The dominant investment view of summer 2008...
"GOLD DIDN'T DO too well lately. Maybe it's time to get out..."
The thought comes up from time to time, writes Bill Bonner of The Daily Reckoning, most recently from a visitor from Maryland.
"If the world economy is slowing down, commodities aren't the place to be," he went on.
"Gold neither. People Buy Gold to protect themselves from inflation. But inflation isn't going to increase in a recession. You'd be better off in cash until this thing turns around."
Our guest voiced what is probably the dominant investment view of summer '08 – that a worldwide slowdown means price increases will slow down too. Without the hot breath of the inflation hounds chasing it, Gold will go back to sleep and the Fed can continue to rescue speculators from their mistakes.
That's why US ten-year Treasury bonds yields all of 3.78% per annum. Yes, investors know they will lose money if inflation remains above 4%. But that risk – or so they believe – is worth taking. Because the safety of the Dollar and the full faith and credit of the US Federal Government stand behind investment in T-bonds.
Besides, inflation is almost sure to go down. No?
This view may turn out to be right. But when we think of moving to cash we pose the question: Which cash? And there's the problem.
The planet's alpha cash, today, remains the US Dollar. And while the Dollar may have some limited upside in a punk market (it's already gone up about 7% against the Euro), the potential downside is enormous.
What if the bond market is wrong about inflation? What if the increase in producer prices – now running at nearly 10% year-on-year – works its way into consumer prices? What if demand from the developing world doesn't slack off as expected?
What if there is war? What if the US economy worsens...and the Feds need to cut rates and offer further $100 billion bailouts? What if Asian, Arab and Russian creditors lose faith in the Dollar and switch to Euros?
Any of these things could be catastrophic for holders of US Treasury bonds. At a yield of just 3.78%, it hardly seems worth the risk. And as for shorter-term Treasury bills, they barely pay anything at all to investors.
So which kind of cash should you hold? We choose Gold because it is cash that no central bank manages. No one prints. No government backs it. And no one ever threw away a gold coin.
Gold will always hold an intrinsic value – and so we'll keep holding gold for investment.