Hardly a day goes by that someone does not ask me what I think about investing in gold. Do I think the price of gold is going higher? How high do I think the price of gold can go? Is gold a good investment? The answer to any and all questions of that nature is “I don’t know.” You can substitute the word “silver” for “gold” and my answer remains “I don’t know.”
Two years ago, gold was $718 per ounce. Today it is $1,340 per ounce, an increase of 86%. Clearly it has BEEN a good investment for the past two years. Too often investors assume that, because an investment has been increasing in value, it will therefore CONTINUE to increase in value (like tech stocks and real estate). This feeling becomes stronger once a person actually owns the investment (like tech stocks and real estate).
Below is a 35-year graph of the price of gold. During inflationary times, gold typically increases in value to offset your loss of purchasing power as the dollar loses its value. In the ’70s, the U.S. experienced inflation that reached double digits. On the graph, you can see where the price of gold spiked around 1980 at $800 per ounce. The next decade was a painful one for gold investors.
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The Department of Labor keeps track of the rate of inflation…they call it the Consumer Price Index (CPI). The DOL does this by tracking prices of a “representative basket of goods and services.” And, according to them, CPI is virtually unchanged for the past two years… we have had almost no inflation at all. Yet the price of gold has risen 86%. Where is the disconnect? If consumer prices have not been going up, why is the price of gold exploding?
As much as the value of gold has been climbing, the value of the dollar is declining. Below is a 20-year graph of the U.S. dollar versus a basket of foreign currencies:
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Since 2001, the dollar has been in a rather steady decline and it is nearing a 20-year low.
There is a significant contingent that believes you should own gold, farmland and bottled water. This “Financial Armageddon” contingent is convinced that fiscal and monetary policy will completely destroy the value of the U.S. dollar and you will need to have gold as a means to barter for goods and services. If this ultimately proves to be accurate, I think that having a means to barter may be just one of your many problems.
Barring the Financial Armageddon possibility, there is no denying that the dollar is losing a lot of respect globally.
So we have a declining dollar which is typically accompanied by inflation. We have rising gold prices which are typically accompanied by inflation. Maybe the proper question to ask is “why don’t we have inflation?” Adding to this mystery are staggering increases in futures prices of commodities during the past year:
Corn – ^ almost 50%
Sugar – ^ over 21%
Wheat – ^ over 30%
Coffee – ^ almost 50%
Cotton – ^ over 88%!!
Soybeans – ^ over 23%
Copper – ^ over 29%
Maybe we do have inflation but just don’t feel it yet. If the price of cotton increased 88% in the last 12 months, increases in the price of clothing are not far behind. Higher prices have not yet been passed on to consumers because consumer demand is so anemic already. Also, massive cost cutting (layoffs) has allowed industries to make profits even with higher cost of goods.
But that can’t last forever and higher prices are almost inevitable. However, before you run out and purchase as much gold as you can, go back and take a look at the first graph. It may be that future inflation is already factored into the price of gold. It may be that the next decade could be as painful for gold investors as the ’80s were.
When we try to assess the value of any investment, we attempt to calculate the present value of all the future cash flows. With stocks, future cash flows are the company’s earnings and the dividends they pay to the investors. With bonds, future cash flows are the interest payments. With gold… there are no cash flows. Gold is only worth what someone else is willing to pay you today (like tech stocks and real estate).
And if you bought gold two years ago and made 86%…the dangerous thing about making 86% in ANY investment in two years is that it can make you think you know what you are doing (like tech stocks and real estate).
Third quarter Gross Domestic Product (GDP) was announced the other day, growing at a sluggish rate of 2%. By this point in a recovery, we should be experiencing growth rates of around 5%. Growth this slow will not come close to creating enough jobs to reduce unemployment. To make matters worse, over half of this quarter’s GDP was due to increases in inventory. It’s nice to know that manufacturers are so optimistic, they thought it wise to increase inventory, possibly because there is a holiday shopping season approaching. However, If their optimism is misguided, excess inventory will eventually be a drag on GDP as production slows… and the double dip recession will arrive.
I am writing before the mid-term elections, but this will probably get posted just after the elections. No one disputes that Republicans will gain seats in both houses of Congress. A gain of ten seats will give them control of the Senate. A gain of thirty-nine seats will give them control of the House. Don’t get too excited either way. Republicans say they can reduce the debt without tax increases by just cutting spending, but that they won’t cut spending on Social Security or Medicare. Democrats are strategically putting off talks about tax increases until after the elections, but are known to be in favor of raising taxes. They also don’t know how to tackle entitlement spending. Neither party will seriously tackle the costs of Medicare or Social Security until they become emergencies (a la Greece this past year). At that time, we might also be faced with a much higher cost of borrowing.
Yes, we are probably going to be experiencing some inflation someday, although with high unemployment causing labor costs to remain under control, it may be longer than you think. Yes, we are probably going to see higher interest rates within a few years. No, we are not loading up on gold. We aren’t saying gold won’t climb to $5,000 per ounce (like tech stocks and real estate) but (go back and look at the first graph one more time) it appears that train may have left the station. What we ARE doing is attempting to keep the duration of our investments as short as possible. Same tune, new month.
This information is provided for general information purposes only and should not be construed as investment, tax, or legal advice. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.