One of our clients’ sent me an article below and asked if I would comment on it. The article is very main steam. But, at least the author says he is slowly coming around and admits it would make sense to own a little gold. That’s better than not owning any, however, I am not swayed by his data or his conclusions.
I hear the same arguments from Backwoods Jack’s number one son, who graduated from a prominent Ivy League school and has had a couple of management jobs in the insurance industry and represents a wide line of financial products that come out of Wall Street. The arguments sound logical and compelling until you listen to what I have to say. (PS. Backwoods says he will place a large six figure order in gold and silver within the next 30 days.)
By N. GREGORY MANKIW
Published: July 27, 2013
A friend posed that question to me a few weeks ago, after watching gold’s wild ride over the last few years. The price of gold was less than $500 an ounce in 2005, but soared to more than $1,800 in 2011, before falling back to about $1,300 recently. He wasn’t sure what to make of it all.
My instinct was to say no. Like most economists I know, I am a pretty boring investor. I hold 60 percent stocks, 40 percent bonds, mostly in low-cost index funds. Whenever I see those TV commercials with some actor hawking gold coins, I roll my eyes. Hoarding gold seems akin to stocking up on canned beans and ammo as you wait for the apocalypse in your fallout shelter.
But I was also wary of imposing my gut instinct on my friend, who was looking for a more reasoned judgment. I knew that some investors saw gold as a key part of a portfolio. The author, the onetime Libertarian presidential candidate, recommended a permanent 25 percent allocation to gold. In 2012, the Federal Reserve reported that Richard Fisher, president of the Federal Reserve Bank of Dallas, had more than million of gold in his personal portfolio.
So, before answering my friend’s question, I dived into the small academic literature on gold as a portfolio investment. Here is what I learned:
THERE ISN’T A LOT OF IT The World Gold Council estimates that all the gold ever mined amounts to 174,100 metric tons. If this supply were divided equally among the world’s population, it would work out to less than one ounce a person.
Warren E. Buffett has a good way to illustrate how little gold there is. He has calculated that if all the gold in the world were made into a cube, its edge would be only 69 feet long. So the cube would fit comfortably within a baseball infield.
Despite its small size, that cube would have substantial value. In a recent paper released by the National Bureau of Economic Research, Claude B. Erb and Campbell R. Harvey estimated that the value of gold makes up about 9 percent of the world’s market capitalization of stocks, bonds and gold. Much of the world’s gold, however, is out of the hands of private investors. About half of it is in the form of jewelry, and an additional 20 percent is held by central banks. This means that if you were to hold the available market portfolio, your asset allocation to gold would be about 2 percent.
ITS REAL RETURN IS SMALL Over the long run, gold’s price has outpaced overall prices as measured by the Consumer Price Index — but not by much. In another recent N.B.E.R. paper, the economists Robert J. Barro and Sanjay P. Misra reported that from 1836 to 2011, gold earned an average annual inflation-adjusted return of 1.1 percent. By contrast, they estimated long-term returns to be 1.0 percent for Treasury bills, 2.9 percent for long-term bonds and 7.4 percent for stocks.
Mr. Erb and Mr. Harvey presented a novel way of gauging gold’s return in the very long run: they compared what the Roman emperor Augustus paid his soldiers, measured in units of gold, to what we pay the military today.
They report remarkably little change over 2,000 years. The annual cost of one Roman legionary plus one Roman centurion was 40.9 ounces of gold. The annual cost of one United States Army private plus one Army captain has recently been 38.9 ounces of gold.
To be sure, military pay is a narrow measure, but this comparison offers some support for the view that, on average, gold should keep pace with wage inflation, which, thanks to productivity growth, runs slightly ahead of price inflation.
ITS PRICE IS HIGHLY VOLATILE Gold may offer an average return near that of Treasury bills, but its volatility is closer to that of the stock market.
That has been especially true since President Richard M. Nixon removed the last vestiges of the gold standard. Mr. Barro and Mr. Misra report that since 1975, the volatility of gold’s return, as measured by standard deviation, has been about 50 percent greater than the volatility of stocks.
Because gold is a small asset class with meager returns and high volatility, an investor may be tempted to avoid it altogether. But not so fast. One last fact may turn the tables.
IT MARCHES TO A DIFFERENT BEAT An important element of an investment portfolio is diversification, and here is where gold really shines — pun intended — because its price is largely uncorrelated with stocks and bonds. Despite gold’s volatility, adding a little to a standard portfolio can reduce its overall risk.
How far should an investor go? It’s hard to say, because optimal portfolios are so sensitive to expected returns on alternative assets, and expected returns are hard to measure precisely, even with a century or two of data. It is therefore not surprising that financial analysts reach widely varying conclusions.
In the end, I abandoned my initial aversion to holding gold. A small sliver, such as the 2 percent weight in the world market portfolio, now makes sense to me as part of a long-term investment strategy. And with several gold bullion exchange-traded funds now available, investing in gold is easy and can be done at low cost.
I will continue, however, to pass on the canned beans and ammo.
N. Gregory Mankiw is a professor of economics at Harvard.
–NYTimes.com, July 27, 2013
I say it’s hard to use long-term studies on gold because the price was FIXED (by the US Treasury and London Gold Pool) until August 1971, so there was no growth in price possible for over a century. In any other commodity, that’s called price fixing. Also, since the 1990s for sure (and most likely earlier), central banks have sold and leased gold to hold back the price. Banks want you in interest bearing currencies and gold is their enemy.
Yes, the price of gold is volatile, but mostly because of the application and release of pressure on its price. Over the last 15 years you can see Goldman Sachs and JP Morgan’s fingerprints all over the price suppression.
There is not other rational explanation of why gold was crushed, nearly $300/oz in a two-day period in the summer of 2011. 1,000 tonnes of gold were sold to crush the price, for no apparent reason – other than it was nearing $2000 an ounce and was sending the wrong signals. No one but a central bank (or banks) had enough physical gold to pull this off. (Yesterday, I wrote that the smoking gun now points to the Bank of England and the source of the gold. Why am I not surprised?). The point is, gold is not allowed to trade freely, and going back to before the Civil War it hasn’t been, so all the “research” in the following article leads to a false conclusion. The major factor holding back gold’s performance was manipulation, not free market movement. Personally, I think it is not possible to use any number prior to the fall of 1971 and then one must factor in or at least consider the impact, especially on the volatility, on the price of gold.
The best time to buy gold is during its Bull Market cycle. (Better yet, at the beginning – and during dips.) We have been in a bull market cycle since gold was in the $250s, commencing in 2001. The cycle is NOT complete. Bull Markets never end without a blow-off stage, where the price goes exponential. When everyone and his barber are buying gold and telling you that you must own some (which has not happened) then the bull market is near completion. Only when there are no more buyers left will a bull market stop and collapse. Record amounts of gold are now flowing into China, India and Russia. Records are being set in one-ounce bullion coins. Check out the numbers from the US Mint. Ed Steer keeps you updated daily.
Gold’s rise over the last 11-years was very orderly; an upward move on a graph of around 45 degrees, not 90 degrees like we in the Nasdaq or the housing bubble.
There is a correction, starting in 2011, but the interesting thing is nothing that favored the bull market in the first place – like the out of control growth of debt, ultra-low interest rates (below inflation) and massive money creation (QE) – changed. Nothing changed but the price. If that is not a clear sign of manipulation, what is? And the plunge in the price resulted in the strongest demand for PHYSICAL gold than at any time in my memory. The fall is a paper drop, on the Comex. Let the game go on. I keep accumulating as the price of physicals is subsidized by the action in the paper market.
I hope you took note of the chart I showed you yesterday, the amazing outflow of physical gold from the Comex. Here it is again in case you missed it.
Someone with very deep pockets is gobbling up all the gold they can get their hands on, at these prices. Who could it be? If I had to guess, I’d say JPMorgan and Goldman Sachs, the very same people who are predicting a FALL in the price of commodities and gold. Yup, tell your clients one thing and bet against it with your own money.
The best is yet to come and when it does, and people calculate what their gains were since 2001, the numbers will humble all of the other bull markets during the 21st Century. There is a saying, “There is no bull market like a bull market in gold.” The reason is because all other bull markets are fueled by greed. A bull market in gold is fueled by fear. Fear is a much stronger motivator than greed.
On Thursday’s gold’s performance
They sold it down, as is always the case, yet I ask myself why? The Fed is still using QE. I guess you could use strong economic numbers as an excuse, but they are massaged, adjusted and mis-represented. A majority of Americans are not seeing any benefits for this so-called growth. The money center banks and large hedge funds are the ones reaping profits from endless QE and low interest rates. They are the big players in the stock market, not Joe Normal. I suppose if they told you that you would never age, you might believe that too – for a while. The wrinkles come out, sooner or later and reality sets in. I expect reality to set in within six months at the outside. It will hit many markets and gold will start to be viewed as the last man standing – or at the very least, an island of safety, which indeed it is.