Posts Tagged ‘Gold’

When markets tank, investors start looking to re-distribute their capital allocations…unloading high-risk and medium-risk  assets in favor of low-risk investments…because the risk premium just collapsed.

And just when that’s happening, the government is looking at reducing spending and therefore cutting into bond sales, reducing supply for one of the best risk-free options on the table.  That will will cut into yields, which will in turn cut into private investment cash flows.

And wouldn’t that reduce the floor under the risk premium?  I think so.  Gold, by the way, becomes a dangerous option when liquidity dries up in the face of demand.  As long as people are buying into gold in order to hold it, and doing so faster than the rate of supply, the price will continue to grow…but the volume of the actual gold market will decline.  As liquidity declines, price volatility tends to increase (because relative supply and demand compresses…this tends to increase the impacts of price shifts).  If this is driven by growing problems in other potential assets, as soon as those other assets stabilize, investors will exit gold.

That will undercut the price, potentially drastically.

Bear in mind that gold is a poor investment, generally, for a very simple reason: it offers no cash flow.  It is poor as capital.  I’m not saying don’t use it as an investment hedge; do that, please!  It is a way to hedge against outside factors impacting the value of currencies, for instance.  However, as a straight-up capital or financial investment, its fundamentals are poor in a healthy economy, as it produces no cash flow.


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Gold has been pimped by a portion of the investment community for ages.  Gold is a strange substance, culturally.  It inhabits very little of the production for most goods, yet is classically one of the highest demand “rare” substance.  Now I don’t think I’ve ever seen a gold bug not pimp gold.  Seriously, never.  No matter the economic conditions, no matter the macro perspective or the state of investor psychology, gold is a good buy.  It hedges against the stock market, except when it totally correlates well with it.  It goes up when the dollar, weighted against foreign currencies drops, it goes up when there’s inflation, it goes up when there’s deflation, it always goes up!

I heard much the same thing about house prices.

Business stock investment in the classic sense follows a very simple assumption: prices movements track business success (or failure) on average.  So, if you locate a business where you have a good idea of how well it will perform, and see that it will succeed, then you buy that stock, hoping to trade it capital for a chance to cash in on the stock’s future price increases.  Maybe you’ll even pull dividends, so you can share in the business income stream.

This also applies to broad market indices, like the DJIA or S&P 500 (or Russell 5000, or whatever floats your boat).  The prices of broad market indices are presumed to track the success of portions of the ecnomy.  Generally, the DJIA and S&P 500 will grow as the US economy does, so if you think the US economy will do well, investing in index funds tracking these will allow you to cash in on that.

Gold, however, is not a business.  Gold is strictly a psychological trade: you are attempting to understand where gold fits in the psychological profile of the investing public and where it fits in their broader decision making.  It doesn’t feel like a strict macro trade.  In some cases, gold will correlate with one macro-level property and at other times it will follow another.  It’s value seems to be a sort of stop-gap, though what exactly it’s hedging varies from trader to trader and depends strictly on their particular portfolio.

All of which says that I don’t know what the fuck gold is doing.  If gold is strictly an inflation hedge, I don’t see why you couldn’t equally well buy TIPS, which guarantee returns over inflation.  There exist other safe investments besides gold, other uncorrelated assets.  What I’m saying is that gold lacks a way to value it fundamentally.  You’re guessing on the basis of other investors; it is investment gambling in its purest form.

Actually, I’m inclined to say the fundamental value of gold is, well, constant.  That’s the argument for it being an inflation hedge…but TIPS works as well for that.  Heck, if you think the US will default on its bonds, go ahead and buy TIPS denominated in Euros or Australian $ or Canadian $ or whatever.  You can, you know.  And those will return above inflation, and may even net you a carry trade bonus on top of that.

But back to gold.  If its fundamental value is constant, its price is set strictly by supply and demand.  Supply is a relatively measurable and static thing.  Demand, then, would account for price fluctuations.  So what drives demand for gold?  Obviously, jewelry demand.  I think I can safely guess that jewelry demand is not growing, as that would only grow with incomes…and incomes have been a bit…um, stagnant.  Unless it’s all the lavish spending for ostenatious jewelry out of emerging markets?  Maybe, I guess.  Demand for gold in manufacturing seems like it’d be similar.

So we’re left with investment demand for gold.  Investment demand for gold distorts the gold market, by the way.  since investors do not return gold to the market, but instead pull it out, it effectively pulls forward gold demand.  None of the gold purchased to be held by investors is removed from the gold supply, rather, it is simply saved away to be resold later…which means the future supply of gold will increase relative to the present supply, negatively impacting price.

And that inevitable event is why I shy away from gold, because it will come, I suspect it will be disorderly, and I’m fucking clueless about when.  I’m content to miss the gravy train, and admit I have been wrong about it for a while, because I just don’t like gambling in a complete unknown.

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