Running a leveraged hedge fund with a long position in gold has not been a lot of fun lately. The price of gold closed in New York at $1,225.20/oz on Wednesday. This was down by 4.1% on the day, lower by 18.6% year-to-date, and down by more than 35% from gold’s peak on September 6, 2011.
I have never owned gold. For years, people have asked me if gold is a good investment. My answer has always been the same: “It had better not be.” This is because if gold is a good investment, neither America nor ordinary Americans are likely to do very well.
Historically, this has been the case. The periods during which gold has been a good investment (the 1970s and the 2000s) have been terrible for the economy, and awful for the average citizen.
Now, has the recent fall in gold prices caused “massive losses?” No. Speculation is a zero-sum game. Think of the gold market as a bunch of guys locked in a room with a fixed amount of dollars and a fixed amount of gold. All they can do is trade gold and money among themselves. For every seller, there is a buyer; and for every loser, there is a winner. Their game cannot impose losses on the people outside the room.
Now, wildly fluctuating gold prices do imply large changes in the real value of the dollar, and that is a bad thing.
An unstable currency imposes huge costs on the economy, but it does so through misdirection of capital investment (including the development of new gold mines that no one needs), not via losses on commodity speculation.
Was gold “worth” $1,895.00/oz on September 6, 2011? Yes, in the sense that participants in a deep, liquid, world-wide market were willing to trade 1,895 dollars for one ounce of gold on that day. No, if judged in the light of historical relationships with other real goods and services.
In 1967, 57.14 ounces of gold would buy you a new VW Beetle with no air conditioning, no power anything, and 53 horsepower. On September 6, 2011, the same amount of gold would have allowed you to purchase a new 2012 Mercedes S550 with 429 horsepower and every luxury feature known to man.
In 1967, an ounce of gold was worth $35.00, which would buy 78 Big Macs. On September 6, 2011, McDonalds would have been happy to sell you 466 Big Macs for the $1,895.00 that you could have obtained for the same one ounce of gold. Yesterday (June 26), an ounce of gold would still have gotten you 301 Big Macs.
Could gold fall farther? Yes. The price of gold and the general price level always equilibrate eventually. In other words, a gold price of $1,895.00/oz on September 6, 2011 made it certain that either gold prices would fall (by a lot), or inflation would rise (by a lot).
How much farther could gold fall? Well, the price of gold would have to go to $316.56 just to restore parity with the Big Mac. And, a $35/oz gold price in 1967 would be the same as $192.50/oz today, after adjustment via the GDP Deflator.
The falling price of gold has certainly boosted the Real Dow, which is the Dow Jones Industrial Average divided by the price of gold. In fact, as of June 26, the Real Dow is up by 55.5% year to date. The Real Dow is also 90% higher than its low point in this cycle, which was reached in August 2011.
An important question is, “Has the Real Dow moved up enough to guarantee the start of a real economic recovery?” After all, thus far, there hasn’t been a lot of GDP growth in President Obama’s so-called “economic recovery,” which is now old enough to start attending the free preschool that he has promised.
The answer appears to be, “not yet.”
The last time that we had a deep recession was in the early 1980s. That time around, by the time that it was clear that a real economic recovery was under way (the end of 1Q1983), the Real Dow had risen by 105% from its local low point, which was reached in June 1980.
Still, it is encouraging that the Dow has been rising while gold prices have been falling, thus producing a soaring Real Dow.
Jobs are driven by economic growth, GDP growth is driven by capital investment, and capital investment is driven by the relative attractiveness of productive investments vs. inflation hedges (e.g., gold). So, a rising Real Dow is always a good economic portent.
It was foolhardy and dangerous for the Federal Reserve to ever let the dollar fall so much such that gold reached $1,895/ounce. It’s good that Ben Bernanke and the boys seem to finally be getting serious about ringing the gold price back down to earth. It would be comforting to know that they were doing this intentionally, though.
From its recessionary low point in June 1980 to the peak of the Reagan/Clinton economic boom (August 1999), the Real Dow rose by 3,089%. For it to do an analogous thing again, the Real Dow would have to rise to 204.1%.
For the Real Dow to reach 204.1 via the same percentage changes in the Dow and gold that occurred during the Reagan/Clinton boom, the Dow would have to rise to 144,905.25, and the price of gold would have to fall to $709.53/oz. However, if gold prices were to fall to “Big Mac Parity” ($316.56/oz), a Dow of 64,649.53 would also yield a Real Dow of 204.1.
Now, will President Obama’s economic policies ever get us to a Real Dow of 204.1? No. However, Jimmy Carter’s economic policies would never have gotten us to a Real Dow of 42.35, either. We need a return to Reaganomics if we are ever to have real prosperity again.
Visualize a Real Dow of 204.1. It would be a great place for America to be. I would not expect the journey there to be an enjoyable experience for the average gold bug, though.
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