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Gold is a hunk of metal that I'm OK without

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February 15, 2010 – Comments (13) | RELATED TICKERS: KO , AUY , CHL

I see the data on the dollar and I'm concerned. But I'm just not into gold. So what do I do? Well, I wrote about three possible approaches that I believe deal with the problematic dollar, but are also better than gold.

In short, those approaches are:

- Commodity-producing companies (and, yes, this does include gold producers)

- Foreign companies (if the dollar is the problem, why not look to companies that work with other currencies?)

- Companies with pricing power (you don't need Coke to drive your car, but companies like Coke have the power to boost prices and not destroy volume)

Matt

13 Comments – Post Your Own

#1) On February 15, 2010 at 3:25 PM, Superdrol (97.22) wrote:

It is tough to trade gold, even using pure technical analysis. 

I think a good alternative to the dollar is indexes.  The Russell 2000 is a good one that has lagged.

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#2) On February 15, 2010 at 3:32 PM, catoismymotor (24.55) wrote:

The commodity producers and foreign companies are the angles I like the most. If you find a foreign commodity producer with a great moat and all the trimmings you could have a real winner on your hands.

 

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#3) On February 15, 2010 at 3:39 PM, TMFKopp (98.42) wrote:

@Superdrol

We're probably on different wavelengths here. I'm not talking about trading any of this. Instead, I'm thinking about what are good long-term investment opportunities.

 

@catoismymotor

Agreed. Though I still like to include that last group since I think if you can find a company with a real, durable moat -- they're out there but they're not all that common -- then you can stay pretty well protected.

 

Matt

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#4) On February 15, 2010 at 6:05 PM, FleaBagger (28.92) wrote:

Matt, there are a lot of flaws in your reasoning.

First, what about the risks faced by mining companies? Inflation increases labor costs, capital costs, etc., none of which is faced by a lump of gold. Your lump of gold is not going to go on strike, it's not going to lose mine equipment to a freak accident, it's not going to have a cave-in, and it's probably not going to be nationalized by a foreign country. While I do think gold mining company stocks are generally good in inflation, they are much riskier than a lump of the metal itself.

Second, foreign companies provide a dollar hedge in other fiat currencies that can, and probably will be inflated by their respective central banks. Every country could simultaneously see 10-25% inflation in terms of purchasing power. In fact, I expect that to be the norm in 2011-2012. In that kind of environment, gold has consistently increased its purchasing power, while companies exposed to foreign fiat currency could see serious declines.

Third, if Coke could have increased their prices without a decline in volume, they would have. It would have been free money! Though I presume you are talking about in an inflationary environment, if Coke were to keep a stable inflation-adjusted price that rises in notional terms. In that case, look at Coke's split-adjusted price at the beginning of 1970: $1.6719, according to Yahoo! Finance. One decade later its price is listed $1.3125. Apparently Coke's pricing power wasn't adequate the last time we had severe inflation. I'm just a young guy, but people had heard of Coke back in the 1970's right?

In summary, sorry for being a wise-@$$, but people need to know that multinational stocks, domestic large caps, etc. aren't an inflation hedge. Mining stocks work only if you have the diversification to withstand company-specific problems. Stocks in any broader sense are absolutely not good investments in times of high inflation.

In short, buying a lump of the heavy yellow metal (no, not uranium yellowcake!) is the easiest way to effectively prepare for inflation. And effective it is.

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#5) On February 15, 2010 at 7:41 PM, TMFKopp (98.42) wrote:

@FleaBagger

"Matt, there are a lot of flaws in your reasoning."

Particularly if you misread the article as saying, "these are better pure inflation hedges than gold." Which is not what I was saying...

If your #1 priority is to battle inflation, be my guest and fill your basement with bricks of gold -- that is going to be one of your best bets. Though I'd still probably prefer something that's actually useful like oil.

"First, what about the risks faced by mining companies?"

Everything you invest in is going to have risks. What happens if your inflation expectations don't pan out? You've got a lot of metal that hasn't done a darn thing for you. Are there risks to miners? Sure, but there are risks to holding gold too. 

"Every country could simultaneously see 10-25% inflation in terms of purchasing power. In fact, I expect that to be the norm in 2011-2012."

I think you're plain wrong on this one, so we're probably not going to see eye-to-eye on that.

"In that case, look at Coke's split-adjusted price at the beginning of 1970: $1.6719, according to Yahoo! Finance. One decade later its price is listed $1.3125. Apparently Coke's pricing power wasn't adequate the last time we had severe inflation."

You're comparing apples and oranges here. Coke's stock price doesn't necessarily move in lockstep with the price of its product. If you buy a stock that's overvalued to begin with, then it doesn't matter how well its underlying product is able to keep up with inflation. I don't have the figures on Coke's stock in 1970 and 1980, so it's tough to say why it might've stayed flat.

In other words, there are risks to investing in companies that sell products that have pricing power -- you can still overpay for the stock.

 

Bottom line though, I think gold is a pretty lousy investment unless you can somehow prove that you're purchasing it at a discount. Is it a better pure inflation hedge than the areas I recommended? Probably. But I think investors are still better off outside of gold.

Matt

 

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#6) On February 15, 2010 at 7:57 PM, TMFKopp (98.42) wrote:

@FleaBagger

One other note on Coke... since you brought up the stock price in particular...

If you settled on gold over KO in 1970 you'd certainly look pretty smart by 1980. But when do you sell? Are you lucky enough to figure on selling right in 1980 (when inflation was still particularly high)? Or do you give up a good deal of your gains in the years to come?

Or do you hold onto it forever? Certainly the 31x return from 1970 to today is nothing to sneeze at, but KO's dividend-ajusted return from 1970 is 93x.

Matt

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#7) On February 15, 2010 at 9:08 PM, FleaBagger (28.92) wrote:

About the riskiness of gold miners, my point is there are more and more complex risks to miners' stock than involved in just buying gold. There is only one risk to buying gold: inflation is less than you thought. If inflation is what you expected, you will profit from owning gold. It's simple, understandable risk, no diversification required. Buy gold, you're ready for inflation. Simple. 

As long as we're talking about investing to beat inflation, Coke's stock price is not "apples and oranges," it's perfectly relevant. It's possible that right now, as people are trying to invest to beat inflation, every stock on the market is overpriced and will have a negative or negligible inflation-adjusted return over the next ten years, as was the case with stocks from the early 70's to the early 80's. More on that later.

As to not seeing eye-to-eye on 10-25% inflation, I guess that's the problem I have with your article. Don't presume to teach people how to invest for a falling dollar if you don't think it's going to happen. If you don't expect it, you don't have a powerful incentive to learn how best to invest for it. Others derisively labeled as "goldbugs" and I do have that incentive.

And finally, as to "when do you sell?" that's always the relevant question when you have unrealized capital gains, isn't it? The answer is: when inflation starts to slow.

I addressed it in more detail in an earlier blog titled "Are stocks going to continue their inflation-adjusted slide?" I answered that with a "yes," as you may have guessed. The quick summary of it is that when inflation fears had just started heating up, and the government was running up huge deficits (huge for their time: nothing like $1,600B), you would have trounced the return of the broad stock market. 

More specifically, if you had bought gold in the early 70's for less than $70/oz, you could have sold at the lowest price point in the 1980's for >300% gain. The very lowest price in the entire decade was $284.25. So just sell whenever you notice inflation starting to come down. It's okay if your timing isn't the bast. In fact, it's okay if your timing is downright crappy. 300%

That's versus ~14% for the S&P (Jan. 1970-Jan. 1980) according to Y!Fin, an inflation-adjusted negative return.

Basically, stocks are not always a good asset class to own. Sometimes the entire market is overpriced, or at least the undervalued ones are much rarer and harder to find. Sometimes it pays to just sell your stocks and buy gold. Most of the 1970's was such a time, as this millennium has been so far. I think that budget deficits indicate that is going to continue for a while. Personally, I'm hedging my silver and gold against moderate inflation by writing puts on stocks that I think might be hidden gems, but the fact remains: gold is king if the dollar is weak. Your article is misleading.

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#8) On February 15, 2010 at 10:57 PM, TMFKopp (98.42) wrote:

@FleaBagger

"As to not seeing eye-to-eye on 10-25% inflation, I guess that's the problem I have with your article. Don't presume to teach people how to invest for a falling dollar if you don't think it's going to happen."

1) you don't have to have quite that extreme of a view to still worry about inflation

2) you were specifically referring to countries outside of the U.S. Assuming other than massive inflation abroad, investing in companies that don't do business in dollars would be a good strategy if you're expecting a fall in the dollar.

 

"Sometimes it pays to just sell your stocks and buy gold."

Yeah, particularly in 1970 and 1999.

Inflation has averaged around 2% between 1999 and today, and yet the price of gold has put up something like 15% per year over that period. I was kind to gold in the article by suggesting that it wasn't overpriced as compared to the price of oil. But is that conclusive? Not really... 

Considering that gold is considered the ultimate inflation hedge, and the price has gone bonkers without significant inflation, then maybe, just maybe, gold fans have been frontloading on the expectation of inflation. But what are the underlying fundamentals on gold? How can you work up what a reasonable price really is?

So to your comment:

"gold is king if the dollar is weak"

Well, maybe, or maybe not. If people have been buying up gold expecting inflation, who's to say that they won't start selling it once inflation actaully hits on the expectation that inflation will be tamed?

Of course, this doesn't negate your point about stocks. Stocks aren't always the best asset to own and at the current level the overall market isn't terribly enticing. I believe that there are plenty of stocks still worth owning right now. 

Matt

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#9) On February 15, 2010 at 11:23 PM, TMFKopp (98.42) wrote:

@FleaBagger

Also, just read your blog post that you linked to...

Does it concern you at all that you seem to be basing your case very heavily on a single observation -- that is, the experience in the 1970s?

Interestingly, between 1941 and 1948, U.S. inflation averaged around 6.9% per year. Over that period, the Dow gained roughly 36%, which your inflation-adjusted analysis would reveal to be a loss in real terms. But that performance still managed to clobber gold, which, based on the numbers that I'm looking at only managed to squeak out 2.5% over the entire period. 

Which is funny right? Maybe not, if you consider that gold had somewhat strong run between 1931 and 1941 when the price level actually deflated. 

Now all of this is obviously fogged up by the U.S.'s on-again off-again relationship with gold-standard-ish systems, but the point still remains that data available to prove your thesis that this is the time to be stocking up on gold is incredibly slim.

Are there definite warning signs for the dollar? Yeah, I certainly think so. I'm just far from sold that gold is the best way to deal with it.

Matt

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#10) On February 16, 2010 at 6:59 PM, FleaBagger (28.92) wrote:

The reason it's difficult to draw effective parallels to our time is because gold was illegal to own between 1933 and 1975. Prior to that, we had a gold standard, so measuring the price of gold is problematic. Perhaps I shouldn't have tried to draw any lessons from the 1970's. Touche. Perhaps the most instructive lesson we can draw from history is that when the Roman Empire started debasing/inflating their currency to pay for social welfare programs and wars, those who held onto the older, truer (i.e. higher percentage precious metal) coins still had something to show for themselves as the Empire declined around them.

About gold in 1941-1948: it's hard to take that as a convincing evincing of the vincibility of gold, because not only was it illegal for Americans to own gold at that time, but loopholes like the krugerrand had not yet been minted. (At least, I believe no effective loophole had yet emerged.) To use dollars to look at gold any time between 1933 and 1967 is pretty unhelpful, but if you're still not convinced:

The dates you pick are very funny. The inflation of 1941-1945 was very different from the inflation of 1946-1948. The former had to do with combined quantitative easing and rationing. The latter was due to sweeping rollbacks in price controls that had already been reflected in anticipated inflation much earlier. With no way for Americans to buy gold bullion, and foreigners being dissuaded from trading dollars for gold by the U.S.'s current account surplus boom, massive foreign aid loans, and newly acquired world reserve currency status, the environment for gold was pretty poor (assuming that there even was a gold market, but there wasn't), especially considering the run-up you acknowledge that gold had enjoyed in the decade prior to your chosen dates.

Now that U.S. individual investors are allowed to buy gold bullion (though most haven't yet), our current account deficit is even greater than our massive CAS in the 1940's, we are witnessing truly unprecedented quantitative easing, and to top it all off, a $1.6T(!) federal budget deficit - the investment environment for gold is much better now, despite it having enjoyed a run-up similar to the one during the Great Depression.

We're in a gold bull market right now. If you don't see that, you don't want to see it. You may argue that it's ending and has run its course. If you measure bull markets in years, that seems to make sense, but I would argue that the 1970-1980 gold bull was actually the 1948-1980 gold bull, finally freed from government manipulation through several measures in the early 1970's.

You don't have to buy it - more gold for me. But because I like teaching, consider this: during gold's last major bull market, it went from a low in the mid 30's to a high of over 800, for a gain of over 2,000%. That's like a great stock that gets touted in those breathless Motley Fool emails. Even if you had bought late and sold late, as I had pointed out in my blog, you would have made a handsome 500 or 600% notional return. 

In the current bull market, we are less than a 350% gain from the lows in 2001, even though the fundamental case for a poor economy, poor stock returns, stagflation, and other gold-friendly factors is arguably stronger now.

Of course, the value of gold is the most subjective valuation the market puts on a physical commodity, because its use in jewelry is negligible compared to its use as a store of value of last resort, and its industrial use is even less still. Gold is a guage of how bad people think the future is going to be. I plan to sell when my expectations for the future of the economy are higher than those implied by the price of gold. And that has not happened yet.

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#11) On February 17, 2010 at 12:04 AM, TMFKopp (98.42) wrote:

@FleaBagger

"Of course, the value of gold is the most subjective valuation the market puts on a physical commodity, because its use in jewelry is negligible compared to its use as a store of value of last resort, and its industrial use is even less still. Gold is a guage of how bad people think the future is going to be."

Which I would say makes it more of a speculation than an investment.

You're talking to someone that likes dividends here. Dividends, which put money back into your portfolio quarter-in and quarter-out, no matter what the market's opinion of the stock currently is. With gold, the price, as you've put well, is pretty much wholly reliant on how people feel and how scared they are about the future.

There are plenty of people out there that invest in art. It's an undertaking that's very different from investing in a business and it's not something that I'd recommend for someone unless they know what they're doing and are really into art.

I feel the same way about gold. 

And to your points about the great gains that gold has had at times -- that's wonderful. There are a lot of stocks that I don't own, never owned, and still wouldn't want to own that have put up incredible returns. My focus is on investments that I feel comfortable evaluating on the basis of their underlying businesses.

Matt

 

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#12) On February 17, 2010 at 8:35 AM, catoismymotor (24.55) wrote:

Silver.

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#13) On February 17, 2010 at 9:31 AM, lemoneater (78.14) wrote:

Let's hear it for aluminum! Well maybe not. Are you aware that at one point in history aluminum was more valuable than gold. http://acswebcontent.acs.org/landmarks/landmarks/al/revolution.html.

I think that I was too late to get gold at a price that would work at beating inflation for me, but I do have some silver. I'm interested in Titanium which seems to be coming into it's own as a material--it even has medical applications. http://articles.latimes.com/2009/oct/28/nation/na-artificial-bone28

 

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