Is Gold a rotten Apple? - The Honest Truth By Ajit Dayal
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Investing in India - Honest Truth by Ajit Dayal
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15 APRIL 2013


Everyone knows my very loud and frequent statements that "gold is something we must all own".

It is there in a table at the end of every The Honest Truth.

Before I move on to whether gold is a rotten Apple, a quick recap on my rationale for buying and owning gold:

  • No paper currency has existed more than 100 years; even the US Dollar as we know it was born on August 15, 1971 - that is the day when President Nixon passed an executive order taking away the obligation of the US government to exchange every ounce of gold for USD 35; President Nixon took the US Dollar off the Gold Standard because foreign ownership of USD notes was more than the gold with the US government;

  • Gold is an insurance against a failure of government policies and aggressive printing of the central banks who - by printing more currency - add to inflation and reduce the value of the very same paper currencies that they were hired to "protect"; in 1971, the price of gold as stated above was USD 35 per ounce; today it is USD 1,480 per ounce - what this means is that the USD has lost 97% of its value against gold; even if you assume you placed this USD 35 at a 5% rate of interest with the US government over the past 42 years - and did not pay any income tax - that pile of paper currency would be worth about USD 272, way below the USD 1,480 price of gold;

  • Gold has been a source of saving and a "last resort" of storing wealth since centuries; it has been used by every persecuted class to move some of its wealth across borders;

  • Gold is a currency: the characteristics of a stable and "reserve" currency are (a) that people trust it, (b) it is liquid and can be exchanged for goods easily, and (c) governments cannot recklessly create more of it - unlike Federal Reserve Chairman Ben Bernanke's ability to create money from a printing press, you cannot create gold from a printing press to increase the supply of gold, you need to mine it from the earth and that supply grows by maybe 4% per annum;

  • Gold is valued by everyone - even by the governments who tell individuals that gold us useless and should not be held; if it is useless, why do they own it? The last time the central banks of the developed world sold their gold to show that it was a useless asset was in the 1999 to 2009 period. Gold was then below USD 300 per ounce till 2002 and below USD 500 till the year 2005; the selling by central banks kept prices low; in 2005 Russia announced it was planning to add to its gold reserves, acknowledging that paper currencies are not the only asset they wish to own; in 2006 China said it would add gold to its reserves; against this backdrop, gold has surged 4.5x in price since 1998, which is more than the Dow (1.6x) and the NASDAQ (1.3x); central banks own about 20% of all the gold in the world - if gold is such a terrible thing to own, why do they still own it? European central banks were net buyers of gold in 2011 for the first time in decades;

  • Gold is not bought for a return; it is bought and kept aside for insurance; in case the world is in trouble and stock markets decline and financial institutions begin to fail (that is precisely what happened in September 2008), then gold will hold its value - it will act as an insurance;
So, with the sharp decline of gold on Friday, April 12, many have asked me: "What happens to gold? Do we sell?"

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A sms from a friend elicited the following response from me: "Gold down like it was after Lehman. By nearly -20% then surged by 100 per cent. Will that repeat and does it matter what the daily price is?"

Based on the price movements since the collapse of Lehman, gold seems to have done a pretty good job of acting as a "hedge" or as "insurance" and a friend in bad times.

Graph 1: Gold recovers quickly after Lehman, still ahead of stocks - will that change?
Source: Bloomberg

But could that story now be over? Has gold had its golden moments?

Could gold be moving into a bear market, just as it did from the time when the Hunt brothers were speculating in silver and gold (1979 to 1980)?

Well, the question has a hint of the answer.

The Hunt brothers were speculating in an environment where interest rates were being raised by central banks which were willing to kill inflation - and subdue the economy to wrench out the excesses. The impact of that was a dead stock market - and gold actually did better than US stock market in that 1979 to 1982 period (Graph 2). It took the election of Ronald Reagan as the President of the United States in 1982 to kick start in the economy and it was only in 1984 that US stocks began to outperform gold.

Graph 2: Reagan bats for stocks via a healthy economy, but gold did better despite its 1980 bubble
Source: Bloomberg

As an aside, note that there are now only a few central banks in the world (be proud to be an Indian, because the RBI is one of those few central banks!) that are willing to resist the pressure from the politicians to print money to get out of an economic mess. Yet, in every graph, the INR returns of gold has been higher than the returns from gold for a USD based investor, suggesting that the politicians in India continue to make us spend more and -despite the courage of the RBI - the political machine has its button on the printing press. That, according to me, is a good enough reason to be wary of inflation in India and to use gold as a hedge.

Is Gold now a rotten Apple?

To another friend querying the crash on silver, I sent an email: "Just bought on Thursday, before the crash, my first little investment in silver. Plan to increase that by 5x as it crashes. The table at the end of the Honest Truth still holds good. A great time to buy something (particularly gold) is when no one else wants it."

To which he responded: "And Apple? Not the one Eve held out to Adam but the one in Cupertino CA. ☺"

My sms to him on that was: "Apple has products that last a few years and then are useless. Gold lasts centuries. Graphs may be similar but underlying values are different".

Graph 3: Apple loses lustre, gold following suit?
Source: Bloomberg

Apple, the iconic consumer is "i" company, has been in trouble from product fatigue and competition since the latter half of 2012 and its stock price shows that (Graph 3). Gold peaked in November 2012 and has also shown signs of technical weakness and fatigue. After 11 consecutive years of gains, gold may be tired.

Unlike Apple, gold does not have to prove its relevance every quarter. Gold does not have to come out with an earnings report nor deal with the impact of poor communication skills of the management of Infosys.

No, gold has proven its resilience over history. It has outlived empires and emperors, it has outlived central bankers and their printing presses, it has been more loyal than politicians and the institutions they have occupied to debase the faith of the general public.

Gold is not bought because you want a quarterly return or an annual return. Its pay-off is over decades - a parent does not "mark to market" the daily progress of a child, one sees how the child progresses over long periods of time.

As Lord Byron penned:
"So, we'll go no more a roving so late into the night
Though the heart be still as loving and the moon be still as bright.
For the sword weighs out the sheath, and the soul wears out the breast.
And the heart must pause to breathe and love, itself, have rest."


Gold may be having a Lord Byron moment, but is silver to be avoided?

In previous Honest Truths, I have argued that silver, because of its "half precious metal and half copper" characteristic is subject to changing views on:
  • What the central banks are doing - the more they print new money, the more there is a need to own a precious metal like gold and silver, and

  • What the global economies are doing - a global economic recovery suggests demand for silver as an industrial metal and that is good for the price of silver; however, a slower global economy suggests lower demand for silver as an industrial commodity and, arguably, a lower price.
Graph 4: Stocking up on some silver?
Source: Bloomberg

But, like I confessed in my email, I am keen to buy some silver - though have less of my money in silver than in gold - recognising the "downside" risk due to a slowdown in global activity.

So we will need to wait and watch to see what happens to the price of gold and silver over the next few days, weeks, and months (Graph 4).

Technically, all the charts look weak. But I am not buying gold and silver for technical reasons.
I am buying it for my security and as a hedge against inflation and the politicians and central banks that have gone berserk on the global stage.

Each of us has a different ability to absorb risk: the ability not to panic when one sees the price decline a day after one buys something - and to stay calm.
To remember why that "thing" was bought in the first place - and to test whether the hypotheses for buying it is still valid.

Graph 5: Gold surged by 400% since January 2004, but note the wild swings
Source: Bloomberg

And please don't rush into buying all the stocks or gold or silver that you wish to invest in all in one day. Spread out your investment.
Buy your "base" position and add to this "base" as you get opportunities.
How much that "base" is differs for everyone - for that you need to get your entire financial plan in order.

Meanwhile, to take another quote from the poet Lord Byron, I hope my investments in gold and silver (which I am making with a 20-year time horizon) do not end up "in silence and tears".

But as long as there are trigger-happy central banks and promise-making politicians around, I don't think there will be tears of pain.

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Disclaimer: The Honest Truth is authored by Ajit Dayal. Ajit is a Director at Quantum Advisors Pvt. Ltd and Quantum Asset Management Company Pvt. Ltd. The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and has not been authenticated by any statutory authority. The author, Equitymaster, Quantum AMC and Quantum Advisors do not claim it to be accurate nor accept any responsibility for the same. Please read the detailed Terms of Use of the web site. To write to Ajit, please click here.


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3 Responses to "Is Gold a rotten Apple?"

Dipesh

Apr 17, 2013

Well the article clearly portraits the writer's penchant for gold, comparing a technology stock with gold is like comparing apples to oranges and this basic premise is forgotten by him. No doubt this is a biased view of the author who seems to have got stuck with gold as an investment bought at higher levels on the stupid premise that gold bought at any level will always increase in value.

Like (1)

taffazull

Apr 15, 2013

Goldbugs should take instruction the following words of wisdom from Krugman in a recent article in the NYT: "Goldbugs and bitbugs alike seem to long for a pristine monetary standard, untouched by human frailty. But that’s an impossible dream. Money is, as Paul Samuelson once declared, a “social contrivance,” not something that stands outside society. Even when people relied on gold and silver coins, what made those coins useful wasn’t the precious metals they contained, it was the expectation that other people would accept them as payment...We have huge economic problems, but green pieces of paper are doing fine — and we should let them alone."unquote.I think suggested allocation for gold should be just the amount needed to meet one year's frugal living expenses in the event of an unlikely disaster.The rest should be put to productive use which includes charity.

Like (1)

Prashant

Apr 15, 2013

Amazing article by an amazing guy. No doubt Ajit is one of the last honest fund managers standing out there. When I say standing out I mean it. I haven't invested in his fund yet but plan to do once I reach India.

This guy really deserves more respect than any of the money managers that promise you heaven and deliver hell.
I wish a long hale and hearty life to this honest person.

Thanks for such beautiful and honest views.

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