The Aftershock Investor: A Crash Course in Staying Afloat in a Sinking Economy (30 page)

Now the U.S. dollar is no longer backed by gold for either domestic or international transactions, and the Federal Reserve can print money whenever it wants. But even so, gold is still important today because people all around the world still think it is important. Gold continues to be considered a safe store of value by nearly every country. This includes the U.S. government, which currently owns more than 9,000 tons of gold with an approximate market value of more than $450 billion.

Conventional wisdom on gold has evolved as the uses of gold have evolved. For a very long time, CW thought gold was wonderful and wanted to own as much of it as possible. Even in modern times, CW still valued gold to varying degrees for most of the twentieth century. But more recently—especially since the early 1980s stock market boom—CW’s interest in gold as an investment has cooled off considerably.

Mainstream investors may have a small percentage of their conventional portfolios in gold, particularly since the financial crisis of 2008, but they generally say that gold is a bad long-term investment for the following reasons:

• Unlike bonds, gold earns no interest.
  
• Unlike stocks, gold earns no dividends.
  
• Unlike real estate, gold earns no rent.
  
• Gold is not a safe haven, like bonds have been.
  
• Gold has no “real” value, it is mostly all speculative.
  
• The price of gold is volatile, and investing in gold is unpredictable and unsafe.
  

In short, CW thinks of gold as just a volatile commodity—perhaps a bit attractive under the right short-term conditions, but too dangerous in the long run.

Instead, CW investors like Warren Buffett are constantly telling us to stick with stocks. Why? Well, for starters, gold has not done as well as stocks over the past four decades, as Mr. Buffett pointed out in his February 9, 2012, article in
Fortune
magazine. Mr. Buffett used the comparison in
Figure 8.1
to show gold’s relative performance. Gold still does well, especially compared to bonds, but not quite as well as stocks.

Figure 8.1
Gold versus Stocks from 1965 to 2000

What $100 invested in gold or stocks in 1965 would be in 2000. Stocks outperformed gold from 1965 to 2000.

However, since 2000, after the stock market boom of the 1980s and 1990s, the S&P 500 has remained essentially flat. Meanwhile, during those same years, gold has climbed almost 500 percent (see
Figure 8.2
).

Figure 8.2
Gold versus Stocks since 2000

What $100 invested in gold or stocks in 2000 would be worth today. Since 2000, gold has far outperformed stocks.

What does Mr. Buffett have to say about gold outperforming stocks in the past decade? He advises us to pay no attention to that. He says rising gold is nothing more than a bubble. Funny how he doesn’t think stocks are a bubble, even though the Dow went up over 1,000 percent between 1980 and 2000 while gross domestic product (GDP) went up only 260 percent. Mr. Buffett implores us to stick with stocks instead of gold because the main reason people buy gold now is in the hope that more people will buy gold later. He sees no fundamental economic reasons for gold to ever rise, so if it does ever rise, it has to be mostly because of speculation.

In the
Fortune
magazine article he wrote: “Gold has two significant shortcomings, being neither of much use nor procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.”

You see, according to current CW, since gold does not have utility value, it is not a worthwhile investment. Now Mr. Buffett would certainly agree that gold will have short-term increases, as will many investments, but it is not as good longer term as stocks are now.

Fundamentally, his concerns have a certain amount of merit. But gold has risen in the past, even for long periods of time, despite its not having a utility value. More importantly, the recent past of 1965 to 2000 is not necessarily a good indicator of what’s going to happen in the next couple of decades. The fundamental economic conditions could be, and will be, very different. These conditions will work very poorly for stocks and very well for gold.

Although Mr. Buffett has a better analysis than most CW investors who dislike gold, the bottom line for most CW investors is that, whatever the price of gold is today, that is the price at which gold is about to “top out,” while stocks, at whatever price they are today, are almost always poised for long-term growth.

As we said before, in the past CW loved gold. CW investors only stopped loving gold relatively recently, in favor of the stock market bubble, the real estate bubble, and the big run-up in bonds since 1980.

The irony here is that one of the reasons that CW does not like gold—because it is not driven by an income stream, such as interest, dividends, or rent (in particular interest)—will be the very reason that gold will do so well in the future, when high interest rates pop the other asset bubbles.

As discussed in detail in earlier chapters, rising interest rates (caused by massive money printing and the inflation it will create) will have a very negative impact on stocks, bonds, real estate, whole life insurance, annuities, and other interest-sensitive assets—some of which are already partially fallen bubbles. Rising inflation and rising interest rates will also pop our two remaining bubbles: the dollar and the government debt bubbles.

But there is one asset that rising inflation and rising interest rates will not be able to push down: GOLD. Therefore, by default, when most other assets are falling, gold is going to look increasingly attractive as people around the world begin to bail out of their sinking investments and pile into the gold lifeboat. Gold will be seen as a safe haven when the U.S. and world bubbles pop.

A key reason that gold will do so well as the other bubbles fall is its very limited supply. Worldwide, only about 2,500 tons of gold are currently mined each year plus only about another 1,600 tons of gold per year are recycled, according to the World Gold Council.

Here is another way of looking at the relatively small size of total world gold. It would take less than three and a half Olympic-sized swimming pools to hold all of the gold ever mined—about 165,000 metric tons, most of which (about 85%) was mined in the twentieth century.

Despite the rise in gold prices in the past decade, the total output of gold mines, even with new mines coming on line, has actually declined or barely increased in recent years (see
Figure 8.3
).

Figure 8.3
Gold Since 2005

Gold mining output has not increased greatly despite a massive increase in the price of gold.

Source: World Gold Council.

Most Americans don’t especially like to invest in gold right now, but keep in mind that the United States is only 10 percent of the world’s gold market. China and India now make up more than half the world’s gold market, and they clearly love gold. There are now gold vending machines on the streets of Beijing, and Chinese banks hand out lots of brightly colored brochures pushing gold to their customers. The Indian people like gold so much, they even have a gold-buying season when gold, mostly as jewelry, is traditionally purchased. High inflation in China and India has increased recent purchasing. Plus, in China, which has seen the highest growth in demand, interest paid by banks is very low, the stock market has done poorly, and real estate is very expensive for most people. So, the alternative investments to gold are not good.

So even if we don’t generally like gold, the rest of the world is very pro-gold and they will not hesitate to rush into more gold in the future. That will make American investors highly interested, too, especially when our bubbles burst and they start looking for someplace to put what is left of their money.

Despite the CW assertion that there will not be enough demand to soak up future supply, just the opposite is true: Demand will far outpace supply, and that will rapidly push gold prices skyward. When the other bubbles pop, there will be a tremendous amount of money exiting stocks, bonds, and other investments. The tiny size of the gold market relative to stocks and bonds worldwide means that when people turn to gold, they will drive gold prices up fast and high.

Think of all the millions of investors around the world who will be trying to jump into those three and a half swimming pools. Explosive demand and tiny supply will create the biggest asset bubble we have ever seen. And as we will explain later in the chapter, after this bubble goes up, it is not going to come down anytime soon.

In general, gold does poorly when stocks do well, and gold does better when stocks do poorly. This is key to why CW doesn’t like gold—they want their stock bubble back! Therefore, for CW, investing in gold is equivalent to shorting America’s bubble economy. People don’t like that because they want America’s bubble economy to last forever.

It won’t.

The first step, once again, is to logically face facts. Continuing to bet heavily on a CW portfolio as we approach the Aftershock is simply not rational. All the CW arguments against owning gold (it doesn’t earn interest, it doesn’t pay dividends, etc.) are all irrelevant if stocks and bonds are going to fall with rising inflation and rising interest rates. Those are the same conditions that will make gold soar. Do you really need to worry about not earning interest when your investment is rising 500 percent or more?

Remember three things: (1) the other bubbles will pop; (2) Apple’s stock alone is worth more than all of the gold held by the U.S. government; and (3) the U.S. government bond market alone is nearly 30 times larger than the value of all the gold that the government holds. Bottom line: Gold investments are very small relative to stock and bond investments.