Why I Still Hate Gold

Those of us who like to style ourselves as contrarians are never “wrong.” We're just early.

At least that is what I keep telling myself. I've had a bearish view on gold for most of 2010, and attempted (unsuccessfully) to short it in the second quarter. “I was just early,” I told myself. And alas, given gold's recent move to all-time highs, it appears that I still am.

In August, I penned a negative piece on gold that resulted in me getting quite a bit of hate mail (see “Sell Gold Now”). Among my favorites were these little gems:

• “Thank God this not-so-bright CFA has and will never give advice to my family concerning anything financial.”
• “I hope you and your clients short as much gold as you can get your hands on. You will get exactly what you so richly deserve.”
• “No one who understood gold would make some of the imbecilic statements in this article.”
• “I love how you b*tch about Indian gold consumption falling, while failing to mention the much LARGER INCREASE in gold consumption coming from China. THIS is exactly the point that defines you as a lying cheat. “
• “I suggest the author get his meds readjusted and, his clients seek wiser advice from the drive-up window at McDonalds!”
• “Yuppie Turd!”

The worst thing an investor can do is to get emotionally involved with their investments. Stocks, bonds, and commodities should all be viewed as meaningless love affairs, not potential marriage partners. Yet investors—and male investors in particular—have an odd way of developing feelings for the assets they buy.

It's Just an Investment, People

Just as sailors have for centuries given their ships a woman's name, to many men a stock becomes “his stock,” and if you insult it you might as well be insulting his wife or mother. In some extreme cases—and I see this with gold in particular—an investor will allow an investment to define them as a person. Being a “gold bug” is not simply believing in the investment merits of gold. It is an identity and one that exhibits many of the characteristics of a radical political movement or even a cult. (There is a fundamental belief: Gold is the “one true store of value” or the “one true currency.” There are also “prophets”—the Murray Rothbards and Ayn Rands, if you will—and “sacred texts”—Atlas Shrugged being the highest profile example.)

When I gave my opinion that gold was a bad investment at current prices, the responses above show how personally the gold bugs took my comments. To them, I wasn't expressing an investment opinion; I was insulting their entire view of the world!

This is not to pick on gold bugs, of course. The “dot com” bubble of the late 1990s had its true believers as well, as have all bubbles throughout history. Anyone who dared to question the investment merits of the high-flying internet stocks was ridiculed as an old fogey who “just didn't get it.” And in the interest of full disclosure, yours truly has lost 90-100% on a handful of investments over the years in which I was a “true believer.” What can I say, it happens to us all at one time or another.

To be a successful contrarian investor over time, you have to suppress your emotions and political views and remain detached. You have to objectively examine the arguments being made for an investment. And in the words of world-renowned speculator George Soros, you have to “Find the trend whose premise is false, and bet against it.”

I must admit, I sometimes have a hard time suppressing my emotional side as an investor. This is why I titled this article “I Still Hate Gold.” It irks me that I have lost money speculating against the yellow metal, and so I want it to fall. And then it irks me even further when I realize that I've allowed my emotions get the better of me.


Knocking Down the Bulls' Arguments

So, fully acknowledging my own psychological shortcomings, let's take a quick look at the bullish arguments for gold:

• Gold is a hedge against the hyperinflation and currency depreciation that is just around the corner due to the Fed's printing of money and the Obama Administration's wanton deficit spending.
• Gold represents stability of purchasing power

I'll pick these apart one by one, starting with inflation. If there was ever a non-crisis crisis, it would be the inflation scare of 2010. There is almost universal agreement among gold enthusiasts that there is a wave of inflation coming from the Fed's machinations that will make the United States resemble Weimar Germany.

Really? Because earlier this week it was announced that core consumer price inflation (which excludes food and energy prices due to their volatility) just hit its lowest reading since the data series began in 1957. Fed Chairman Bernanke is worried about deflation, not inflation. The money supply, despite the Fed's tinkering with the monetary base, has not grown significantly because money is being destroyed by the private sector faster than it is being created by the Fed.

I know, I know, the government must be cooking its books. Of course it is. That's why the bond vigilantes have pushed bond yields higher…oh wait…bond yields are still near all-time lows.

Yes, the Fed is manipulating the bond market. I get that. But the Fed, while the biggest buyer of bonds these days, is not the only buyer. And if bond investors were truly concerned about inflation or dollar depreciation, the 10-year Treasury would not be yielding less than 3%. The 1970s are not making a comeback. When I see a divergence between the bond market and the gold market, my bet is that it is the bond market that will ultimately be right.

But doesn't gold at least represent stability of purchasing power in an unstable world? Again, not so much. Consider this little quote from the Financial Times. “If there were no dollar, and US shoppers paid for their groceries with gold coins, since 2000 the amount of gold needed to buy a loaf of bread or rent an apartment would have fallen by three-quarters. Deflation of 75 per cent in a decade is not an ideal characteristic for money.” (From “In Gold They Rush”)

I should also add that investors who held their wealth in gold would have seen their purchasing power ruined in the two decades from 1980 to 2000, and that gold—unlike stock, bond, or real estate investments—pays no income.

The basic assumptions underlying the gold bubble are flawed and driven more by charged ideology and anti-establishment sentiment than by actual economics. The time to have bought the barbarous relic was in 2000, when it traded for less than $300 per ounce and no one wanted it, and not ten years later after it has risen by more than a factor of 4 and when it has become fashionable.

The contrarian move would be to sell gold and buy blue chip stocks—which are about as unloved today as gold was in 2000. But alas, I was “early” on this trade…

Charles Lewis Sizemore, CFA

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