Is Gold a good investment? Over the 50 years of my investment experience, the potential for price appreciation of gold has always come into consideration by investors when the dollar is experiencing devaluation either through inflation or through excessive monetary policies of the Federal Reserve.  From 1970 when President Nixon took us off the gold standard until 1980 when Ronald Reagan was elected and Federal Reserve Bank Chairman Volker instigated harsh restrictive monetary policies, Gold rose in price from $200 per ounce to $850 an once ($2359 adjusted to today’s dollar value).  Speculators made or lost a lot of money as they traded futures which gave them huge leverage.  The gold bubble was much like the housing bubble, the 2008 oil futures bubble or the U.S. Treasury bond bubble today.  It just kept going up day after day and the Gold bugs were out there telling everyone the price was going to rise to $2000 or $2500 per ounce.  The parabolic curve was frightening when in juxtaposition to the prices on the stock market.  But like all speculative moves, when holders wanted to get out, they found that they were trying to sell to each other and the downward pressure saw the price of Gold fall by 75% in a matter of a year.  There is no investment (if measured by comparison to a business that earns a profit and shares some of that profit in the form of dividends to their shareholders) in holding gold.  There is only the hope of price appreciation.  Like raw land or other inert commodities, there is a cost to store such property and over time this negative cash flow eats away at the perceived appreciation that takes place due to price changes.  In the period from 1980 to 2000, the price of gold fell 90% from its high in 1980 while the Standard and Poor Stock index rose over 400%. 

Now we are at a place where some of us are concerned about the prospects for interest rates to rise to double digit levels again as the U.S. Treasury tries to finance higher and higher amounts of debt during the coming decade and the outlook for economic growth sufficient to pay the interest let alone repay some principal is more moderate than it has been before the 2007-09 recession.  If one believes that the Federal Reserve will monetize some or most of the increase in this huge debt then I suppose Gold or any commodity including oil, will rise in price.  But remember this, if the Fed prints money and dollar costs of goods and services go up, those managements that are able to adjust quickly to the cost of doing business and raise prices because their product or service is inelastic to demand, the company will be able to maintain their profit margins thus producing higher and higher nominal dollar income.  There are plenty of good investments with inelastic demand or semi inelastic demand and their earnings and dividends will rise in an inflationary period.  I find it more comfortable to hold investments in these kinds of companies than a “claim ticket” for a measure of an inert product like Gold stored someplace in a depository, speculative price volatility not withstanding.

One Man’s Opinion-  Bud Brewer

August 17,2007.    When I was a kid, one of the simple type games we used to play while sitting around the kitchen table after dinner was a card game I called “building a house” Each player would stand one or more playing cards on their side and in turn place them against or on top of each other so that a structure would be built as high as possible before one or the other players made it fall as they put their last card in place.  This “House of Cards” syndrome and its inherent risk of collapse has some anological comparison to how the financial structure of economic systems function here in the United States and around the world.  While far more sophisticated, the money, banking and credit system overseen by our Federal Reserve Bank and Central Banks in other parts of the globe nevertheless has tiny elements that could bring into focus the possibility of and fear for financial implosion that is much similar to the House of Cards game we played.

Now having said that, lets see if we can gain some perspective of what the “norm” is or should be for constructive administration of monetary policies and the oversight of financial institutions operating in free markets around the world.  The health of the U.S. economy is typically measured by the percentage change and direction of its Gross Domestic Product.  This GDP is an amalgamation of output in manufacturing and services that are purchased by the individual, institutional and government consumers.  The money a producer or provider receives for this output may be made up of a small portion of currency but for the most part it is represented by a preponderance of dollar bank credits.  The willingness of a producer to accept dollar bank credits in exchange for their output is based on their expectation that they will be able to turn around and pay their obligations by transferring these bank credits to other producers or service providers.  The difference between dollar credits earned by institutions or individuals from their output or work and the amount of their consumption purchases becomes savings.  These savings are generally held by banks as an obligation payable to or FBO the saver and for which the bank will add additional dollar credits representing compensation to them for the use of that dollar credit.  In many cases, these credits are exchanged for equity or debt ownership in securities, real estate and in some cases, commodities.  The structure that provides the tract on which all these transfers of credits take place is governed by State and Federal Banking regulations and by the Federal Reserve turning the money spigot on or off depending on whether or not they see the need to ease the ability for individuals and institutions to obtain temporary loans for their discretionary purchase of consumer items or longer term loans for the  payment of mortgages or other fixed obligations.

This entire system depends on the degree of confidence consumers have in the ability or desirability to exchange their dollar credits for some other asset.  As long as the credits are moving in the system, the economy and the producers of goods and services are selling their product and exchanging value for value.  The problem comes and it did come in this summer’s near collapse of the financial system when the mortgage banker increasingly came to  discover that it became more and more difficult to sell mortgages he  was generating and that his source of bank credits needed to hold and create mortgages was drying up.  The financial system was freezing up.  It is sort of like the human body having plenty of blood (currency) but the heart has stopped pumping it to the circulatory system.

One critical form of the “blood” in this system is the financial obligation called Commercial Paper.  When banks or institutions cannot sell and investors eschew the purchase of these short term (30-90 day) obligations, it is like the heart stopping its beating. The reason for this near disaster is the growing fear that the underlying values being used to price these and other longer term paper liabilities are over stated.  This fear leads to investors selling down collateralized financial obligations (Mortgages, Commercial  Paper, etc) and brings to a virtual halt the liquidity of fixed income markets leading to the suspension of funding for private acquisition deals or leverage buyouts.

It was early this morning that the Federal Reserve, having concluded that they needed to step in and try to stem the tide, decided to reduce the discount rate by 50 basis points.  This act, which is intended to make it possible for banks and mortgage companies to sell some of the paper they hold and provide an alternative for the realization of funds to procure working capital or monies to fund other approved mortgage commitments brought an explosion of buying into the security markets and reversed a great deal of the apprehension Traders and Hedge Fund managers were feeling about going into the weekend heavily unbalanced in their risks.  This, along with a multi billion infusion of money into the system by a purchase of Treasury and re-purchase agreements, seemed to generate a strong sense of stability to the money markets around the world.

Although the Fed’s action brought a sense of calm to the markets and was most appreciated by the investment community, the experience of the past 30 days brings into focus the impropriety of lending money to creditors who’s collateral is illiquid and/or probably overvalued to the extent that the loan amount is greater than the fair market value of assets securing it.  These type loans will no longer have a secondary market nor will the issuer be able to combine them into a security and sell them at par value.   The mortgage broker will now have to limit the amount they lend to borrowers to a figure that investors can be comfortable with, perhaps only as much as 80% of appraised value.  This will be good for the financial markets but it will certainly have a negative affect upon the price and volume of real estate transactions.

The ultimate negative impact upon the world as well as the domestic economies will be caused by the reduction of and maybe by substantial amounts, the ability of consumers to monetize the excess equity in their primary and secondary residences.   This impact will be felt in household purchases and ultimately in the earnings of many if not all consumer companies.  With this negative impact upon our economy and those that serve our appetite for imports our economy may be less robust in the coming year.

One Man’s Opinion — Bud Brewer