Sunday, September 4, 2011

Another Bone for the Gold Bugs

Although I think gold is in a bubble, a few weeks ago I wrote this post explaining why I thought at least some of gold's price moves were rational.

Last night I ran across the following article and my thoughts on it will no doubt amuse the gold bugs. Hey, I'm an equal opportunity heckler.

June 21, 2011
3 Reasons the Gold Bubble Will Burst

Myth #1: Gold is an investment

I would define an investment as an asset that creates value and income over time. Stocks, bonds, real estate, even livestock and some machinery for businesses would all qualify.

1. The asset must create value and income over time.
2. Bonds qualify as an investment.
3. TIPS are bonds, therefore TIPS are an investment.
4. The real yield on 5-year TIPS is negative.
5. 5-year TIPS cannot create value and income over time, therefore 5-year TIPS cannot be an investment.

Using this article's own definition of an investment, 5-year TIPS are an investment and are not an investment.

Clearly there is a serious logic problem in the author's definition of investment.

Don't even get me started on the lack of value creation and income generation of stock and real estate investments since I started this blog.

Myth busted? Hardly.

Myth #2: Gold is a store of value

This is an easy one. Is gold a store of value? Absolutely.

As long as gold doesn't fall to zero dollars then it will store at least some value. Even a cracked glass can be a store of water (as long as you don't fill it above the crack).

Greenspan said in 1966 that there can be no "safe" store of value in a welfare state. Is gold a safe store of value? No, but nothing is.

Is gold a good store of value at these price levels? I don't believe it is over the long-term but I could be wrong.

Even if it was the author's intent to suggest that gold is not a good store of value at these prices levels and/or over the long-term, then it is still impossible to bust the myth based solely on personal opinions.

Myth busted? Hardly.

Myth #3: Gold is a contrarian trade

This claim is almost laughable, but it wasn’t born in a vacuum.


The total market capitalization of all publicly traded companies of the world was thought to be $51.2 trillion in 2007 and just $40 trillion in September 2008. Note the $11.2 trillion decline.

The total debt of the world is thought to be $109 trillion in 2010.

At $1750 per ounce, the total value of the world's gold is thought to be $9.2 trillion.

Gold represents roughly 5.4% of the total ($51.2 trillion + $109 trillion + $9.2 trillion). Further, stocks lost more value from 2007 to 2008 than the value of all the gold that's ever been mined. It could easily happen again.

That's not even counting the trillions upon trillions of dollars in global real estate ($18 trillion just in household real estate assets in the US).

If one is seriously concerned about the state of the global stock markets, global real estate markets, and global debt markets then I think it could be easily argued that gold is still a contrarian trade.

Myth busted? Hardly.

On the one hand, I think gold is mighty expensive compared to toilet paper. I think that is a huge red warning flag.

On the other hand, I do not agree with the author's conclusion that the "gold’s bull run is based on weak arguments that don’t hold up to scrutiny." From where I stand, none of his three supposed myths hold up to scrutiny.

If holders of long-term treasury inflation protected securities (such as myself) experience serious pain, then hindsight will more than likely show that gold was a bargain even at these levels. The emphasis is on the word "if" though. Only in hindsight will we know for sure.

The following chart shows what an investor can expect to earn by buying today's 0.9% 30-year TIPS and holding it until maturity.

Note what the combination of high inflation rates and high tax rates does to TIPS performance. Inflation protected securities offer pretty good protection but only if inflation doesn't get seriously out of hand.

Although TIPS investors would be doing much better than nominal treasury investors in such an environment, there would still be pain if inflation picked up (due to the taxation of the inflationary gains each year). The greater the inflation rate, the greater the pain.

As a TIPS investor who holds TIPS to maturity, I am fairly well protected against a 1970s style inflationary environment that never ends (7.5% per year inflation). I am not well protected against hyperinflation. Gold investors are much better protected should that happen. The risk is not trivial but it is one I am willing to take.

I personally think gold is in a bubble and that it is unsafe to be investing in it at these levels (with the caveat that I don't think anything is safe right now, other than toilet paper and basic necessities). It is just an opinion though. I certainly cannot prove it beyond a reasonable doubt. In other words, if gold was on trial here I would have to find it not guilty.

Thanks to Troy for pointing out that the $18 trillion in real estate was just the household real estate assets, not all land value. I should definitely have made that more clear.


fried said...

I find your lack of faith in the precious...disturbing. As a small percentage of your wealth, it is a nice little speculative play. As Honshu begins to glow in the dark, and the Eurozone lurches from crisis to crisis, it tends to the upside.
Which is nice. It is also very shiny.
And on the deflationary side, as currencies devalue, it floats.
But not picking an exit matters.

Stagflationary Mark said...


I find your lack of faith in the precious...disturbing.

For what it is worth, I did have a third of my investments (not counting home) in gold and silver bullion from 2004 to 2006. I eked out 50% simply trying to preserve some wealth.

But not picking an exit matters.

In hindsight, one could have wished for a better exit point.

If wishes were horses, we'd all be eating steak! - Jayne Cobb, Firefly

Troy said...

$18T of US RE is a joke.

That's only $150K per household.

It wouldn't surprise me if there's $18T of total improvement value alone.

Raw land value, it makes my brain hurt to calculate.

California has 800 miles of coast, going with $1M per acre for the first mile inland, that's $500B of land value right there alone. That estimate is probably an order of magnitude off.

We've got 300m acres of cropland, 75m acres of woodland.

That's $2T in agricultural land @ $5000/acre.

How much is LA land worth?

Be fun to map this out.

Stagflationary Mark said...


Oops. I should have said household real estate assets. Sorry about that. Good catch.

For what it's worth, my mom's house is $150k in Spokane, WA.

Stagflationary Mark said...

I'll update the post to fix the wording next time I'm on my computer.

Skye said...

I for one would like to see your toilet paper in gold graphs (long term if possible. Did they even use TP in the olden days?)

Troy said...

I should have said household real estate assets. Sorry about that

Thing is, the Fed can only find $1.7T of non farm, non residential RE value in the US.

Again, that looks to me to be just the improvements alone.

We have 130M workers. $1.7T is an average workspace of $13,000!

We all don't work in tiltups in Spokane, do we?

The Fed's numbers are ludicrous -- $25T total real estate value is only $80,000 per capita.

The floor of what we each occupy and use would be about $80,000, not the average.

$25T *might* cover the unimproved land value, OR the existing stock, but not both.

Construction has been ~5% of GDP for a very long time, and depreciates slowly. Buildings built in the 1960s and 1970s are still economical to operate, that's 50 years of accumulated supply to count.

Stagflationary Mark said...



We all don't work in tiltups in Spokane, do we?

Well, it is a city of 209,000 and my mom does live inside of it. That said, my mom does live in a smaller house than most.

In July 2011 the median home price was $222,000.

$222,000 x 67% home ownership rate = $149,000

Just a thought.

Stagflationary Mark said...


Here's something to look at while I try to find something better.

Toilet Paper Economics Revisited

tj and the bear said...

Someday TIPS will only be a useful alternative to TP, so you're "covered" both ways. ;-)

Seriously, if you look waaaayyyyy out by far the most valuable commodity in the world is water, but damned if that "marginal utility" doesn't come into play. So forgive me if I don't sweat any comparisons to the squeezably soft.

The only reason I've heard that people consider Gold a bubble is it's high price. Sorry, not good enough, especially when priced in paper that's actively being devalued. Bubbles are predominantly a mass psychological phenomenon, and frankly there just isn't solid evidence for that.

Stagflationary Mark said...


Here's about the best I can do for now.

1930's Food and Groceries prices

Clifton Toilet Tissue 9 cents for 2 rolls Ohio 1932

That was probably full retail and who knows what you actually got. Plenty of room for error here when trying to do an apples to apples comparison. That said, let's do the math anyway.

In 1932 an ounce of gold was $20.67.

The gold ounce to toilet paper roll ratio was 459 to 1. ($20.67 / $0.045 = 459)

You can now buy a 500-sheet 2-ply roll at Costco for about 50 cents. It is a giant roll (Marathon brand). They did not have 2-ply in 1932. They did not have Costco. Therefore, quality has gone up and cheaper ways to buy toilet paper have appeared. Win win.

At $1900 an ounce, the gold ounce to toilet paper roll ratio now stands at roughly 3800 to 1. ($1900 / $0.50 = 3800)

Stagflationary Mark said...

tj and the bear,

Someday TIPS will only be a useful alternative to TP, so you're "covered" both ways. ;-)

@#$%! All my TIPS are in electronic form! I will only be able to virtually wipe! Hahaha! ;)

The only reason I've heard that people consider Gold a bubble is it's high price.

I don't believe I have used that argument here. I am always comparing gold's price to something else that I might also hoard.

I specifically avoid saying what I think about gold priced in dollars. I'm all about gold to [fill in blank] ratios.

When I felt gold was too expensive at $1000, it was only in comparison to toilet paper. There will come a time when the price of toilet paper outperforms the price of gold in my opinion. It could be either because gold comes down in price, toilet paper goes up in price, or both. That's the risk gold bugs have over the long-term.

Stagflationary Mark said...

In other words, those who hoarded gold in 1980 thinking it would be a great long-term toilet paper hedge were quite disappointed over the following 20 years.

Stagflationary Mark said...

Seriously, if you look waaaayyyyy out by far the most valuable commodity in the world is water, but damned if that "marginal utility" doesn't come into play. So forgive me if I don't sweat any comparisons to the squeezably soft.

Marginal utility?

US Army Rations - World War II

Another objective was to furnish sufficient food to take care of five men for one day. The first specification for a 5-in-1 ration proposed a unit of three menus, each consisting basically of B ration components such as Army spread, vegetables, meat combinations, evaporated milk, fruit juice, fruits, dehydrated soups, cereal, and beverages as well as such common items as biscuits, hard candy, salt, sugar, and toilet paper.

There was no gold in the kit. Just sayin'.