The Case Against Gold

March 04, 2009 | By: Bruce Krasting

If you lucky enough to have a few bucks left in your pocket to invest these days, you are faced with the dilemma of what to do with them.

No question but that stocks are cheap. But the chances are you already own stocks and you have lost 50% in the past year, so why would you want to add to that category? For those out there that are waiting for that Vee shaped stock market recovery, forget it. That is the least likely scenario out there. We are not getting out of this mess anytime soon. Pick any stock that you like. Regardless of how cheap it is today you can still lose half of your money in a fortnight.

Bonds are the other traditional alternative. They are problematic too. Either you get a high-grade bond like Treasuries that pay you nothing or you can invest in any of the busted corporate bonds that are already trading at big discounts. It is not hard to find decent corporate bonds around these days that pay you a yield north of 6%. So what? Most corporate bonds are going to be downgraded in the coming years. Do you really believe that GE can keep that AAA? Not a chance. Keep in mind that the vast majority of corporate bonds are never paid off. They are just re-financed. In today’s market even the likes of GE can’t go to the capital markets without the benefit of an FDIC guarantee to get the bonds out the door. As it looks now, a lot of those corporate bonds that look so nice today are going to pay you off with more paper, not cash. The “best case” is for a recovery in the global economy. While that does not look likely, if it should happen it would result in a rapid increase in interest rates and there goes your bond portfolio.

Real Estate is another big investment category that looks like an area to avoid. I think that REITs in general are just a huge black hole waiting to suck you up. Walk around the main streets and malls of your area. The stores are closing folks. In a year we will have lost an incredible amount of commercial real estate tenants. If you think there is safety in commercial REITs you are just going to be disappointed.

What is “safe” has a negative carry to inflation so you lose. What is worth looking at is fraught with risk. If anything that is backed by “paper” is suspect, then surely Gold has to look good.

The market seems to believe this. We briefly broke through $1,000 last week. The TV talking heads that are not allowed to speak on camera without a “BUY” recommendation on something have been touting the yellow metal non-stop.

I do not make market calls. There are too many surprises out there on a daily basis to stick one’s neck out. If gold were to be either $700 or $1,200 in two months I would not be surprised. The only market bet that I am prepared to make is that substantial volatility in all asset classes will be the norm in coming months. Clearly an opportunity to make money. Just as clearly an opportunity to lose some more.

With all of this chaos, it is not surprising that Gold catches a bid. It has always been a go to asset class in times of trouble and we have some trouble.

One of the big arguments for gold is that all of the money that all of the Central Banks are printing these days will come back to haunt us at some time in the future and inflation is going to come roaring back on a global basis and gold is going to soar when that happens.

That will almost certainly happen. I wish today that the near term forecast had a risk of inflation attached to it. Bunk. Take a look at all of the other asset classes that are a store of wealth. They are tanking. On that basis, gold may retain its value better than stocks, bonds and real estate, but that just means you will lose less. All investments are “Timing Trades”. In 2009 timing is everything. We are facing massive deflation today. On a global basis the Private Sector has reduced consumption by an astronomical 10% on an annual basis in just the past few months. Inflation will be the end result of the problems of today. But first we must ride ourselves through several more years of deflation before inflation becomes the “big risk”.

Historically gold has been a place to hide when the dollar is weak. If the dollar falls by 10% against the Euro, gold has to move up vs. the dollar . That is just the way that the capital markets have moved. That is not the case in 2009. The Euro/$ is reflecting the problems in Europe and all those troubled countries east of Germany. For the foreseeable future these fundamentals will not go away. Therefore gold is currently running against its historical trend. Always a red flag.

A long time ago, I was a young buck trading commodities. It was a time like last spring when commodities were hot and money was flowing to them. Copper was my commodity then. The price was pushing $3 per pound and I was super bullish. A guy who had been watching the tapes for a long time stopped by my desk and dropped off a roll of pennies. He said, “It can’t go higher. They will just melt the pennies”. Way back then pennies were made out of copper versus the zinc of today.

Of course he was right. In the months and years that followed copper slipped back to that comfortable $1-2 range that it is stuck in today.

There is a well-quoted fact. 98% of all the gold ever mined is still out there. In the next few years, things are gong to get very tough for all manner of consumers. When there is no food in the cupboard, when there is no money to pay for health insurance or doctor bills, gold will be liquidated. When we have sucked through our cash savings, we are going to liquidate what is left to keep things going. That means that people will sell their gold. When you can sell that old wedding ring for $400 and you are hungry, it is not much of a choice.

Watch the business channels in the US. There are non-stop commercials, “Sell Your Gold Now”. An industry has emerged where small gold holders can mail in their jewelry, have it melted and get a check in the post. This trend has not had a meaningful impact on global supply/demand conditions yet. But, as the economies around the globe slow further, as consumers and governments run though their liquid reserves, they will sell what is still liquid and has some value.

Gold is off nearly 10% since that $1,000 print. It was fear and front running that got it to that price. There was no real demand. If you feel today that you are long and wrong, take heart. The ‘fear’ thing is not going away any time soon.

To be a bull in anything today, you have to be able to make a case for a ‘double’ in the next twelve months. This means gold at $2,000. Gold bugs, there are an awful lot of things that are more likely to double from today’s levels in the next year than gold. Let’s face it. If the S&P is at 500 in a year, gold is a short too.

There is no “safe” place to hide.

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