Tuesday, November 30, 2010

Has gold ended its bull run?

The price of gold has soared in the last decade. Can it continue?

Two views make a market, as the saying goes. in "Gold's Run is Over -- I'd Much Rather Own This Stock", Tim Begany writes:

"Gold is the worst investment around. Anyone buying it now is doing so at their own risk, near the end of a bull run that's apt to end badly.

A major clue gold's time is up: institutions and hedge funds are starting to get out.

In October, for example, these big players reduced their long gold futures by -9%. Meanwhile, small investors added +5% to their long gold positions. It's a familiar pattern in which large investors exit the market of an overheated asset in a timely fashion, leaving the little guy to drive the final run-up to the big pop.

I give gold up to another year, maybe two, before it peaks. From there, it's all downhill."

Tim prefers shares in an ex-bankrupt company - Owens-Corning (NYSE: OC) - that makes insulation for buildings.

Bargain-hunting among distressed firms can be rewarding. The financial journalist George Goodman (aka "Adam Smith") once interviewed a fund manager who'd bought stock in the Santa Fe railroad, then bankrupt. The manager explained that the land, buildings and rolling stock had substantial value that was not yet reflected in the share price. This was decades before Warren Buffett and George Soros (an ex-railway porter) discovered their recent interest in choo-choos - maybe for similar reasons. (But it's worth noting that Soros recently sold his holdings in Canadian Pacific - cold feet?)

And it's true that the ratio of the Dow to gold has dropped below the long-term average since the closure of the "gold window" in 1971:

- though the ratio hasn't fallen to its 1980 low. It's also true that gold has outpaced inflation in a way not seen since the end of the 1970s:

So why do the gold bugs still have a voice?

I'd say it's because, as in 1980, these are not "normal" times. JK Galbraith said "The only function of economic forecasting is to make astrology look respectable" and all their cyclical predictions are junk when an asteroid is spotted coming in our direction. That asteroid is a combination of the vast debts of Western nations, the dependence of much of their populations on wealth transfers within those economies, and globalized trade.

Can we deflect it with rockets of bailout and default? The bailouts appear to be devaluing our currencies and may end with high inflation in necessary commodities; sovereign debt defaults would affect not only international relations but the mutual and pension funds on which many of us hope to live in retirement. If the biggest banks are allowed to fail and their shares go to zero, what will that do to Everyman's portfolio?

Gold is a speculation unlike most others: it's a vote of no confidence. As such, it's a systemic indicator, not an ordinary item of trade. At this level of the debate, graphs are meaningless. Among the bears, opinion is divided between people like Peter Schiff who think we can make something out of this crisis, and those like Michael Panzner who believe that when a civilization falls, even the richest citizen can lose all. For example, the biggest-ever hoard of Anglo-Saxon gold was discovered last year, not far from where I live. It's thought to be from the Kingdom of Mercia in the 7th or 8th century. The people who put it there never came back.

We should turn our minds from playing with money to repairing the framework of our nations, and preserving our liberty and democracy.

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.

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