Replies to post #280 on The Global Demographic Tailwind

[DewDiligence]

I would rather own companies that mine industrial metals such as iron ore, where The Global Demographic Tailwind ensures a robust long-term demand irrespective of any changes in investing fashion.

[DewDiligence]

Gold Is Just Another Fiat Currency

[The author of this piece in Barron’s is the chief investment strategist for First Michigan Bank. The discussion echoes the points made by OakesCS in #msg-50601066.]

http://online.barrons.com/article/SB127508630235098425.html

›MAY 29, 2010
By RICHARD WIGGINS

Perceptions in markets change rapidly, and cash frequently flows in the wrong direction. Today, with television commercials touting gold nonstop, a lot of people are getting all worked up about the rising price of the oldest form of money.

As the price of gold has set records, investors have flooded in to load up on bullion and coin.

Demand for physical gold is projected to rise to 52.3 million troy ounces, the highest in history; and sales of American Eagle gold coins have jumped 65% so far this year, according to the U.S. Mint.

Gold may be the "currency of last resort," but premiums on gold coins have soared to levels never before seen. One-ounce coins are now trading far above their bullion value [a good bubble metric, IMO], as people continue to chase them, and mints worldwide are unable to keep up with demand.

People chase performance: Mutual-fund performance correlates with inflows of new money from investors, but which is cause and which is effect? Money always draws a crowd, and the top-performing mutual funds right now all focus on gold.

The highest concentration of gold holdings has always been central banks and the International Monetary Fund, but some of the biggest hoarders of gold today are the exchange-traded funds, which have bought bullion as they attracted waves of new investors. The SPDR Gold Shares (ticker: GLD), with $37 billion of the yellow metal, is now the world's sixth largest owner of gold.

Even gold bulls you may have seen on CNBC or Bloomberg will admit that there is a $200-$300 premium in gold because of ETF gold funds.

Gold's last real heyday was around January 1980, when Americans were taken hostage in Iran, inflation was out of control and there was civil disorder in Saudi Arabia. That doesn't mean this kind of thing can't happen again, especially since interest rates in this country are dependent on the world's tolerance for allowing America to live beyond its means.

But gold is a special commodity. Virtually every ounce ever mined—whether for use in jewelry or anything else—is still around. It doesn't rust or decay, and we keep mining more each year. It's not like oil, which we use up.

Another part of the logic for gold-that whole flight-to-safety thing—doesn't exist anymore. Maybe once upon a time, gold was a handy way to buy passage out of an oppressive country, but not anymore. When everybody obsessed about gold, and it was highlighted as a great doomsday hedge against inflation and currency risk, financial futures didn't exist. Now they do, so gold is a third-rate safe haven: It pays no interest and costs money to insure. (Textbooks say it has a "positive cost to carry.")

The big argument for gold is that all of the money that the Federal Reserve is printing -- 18 years of easy money -- will come back to haunt us at some time when inflation comes roaring back. Yet if today's investors are worried about U.S. inflation, they can go out and sell T-bonds, or buy the euro or another currency and earn interest while they're doing it. Investors afraid of 1970s-style inflation also should be buying Treasury inflation-protected securities.

It's possible that gold might continue to rise: On an inflation-adjusted basis, gold is far from its peak level of 1980, which was the equivalent of about $2,300 in today's inflated dollars. But it's much riskier now: Where the most money goes, that is where the greatest risk tends to show up. It pours into sectors when they get more and more pricey, and then flees when prices decline.

Wall Street is just a corner of the public mind. It follows fads, so money congregates in outlandish places. In the counterintuitive world that is the investment markets, you don't want to be where the smart money is. You don't want to be "where it's at."

A vital observation of the fun-starved Austrian school of economics is that investors err together, so unanimity of opinion is a danger sign. In past decades there has always an overvalued sector-a steaming corner of the market where money was converging -- and outperformance has come from getting out ahead of the crowd.

- In the 1950s, avoid electronics.

- In the 1960s, avoid franchise restaurants.

- In the 1970s, avoid the Nifty Fifty and fixed income.

- In the 1980s, avoid energy and biotech.

- In the 1990s, avoid Japan and the Internet.

- In the 2000s, avoid real estate and home-building.

All bubbles have nearly identical characteristics. The second half of the 1970s witnessed the outperformance of energy issues. At $30 barrel, oil companies were clearly in fat city. But the gonzo run-up in oil prices that propelled this sector in 1982 contained the seeds for an eventual glut that eventually sent it right back down.

Similarly, gold, which was outside the pale of serious discussion in the 1970s at $35 an ounce, entered the investment mainstream at $600 and $700 an ounce between 1978 and 1980, when it was quadrupling.

Only 15% of gold is used as a monetary metal; the rest of it is used as a commercial metal, and that use, particularly as a corrosion-resistant electrical conductor for semiconductors, is declining. Regrettably, it is a soft, semi-useless metal with very few industrial applications.

Gold is just another fiat currency. The only reason gold is valuable is that we believe it is valuable. Ultimately, this gold bubble ends in tears. When and how far gold's price will decline is anyone's guess, but a smart bet is “sooner rather than later.”‹