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210 year trends part 2: Gold

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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.

17 Comments – Post Your Own

#1) On July 10, 2010 at 12:55 AM, Momentum21 (44.78) wrote:

Nice...this thread will be interesting to follow. : ) 

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#2) On July 10, 2010 at 9:22 AM, Eudemonic (60.64) wrote:

I find it strange that gold vendors exchange their gold for fiat currency and vice versa.

 checklist34: In your studies, have you found any indicators that tell when the bubble is about to burst?

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#3) On July 10, 2010 at 9:22 AM, Eudemonic (60.64) wrote:

I find it strange that gold vendors exchange their gold for fiat currency and vice versa.

 checklist34: In your studies, have you found any indicators that tell when the bubble is about to burst?

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#4) On July 10, 2010 at 10:17 AM, dbjella (< 20) wrote:

I look at gold and silver from a supply and demand perspective.  As the worlds fiat money becomes more and more worthless people, countries and central banks look to the only tangible money they can find.   The "bubble" is not only a reflection of speculation, but a protest of world gov'ts spending fake money that they just don't have.

This is just my simpleton view.

+1 I have enjoyed these last two blogs :) 

 

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#5) On July 10, 2010 at 11:15 AM, RonChapmanJr (33.57) wrote:

if you have any gold or silver i will be happy to buy it from you at spot price.  :) 

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#6) On July 10, 2010 at 11:36 AM, MegaEurope (20.43) wrote:

"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."

Not quite true, if you bought stocks at overpriced highs in 1929, 1968 and 2000 you would still eventually come out ahead of assets that were underpriced at the time.  Over the short term the price is most important, but over the long term the quality of the asset becomes most important.

My guess is that the social constructs around gold have changed so that it will not return to its historical value.  But its long term appreciation will not be anywhere near high quality stocks.

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#7) On July 10, 2010 at 3:03 PM, checklist34 (99.73) wrote:

36 year price history of gold:

 

200 year history price of gold adjusted for inflation #1:

 

And another 200 year history price of gold adjusted for inflation:

 

The two charts above are somewhat different than Dreman's chart, in that they show gold falling only back to about $1, not well below.  

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#8) On July 10, 2010 at 3:05 PM, checklist34 (99.73) wrote:

crap, that last picture didn't come through.  You can see it here:

http://static.seekingalpha.com/uploads/2010/7/8/saupload_gold_prices_since_1800.jpg

related to an article that just popped up recently, ironically, with roughly the same conclusions here:

http://seekingalpha.com/article/213701-yes-gold-is-a-decent-inflation-hedge-but-it-s-a-lousy-investment?source=hp_wc Report this comment
#9) On July 10, 2010 at 3:10 PM, checklist34 (99.73) wrote:

thanks momentum

Eudemonic, no.  I haven't any idea.  The last gold bubble peaked quite a bit higher than today.  

Shorting gold would be risky, risky business, as I would not doubt that a zoom to $2000 could happen, so if shorting it I would only do it with puts (finite amount of $$$ to lose) and I would also buy calls (so you'd make money if it went really up).  A "straddle" as its called, you ar ejust betting that the price moves significantly.  

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#10) On July 10, 2010 at 3:12 PM, checklist34 (99.73) wrote:

dbjella, for sure.  The price of gold is a reflection of peoples disgust, I agree.

Ron, if I owned some gold, like bullion or whatever, I would probably just buy puts on it and keep it, because that would be extremely cool to own.  

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#11) On July 10, 2010 at 3:14 PM, checklist34 (99.73) wrote:

MegaEurope, good point. 

But you would have been behind on those investments for quite a while relative to others (decade or 2).  But very good point.  

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#12) On July 10, 2010 at 3:43 PM, WallstreetKnight (43.34) wrote:

Is there any decay with listed 'paper gold' such as GLD?

If one wanted to "invest" in gold, is it best to do by physically purchasing bullions or by putting money in a gold ETF/trust? 

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#13) On July 10, 2010 at 3:58 PM, checklist34 (99.73) wrote:

WallstreetKnight:  if there is decay in GLD its modest.  This is a potential problem, I would imagine.  I am not an expert on gold or these ETFs...

but since 2005, if GLD has exhibited decay, it is very modest at not more than 1% or so over that time.  

And that "decay" may simply be the accumulated fees taken by the operators of this ETF

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#14) On July 10, 2010 at 7:57 PM, 100ozRound (29.51) wrote:

"By 1996 gold had fallen back to roughly $1."

Checklist - can you eloborate?  In what sense was gold worth $1?  Is this a ratio of some sort?

 

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#15) On July 10, 2010 at 8:15 PM, checklist34 (99.73) wrote:

100ozRound,

In Dreman's book he had a chart where the value of each of (cash, bonds, t-bills, gold, stocks with dividends reinvested) started at $1

Gold had fallen back to $1 by 1996, after being >$5 in 1980

All were adjusted for inflation.  Cash was 7 cents 

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#16) On July 10, 2010 at 8:24 PM, 100ozRound (29.51) wrote:

Gotcha - now it makes sense in context.  Thanks!

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#17) On July 24, 2010 at 8:10 PM, WallstreetKnight (43.34) wrote:

I wonder what the best way to invest in gold long term?

An ETF or physical bullions?

The problem with physical is the wide spread differential when buying and selling.  And I feel that ETFs would decay somewhat significantly over a 10-20year holding period. 

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