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The Worst Argument Against Gold - Part II

By: Ed Bugos

Yesterday's rant on Kanada's Globe & Mail article, "The Case Against Gold", garnered a lot of feedback and so Jeff asked me to take the helm again on today's blog in response.

It received a lot of feedback for a number of reasons.  The most common response was from Canadians themselves who wrote in to tell us that Canada is spelled with a 'C' and not a 'K' and that "not all Canadians are socialist."

I agree.  I am Canadian and while Jeff considers himself a 'citizen of the world' and dislikes all borders and governments, he was born and raised in Canada too.  So, that's two more of us that aren't socialist.  We know they exist.  But the country has a long history of leaning somewhat to the left and so we give it the moniker, Kanada.  Don't feel too bad though, we call the US the USSA now too.  It's hip and trendy.  Everyone's gone socialist/communist now.  Except the people who used to be socialist/communist, like Russia and China.  Strange, that.

Now, getting back to the matter at hand, the Globe’s case against gold is as old today as it was when we first heard it ten years ago.

It goes like this.

First, you find a bear and claim he’s the only one.  The Globe found an obscure investment adviser named Tim McElvaine, who, it claims “is a lonely figure these days” due to his bearish position on gold.

Before we even begin, let's quickly comment on how "lonely" it is to be bearish on gold.  Throughout much of the 20th century, gold & gold mining shares constituted a very significant percentage of global assets.  Over 20% throughout much of the century.  Now, as of 2009, what is the percentage of global assets held in gold or gold mining shares?  0.8%.

It's lonely alright, but not for gold bears.  For gold bulls!  No one owns gold.  Ask your neighbor.  Unless he subscribes to The Dollar Vigilante or is otherwise unusually, highly intelligent, he will not own one ounce of gold.  He'll own money market funds, blue chip stocks, bonds of all flavors, but he won't own even one gold coin.

Just look at the ownership disparity between US Money Market Funds and Gold ETFs as put together in this graphic from Jeff Clark, editor of the excellent Casey Research's, Big Gold:

I can think of many words for people who don't own gold but lonely is pretty much the last of them.

But let's get back to the interview conducted with Tim McElvaine.  Unbelievably, considering this guy was used as their main source for their "case against gold" he starts right off by pointing out that he really knows nothing about it.  He states,  “I'm as confused as the next guy about what’s going to happen with currencies and whether Ben Bernanke is right or wrong. But I’m not sure a whole bunch of yellow stuff in a warehouse is going to do much.”

Frankly, we were surprised they even printed that quote as it, bluntly, makes the guy sound like a complete moron.  He probably isn't a moron, but the poor guy is being asked to give his opinion on something in which he admits to having no knowledge of!

But, moving on to the main points of the article...

The article drags out all the same reasons why gold and gold stocks are "overvalued" that have been mentioned since the beginning of this gold move in 2001:

1.    the metal has no real use
2.    jewellery demand is falling
3.    investment demand is rising because of fear AND is fickle
4.    gold stock underperformance means gold is too far ahead
5.    gold stock earnings multiples are high
6.    comparisons to 1980
7.    fundamentals are against us

Making these arguments all the more stale is the fact that the article cites perma-gold bears like Jeff Christensen and Jeremy Grantham.  I don’t think they understand anything about currencies and central banks either.

Some people will believe anything if it works.  Their problem is that they are still beholden to the last generation, which is the one that was corrupted by the progressive ideals of the fiat money doctors.

Only from that perspective could one say that: “It wouldn’t take much to skewer the price of gold a second time.”

Obviously the author is thinking of the 1980 top when gold subsequently fell from $850 an ounce to as low as $300 in 1985.

Anyone who knows anything about that period of time can remember that by 1980 prices were generally rising rapidly, and the Fed, in response to these factors, finally was forced to abandon its easy money policy (it was either that or destroy the dollar in a hyperinflation as Jeff noted in a prior article) allowing interest rates to soar to levels that helped return the economy to more sustainable patterns of saving and consumption.  In other words, the Fed and the Government finally allowed markets to clear and malinvestments to liquidate.  People were sick of Nixon’s socialist policies and the general government interventions of the period – hence the reaction and rise to prominence of laissez faire types.

Thus, the article above expects gold to buckle as, “An improving global economy would send interest rates and bond yields higher, which would make the opportunity cost of holding gold – which pays no dividend – prohibitively expensive. Money would probably flow out of gold investments and into other assets, such as stocks and bonds.”

Nowhere in here does the author seem to recognize that interest rates were rising for 30 long years by the time 1980 came around.  Gold kept rising throughout.  The insight he is missing is that interest rates were never allowed to rise to their natural levels until the end of the seventies.  The assumption that the economy will improve is rooted in nothing.

And we can tell you it would take just as much as it did in 1980 to skewer the price of gold today.  The problem is that today there is nowhere near the will to abandon the policies that threaten to destroy the reserve currencies as then.  In fact, it is, in many ways, not even possible for rates to rise to prior 1980 highs without rendering the US Government insolvent, as Jeff also pointed out in his article on Volcker.

And so, until the day that rates rise to the point of rendering the US Government insolvent the bears will watch in marvel as the investment demand continues to come out of the woodwork and inflate the holdings in gold.

People such as Berman have, plainly put, got it all wrong.  They use a commodity production model for valuing gold instead of an asset pricing model, because they don't realize that gold is not a commodity but is a financial asset.  They also confuse market volume with demand.  And they think that jewellery demand is a main driver in the gold price - which it is not.  The annual amount of gold produced is but a small part of the total above ground supply of gold and therefore annual jewellery demand is inconsequential.

But, more than anything, they utterly fail to see gold price increases as reflecting the collapse of a non-free market financial system supported by government fiat. 

One day they will see.  We will keep our eye out for Berman's 2012 article entitled, "The Case For Gold".  Maybe then we will consider that we may be nearing the end of this gold market move.

Regards,

Ed Bugos

TDV Senior Analyst

Posted Wednesday, January 12 2011