Please don’t call gold an investment, but rather an insurance policy: a look at premium paid vs. coverage received
Courtesy of Financial Hippie
Not an investment… Any time someone is trying to pitch gold to you as an "investment", he is probably trying to sell you commemorative coins for 2x the intrinsic value. Gold doesn’t make sense from a fundamental investing point of view.
- It can’t create value on its own
- It currently trades at more than 50% of replacement cost
- Demand comes from the eyes of the beholder. Industrial use is barely over 10% of total demand. Annual mining of gold only contributes to 1.5% of total above ground stock. We have a few hundred years of above ground supply for industrial use. Just the scrapping of gold every year covers industrial demand by 2x. Why are we even mining this stuff?
Buffett shies away from gold, because he’s bullish on America long term and doesn’t feel he needs such an insurance policy, right or wrong.
… but a much needed insurance policy against the establishment. Scary and unprecedented numbers coming out of both fiscal and monetary policies worldwide are increasing demand for protection of wealth. But hold on, just like buying any insurance product, you have to think about how much premium you are paying vs. the coverage you are receiving.
Let’s first take a look at how much premium the coverage costs. I’m going to triangulate the premium in 3 ways.
1) The eyeball regression method. If I draw a fitted line through the graph, the predicted value is probably $500ish 2000 dollars or $550 today. Premium = $400.
Real Price of Gold vs. Inflation Expectations
2) The comparable method. The CRB Commodity Index is down 40% since last June. Gold? roughly flat. Premium = $400 to $500.
3) The inductive method. If inflation expectations since 5/31/09 has been cut in half, shouldn’t the price of gold also be cut in half? Premium = $400 to $500.
Let’s call it $450.
Different payout scenarios under the coverage. If you believe inflation expectations will go beyond the scenarios that I have outlined below by year end 2012, then you should vote for Ron Paul.
Scenario 1. Bernanke surprises pundits, tightens earlier than expected. Inflation expectation remains at 2-3% range. Trend line value of gold increases to $600 through 3 years of 2.5% inflation. You lose $350 in premium for the coverage, but you are ecstatic because your mortgage rates will not come close to your parents’ rates in the 80s. Jim Grant loses half of his writing material.
Scenario 2. Bernanke leaves the gas pedal down a little longer than necessary, openly admits inflation is a threat, sounds super hawkish and tightens a little just to show he means business. 5-6% inflation expectations in 2012 = $800 in real price of gold (using PCE deflator, 2000 = 100), or $1100 nominal at year end 2012. You don’t know if you should collect your insurance for a small gain or roll it over. Jim Grant advises you to roll it over of course.
Scenario 3. Bernanke can’t tighten because fiscal deficit is severely crowding out private investment. Interest rates are already high while the economy is still weak. Bernanke refuses or is not independent enough to mimic Volcker, ie. squash inflation but create a recession while doing it. Inflation expectation is +10%, highest it has ever been since the University of Michigan survey first started asking the question in the late 70s. Gold is $2000 in 2000 dollars, or +$2500 nominal. Your policy has paid off, but you’re not sure how good you feel about your future prospects. You turn on the TV, Jim Grant is running for office.
These are the outcome and payouts as I see them. You can assign odds to each scenario yourself, or disagree with my scenarios all together. For now, I’m in between scenarios 1 and 2 and carry no gold position. Whatever you decide, please don’t call gold an investment. Successful investments make you feel good when you make money, while insurance gives you a bitter taste in your mouth when collected.
But what I really want to know is… what is Greenspan telling Paulson? It is public knowledge that Greenspan is on Paulson’s payroll. I wonder what Greenspan has said to Paulson that would make him put on such a large gold position. Could the conversation be something like this?
Paulson: "Alan, you got us into this mess, what do you think? You think Bernanke has any chance of steering the country out of this situation in one piece?"
Greenspan: "Dude… no way… I messed things up really bad… he’s got no chance. Buy all the gold you can get your hands on."
