Michael Olivero
The official blog of Michael Olivero, Software Architect & Humble Entrepreneur

Gold - To be or not to be?

Friday, 10 February 2012 08:36 by Michael Olivero
Warren Buffet, a few months back, said if a all the gold in the world were to be combined into a large cube, it would measure a paltry 68 feet wide on each side worth $9.6 trillion. With today's valuation he argued you can do much better things with the value rather than own all this gold.  While true, especially long term, there are a few problems with this statement.  The first problem is, no single entity will ever own all the gold of the world -- if so, then it's value will become immeasurable.
 
While true, the only common variable in question is the valuation of currency.  How do you value gold today?  You compare it to the dollar and it would cost you $1750 to buy an ounce of it.  What happens when the dollar appreciates in value?  Gold, relatively stable in quantity, will have to decrease and vice versa increase if the dollar declines in value.
 
So clearly, the value of the dollar is directly inversely proportional to price of gold -- however this is not the only influencing factor.  Using Buffet's analogy on preferring buying a company producing gobs of profit over a century over buy gold which will sit in a vault may sound reasonable.  A better way to compare this is assume the value of currency goes to near zero because of huge debts (ex Greece currency) then what value will a good company, say in Greece today, producing gobs of profits in say greece's old currency, be worth? Little -- no one would want the greek drachma.  Greece had to increase rates to 10, 20, even 30% to sell bonds to investors - the return had to be sufficient to warrant the risk!
 
From my perspective, born as a US citizen, it's unfathomable but if US debts increase (as projected for the next 10 years) it may loose more of its rating and trust around the world and consequently it's value. The only thing allowing it's value to remain, and interest rates to be low, is the perception of the dollar as the universal global currency. Meaning, when the euro's credibility suffers people run to the dollar -  making bond auctions here relatively cheap from the excess demand.  This demand allows the US to keep rates low or even move them lower as dollar investors would buy the bonds anyhow just for the perceived safety.  This in return, allows the US to have a relatively "free ride" in navigating the financial turmoil by simply selling bonds at auctions as needed to meet liquidity needs to prop up the economy in the form of bailouts and the quantitative easing necessary throughout the later part of the last decade. That is the only reason why the US has been able to leverage low interest rates throughout the deepest recession in my lifetime.  
 
As soon as a world currency steps up as an alternative (what many thought the euro to be at one time) then the dollar will drop precipitously to correct for its over leveraged position.  Some of these concerns are clearly present today although stubbornly subdued due to the dollars prominence world wide.  With deficits expected to increase for the next 10 years, the leveraged position slowly erodes with decreasing value and appreciation similar to Greece's fallout -- although much quicker.  These signs are already present in the current price of the gold and should continue for the intermediate future -- how so you may ask?
 
Since world commodities are priced in dollars like oil and gold, these commodities will inevitably adjust inversely to the dollars movement as mentioned earlier.  To stabalize a currency, traditionally countries buy and amass gold (ex Wikipedia the gold standard for the US). Recently there is a huge movement to acquire gold by many countries for its stabilizing effects. Venezuela is shipping its gold from overseas banks; China has increased it's rate of purchasing and Russia has double it's own too.   Overall it's desire has increased as a simple safe haven when instability exists.
 
In conclusion, long long term, say 100 years like Buffet affirms, yes prosperity and opportunity abounds more than owning some gold, short term however it's use as a safe haven is inevitable as are other world commodities. Personally I prefer oil, it's also priced in dollars and is in demand like gold, however unlike gold, it depletes and produces a tangible value in the form of consumption.  A gallon of gas in 10 years, all things remaining equal, will be higher than the gallon is today - for sure.  Factor in depreciated dollar and a barrel of oil may be $200 -- 100% return over a 10 years.  Why else do you think renewable energy has become a trendy topic in the last few years?
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Comments (3) -

February 10. 2012 09:32

That's a great point. However, this is Warren Buffet we're talking about - America's, no scratch that, the World's most renowned investor. I'm sure he understands the inverse value between currency and gold.

Marlon

February 10. 2012 10:21

Of course he is the worlds most respected investor, self made at that. If I implied he comments are wrong then I might need to revise my post to clarify. His views are perfectly correct when viewed from a long term perspective. He suggests 100 years for his comparison. A hundred years ago the US, and the dollar, was second to Britain and the British pound. My perspective is medium turn over the next decade and the increasing appreciation of commodities - particularly useful ones like oil. Gold only because of its stabilizing factor in an increasing destabilizing world environment over the next few years.  The world is going to dig itself out of this hole before a hundred years and gold holders for the entire duration would have a loosing investment over stocks. I'm certain Buffet's view and remark refers beyond a decade - that's the only way he invests. Short term there might still be more to come in this painful world downturn and a hundred years from now oil may even be priced in yuans.

Michael Olivero

February 10. 2012 10:49

"Summing up the situation, gold is rising in price because we’re in a long-term secular bear market for stocks. Such markets usually correspond to weakness in the economy as well, during which money tends to flow into commodities and precious metals. What we are seeing now is similar to the 1970s. These cycles, as I stated, tend to last 15 to 20 years — we are about 10 years into this cycle, meaning we could have another 5 to 10 years in this current bull run for gold.

That’s the super cycle we’re playing as we seek out both bullion holdings and gold-mining stocks. Such stocks not only give us a cheaper entry point into the rise of bullion’s value, but they also provide us opportunities to make money in an otherwise stagnant stock market overall. Instead of sitting on the sidelines while markets stall over a 20-year period, we can continue to build a nest egg with retirement always in focus.

As for the drivers of this particular bull market for gold and slow period for stocks, we need look no further than the U.S., which because of its ongstanding superpower status and the dollar’s positioning as the world reserve currency wields massive influence on the world economy at large.  That influence, right now, is negative. Instead of pursuing more well-rounded and thoughtful solutions, the U.S. is funding its massive deficit problem by printing and borrowing money. That policy puts pressure on the dollar and, as the antidollar trade, fuels interest in gold. The U.S.’s budget problems aren’t going away anytime soon, at least until a majority of elected officials show the fortitude to make millions of constituents angry by reducing government benefits going forward. Obviously, that’s an unlikely scenario — it seems little in the way of legitimate reductions will take place until the government is literally pressed against the wall with no other options at its disposal to stall the inevitable. No, not when there are voters to placate and a presidential election to win for your party.  Meanwhile, the U.S. actually desires a weaker currency right now, meaning downward pressure on the dollar will continue. Part of the flawed government plan to get out of the economic rut it is in is to devalue its currency — the U.S. is putting pressure on China to revalue its currency, and it wants the dollar to be weaker against the euro and others as well, as a way to boost exports.  Any one of the current U.S. travails by itself is enough to nudge a short-term movement in a market. An announcement of another round of QE actually spikes stock markets, while U.S. budget deficits dominating news headlines can nudge people toward gold" - David Skarica

Francisco