S., that means about 80% of their portfolio based on the typical 75% stocks (80% U.S. 20% Foreign), 20% bonds (U.S. Govt. and U.S. Corporate) and 5% Real Estate or Cash (or some version thereof) that most Financial Advisors recommend for their clients.
One has insurance for their life, house, auto and health but never for the U.S. Dollars their portfolio is priced in. A 10% to 20% diversification into this insurance the last 10 years would have gone a long way to protect investors.
CFA: The recent price run is purely momentum-driven. A December “Wall Street Journal” article stated that the price of gold had risen in 21 of 24 trading sessions. In less than two months, its price had jumped more than 20% after hitting $1,000 per ounce in mid-September. As Galbraith details, expectations (and not fundamentals) are responsible for sending gold prices upward.
My Reply: Wrong. The Dollar Index was breaking to lower lows. India was buying 200 Tonnes of gold. Vietnam was lifting the ban on gold imports. Lately the dollar index has been rising and gold falling. This isn’t rocket science.
Doug Eberhardt is a 28 year financial services veteran and precious metals broker selling gold and silver at 1% over wholesale cost. Doug has written a book to help investors understand how gold and silver fit into a diversified portfolio, how to buy gold and silver, and what metals to buy. The book; “Buy Gold and Silver Safely” is available by clicking here Contact phone number for Buy Gold and Silver Safely is 888-604-6534
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