BackRe-examining the case for gold
To the extent significant risks have not played out yet, gold isn't an insane or purely faith-based one-way bet
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The spot price of gold fell some 28% in 2013 and I have been a strong advocate of the diversification/insurance value of gold for an internationally diversified portfolio. Barry Ritholtz is a well-known blogger and fund manager in the US. His recent Op-Ed in Bloomberg on the reasons why gold investors lost heavily in 2013 caught my attention. Since it is a reasonable and cogent critique of the case for gold, it prompted a re-examination of my beliefs. He gives 10 reasons as to why gold bugs lost their shirts in 2013. We focus on his reasons No. 1, 6 and 9 in the reverse order.
Conspiracy theories
Point (9) is a standard criticism against conspiracy theories. Yes, gold shines when the world is about to collapse. But for us to maintain an insurance against a possible collapse of the existing world order, threatened by massive inequality and several pockets of regional tensions, is not outrageous. To maintain that small insurance, one does not have to attach a very high probability to the possible collapse of the existing world order. Even a small probability of an event with very large significance and consequences is both necessary and sufficient to maintain insurance.
No asset is a one-way bet
He is right that gold, or for that matter any asset, is not and cannot be a one-way trade. I know why gold prices plunged between 1982 and 2000. I have to ask myself if we are going to get back to 1982-2000. If the probability is good or very high, then gold bugs should have ended their obsession with gold.
With forward guidance from the Fed, with the Bank of Japan printing yen copiously, with China unwilling to or unable to shake off its addiction to credit and with the European Central Bank waiting to print euros, international policymakers (not just in the US) are not creating a return of 1982-2000—return to sensible monetary policy, productivity gains, US leadership in technology and in global politics, fiscal surplus, etc. Structurally, the industrialized world, in particular, has not had this level of debt (public and private) in absolute terms and relative to gross domestic product (GDP).
The inflation narrative
Less dramatic is the possibility of inflation. Yes, inflation has not spiked up, based on measured consumer price index (CPI) data. But with incomes stagnant and with median household income declining, the squeeze in purchasing power is real. That is what inflation does. But without inflation, policymakers (and private corporations) have achieved the squeeze in real incomes. In other words, measured changes in CPI in several advanced countries may be understating the true change in the cost of living.
However, let us assume that official CPIs are not understating inflation. But we also know that inflation occurs with a lag. It occurs when monetary stimulus is not withdrawn as willingly and as swiftly as it is introduced. Monetary stimulus needs to be withdrawn when the money multiplier starts to rise. Then, the stock of money (or, credit) has to be shrunk quickly. Based on past performance, it is safe to assume that Anglo-Saxon policymakers will be slow to shrink the stock of money when the money multiplier kicks in. Then, we shall see a spike in inflation.
Inflation did not show up in official data after the stimulus unleashed by global central banks in 2001-03. It showed up in 2006-08. Yes, this time there is a big difference. The US has more oil and gas than six years ago. Supply of this most important resource is much higher therefore in the US and hence globally. But, equally, the monetary stimulus is much stronger, globally more pervasive and likely more persistent than it was in 2001-03.
We should also remind ourselves that inflation has shown up in asset prices as it happened post-2001-03 stimulus. Real estate prices in many parts of the world have comfortably exceeded the 2007 valuation norms. In the US, real estate prices may not have crested previous valuation peaks but other types of assets—high-yield bonds, for example—have bubbled up. Further, other types of speculative activity such as leveraged buyouts and Payment-in-Kind bonds have picked up more strongly than anyone could have predicted. These are as much signs of overheating as inflation is.
So, what will follow next? If these signs of overheating do not recede gradually and if policy does not ensure a soft-landing for asset prices, they either eventually lead to acceleration in the cost of living or something else happens.
What is “something else"? These speculative activities peak and then burst. They leave a trail of destruction. What will the monetary policy response be, then? Will they ease further? Do they have scope for it? If they “discover" scope to ease somehow, what does it do to confidence in paper (fiat) money? Gold may then become the only refuge for sane investors.
To the extent these risks have not played out yet and to the extent these are not risks with insignificant probabilities attached to them, gold is not an insane or purely faith-based one-way bet. Not yet.
V. Anantha Nageswaran is the co-founder of Aavishkaar Venture Fund and Takshashila Institution. Comments are welcome at baretalk@livemint.com
To read V. Anantha Nageswaran’s previous columns, go to www.livemint.com/baretalk
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