Recently, we have been asked our opinion about gold. More specifically, should we be buying a lot of it? The conventional wisdom is that the Federal Reserve is printing a lot of money and the Obama administration is running massive budget deficits, both of which are going to make the dollar worth less, if not worthless. That being the case, how does one protect oneself against a decline in the value of one’s currency?
There is a significant contingent out there that thinks the answer is to buy gold.
We’ve heard that gold is going to $1,500 an ounce….$2,000 an ounce….maybe even higher. It seems as though some investors are factoring in “financial Armageddon.” Below is a 30-year chart of the price of gold.
If you recall, during the summer of 2008, the price of a barrel of oil climbed to $145. At that time there were “experts” predicting the price would climb to $300 per barrel. There were all sorts of plausible reasons why the demand for oil was vastly exceeding the supply. The most commonly cited cause was the meteoric economic growth of Southeast Asia (China in particular). It seemed everyone was convinced that China had an unstoppable and insatiable demand for energy. Below is a 30-year chart of the price of a barrel of oil.
A barrel of oil didn’t quite make it to $300. On the contrary, the price of oil fell by over 75% from $145 to $34. It has since rebounded to above $70.
Do we think the gold chart is going to replicate the oil chart? We don’t have a clue. Trying to pin down the future price of gold is futile. However, when the far right side of a 30-year chart of ANYTHING looks like the launch of a rocket, it is a high likelihood that train has already left the station.
What about inflation, you ask. When we had hyper-inflation in the ’70s (which is missing from the 30-year chart), gold increased in value significantly. This is true. If we have hyper-inflation today, gold may produce the same results….or it may have already anticipated the hyper-inflation because investors remember the ’70s (it wasn’t THAT long ago). Today’s price might already be accounting for hyper-inflation. In that case, you could be right about hyper-inflation and still not benefit from owning gold at its current price.
Or we might have very little inflation in spite of the Fed printing money. One component of inflation is caused by wage pressure. As prices and corporate revenues increase, employees demand higher compensation. There is no wage pressure today. Labor unions were much stronger in the ’70s. Today, unions have little clout and, with unemployment exceeding 10%, workers are reluctant to demand increased compensation. Another component of inflation is a function of the velocity of money (I’ve mentioned this in earlier Commentaries). The more quickly money changes hands, the greater the potential for inflation. Today, there is almost no velocity. Consumers are de-leveraging instead of spending and banks are reluctant to lend.
What about the declining value of the dollar due to the large amounts of debt our country is accumulating? This is a reasonable fear. As our country continues to borrow and increase our debt, there could be a threat to the value of the dollar. The budget deficit for the fiscal year ending September 30th was $1.42 trillion (almost $1 trillion more than the previous year). The deficit for just the month of October was $176.4 billion so we are well on our way to another year of spending much more than we are earning. However, this is not “news” and it is possible this is already reflected in the value of the dollar. Below is a 30-year chart of the dollar index (an index that values the dollar relative to a basket of 6 other currencies – the Canadian dollar, Japanese Yen, British Pound Sterling, Swedish Kroner, Swiss Franc, and the Euro).
As you can see, the dollar is trading at almost a 30-year low. That doesn’t mean it won’t decline more but it is clearly factoring in a fair amount of pessimism.
Another reason the dollar may find some support is that the value of the dollar is very much a “relative” issue. In other words, we try to figure out what the dollar’s value is “relative” to other currencies. We need to be mindful that the U.S. is not the only country having financial problems. Britain is similar. Spain has 18% unemployment. Greece is having suspect credit issues. Japan has been in a slump for ten years.
Needless to say, we don’t think it is a given that the dollar will continue to plummet and that gold will continue to soar. It is easy to get caught up in the emotional climate and assume that price trends will continue. Looking at prices over a thirty year period can help put things in better perspective.
Global stock markets continue to climb from the low levels experienced in early March. The S&P 500 has increased over 60% and the EAFE Index has increased over 70%, although both are well below the high points reached in October, 2007. The general consensus is that the recession is over and the worst is behind us.
If the worst is behind us, why did the U.S. Senate feel they needed to pass a bill extending unemployment benefits an additional 14 weeks? If the worst is behind us, why did the U.S. Senate feel the need to extend the tax credit for first-time home buyers for an additional six months? In the new bill, they even added a $6,500 tax credit for homeowners who have lived in their house for at least 5 years and are moving. If the worst is behind us, why is there such a major push from the Obama administration to modify existing mortgages?
It can be dangerous to say “this time, it’s different”. Every recession seems to appear different from previous recessions and yet, most of them run very similar courses. Investors are always most fearful at what usually turns out to be the bottom.
At Boyer & Corporon Wealth Management, we are as concerned about the global economy today as we were two years ago. We have weathered the sub –prime mortgage crisis and we successfully stared down “Financial Armageddon.” It is a major positive that those two economic events are behind us. However, it continues to bother us that:
- 23% of homeowners with a mortgage owe more on their mortgage than their home is worth. Even if they CAN make their mortgage payment, some homeowners are wondering if it makes financial sense.
- 40% of homeowners that took out a mortgage in 2006 owe more on their mortgage than their home is worth. They have to be wondering if their home will EVER be worth what they paid for it…and if not, why continue making mortgage payments? Why not give it back to the bank and go purchase a cheaper house?
- There were over 300,000 new foreclosure filings in October, the eighth consecutive month over 300,000.
- Dubai announced in October that it may default on its debt. When the U.S. real estate market peaked and homeowners began to default on their mortgages, it was first noticed in the areas of “excessive indulgence” (Las Vegas, Phoenix, areas of Florida and California). But the rest of the country was not far behind. In the world of sovereign debt, the obvious symbol of “excessive indulgence” is Dubai. We would not be surprised if Dubai is only the first of many countries to make such an announcement.
In the world of investing, it’s dangerous to say “this time it’s different”. You might be considered delusional to think there is something unique about a recession that is going to make it behave much differently than previous recessions. Nevertheless, we are going to go out on a limb and say, “this time it’s different. For many reasons, Boyer & Corporon Wealth Management continues to feel the Fed is once again encouraging “market bubbles” and, although our accounts have some equity exposure, we are reticent to increase it at this time.
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.