STAFF NEWS & ANALYSIS
Hold on a Minute: Gold Is Just Another Commodity – Bet on Equities Long Term?
By - February 25, 2009

One might as well end with a big theme [and] we shall end with a chart covering a 90-year period, and the issue of metal versus paper assets. The graph is disarmingly simple. It simply shows the ratio of the Dow to the gold price since 1920. As can be seen, there have been three clear peaks in this ratio: in 1929, in the mid-1960s and in 2000. And it also shows three lows: in the early 1920s, in the 1930s after the crash and around the time of gold's record high (in real terms) in 1979-1980. At those lows, the Dow and gold were almost equal. With gold flirting with $1,000 per ounce, could we be headed there again? A Dow/gold ratio of 2 would imply the former falling to 2000 or the latter rising to $3500 an ounce. Enormous profits would be made by those who got this call right. – Economist

Dominant Social Theme: No trust in gold.

Free-Market Analysis: Lord, one hardly knows where to begin with this article. Its basic premise is that the Dow keeps going higher forever while gold only goes high and then comes right back down again. Therefore stocks are a better buy and hold over the long term.

Really? Is this truly any reason not to buy gold? Is this any reason not to hold gold? With regularity, gold goes up when turbulence hits the fiat marketplace. Had you purchased gold in 2001 when it was hovering near US$250 and held it you would have quadrupled your investment – versus stocks which are now down to levels last seen in the 1990s, a drop closing in on 50%. Equities a better long-term bet? Right now to most investors equities feel like a long and terrible slog that offers no assurance of a happy ending. Here's some more from the Economist article:

Enthusiasts will say that, unlike financial assets, gold is nobody else's liability. But the same is true for any commodity. Indeed, most other commodities are a lot more useful. If a real dystopia appears (think "Mad Max" or "I Am Legend"), most of us would rather have oil to power our generators or cars than gold. Where gold is a hedge is against a loss of confidence in paper money, on the lines of Weimar Germany in the 1920s. A lot of its current appeal is down to fears about the long-term effects of quantitative easing, soaring fiscal deficits and all the other measures being used by governments and central banks to deal with the crisis. But here is a puzzle. The index-linked government-bond market is not forecasting inflation at any significant level over the next ten years. The market may be illiquid, but if investors were truly concerned about inflation, we would surely see more movement in the asset class. Either gold investors or bond investors are wrong.

Let's unpack this a bit. First of all, gold is NOT a commodity (nor is silver) – at least not when it comes to finance. Sure, they are commodities in the traditional sense, but if you look at the market for copper, zinc, etc. and then contrast them to gold and silver over time, you will find a price correlation that has to do more with economic issues than an ordinary "commodities" pattern. By lumping gold (and silver) with commodities, the author is conflating two dissimilar items.

More than 140 years ago, Carl Menger pointed out in Principles of Economics that the economic value of a good is determined by the need it fulfills – it is not intrinsically related to the good itself. Absent of any need requirement, no good has any value. It is only the desire of human beings to satisfy their individual needs that gives any good an economic value. So what the author above conveniently forgets to mention, or doesn't understand, is that human beings require an HONEST basis for the exchange of goods and a store of value. Or put another way – HONEST MONEY. And for thousands of years human beings have determined that the natural characteristics of gold satisfy that requirement – not copper, zinc or oil for that matter. And certainly not artfully decorated pieces of paper.

Second, the price of gold is not merely an inflation indicator. People were probably starting to dig gold out of the ground 50,000 years ago when human brains went through a final "big bang." Gold and silver are inextricably linked to the human condition. People find gold, buy gold, hoard gold for reasons that are much more fundamental than any anxiety they may have over monetary inflation of their chosen fiat currency.

A final, amazing excerpt:

Is there any fundamental reason why the value of the Dow should revert to the mean, in terms of gold, over the long period? Not really. One would expect gold to rise with inflation, but one would expect equities to rise in line with economic growth. That should result in a gentle uptrend for the Dow over the long run. (A good deal of the total return comes from the dividend yield, which this graph does not capture. But assuming the yield on the market is unchanged over the long term, the Dow should rise in lines with dividends.

It should be abundantly clear to anyone who does not write for the Economist (and has legitimate hard-money leanings) that there is no "mean" for the Dow to revert too. Absent incredible, prolonged efforts of the monetary elite, worldwide, there probably would not even be a Dow now, the average having collapsed along with the market itself and the banking system. It may all still collapse, but in slow motion like a soufflé and that will give the elite leadership and the elite media enough of a head-start to paper over the detumescence with so much propaganda that many may not even notice the particulars. Too bad for them, especially the ones that will continue to read the Economist.

We have always been of the opinion (at least once we started to figure all this out many years ago) that the Economist is a weekly love note from the biggest bankers and banking families to the rest of us. This article does nothing to disabuse us of that notion. In fact, this particular note sends various additional messages — some of them unintended. Most importantly it seems to illustrate the difficulty that the anti-gold, pro-fiat crowd is having right now in justifying the current system.

After Thoughts

The stock market collapse of the 1930s lasted ten years (actually 15 with the war) before the Dow "reverted to its mean" whatever that means. All that went up during that time was gold and gold-related equities, specifically mining stocks. Nothing else, according to those who have researched the period. The 1970s showed us the same pattern. Gold up, during the 10-year period and everything else pretty much down (though commodities and housing had a good run for a while). The great unwinding of the 2000s only really began a few months ago – and there are miles to go. Gold is likely nowhere near a peak. All the oh-so-arch Economist articles in the world will not make it so.

You'd think that after 140 years had passed since Menger started the ball rolling they would have had the opportunity to become at least vaguely familiar with common sense, free-market economics.

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