Gold hits $1,100

November 6, 2009

Methinks gold is rising because investors are anticipating a big second stimulus to counter the rising unemployment rate.

I’m a fan of gold as insurance, especially for high net worth individuals who want some of their wealth “out of the system.” It protects against violent deflationary or inflationary episodes, both of which can wipe out the value of paper wealth very quickly. That said, the premiums to buy that insurance are getting pretty expensive…

Personally, I don’t see how we escape this crisis without a dramatic decline in paper wealth. Credit can’t expand forever, much as the Fed and Treasury would like for that to happen. Eventually the cycle goes into reverse because the government no longer has the balance sheet capacity to absorb more of the private sector’s liabilities. When that happens, asset values crater. The economy is so over-levered in my estimation, its equity value is probably negative. There’s a reason the Dow declined 90% a few years into the Depression. (Stocks have some option value, so they aren’t going to zero.)

The government is aware of how violent deflation can be…ergo, the stupendous show of monetary and fiscal support over the past year. But seems to me all we’re doing is re-inflating the bubble, using the public balance sheet for financing instead of private balance sheets.

Some would argue that so long as there is an “output gap” this won’t be inflationary. I disagree. I think runaway stimulus means the U.S. will eventually face a “sudden stop” situation á la Argentina or Ireland when credit markets lose confidence in U.S. paper. They’ll see the only way they will be paid back is via direct monetization. When that happens, the bid for dollar-denominated assets could disappear more quickly than folks might be willing to admit.

But these dynamics could literally take years to play out. We still print the currency in which our debt is payable. Some consider this a huge advantage. To me, we just have more rope to hang ourselves with.

And I’m not saying this is going to happen. It’s entirely possible we get our act together and let the economy deflate gradually, using stimulus to support a gradual de-levering of the economy. But politically that may not be possible, and so the correction may be forced on us. To hedge that risk, it’s not a bad idea to diversify out of paper wealth into tangible wealth.

BTW, I don’t think you make money on gold in the long run. I think, at best, you protect the purchasing power of the dollars you already have.

From Marketwatch:

Gold futures rose to a new record high of $1,100 an ounce Friday after data showed the U.S. unemployment rate topped 10% in October, raising the metal’s appeal as a safe asset. Gold for November delivery gained 1% to $1,100 an ounce on the Comex division of the New York Mercantile Exchange, the highest level for a front-month contract. The more actively traded December contract rose to $1,101.90 an ounce.


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OK …. so you see a disaster coming as do i but you are pretty neutral on gold ……. what do you actually LIKE doing at this juncture ? sitting on cash is a disaster if your scenario plays out . I think Buffet overpaid for BNI out of gnawing fear he was going to watch his multi-billion hoard of cash devalue away to nothingness and was afraid to buy gold at the top so offered BNI such a ridiculous premium it took < 15 minutes to say yes !

Posted by divvytrader | Report as abusive

actually cash in the mattress may be a decent option as well. The sudden stop scenario is kind of a deflationary inflation. The currency loses value relative to other currencies. At the same time, currency you have in the system can disappear. It may be helpful to diversify out of bank deposits into good old benjamins.

But again, this is the kind of thing that isn’t going to play out tomorrow…

That’s why I’m wary of folks jumping on the gold bandwagon right now. I don’t see that our fiscal prospects have gotten that much worse since gold was at $1000. What I do see is a rush by investors to buy the stuff. Reminds me a bit of the bubble in oil prices two summers ago.

The price of oil in dollars looks like it will rise for a while. But it certainly overshot due to speculative mania. If you buy it at the top, be prepared to ride it back down before the trade becomes a winner….

Posted by Rolfe Winkler | Report as abusive

Rolfe …

Say in 2012 we end up with hyper inflation, could the DOW jump to 100.000 or higher?

Take a look at the Bovespa (Brazil), it’s at 65.000 points.

The U.S. has a much larger economy. If Brazil were using the dollar, would the Bovespa be at e.g. 6.500 or lower?

It’s a wild thought, but could it be possible that the DOW could fall to 1000-4000, during the next crash due to deflation, and then jump up to 100.000 due to hyperinflation after 2012 ???

In that case, stock in any company which doesn’t get broke will be a good hedge against hyperinflation.

Posted by Marco | Report as abusive

Of course it’s not gold that moves but the US dollar. Gold merely reacts. With the economy and the markets on the mend, it means a growth of more than 4 percent and potentially as high as 7% this quarter’s final months. It also implies that the appearance of deflation will be systematically replaced by the reality of inflation.

Investors were surprised by the large increase in the price of crude oil in May, at a time that consuming countries’ inventories of crude and refined products were near a 20 year high. The mystery, as usual, is cleared up by recognizing the fact that oil prices are driven by the decline in the dollar and that oil has been cheap relative to gold since late last year.

As is typically the case, the fastest price gains in equities and commodities have been those just following the turning point. Many investors may have missed out on those extreme gains, but there’s still opportunity left in commodities, especially farm commodities.

As the private sector recovers, the public sector sickens. The federal government saddled with huge new obligations that have already begun to compromise the ability to service its debt and borrow fresh funds, means that in time fed auctions are likely to increasingly disappoint, and low long-term interest rates begin dissolving. A symptom of government’s steady march toward insolvency is the persistent rise in the price of gold.

Luis de Agustin

Posted by Luis de Agustin | Report as abusive

Let’s take one step back:- on the one hand we have the holding of physical gold which should yield capital gains or losses; and of paper gold which yields capital gains or losses and dividends. I am careful to link gold, currency and other economic drivers and multipliers. There is no grand unified theory or consistent empirical. Gold is held or produced. A few weeks ago we noticed that not all holdings are accounted for, so let’s just assume it is worn as jewelry and home decorations or Kruger Rand. The latest IMF sell-off of bullion to India begs the question:- where will the cash proceeds be channeled to ? The US ? The increase in gold price improves the strength of the capital accounts of any country. There is a lag between mining production and sales. It takes quite a while to extract, treat, market and actually sell. China supposedly has the largest underground reserves, but must still extract it. Mines in South Africa might be depleted and it now requires ‘deep mining’, which is very costly. As far as inflation goes, it applies to any commodity, in physical or paper form. The same goes for hedging. The way it is going now, I would rather hedge with water.

Posted by Depeche Mode | Report as abusive

Pardon my (infinite it seems) ignorance, but when you say stocks “have some option value, so they aren’t going to zero” what does that mean?

Posted by Dave Narby | Report as abusive

Dave….good question. When I say “option value” I mean that the stock gets so cheap it’s trading like a call option on the possibility of a rebound.

That’s just me shooting from the hip, by the way. I haven’t done a rigorous analysis to demonstrate it. I share it b/c it’s a thought that informs the way I invest my savings.

Posted by Rolfe Winkler | Report as abusive