TAG | Federal Reserve System
Why the Sun is Setting on Gold
by Alexander Green, Investment U’s Chief Investment Strategist
Tuesday, February 22, 2011
Six weeks ago, I wrote a column advising short-term speculators to sell their gold.
Since that time, the metal has drifted lower. But the brunt of the decline is likely still ahead.
As I’ve said before, gold is difficult to value under the best of circumstances. It pays no interest, has no earnings, provides no rent. What gold will be worth next week or next month is whatever buyers will pay for it at the time. And that, in technical terms, is a guess.
I’ve heard gold bugs make their case. Some are based on emotion. Others are based on political fantasies about the Federal Reserve turning us into the Weimar Republic circa 1923, or modern-day Zimbabwe.
What I rarely hear them talking about is pedestrian stuff like supply and demand…
When Buyers Become Sellers, Look Out Below
Billions of dollars have been spent building gold mines over the last few years, so it’s not inconceivable that supply could begin to outstrip demand.
Of course, demand itself is fickle.
In 2005, investors made up just 16% of total demand for gold. Today, it’s more than 40%. Gold ETFs have taken in more than $50 billion since 2004.
What will happen to the price of gold when these buyers become net sellers, as many will when it becomes clear that the party is over? Paulson & Co., a hedge fund, now holds more than $4 billion in the SPDR Gold Trust ETF (NYSE: GLD). I wouldn’t want to be standing in front of his eventual liquidation. And, like most hedge fund managers, Paulson is not a “buy-and-hold” investor.
Some bulls justify buying gold at these levels because it briefly traded at more than $800 an ounce in 1980. And they say if you simply adjust for inflation, gold should be trading at $2,300 today.
That’s weak. Here’s why…
Don’t Be Blinded by the Gold Light
Gold badly underperformed inflation – not to mention stocks, bonds, real estate and burying your money in a hole – for 20 years after 1980. Why is it suddenly destined to catch up now?
Or look at it another way: On August 25, 1999, gold traded at $252.55 an ounce. Adjusting for inflation, gold should be trading at $339.65 an ounce today.
Granted, my starting point is the 30-year-low. But then, a calculation based on the 1980 high is just as arbitrary.
It’s understandable that gold spiked during the 2007-2009 financial crisis. Gold is an excellent barometer of investor anxiety. But that crisis is over. The recession – defined as two straight quarters of negative GDP growth – ended in June 2009. And inflation is running at just 1.2%.
So why is gold still in the stratosphere?
What to Do With Your Gold Holdings Now
Yes, I know the price of food, gasoline, health care and college tuition are all going up much faster than the official inflation rate. But let’s also concede that the price of cars, computers, appliances, electronics, furniture and, not insignificantly, homes – the biggest asset most consumers will ever buy – is coming decidedly down.
Experienced investors know that after an asset has made a huge run, the little guy – forever a day late and a dollar short – starts clamoring for a piece of the action. At that point, the bloom is off the rose. It’s too late to buy and generally high time to sell.
Take my old neighbors, Sam and Brian. They lost their shirts in Internet stocks in 2000-2002. Now they’re stuck with huge negative equity in Florida condos that they bought pre-construction – a “no-brainer” in 2005.
So what are they doing with their rapidly vanishing capital today?
You guessed it. Now that gold is up five-fold in the last 10 years and three-fold in the last five years, they’re convinced that a big move lies just ahead.
Maybe. But what’s certain is that one lies just behind.
My advice? Keep your gold bullion and blue-chip mining stocks that you own as an inflation-hedge or part of your long-term asset allocation.
But if you’re counting on gold to dash higher, note that the last time investors bought into a gold mania it took more than 25 years for them to break even – not counting inflation.
As Mark Twain famously said, “History may not repeat itself. But it rhymes.”
Good investing,
Alexander Green
26
Long-Term Treasury Bonds: Consider Yourself Warned…
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Long-Term Treasury Bonds: Consider Yourself Warned…
by Alexander Green, Chief Investment Strategist
Monday, July 26, 2010: Issue #1309
The brickbats are starting to pour in.
For months, I’ve warned readers about the bubble developing in long-term Treasury bonds.
Yet what was the top-performing asset class in the first half of 2010?
You guessed it: Long-term Treasury bonds, with a total return – price gains plus interest – of 13.2%.
Why is this happening? Two reasons…
- U.S. stocks performed poorly over the first six months of 2010 – down 5.6%. That’s driving many to the perceived safety of Treasuries.
- The anemic euro is making U.S.-dollar-denominated securities attractive to international investors. And Treasuries are the traditional choice for those fearful of equities.
So does this mean there isn’t a bubble after all? Hardly. In fact, the risk now is greater than ever…
1999: An Internet Odyssey
In the fall of 1999, I belonged to a ritzy tennis club – a time when Internet and technology stocks were all the rage.
My playing partners knew I was in the money management business, so there was plenty of chatter among them about “the New Era” and how “the Internet changes everything.”
Occasionally, one of my buddies would ask which Internet stocks I was buying.
“None,” I said. (I was early to get into the sector and early to get out.) The valuations were outrageous and I didn’t think it would end well.
They were surprised by this view, but kept enthusiastically buying and trading Internet stocks like almost everyone else. And, indeed, those stocks kept right on going up.
As the weeks went by, a familiar ritual developed. I’d walk up to the group and – knowing I didn’t own any – they’d ask how my Internet stocks were doing.
Laughs all around.
This went on week after week, month after month. And judging by the guffaws, the question was funnier each week than the week before.
Until one day it wasn’t funny at all.
2000: Nightmare on Wall Street
In March of 2000, the Nasdaq started coming apart and Internet stocks nosedived. As I approached their courtside table one morning, they abruptly stop talking.
“Morning, guys,” I said. “How are your Internet stocks doing?”
Funny… that line was hilarious before. Now it generated obscene gestures, as well as various suggestions for me and “the horse you rode in on.” Hmm.
What is the lesson here (other than that we shouldn’t laugh at the misfortunes of others)?
It’s that you cannot make a rational judgment about when irrational behavior will end.
The “Twin Demons in the Distance” For Treasury Bonds
Internet stocks went up longer than any logical analysis would predict. So did home prices a few years ago.
And the situation with long Treasury bonds right now also defies analysis. Unless, of course, we’re headed into a massive, deflationary period. But if that’s the case, why are gold and inflation-adjusted Treasuries (TIPS) moving up, too?
Either buyers of gold and TIPS are wrong – or buyers of long-term Treasuries are wrong. I think you know where I stand.
As The Wall Street Journal reported on July 6: “The huge stimulus the Federal Reserve and U.S. government have provided to the economy over the past few years will inevitably push up both interest rates and consumer prices. While the threat isn’t imminent, it’s not too early to take steps to protect the bond part of your portfolio from those twin demons in the distance.”
Consider yourself warned.
Good investing,
Alexander Green
19
Use These “TIPS” to Protect Yourself Against Inflation
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Use These “TIPS” to Protect Yourself Against Inflation
by Alexander Green, Chief Investment Strategist
Monday, April 19, 2010: Issue #1241
A recent Communiqué column of mine, in which I recommended Treasury Inflation-Protected Securities (TIPS), outraged a number of readers.
Why was it so upsetting? Because – and don’t ask me what they’re smoking – 17% of Americans actually approve of the job Congress is doing.
Taking both parties to task, however, I wrote:
#1: When George W. Bush and his fellow Republicans came to power a little more than nine years ago, they promised to cut wasteful spending, limit the size of government and move closer to a balanced budget.
Instead, they…
- Created a Medicare drug entitlement that will cost nearly $1 trillion in its first decade…
- Started a string of expensive financial bailouts that continues today…
- Passed a record number of earmarks…
- Increased federal spending 58% faster than inflation…
- Presided over a $2.5 trillion increase in the public debt.
#2: Then, last November – anxious for change – voters threw the bums out and put the Democrats in charge. The Democrats promised to change this reckless course and restore fiscal sanity to the country.
Instead, they tripled the budget deficit in their first year. The White House and the Congressional Budget Office now estimate that this year’s deficit will explode to $1.56 trillion – a post-World War II record at 11% of the overall economy – and add $9.7 trillion in debt over the next decade.
Facts vs. Opinions
Here are the other points I made…
#3: The Obama Administration’s own projections see the federal debt hitting $18.5 trillion by 2020. However, that was before the passage of the healthcare reform bill – the biggest new entitlement since the creation of Medicare in 1965.
#4: Unfunded liabilities for Social Security, Medicare, Medicaid, the prescription drug benefit and the new federal healthcare program have now jumped to $108 trillion, nearly eight times our annual GDP.
#5: Moody’s has threatened to downgrade the Triple-A rating of U.S. sovereign debt, perhaps within three years. A drop in our credit rating would both decrease the perceived safety of Treasury securities and increase the interest that Uncle Sam – excuse me, you, your children and your grandchildren – will pay on the deficit.
#6: Credit Suisse recently produced a report pointing out that the country whose debt profile most resembles that of Greece is – hold your breath – the United States. (If you believe a picture is worth a thousand words, try this: http://www.usdebtclock.org/)
#7: Down the road, Washington – with the reluctant consent of the Federal Reserve – could opt to solve this problem the way so many governments throughout history have – by inflating our way out of it.
Inflation: The Bane of Debt-Holders & A Godsend to Debtors
Inflation is the bane of debt-holders, of course. But it is a godsend to debtors – and Uncle Sam is the biggest of them all – as they can repay fixed obligations with increasingly worthless currency.
What surprised me was not that some readers had a difference of opinion. I always welcome that. It was that respondents uniformly barked that they didn’t want to hear my “political opinions.”
Opinions? Go back through these seven points and tell me which one contains an opinion. Even the last one modestly states that Uncle Sam “could opt” to inflate our way out of this problem.
As Jack Nicholson reminded us in A Few Good Men, some people can’t handle the truth. Especially when it’s something they don’t want to hear.
For example…
- When we warned 11 years ago about the massive bubble in Internet stocks, the majority of respondents gushed about the New Era and insisted we “just didn’t get it.”
- When we warned six years ago about the ominous housing bubble, many scoffed and insisted that home prices “always go up.”
- When we talk today about the threat to your financial security that Washington is creating with its Ponzi-style entitlement schemes, a lot of investors don’t want to hear that, either.
Believe me, I hope I’m wrong. I don’t want high inflation any more than you do.
Fortunately, inflation today is as tame as a kitten.
The Benefits of Treasury Inflation-Protected Securities & Three Ways to Buy Them
I only suggest that you buy Treasury Inflation-Protected Securities ( TIPS) as an important insurance policy. (Because when inflation – the thief that robs us all – rears its ugly head, neither stocks nor bonds do well.)
You can purchase inflation-protected Treasuries (TIPS) in three ways…
- Directly ( http://www.treasurydirect.gov/indiv/research/indepth/tips/res_tips_buy.htm).
- Through the Vanguard Inflation-Protected Securities Fund (VIPSX).
- Through the ETF equivalent – the iShares Barclays TIPS Bond Fund (NYSE: TIP).
There are several advantages to buying TIPS…
- TIPS pay interest every six months, just like a regular Treasury bond. But unlike traditional bonds, your principal increases each year by the amount of inflation, as measured by the consumer price index (CPI). Semi-annual interest payments also increase by the amount of inflation.
- The interest you receive is exempt from state and local (but not federal) income taxes.
- TIPS are less volatile than traditional bonds.
- They’re also excellent diversifiers.
Some investors complain that these securities haven’t done anything exciting lately. Of course not. We’ve been in the grip of disinflationary forces, not inflationary ones – and that won’t change next week or next month.
Protection Against The Government “Doing Something”
But as the deficit keeps expanding and the electorate grows increasingly unhappy, pressure will mount on the government to “do something.”
That “something” could be a decision to inflate our way out of this mess, rather than risk the kind of deflationary spiral that Japan has endured over the past two decades.
Bear in mind…
- The Fed has already taken interest rates close to zero…
- Congress has already tried a massive fiscal stimulus…
- The Federal Reserve has already created trillions out of thin air to mop up worthless securities.
If the economy stumbles again and further government action is taken, it could be even more reckless, resulting in inflation.
In the interest of full disclosure, however, that’s just my opinion.
Good investing,
Alexander Green
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