Gold News

The Paperbugs' Pet Rock Theory

Here they come, seeing gold as always a bad investment decision...
The LATEST plunge in the Dollar price of gold has caused all sorts of paperbugs to come crawling out of the woodwork, writes Tim Price on his blog, ThePriceofEverything.
Perhaps the highest profile among them was that of Jason Zweig, columnist for the Wall Street Journal, who suggested that:
"...even as Greece has defaulted, the Euro has sunk against the Dollar, and the Chinese stock market has stumbled, gold [has] been sitting there like a pet rock."
Zweig is right that it is time "to call owning gold what it is: an act of faith." But he fails to take the next logical step and ask for the corollary:
Why have so many investors (as opposed to speculators) undertaken this act of faith?
Just as pertinently, why does he not ask why investors (as opposed to milch cows) should retain any faith in the paper currencies that central banks are doing everything in their power to depreciate?
As Zweig observes, it is legitimate to point out that unlike stocks, bonds and real estate, gold generates no income. But nobody ever demanded that it should.
Crucially, as part of this debate, paper currency itself pays no income, either – an argument that even Warren Buffett has never acknowledged, preferring, disingenuously, to compare the apples of productive assets with the orange that is unproductive gold.
Paper currency itself is comparably inert, but a lot more impermanent and flammable. Paper currency can only become an income-generative asset by converting it into a bank deposit, whereupon one relinquishes any last claim to financial independence and becomes an unsecured creditor of the bank. Perhaps gold is not a financial asset per se or "simply" a commodity. 
Perhaps gold, too, is money?
J.P.Morgan certainly thought so, a century ago. So do central banks, today – or why else do they continue to hold gold as part of their reserves? It is surely not, as Ben Bernanke once weaselled, just down to "tradition".
The debate continues to rage because most of the debaters refuse to agree on terms. We ourselves regard gold as a monetary metal, an alternative currency and a store of value – over a period perhaps best described as 'the medium term'. It is not an investment but, per Mr.Acavalos, a conscious decision to refrain from investing.
Gold, in other words, is the part of the portfolio that isn't "in the market", so to speak.
In our client portfolios we hold gold alongside more conventional investments such as high quality bonds (assuming they can be found), 'value' equity investments, and alongside less conventional investments, such as systematic trend-following funds. Do we expect each and all of these types of 'assets' to rise in value at the same time and to the same extent? No, because they're not correlated to each other. That's precisely the point.
The whole purpose of the exercise is to ensure that a portfolio contains genuinely independent parts that behave in different ways during different market environments. We will look to sell our gold holdings when the financial environment that gave rise to its purchase in the first place – one that included all-time high levels of debt, globally, and widespread currency warfare, and the risk of systemic financial crisis – finally transforms into something demonstrably more stable.
The "fundamentals" of this environment have in actuality worsened even as the price of gold has slid in US Dollar terms. That experience has been surprising, but any gains in value by more traditional assets over the period will have mitigated the surprise somewhat.
James Grant, writing in last week's Financial Times, humbly suggested, against the spirit of the times, that
"Prices should be discovered in the market, not administered by a government. Actually, we do not all so agree. In response to the incentives set before them, investors pursue the main chance. In the case of European sovereign debt, they continue to buy, more or less without regard to the underlying strength (or lack thereof) of debtor states. They buy because the ECB has pledged to buy.
"The phenomenon goes further – much further. Be it the US Federal Reserve, the People's Bank of China, the Bank of Japan or the ECB, central bankers' first financial-markets objective is not the integrity of prices and exchange rates. It is rather crisis prevention – to keep the bouncing bond and stock market balls moving in their sanctioned orbits. (For an individual to fix Libor is a crime. For a central bank to suppress European bond yields is an act of financial statesmanship.)"
A question. Is there a price for any financial asset, anywhere in the world, that does not in some way reflect official price manipulation of one kind or another? In the case of western bond markets, or Chinese stocks, the question answers itself. If gold were somehow divorced from this trend, the only difference would be that it is the only 'asset' whose price is being artificially suppressed as opposed to boosted.
We don't know whether or to what extent the price of paper gold is being manipulated. We can observe that some of the games being played in financial futures markets make no commercial sense, other than to smash prices lower in the cause of making a quick momentum-driven buck.
But we repeat: until the financial environment improves to a sufficient extent to make the requirement for portfolio and / or systemic risk insurance obsolete, we're not changing a strategy founded on the principles of asset diversification and capital preservation. We still live with unprecedented monetary debauchery.
It's not about what gold's worth, in Dollar terms. It's more fundamental than that. What's the Dollar – or any other currency, for that matter – worth, as expressed in anything else? Jason Zweig correctly refers to the decision to hold gold as an act of faith. He should ask himself what, then, is backing all those trillions of Dollars, Pounds, Euros and Yen all being cheerily printed out of nothing.
London-based director at Price Value Partners Ltd, Tim Price has over 25 years of experience in both private client and institutional investment management. He has been shortlisted for the Private Asset Managers Awards program five years running, and is a previous winner in the category of Defensive Investment Performance.
See the full archive of Tim Price articles.


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