An Essay on Gold – Gold Investment Outlook

by JR Robinson on November 9, 2011

It has been my experience that investors greatly prefer clear, unambiguous guidance from their advisors. When it comes to traditional assets, I think I have done a pretty good job of meeting this expectation. For instance, I have been clear in cautioning clients against bonds and in favor of cash. Similarly, I think I have been clear over the past two years in articulating a defensive view on stocks, and, most recently, in advocating consideration of stocks of companies with attractive dividend yields and established records of dividend increases. I have also documented, in writing, the evolution of a philosophical paradigm shift away from exclusive reliance on Modern Portfolio Theory to the more avant-garde concept of tactical allocation. When it comes to an opinion on investing in gold, however, my position may reasonably and charitably be described as “agnostic”. Although gold has been the center of many client conversations recently, to date, I have neither discouraged nor encouraged investments in the yellow metal.

The reason for my heretofore decidedly unhelpful position is simply that there is very little fundamental information upon which one can form an opinion. Unlike commodities such as oil or copper, gold is of little importance as an industrial metal. The intersection of supply and demand is determined entirely by speculative interest. This uncomfortable reality has long presented a thorny conundrum for investment advisors, as illustrated below in the quotation from legendary Vanguard founder, Jack Bogle:

“Gold is probably particularly overvalued. Here’s this totally speculative so-called investment, which has no internal rate of return. Stocks have earnings growth and dividend yields, and bonds have interest coupons. Gold has nothing except somebody’s opinion. But in this kind of environment, it may take years, or maybe even decades, to get back to a reasonable level. When will speculators stop speculating? I don’t think anyone knows the answer to that.” (Source: Investment News 9/27/2011)

Gold Investment Outlook – Some Perspective

To put the speculative interest in gold in perspective, over the past 10 years the price of gold has risen from around $250 per oz. in 2001 to a 2011 high of over $1800 per oz. Of course, for the previous two decades gold had been a pretty lousy investment, trading as much as 60% down from its peak in the 1980s – not exactly a stable store of value by any stretch of the imagination. Given this erratic history, I hope I can be forgiven for being a tad reluctant to stick my neck out in making recommendations one way or the other.

At the same time, however, I have been sticking my neck out by consistently suggesting through many forms of client communication that traditional long held investment mantras may be changing and that the world is a much more dangerous place for investors than it has been in recent history. Extreme levels of consumer and sovereign debt, political dysfunctionality, program trading, etc. all paint a picture of unprecedented global instability. As a result, I have been unequivocal in advocating the importance of preparing for a broader range of potential economic circumstances than ever before. No longer should it simply be assumed that the stock market will average 8-12% per year over the long run. Instead, as the past decade has sorely illustrated, investors might be wise to consider the possibility of having a bad 20 or 30 year run in the stock market or of having a great deal of volatility with very little net upward progress. Gold, for its part, is perceived as an asset which will retain its value or even appreciate during times of economic crisis, and there is little dispute that fears of pending economic disaster have fueled a large portion of the recent speculative run-up in its price.

So where does that leave you and me? Instead of wimping out with the usual “I dunno” response, I am prepared to pop my head out of the turtle shell to suggest that gold will not be retreating back to $800 per oz. any time soon. In my opinion, there is no shortage of really scary problems in the global economy, and it is difficult to envision that the majority of these potential pitfalls will be resolved in the near or even intermediate term. In Michael Lewis’ latest book, Boomerang, a Texas hedge fund manager was asked where he would advise his mother to put her money. His reply? – “Guns and gold”. Not exactly comforting.

In sum, I still have no idea whether gold will continue to soar past $2,000 per ounce or, as some folks even predict, to $5,000 per oz., but I also think it is foolish not to acknowledge that there are an awful lot of metaphorical economic arrows in the air right now. The threat from these arrows is likely to persist for several years, and will likely continue to provide justification for investors to use gold as a shield. That is still about as far out as I am willing to stick my neck out on this issue, lest I risk getting it chopped off. However, for those who are inclined to purchase gold at today’s prices, I submit that you should sincerely hope you are making a losing investment. If gold heads skyward to $4,000 or $5,000 per ounce, it will likely mean that things are going very, very badly for the world.

Aloha,

John R.

Financial Planning Hawaii

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