Friday, August 19, 2011

Two Bones for the Gold Bugs

It is thought experiment time.

Bone #1

TIPS and gold tend to move together. Both rise as real interest rates fall and both rise as future long-term growth assumptions fall.

A 5 year TIPS matures in 5 years.
A 10 year TIPS matures in 10 years.
A 20 year TIPS matures in 20 years.
Gold matures in infinite years.

If real interest rates fall 1% evenly at every point in the future then how should the price react?

A 5 year TIPS rises about 5%.
A 10 year TIPS rises about 10%.
A 20 year TIPS rises about 20%.

So what would gold do? It has an infinite maturity. I don't think it would be rational to argue that it would rise infinity percent but I do think it could be rationally argued that it could rise more than 20%.

Bone #2

Let's look at the recent data.

I'm up roughly 35% on the 30-year TIPS I bought in February. Gold investors are up roughly 35% on the infinite-duration gold they bought in February.

The rise in gold since February matches the rise in long-term TIPS since February. Since I believe that the move in TIPS has been somewhat rational then I must also believe the move in gold has been somewhat rational. Based solely on this information then I should be no more of a gold heretic now than when gold was roughly $1400. In general, that's probably true.

That said, the same gold process should also work on aluminum. If it does not, then something else is going on too. That something else is what I have a problem with when it comes to gold at these prices. In other words, if aluminum was keeping up with gold then I would not be a gold heretic.

The price action in aluminum vs. gold would definitely make me nervous as a gold investor. It doesn't make me nervous as a TIPS investor though. I am tied to general price levels (as reported by our government, which can in theory make me nervous). If gold falls compared to aluminum then I'll still do okay. Think the 1980s and 1990s. Gold was falling even as inflation was rising.

It also does not make me nervous because I plan to hold my TIPS until maturity. The lack of maturity for gold has been its blessing but it can also become its curse. Having no maturity means that gold investors must someday sell it to someone else and it is the hope that there will be a buyer. There may be a great many buyers. There may be few. Who really knows? I sure don't. That's the risk.

And lastly, perhaps I would see things differently if I was younger. In theory, I do not have needs that need to be met infinitely far into the future. I'm more concerned about the time frame 30 years from now. I'll be 77 years old and I have no children. I intend to exhaust most of my nest egg and die mostly broke (of old age hopefully).

Just opinions.

27 comments:

Jazzbumpa said...

There is indeed something else going on, and that thing is a gold bubble a decade in the making, and the exponential rise is now blatant. So, no - there is no reason at all to believe that the move in gold has been in any way rational.

TIPS are up because all Treasury Bonds are up. Check out TLT. I wouldn't touch them at these levels.

The downside of gold - unlike your TIPS (and you really ought to give some serious consideration to realizing a 35% profit at this point - think about the opportunity cost of holding) is that it pays no interest - ever.

It functions as a store of value, and a medium for speculation (being long obsolete as a medium of exchange.) When speculation takes the price out of a reasonable range, then its ability to store value implodes.

When the smoke clears, in a year or six, look for gold to be under $400/oz.

Cheers!
JzB

Stagflationary Mark said...

Jazzbumpa,

Long ago I created a rule for myself when it comes to selling.

Would I buy at these prices? If the answer is no, then I tend to hold. If the answer is hell no, then I must sell.

Long-term TIPS have not reached the hell no stage in my opinion. The 0.93% real yield is crappy in my opinion, but since I've been predicting the death of real yields for years it does not come entirely unexpected.

That said, I do not really expect further appreciation.

I am not a buyer of 30 year TIPS at these levels. Fortunately, I do not have to be. I've already locked in the yield. I have no need to buy additional 30 year TIPS.

Also keep in mind that I am really rooting for higher real yields. I will not be heartbroken if treasuries sell off. I maintain a bond ladder and buy additional TIPS as old ones mature. My next purchase will be a small investment in the 10-year TIPS in January.

Falling real yields only hurt me, since I hold until maturity and reinvest.

Stagflationary Mark said...

As a side note, a 0.93% inflation adjusted long-term yield still beats a 1% nominal yield on short-term savings accounts (barring another deflationary event that I cannot time but would seem likely).

There are opportunity costs regardless of what we do.

It is easier to hold long-term TIPS if one expects long-term growth to be pathetic. I'm in the pathetic camp but am fortunate that I got there before some others did (namely those piling into TIPS now).

I really should thank the financial experts such as Jeremy Siegel for warning of the dangers of long-term TIPS at the very time I was buying them, yet all I seem to do is heckle. Go figure.

Mr Slippery said...

Wow, Jazzbumpa is quite the gold heretic, too. I am with Jazzbumpa on taking TIPS profits. That is just low hanging fruit, but I understand your motivation.

I will beat this horse one more time, the difference between gold and every other commodity on the planet, including aluminum, silver, platinum, wood, copper, lean hogs, soybeans, corn, etc. is that all major central banks in the world hold gold on their balance sheet. If that distinction does set gold apart in your mind, then I give up.

When central banks buy gold, the price goes up. And they buy it by the TON. Who will buy my gold? Central banks of the world. When they start selling again, by choice and not as a matter of survival, the gold bear will have returned and planet will be at peace with promise of infinite quantitative easing.

Now, it is clear that recent price action has been frothy with a slight vertical after taste. A time to reap profits, which I have done. But I think, only my opinion, that the gold bubble has a ways to go.

Soros makes clear in his writing, that investing in bubbles is a rational thing to do. It is the only way to reap outsized profits. Whenever he recognizes a bubble, he immediately buys into it. The trick is to get out at the right time, and I am devoting many brain cycles to that plan right now. Will I get the exit right? I don't know, but this has been the trade of a decade for me so far.

Will gold go back to $400 when the smoke clears? It might. But what happens between now and the when the smoke clears? I don't see any signs of clearing. I see the fire getting hotter and the smoke getting thicker.

What the resolution to half a dozen bankrupt euro nations? What is the resolution to 8-10% of GDP deficits for the USA? What is the resolution to 210%+ debt levels and declining demographics in Japan? That is bone #3.

Stagflationary Mark said...

Bonus thought.

It is extremely difficult to offer rational advice to retirees who are looking for safety right now.

Risks abound regardless of what is chosen.

Most retirees cannot afford to take the risk of reaching for yield by increasing bond duration. Long-term bonds are by their very nature risky. If you need the money in the short-term, then you should not be investing in the long-term.

The alternative is what? Embrace stock market risk? Yikes!

Earn -1% on 5 year inflation protected treasuries? Ouch.

Earn 1% in an online savings account when inflation is over 3%? Ack.

No good choices without taking a gamble on what you think inflation will do from here. And let's face it, it is a gamble. Nobody has a crystal ball that's 100% perfect.

Stagflationary Mark said...

Mr Slippery,

If that distinction does set gold apart in your mind, then I give up.

I see the distinction but see it in a different way. I do not think central banks are competent. They sell gold when it is cheap and they buy gold when it is expensive. Put another way, I see central bankers as being human. They sway to the same emotional bias that we all do and I therefore just don't trust their opinions all that much.

Further, we're now on a plutonium standard. It is the element that citizens are banned from owning (and rightly so). It is the element that can decide our fate in a war. It had zero value during the Great Depression (it wasn't even discovered until 1934) but it certainly does now.

Gold is a relic of the past and is therefore tied to emotions more than practicality. I've been there myself. I know the pull of the metal. I'm really not trying to bash here. (I'd be bashing myself as a former gold owner.)

At some level, hoarding gold is a bit like hoarding spears though.

There's a joke about bringing a knife to a gun fight. There's no doubt a similar one about bringing a spear to a bomb fight.

Just opinions.

Stagflationary Mark said...

Mr Slippery,

One more thought.

I am with Jazzbumpa on taking TIPS profits. That is just low hanging fruit, but I understand your motivation.

Now, it is clear that recent price action has been frothy with a slight vertical after taste. A time to reap profits, which I have done. But I think, only my opinion, that the gold bubble has a ways to go.

Long-term TIPS and gold rose by a similar amount. You think I should take profits on TIPS. You took profits on gold.

That's consistency.

You are willing to hold some gold because you think gold has further to go and I am willing to hold some long-term TIPS.

That is also consistent.

Just an observation. We're really not all that far apart here.

Stagflationary Mark said...

I also want to make something else clear here. I have a fairly balanced bond ladder. It does now lean a bit further out, but I am not betting the farm on long-term TIPS. I've simply allocated funds to meet my future needs.

Mr Slippery said...

Just an observation. We're really not all that far apart here.

I agree, we're not all that far apart.

I don't really qualify as a true gold bug. More of a pragmatist. I hoard gold because the CBs do. They create the money, set interest rates, and make the rules.

I am like the seniors you described facing bad investment choices, just not a senior yet :) So I kick and scratch and claw to preserve purchasing power and maybe eek out a little profit for the effort, yo.

Stagflationary Mark said...

Mr Slippery,

No easy answers here.

It is definitely becoming harder and harder to make money off of money.

I've also been thinking a lot about the psychological damage of 0%. When real rates drop from 2% to 1% we adapt. When real rates drop from 1% to 0% we adapt.

However, there is definitely an emotional response when real rates drop below 0%. That is the moment when you can prove that purchasing power is actually being lost. I can't say that it is entirely rational. It is simply a smooth scale. There's really nothing all that special about 0%.

I wonder if Bernanke has factored in that emotional response. I doubt it very much.

I can tell you what it does to me. Less discretionary spending! Bunker mode!

That said, I'll be heading off to see a discretionary movie and eat some discretionary food with a friend. Perhaps I'm becoming desensitized based on my fake 30-year TIPS profits (I say fake because I'm not actually cashing out), lol.

Jazzbumpa said...

It is definitely becoming harder and harder to make money off of money.

Yet that, to a very large extent, is what the rentier class does. Hence, perhaps, the development of over more obscure and impossible to objectively evaluate derivatives?

What they have done over the last decade + is blow a series of bubbles - Tech stocks, real estate, commodities, oil, and above all gold.

It may well be the ruin of us all.

Re: your ladder. Just think, if you took your guaranteed 35% profit now, you could either make your next rung 35% larger, or your next 10 rungs 3.5 larger each.

Or throw one hell of a fine party.

Just sayin . . .

Cheers!
JzB

getyourselfconnected said...

Some peoples time frames are different. I dont think in terms of 40-50 years, not my luck. 10-20 is a best hope.

tj and the bear said...

Mark,

You don't seem to be getting my point, even though you repeatedly keep making it yourself...

GOLD IS PURELY PSYCHOLOGICAL.

I also came to realize that gold's value is determined by others. If I was the last person on earth, then gold would have virtually no value to me. I'm a fairly cynical, skeptical, and independent person. That doesn't sit well with me.

Guess what? Our world is full of people, and people throughout history have been attracted to gold. It's not rational, it's not logical, but it is what it is.

If your wife/GF is like most, some gold jewelry will get you some "appreciation"; aluminum will get you the couch.

Governments always tell you gold & guns are bad, yet those are the things they insist on hoarding.

Get the picture yet?

p.s.: I find it seriously laughable that you apply the aluminum test directly to gold but dismiss the same for TIPS because the value of a government issued piece of paper is justified by a government issued price index.

Stagflationary Mark said...

Jazzbumpa,

Re: your ladder. Just think, if you took your guaranteed 35% profit now, you could either make your next rung 35% larger, or your next 10 rungs 3.5 larger each.

That assumes that real yields go back up. Rarely it is that easy to make money.

Further, I am earning over 2% on my 30 year TIPS regardless of what the market thinks they are worth and will do so for 30 years.

Stagflationary Mark said...

GYSC,

I definitely think in terms of 30 years. For what it is worth, I still have 19 years left on the I-Bonds I bought in 2000.

Stagflationary Mark said...

tj and the bear,

p.s.: I find it seriously laughable that you apply the aluminum test directly to gold but dismiss the same for TIPS because the value of a government issued piece of paper is justified by a government issued price index.

Well, I'm certainly pleased that I made you laugh, lol.

In all seriousness, I DO apply the aluminum test to my TIPS. There really isn't much to see.

1. Unlike gold, TIPS have not risen 7 fold in the last decade. TIPS may be a bit pricy compared to aluminum but it certainly isn't anything like that.

2. The value of TIPS are much more related to the value of aluminum than they are to gold. Aluminum is something I use every day. A large spike in aluminum would affect my ongoing expenses somewhat. The large spike in gold has done very little though.

3. I do own plenty of aluminum foil as a hedge against future aluminum expenses. I therefore seem to like both aluminum and TIPS.

If your wife/GF is like most, some gold jewelry will get you some "appreciation"; aluminum will get you the couch.

We both very much appreciate the couch. Neither of us wear any gold jewelry. Heck, I don't even wear a watch (gold or otherwise). We do enjoy playing games on the PS3 though. So I guess neither of us are like most.

Since you do believe that gold is purely psychological then it really shouldn't bother you that I have chosen to no longer participate in something that emotional. ;)

Stagflationary Mark said...

Jazzbumpa,

More thoughts.

I locked in a real yield because I thought real yields would fall.

What if I sell TIPS now and real yields continue to fall (as the economy continues to deteriorate over the long-term).

Real yields were highest when there was high real GDP growth.

Real yields are now low since there is little real GDP growth.

What's going to create high real GDP growth over the long-term again? You tell me and we'll both know.

Stagflationary Mark said...

tj and the bear,

If your wife/GF is like most, a "brand new home" will get you some "appreciation"; aluminum will get you the couch?

Just food for thought.

Stagflationary Mark said...

I just want to thank everyone for their valuable input in the last few posts. It has been productive.

I've been thinking it over and am actually considering the sale of some of my long-term TIPS. I'm going to take a stab at trying to figure out the likelihood of another deflationary event first though, because that seems to be the primary reason real yields would rise.

I do lean deflationary in the short-term. Perhaps it is worth the risk.

The good news is that the major purchase was within my IRA. It therefore wouldn't trigger a taxable event. The bad news I've already spelled out. I've got a very uneasy feeling about our real long-term growth prospects.

Time will tell. I'm certainly willing to explore this further.

nanute said...

Mark,
I'm not one for giving advice, but if I were in your position, (non taxable), I'd definitely take some profit. Holding it in cash or equivalents for a while won't hurt at the profit level you'd realize. I moved all my retirement account holdings last year into bond funds, and am now considering taking some profit. The question is where to put it after holding in cash for a while. I'm thinking that an S&P500 index fund might be a good bet. The question is where is the bottom of the index? For my money, Vanguard's extremely low expense ratios look attractive. Granted, expense ratios shouldn't be the only consideration, but over long periods of time, .5% more in expenses can take a lot out of your wallet.

Stagflationary Mark said...

nanute,

The question is where to put it after holding in cash for a while. I'm thinking that an S&P500 index fund might be a good bet.

I hear you, but what if we slide into Japan's ongoing mess? That's a very real concern to me. I can point to several guaranteed epic exponential trend failures (employment and port traffic to name but two). They may just be the tip of the iceberg.

In theory, all I really need is capital preservation. I no longer need to hit the ball out of the park. In hindsight, taking profits to await better opportunities may end up actually being the greedy move (if better opportunities never appear).

My goal since 2004 has never been to maximize rewards but instead to lower near worst case risks. That is still my mindset.

If 9 times out of 10 I could grow wealthier but that 1 time out of 10 could seriously hurt me then I'd prefer to pass (that was not always the case). My situation is rather unique in that regard. I'm perfectly happy with the resources I have. Doubling them won't make me anywhere twice as happy.

I think I'll probably try to come up with some sort of "what if" decision tree this weekend to help me decide (and share it as a new post).

tj and the bear said...

If your wife/GF is like most, a "brand new home" will get you some "appreciation"; aluminum will get you the couch?

You're making my point yet again, but let me put it in even more basic terms: GOLD IS PRIMAL, just like sex, power and the "nesting" instinct.

We're very much alike, except in that you don't seem to realize that gold isn't about us (including our better halves), it's about everyone else. As long as THEY value it then it doesn't matter what we think.

Comparing to aluminum makes no sense whatsoever. 99% of the gold ever mined is still around in one form or another, and most of that sits in vaults never to see the light of day. True uses are statistically insignificant; I don't even consider jewelry to be real consumption.

It's a different beast altogether, so you need to free yourself from thinking about in personal and/or standard commodity terms and grasp it's true nature.

---

BTW, my favorite PM is actually silver. It combines the "true money" psychological nature of gold with an extremely bullish commodity profile.

Stagflationary Mark said...

tj and the bear,

I really don't think I am making your point.

The "brand new home" was also primal and those who bought homes based on primal instincts did not do so well in hindsight.

I would be far more bullish on gold if 99% of the gold ever mined was NOT still in existence. That is hardly a bonus for those who own gold.

Take oil. When it is burned it is gone. It can run out.

It's a different beast altogether, so you need to free yourself from thinking about in personal and/or standard commodity terms and grasp it's true nature.

This is exactly why I am a gold heretic. You see gold as a religion. I do not.

Stagflationary Mark said...

I need to reword that.

You see gold as a religion worth worshiping. I do not. I am no longer a believer in the faith.

Stagflationary Mark said...

One more thought.

It wouldn't be the first religion that could thrive without my presence. In general, I'm an agnostic with serious athiest tendencies.

Wisdom Seeker said...

Mark, as a strictly pragmatic approach: If we re-run 2008, and it appears we might since the European banks are in the same basic position now that the US banks faced back then... Then we will see both TIPS and GOLD fall in price as the market senses deflation (and as "investors" facing margin calls are forced to liquidate relatively sound holdings).

I think you've got an excellent chance of being able to make the same 35% twice!

I've sold some TIPS and some gold recently, but I didn't sell all of either holding because I think the current trends haven't broken yet ... and I could be wrong about the impact of the current leg of the debt crisis.

P.S. I share your agnosticism ... and it seems to be a sound approach to investments and other economic religions (which they are). Question and seek to understand, but retain doubt. Both atheism and fanaticism are expensive by comparison!

Stagflationary Mark said...

Wisdom Seeker,

I think you've got an excellent chance of being able to make the same 35% twice!

It would not surprise me in the slightest, lol. Sigh.

That said, I would not complain. I have quite a few years of living expenses sitting in cash right now. Throw me a decent opportunity and I would risk parking some of it back in TIP.