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Weekend reading: Peak gold or peak gold price?

Money articles

My regular Saturday comment followed by this week’s blog and financial site links.

I can’t decide whether I should feel frightened at no longer having any exposure to gold, or pleased I’m not taking part in a bubble.

Generally I subscribe to the Keynesian view that gold is a ‘barbarous relic’. I sold my holding in Blackrock’s Gold and General fund during the credit crisis to buy more cheap shares.

Like many modern investors I don’t like gold because it’s a near-useless lump of metal that’s only worth what someone will pay for it.

But equally, I can see that’s what gives it special status when diversifying a portfolio. Gold is uniquely useless, and that makes it a potentially pure bet on money supply, compared to say copper or silver which also have industrial uses.

This week saw the gold price fly past $1,100, and the usual justifications trotted out:

  • There’s an inflation timebomb ticking away, so buy gold
  • Quantitative easing and cheap money threatens the survival of paper currency
  • Central banks in Asia are buying more gold
  • Supply is diminishing while demand is increasing
  • The future is more uncertain — only gold gives certainty

Most of these don’t stand up to scrutiny.

For instance, the inflation-adjusted price of the 1980 gold price peak of $850 is well over $2,000 an ounce in today’s money.

Gold bugs cite this as proof gold is cheap even after a nearly decade long bull market from the sub-$250 lows at the turn of the Century — they ignore the fact it proves gold has been a terrible inflation hedge over 30 years.

I don’t doubt we face an inflation threat, but if inflation does strike then interest rates will rise, too. Gold is currently cheap to hold, despite the fact it doesn’t produce an income, due to very low interest rates. If interest rates rise to say 5% (pretty low historically speaking) then that will be the ‘negative cost of carry’ of holding gold.

In other words, gold will have to rise 5% a year just to make up for the opportunity cost of holding it.

The supply/demand argument is also more complicated than it seems. It’s true demand has increased (prices wouldn’t be rising otherwise) but this is mainly due to the rise of gold ETFs (dubbed ‘The People’s Central Bank’ by some wags).

Demand for jewelry from countries like India actually fell with the recession.

Of course, 5% a year would be a cheap price to pay if paper money and civilisation was really falling down around our ears. But the reality is if that happens, a few nerdy gold bugs aren’t going to inherit the earth with their gold coins stuffed down their pants. They’re going to be robbed.

Gold secured safely in Switzerland might remain yours, assuming the Swiss get through the great collapse with their usual aplomb. But will you be able to reach it? At the end of civilisation you want friends with guns, not something that makes you a target.

Even having such a discussion suggests something mad is afoot — at the least a toppy bull market, maybe a bubble.

The UK Prime Minister Gordon Brown famously signaled the bottom of the gold bear market by selling off the UK’s reserves at around $260 an ounce. Ever the savvy socialist, he even told the market of his plans, further driving down the price.

What might signal the top of the gold bull market? Always a guessing game, but I see Barrick, the Canadian gold mining giant, says we’ve reached ‘peak gold’ in terms of supply. Accordingly, it is making a big bet on future prices rising, says The Telegraph:

Barrick is moving fast to wind down the remaining 3m ounces of its infamous hedge book over the next twelve months, an implicit bet on rising gold prices over time.

Mr Regent said the company had waited too long to ditch the policy, which has made the company enemy number one among ‘gold bug’ enthusiasts. The hedges oblige Barrick to deliver part of its gold into futures contracts set long ago at levels far below today’s spot prices.

The strategy worked well in the falling market of the 1990s, but has cost the company dear in lost profits this decade. “Hindsight is always 20/20,” said Mr Regent, who was appointed from the outside earlier this year.

Barrick bit the bullet in the third quarter, taking a $5.7bn charge against earnings on hedge contracts. Liberation is at last in sight. In 2001 the hedge book topped 20m ounces.

Hindsight is indeed a 20/20 game. I wonder if Barrick winding down its gold price hedge could be a sign we’re approaching the top of the bull market for gold?

From this week’s personal finance blogs

  • How to find a job even if you have an ugly resume – Wealth Pilgrim
  • How to create a personal finance firewall – Frugal Dad
  • Surround yourself with successful people – ShoeMoney
  • It’s not how much you pay in costs, it’s the total return that matters – CBS Moneywatch

Other interesting financial and money articles

  • Bolton and Woodford on boom versus doom – The Times
  • And finally… 50 practical tips to last you half a lifetime – The Times

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{ 12 comments… add one }
  • 1 Rob Bennett November 16, 2009, 2:17 pm

    I pretty much share your take, Investor.

    I bought a small amount of gold (about $10,000) a long time ago, when it was at a far lower price. I don’t feel comfortable putting too much in gold for just the reason you cite — it doesn’t generate a regular return so you need to have big price increases to make up for the opportunity cost of not being invested elsewhere.

    The plus on gold is that it adds lots of diversification to a portfolio focused on stocks or even TIPS/IBonds (this became my focus in 1996, when stock prices went to levels I view as insane).

    I’ve earned a handsome return with my gold investment. I would have been richer today had I made a bigger bet. But there were many years when gold went up not at all and I question whether I could have stuck with gold through those years had I put a larger percentage of my portfolio in gold. I don’t feel too much regret (I do feel some) over not having given in more to my enthusiasm for gold at the prices it was selling for in earlier years (my recollection is that my buying price was around $340).

    Rob

  • 2 The Investor November 16, 2009, 9:33 pm

    Great price Rob! I think gold will remain a portfolio diversifier but unfortunately it seems more likely to diversify in the wrong direction from here! 😉

  • 3 Financial Samurai November 17, 2009, 1:34 pm

    Not sure if you saw, but I sent a shout out to you in my weekly recap, whoo hoo!

  • 4 The Investor November 17, 2009, 3:13 pm

    Thanks, I’ll check it out. 🙂

  • 5 THEBIGMAN November 17, 2009, 4:46 pm

    Why would Barrick winding down its gold price hedge be a sign we’re approaching the top of the bull market for gold? Surely this means they’re not going to be giving away tomorrow’s gold at today’s prices!

  • 6 The Investor November 17, 2009, 7:39 pm

    Hi TheBigMan… Maybe (and it is only a maybe!) because established companies do bold, radical things at exactly the wrong time. For instance, here in the UK the mighty GEC turned itself into a dotcom and blew through billions in the dotcom era. Another example from the US is when AOL merged with Time Warner in a merger of equals that proved idiotic and value destroying. Ask anyone under 30 who AOL is today and you’ll likely get a blank look.

    Another example: RBS buying ABN Ambro at the height of the banking boom / credit splurge. At that same time, private equity companies were stalking the very biggest names in the market, having already swallowed some middle rankers. At the time it looks like a sign private equity is in the driving seat – in retrospect, it shows the market was overblown, as all this debt blew up when the tide went out.

    It’s only a hunch re: Barrick. Nobody rings a bell at the top! 😉

  • 7 The Digerati Life November 19, 2009, 3:23 am

    I look upon gold as “insurance” for my portfolio: I don’t expect it to do well (or anything for that matter) unless times are uncertain and everything else is considered “upside down”.

  • 8 Enquirica November 12, 2010, 5:08 am

    Ultimately, the question is not how high gold can go, its how low fiat currency can go. While the debate about whether gold is in a bubble or whether we are in a deflationary or inflation environment continues, the monetary authorities in the developed world have embarked on a well-publicized campaign of currency devaluation via low interest rates. Central banks can control interest rates or exchange rates – not both – and they are opting for record low interest rates with little concern for the debasing consequences. There should be no debate on this matter – central banks have a perfect track record in one area and that alarmingly is in currency devaluation. The US and Canadian currencies have suffered a greater than 95% loss in purchasing power since the inception of their respective central banks. Enquirica Research has published a report – “Guide to Inflation Hedging 101″ go to http://www.enquirica.com/index.php?option=com_content&view=article&id=11&Itemid=19 and signup for access.

  • 9 Michael September 3, 2011, 2:12 pm

    Its three years later and the price is currently $1882. I would say it was a very good ROI, a %70 increase.

  • 10 The Investor September 3, 2011, 2:26 pm

    Yep, it’s been an incredible run — and it’s occurred in less than three years… in fact it’s less than two years! But this stuff is always trivially easy to see in hindsight.

    The following article closely matches my own view as to what will happen in the next few years with gold:

    http://www.fool.com/investing/general/2011/08/30/gold-and-stocks-a-prediction-and-a-challenge.aspx

  • 11 cab September 11, 2011, 10:05 pm

    Funny to read these old posts, a year or so and gold is at $1,850. LOL… And they call us gold bugs! Greece, spain, Italy in the tank, US, still spending like a drunk sailor and ole Ben Bernake is printing money like the new york times prints news papers.

    Buy as much as you can!

  • 12 Johnlaw1971 November 1, 2012, 11:13 pm

    Sigh. Monevator’s planet sized precious metals blind spot, and the concomitant Nelsonian treatment of the impending sovereign debt and currency crisis and monster stock and bond market collapse spoils what is otherwise an excellent blog.

    I shall revisit these pages after the reset to reach the virtues of Austrian economics and hard money to a hopefully more receptive audience, and to ask for advice on how to invest my hopefully preserved capital into a diversified basket of income producing assets ( which is something this site excels at).

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