210 year trends part 2: Gold
July 10, 2010
– Comments (17)
In my last blog I took a look at the 210 year performance of equities. 6-7%/year, with remarkable consistency across circumstance, country, and time. Bubbles and busts and volatility and people jumping out of windows over short periods of time, but extreme consistency over long periods of time.
Presumably this reflects the ROI or ROE of businesses over time. The fact of the matter is that businsses that become unprofitable go away, replaced by businesses that are faster growing and more profitable than they were. Some come, some go, some endure, but over time capital flows to businesses that are making a profit, and this is reflected in the broad market indices. There is no other explanation for this performance over time: its a reflection of the profit potential and productive capacity of business.
Now lets take a look at gold. Gold, of course, was correlated to the dollar for a very long time via the gold standard. With the removal of this standard came market volatility, although this market volatility is reasonably new.
From 1802-1970ish, gold was worth (data from Dreman's "Contrarian Investment Strategies") about a dollar, varying a bit... In the '70's gold spiked dramatically to about $5-6 (eyeballing the graph) in the great gold bubble that peaked in 1980. In reality, the actual peak of the spike was probably close to $10 or maybe even more. But the chart presented by Dreman is a 200 year chart, and as such the spike is compressed.
By 1996 gold had fallen back to roughly $1. But it continued down from there... bottoming at 50-60 cents in the early 21st century. At this point in time gold was cheap like stocks were cheap in March 2009 or 1932. Extremely cheap relative to the historical trend, extremely.
In the time since then, gold has gone up about 5 times, outpacing everything, including inflation. Inflation in the last decade was about 28% (from a table I just googled) so a $1.25 in 2000 in about $1 today. But gold, at 50-60 cents in 2000, is $2-2.50 today. So instead of being for sale at a 40-50% discount from the historical trend, gold is for sale at a PREMIUM of 100%+. That is beyond the premium on the S&P 500 at the peak in 2000 although probably not yet at the premium applied to the Nasdaq at the 2000 peak. A historical premium, although nowhere near the premium that existed in 1980.
So gold, folks, is far above the trend, far. And enjoying a nearly 10 year old secular bull market. Stocks are below the trend, significantly, although no longer wildly below (about 25%) and suffering a secular bear market.
Never in history has buying something in a secular bull and far above its historical price yielded better long term (think alot of years) returns than buying something in a secular bear well below its historical trend.
Buying gold now is betting on, basically, a bubble, or super-bubble. It is far above its historical trend.
FAR.
When I first began permusing the blogosphere, gold was touted as the ultimate inflation hedge, as fiat currencies were worthless it would ultimately preserve your wealth as fiat's went to $0. In the last 3-6 months and ONLY, in my reading, in the last 3-6 months its become touted as a deflation hedge as well. Basically the current sentiment, as touted by gold bulls, is that gold will win no matter what.
Gold is the subject of infomercials and vending machines in airports, my buddies wife just put her share of their life savings completely into gold, because of china and the dollar going down and it preserving wealth.
Gold has all the makings of a bubble. Its popular among the "retail investors", its popular among pros, its touted as being inevitably a winner (inflation or deflation, doesn't matter, gold wins), the story is changing (used to be inflation winner, now its a winner no matter what).
Gold is popular and a very long trend favors gold, gold is above its historical valuations.
Right now, folks, gold is not value buying, but trend following. As per usual, retial money is following the trend (what have you done for me lately).
...
I know I will be flamed for this, but... there is little basis in history to suggest that, from here, far, far above its historical trend, gold is a good buy. To buy it you are essentially speculating that a very big bubble will form.
In my view, the best play on gold is a straddle. Short it, via puts, long-dated, and go long in case a truly supreme speculative bubble forms, via calls, long dated.
Whats the value of gold? Probably about its historical average. Which is alot lower than here. A whole lot of inflation is built into the current price of the stuff. But respect the fact that a big bubble may blow, and simply bet that in a very long time gold won't be where it is today.
And I bet you will wind up a winner.
But don't stay long a mega-bubble if one forms.
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