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Gold Has a Sinking Spell
(January 26, 2011) Gold prices today are down nearly $100 in less than a month’s time, after gaining about 30% versus the dollar in 2010. The year 2011 so far is telling us a different story – but what is that story?
Gold is that inert, irreplaceable, and inescapable element financial instrument that is like no others. Although its utility is negligible, for thousands of years gold has been brought up out of the ground at great effort and expense, and then, at further expense, returned to the underground for safe storage.

If there wasn’t gold on this earth, then we would have to invent something like it. That something would have to be hard to produce so that it would be rare, preferably soft and malleable, definitely tarnish-proof so that it can’t be mistaken for something else, and it would be nice if it was an attractive color (such as yellow, like the sun) and could be worked into attractive ornamental things such as jewelry and the like.

Of course, even if you could invent such a thing, you wouldn't make everyone happy.

"And I don't see how you become rational hoarding gold. Even if it works, you're a jerk." -- Charlie Munger, Berkshire Hathaway Vice Chairman, October 2010

I’m sure that since he made that statement, it has been pointed out to Mr. Munger that, although holding gold does not make one ‘rational,’ it certainly has made people richer than holding Berkshire Hathaway stock over the past decade. In 2001 you could have spent around $60,000 on one share of Berkshire stock, or bought two hundred ounces of gold. The Berkshire share yesterday traded around $124,000, while the 200 ounces of gold now would net you some $266,000.

Of course, past performance is no guarantee of future price moves, but the $142,000 difference goes a long way to make up for being called a jerk by an aging insurance company mogul.

Gold’s price performance against the dollar over the past ten years or so has been nothing but spectacular, and for those who consider gold a dead and worthless metal, and its private ownership no more than hoarding, this fact is bound to rankle. For those who diligently researched and invested in stocks, bonds, or real estate over the past decade, the idea that they could have just bought gold ten years ago and watched it more than quintuple in price sort of mocks the idea of ‘active investment.’

There is no denying that there is a bias against gold in our American culture. Not against the metal itself, but the public image that adheres to its owners. Gold’s negatives emerge chiefly from the miser stereotype, that image (softened somewhat by Disney’s character Uncle Scrooge McDuck) of a lone figure, hoarding his gold rather than ‘sharing’ it with the economy.

Gold’s tainted character in the US was born during this country’s last economic calamity, the Great Depression of the 1930s. Gold, which had been money itself in the US since 1795, suddenly was forbidden to be owned by US citizens, and gold holders came under social pressure. FDR, following the rest of the world, took the United States off the gold coin standard, beginning an era in which hoarding gold in coin and bullion form was actually illegal for many decades. The patriotic thing to do in 1933 was to turn in your gold for Federal Reserve Notes, thereby doing your part, it was hoped, to stimulate the economy.

History often repeats itself. And today we find that, once again, stimulating the economy seems to the primary avowed goal of the Federal Reserve and US Treasury. Yet gold is no longer tied to the dollar, and there is no requirement that citizens turn in their gold for any reason whatsoever. And gold is the ultimate protection against the ongoing weakness in the dollar.

Our dollar, through its role as a world reserve currency, has enabled the US to sustain a level of spending that otherwise would not be possible. In essence, we have borrowed our way to prosperity. Yet, changes in the world economy are bringing China to the forefront, whose strong economy supports an increasingly strong yuan.

The January 22 issue of the Economist, in an article entitled “The Rise of the Redback” puts our dollar’s status into perspective:

“China’s president, Hu Jintao…told two of the country’s newspapers that the international currency system was a ‘product of the past.’ Something can be a product of the past without being a thing of the past. But his implication was clear: the dollar’s role reflects America’s historical clout, not its present stature.”

President Jintao’s words are very diplomatic, but the truth is there: In a world of fiat currencies, the strength of one nation’s currency stems chiefly from its industrial might and productivity. Nostalgia for the dollar’s past invincibility only carries so far.

Inflation tells the tale. The January 24th Wall Street Journal headlined on its front page: “Global Price Fears Mount” Agricultural commodities are making headlines: cotton is at a record $1.59/pound, along with wheat, corn, and a host of other crops. Which in turn drives prices at your local grocery higher, and makes farmland more expensive.

Yet, despite growing evidence of inflation, precious metals prices this calendar year are experiencing a correction. But such moves are nothing new during this ten-year bull market in gold. Nothing goes straight up.

Take for example the tumultuous year of 2008. During that period of economic unpleasantness, gold prices first touched the $1,000 mark in March, only to trade down to $713.00 eight months later. From there, gold prices rallied, and despite the 28% price dip in eight months, gold prices actually closed up for the year 2008.

Felix Zulauf of Switzerland’s Zulaug Asset Management commented on gold’s recent price action in Barron’s “Roundtable” discussion in the January 24th edition:

“The price of gold has run up to an extreme point, and gold is technically vulnerable to a big shakeout this year, particularly if emerging markets tighten and life real interest rates. But shakeouts will be followed by higher prices, and would just represent opportunities to buy. Gold could fall to $1,150 or $1,200 from $1,370 now. I would be a buyer at those levels.”

Predicting gold’s short-term future is always an impossible challenge. Gold prices may or may not recede to 2010’s average price of $1,224, or maybe Mr. Zulauf is right that gold will sink further still.

Currently, US equities are trading at multi-year highs, the recession has been declared over, and glimmers of economic optimism abound. Yet, oil prices are approaching $100/barrel again, and with rising prices worldwide for many commodities, products, and services, the argument that we are facing a deflationary future looks weaker by the day.

Gold, in the end, is still the insurance you buy when you are not sure exactly what it is that you are insuring against. If you are a potential buyer, what could be more favorable than the price of that insurance going down?


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