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Gold, Great for a Trade, Risky as an Investment
I feel compelled to pen my opinion of gold as a long term investment. Today,February 18, 2009, Gold has suddenly become the popular investment. When JimCramer (the ultimate contrary indicator) starts beating the drum for gold on CNBC,the game is all but over.What is wrong with gold or other precious metals like platinum or silver, as aninvestment? One word: productivity, or more precisely, the lack thereof. Gold ispassive. It doesn't do anything, has no fundamental uses, or promote economicgrowth in any way. It is symbolic alone, even as jewelry. It is the ultimate "safehaven investment". So, at times like now with rampant fear, gold will outperformrelative to other investments. But unlike equities, those gains will not, can not stick.Because gold is safety in a stormy sea, once the seas calm, the need for gold isgone. And down it will drop like it has many times before.We need only go back to 1980 to see the last time gold served as a safety valve fora world fearful of energy crises and out-of-control inflation in the world's biggesteconomy, America. On January 21st of that year, gold peaked at $850. The nextday, it was back down to 737.50, a whopping 15% drop in 24 hours. Soonthereafter, Paul Volcker alleviated concern over the declining value of a dollar by jacking up interest rates, eventually to 20% in June 1981. This not only changed theperception of inflation, but also provided a very attractive alternative to gold in termsof return: US Treasury bonds. By the end of 1980, gold was back under $600 not toreturn to that level until 2006, over 25 years later.
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This time around, gold bugs are in opposing corners in their reasoning for gold: thethesis goes it is a great investment, a) because the economy is collapsing and weare heading for global deflation, or b) the global governments are printing paper likecrazy to "reflate" and we are heading for global inflation as that printing inevitablyovershoots. The fact that both theses arrive at the same conclusion, which is "buygold", is suspect. Deflation should devalue all hard assets, including gold, as papercurrencies strengthen. Reflation is currency neutral, causing neither appreciation ordepreciation of the dollar in respect to gold, as printed money replaces moneysupply lost to debt writedowns. Only significant inflation (more than 5%) caused bymoney supply expansion overshoot as in the late 1970s, should logically result inhigher gold valuation in respect to money (the dollar).Another anomaly that must be resolved to make a long term case for higher goldprices is the current disconnect between gold and oil. A long term 50 year plot ofgold prices against oil prices shows they move in tandem by a ratio about 15 to 1(oil barrel to gold ounce). This is logical. Both are hard assets. Oil actually providesmore economic value than gold, but as a commodity, it is seen in markets as being
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