-- Posted Tuesday, 18 January 2011 | | Source: GoldSeek.com
By: Moses Kim
Gold is an asset that people believe is difficult to value because frankly, people don’t put in the effort. Analysts will always talk about how they value companies based on either cash flow or dividends as if it were some kind of hard science. They won’t tell you that their assumptions go out the door as soon as the business cycle turns, which is regularly. In times of panic, their assumptions look outright foolish. I can only say that there is a bias with gold that makes sense if you understand the implications of rising gold prices. There is no other global asset whose changing prices signifies as much.
Everyone just assumes that $3000 gold means hyperinflation. In my opinion, this is not how you should think about gold. If a hyperinflationary event were needed for me to profit , I honestly would not invest more than a very small portion of my net worth in gold. Just like in any other investment, I want a margin of safety. In other words, by no means do I think there needs to be a hyperinflationary event for me to have huge gains in gold. Gold is still undervalued and the more people scoff in disbelief, the more I am inclined to buy into a correction.
Debt and Gold
Debt and gold are joined at the hips. People often misunderstand how debt affects the price of gold: some people think debt is inherently deflationary, others believe it is inflationary. Excessive debt can be deflationary, but only if governments decide to bite the bullet and avoid devaluation while promoting austerity. Money needs to flow to the indebted nation’s currency, which tends not to happen when you are the global debtor nation. With QE2 and deficits that remain near record levels, we all know this option is already off the table. We are seeing a form of default, as the “bond king”Bill Gross mentioned in the annual Barron’s Rountable.
We are looking at a currency that almost certainly will depreciate relative to other, stronger currencies in developing countries that have lower levels of debt and higher growth potential. And, on the short end of the yield curve, we are looking at creditors receiving negative real interest rates for a long, long time. That, in effect, is a default.
Everyone knows about the magic of compounding interest. This concept was revolutionary to a young Warren Buffett and factors heavily into his investment approach. It explains why he believes the preservation of capital is key. Keeping this in mind, it’s amusing that people say government debt is not a problem when they know it grows exponentially. Even if we somehow balanced our budget (impossible), debt would continue to grow organically. Is it just me, or has the trajectory of our debt growth changed?
Now let’s do some calculations to see where gold fits in all of this. When gold peaked in 1980 at $850, the national debt was under $1 trillion. If gold were to match the growth in debt, this would mean a price north of $10,000. Take the gold price in 1975 of $175 and adjust it to debt, and you get an implied price today of $5000. Are you starting to see why $1360 is cheap?
Stocks and Gold
I’ve already mentioned how it is borderline comedy that no one says a word when the Dow rises from 1,000 to 14,000, but when gold goes from $250 to $1360 it’s a bubble. Hmm, bias perhaps?
Let’s take the Dow’s rise since 1975 and assume a similar rise in gold from its 1975 prices. This gives us a price of about $3000 in gold. Take the 1980 high in gold and chart it against the Dow, and you get a price of over $10,000. I must ask, against what asset exactly is gold overvalued?
Broad Ownership of Gold?
There is this myth that gold is a widely held asset and is in a frenzy. Yet the market capitalization of gold relative to bonds, stocks, and money market funds is about 20% of peak levels. 2009 was a record year for net inflows to bond funds at $350 billion. 2010 wasn’t far behind. This comes at the same time our debt growth is accelerating and our obligations are coming due. There’s a bubble brewing, but it sure isn’t in gold. Believe it or not, gold is till cheap based on objective analysis. Money will flow out of bonds and into gold. Trust me, you want to step in front of this trend.
Moses Kim
http://www.expectedreturnsblog.com/
-- Posted Tuesday, 18 January 2011 | Digg This Article
| Source: GoldSeek.com
