‘The big education for me is that civilisation is fragile and can be destroyed in a heartbeat' - Jeremy Brade, former peacekeeper in Sarajevo.

Wednesday, August 04, 2010

Is gold a safe haven?

I've looked at gold a number of times on Bearwatch, trying to see whether it's a protection against inflation and/or falls on the Dow Jones Index.

The trouble is, there's so much wealth in the world that the relatively small market in gold can be manipulated by speculators, so it doesn't compensate for inflation etc in a smooth way.

It is also, many suspect, manipulated by central banks and governments, in order to preserve the illusion that the economy is under control. Sharp rises in the price of gold are traditionally seen as a vote of no confidence in national economic management, especially paper money (the last official link between gold and the US dollar was broken in 1971).

The graph below correlates gold and the Dow since the beginning of the 20th century. It's interesting because it shows how major crises impact on investment and gold.

It's also interesting because it suggests some sort of cycle, and the logarithmic scale makes the peaks link up in a straight line. Less so the troughs - many "gold bugs" keep looking back to the panicky spike in the gold price in 1980, which was clearly very exceptional (though the gold bugs still hope it's a benchmark for the future).

Beware: the human mind is very good at perceiving patterns, and will force them onto random data, which is why people used to think they could see canals on Mars.

Having said that, note the green line on the graph, which indicates the long-term trend. In particular, note that the blue line is now well below it, though nowhere near previous troughs. This could mean that gold is overpriced, yet still in the zone where a "bigger fool" may come along and pay even more for it. Such is our vanity, we tend to think we'll never be the biggest fool, ourselves.

On the other hand, since this graph relates gold to the Dow, it could suggest that the Dow is underpriced, and I have been reading a number of commentators who expect a continuation of the recent recovery in the stockmarket, though this opinion is not universally shared.

A further caveat: the graph looks as though it's a fairly regular cycle, but there are features of our present situation that are not cyclical, at least not in the usual few years/couple of decades frame. Some see the downwave of several longer-term cycles coming together in the not-too-distant future - here's an example from Charles Hugh Smith:

Here are some other reasons why the present recession (I believe it hasn't finished and has only been disguised by recent official financial intervention) may not be part of the "normal" business cycle:

  • The ratio of total personal and public debt to GDP is the highest in modern history - higher even than just before the Great Crash of 1929
  • There's been a social change in the West over the last generation or two, that has seen families become dependent on two earned incomes instead of one, so the option to earn more by sending one's partner out to work has already been exercised by many
  • In developed and developing economies (e.g. China), the average age of the population is increasing. This means that more of the populace is looking to spend money on their needs (and older people need more healthcare), and fewer are in work and saving money
  • National economies have become much more closely linked with one another. Many Western economies are in a similar, difficult financial situation and many Eastern economies have come to depend on trade with us, so that global fortunes are co-dependent in some ways. Investors may not be able to escape these problems by moving their money into other countries
  • International trade has put highly-paid Western workers in much closer competition with workers in other countries where wage levels are far lower. Western wages per hour, already stagnant in real terms since somewhere in the 1970s, must (I believe) eventually come closer to Eastern pay rates; yet mortgages and other personal debts won't reduce just because the pay packet gets smaller
  • Developed nations have set up expensive public systems of health treatment, education and social welfare benefits. It is going to be extremely hard to reduce these commitments in order to reduce taxation

Respected commentators like Mike Shedlock and Marc Faber (see yesterday) believe that the US, UK and other countries will not be able to square the circle. They differ only in how they think the disaster will play out.

In short, I would say that investing in gold is indeed a speculation, and to get into that market now appears to be coming a little late to the party, but if you share the wider outlook of many of the "bears" I've been following for the last 3 years, it may still be worth considering as an insurance against disaster. Perhaps we're at the point where we might even be prepared to accept a degree of loss on such a speculation, rather than lose far more if we remain in cash and see inflation destroy the value of money.

Investing in gold isn't the only precaution to consider. Look at what Faber says in the interview I posted yesterday - he's thinking in much bleaker terms and talks about buying agricultural land, moving out of the city etc. Faber isn't the only gloomy one: US Congressman Ron Paul is predicting social unrest when the government begins to fail on its commitments to citizens.

In short, the recent past is no guide to the future. Those graphs issued by investment funds and financial retail outlets, showing growth over 3 or 5 years (or whatever carefully-selected period makes their recommendation seem promising) are, in my opinion, pretty much useless. Whichever view you take, it is now important to make that a wider, longer view, because macroeconomic factors have become more significant.

And yes, the doomsters could also still be wrong, either about how things will go, or how soon, or both.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.


Paddington said...

If things don't completely crash, I foresee a 3-tier society:

1. The rich and powerful
2. The technically competent, including plumbers, engineers and technicians
3. Everyone else

Sackerson said...


myopia said...

As very much a lay person love your posts.

As to how things will play out I'm not really sure I have a clue what Mike Shedlock thinks the end game is?

I did think the first part of this was an interesting post


Sackerson said...

Thank you, Myopia. "Lay": After all that's happened in the last few years, we begin to feel that there are very few experts.

"Mish" foresees deflation, a reduction in the amount of money and credit in the system. I (and others) think that this will become intolerable to consumers/voters and the money system will be tinkered with to produce inflation.

The link to Ritholtz was helpful, thanks. It seems he foresees inflation.

myopia said...

""Mish" foresees deflation, a reduction in the amount of money and credit in the system. I (and others) think that this will become intolerable to consumers/voters and the money system will be tinkered with to produce inflation.

Yes my lack of clarity on where Mish forsees things going revolves around the politics. All Mish's points regarding deflation make perfect sense to me its the short to medium term social ramifications of this and how politicians react that seem to be key.

Or perhaps Mish is of the view that however politicians respond the ship has already sailed.

"The link to Ritholtz was helpful, thanks. It seems he foresees inflation. "

Indeed it seems they expect deflation and governments to respond with QE to counter.

There statement

"Combining a subjective monetary policy-making “system” with its inability to scientifically or rigidly make economic prognoses and prescribe solutions should be troubling to all investors (and to everyone else)."

pretty much sums things up.

Sackerson said...

Been thinking about what you said re Mish and deflation. Both he and Karl Denninger regard deflation as inevitable, but that doesn't preclude price inflation - only yesterday I saw a 70s word back in the news: stagflation.

myopia said...

stagflation - ah the worst of both worlds :)

Interestingly - right on cue - reading Mish's post today its clear he thinks central banks can do little to prevent deflation and that governments are both moving away from stimulus due to a combination of short term politics and a growing skepticism about its efficacy.