Gold-Stater: Gold Market Myths and Fallacies
When investing in gold, one will encounter all manner of theories, claims and promotions. They can be confusing. When investing, the more confusing something is, it's a good bet the confusion is there for a reason. Generally, it's not because you're stupid. It's because the proponent of the theory is trying to mask nonsense.
First some myths.
Myth 1: The Gold silver price ratio must return, over time, to the naturally occurring silver:gold ratio of 17:1. This makes no sense. During periods of speculation silver outperforms gold. Period. Hot money puts pressure on silver because it's a thinner market. During periods of deleveraging silver will get crushed. So will gold at first. But gold will recover and make new highs because gold is the ultimate safety play, while silver will languish.
Right now the whole market is in a speculative frenzy because of Bernanke's hot money scheme (Bailouts 1,2,3 etc, QE 1,2 etc). So silver is outperforming. When the hot money delevers, conditions change.
Myth 2. As the price of gold rises, eventually gold stocks will become so profitable they vastly outperform the bullion price. This makes no sense. The price of stocks is dependent on the Price to Earnings ratio the market is willing to award stocks. During periods of deleveraging the PE ratio can contract into the low single digits. If this were to happen gold could soar and gold stocks could still collapse. Another way to say this, is that gold stocks are paper. If people come to mistrust paper, paper will get hit, even if it has some relationship to gold.
Some analysts point to the post 1933 period of deflation when gold stocks soared. What they forget is that there was a gold confiscation, so the only way to own gold during that period was through stocks.
Myth 3. If gold goes up over time, you should take advantage of this fact by levering your position. There are various leverage schemes out there. Beware. Leverage is another word for risk. The more leverage, the more risk. If someone claims risk-free leverage, they're saying risk free risk. That certainly sounds like nonsense.
Myth 4. Bullion is for the End of the World, bunker mentality investor. Nonsense. It's true that it takes some thought and effort and perhaps expense to store bullion. But the whole point of owning bullion is not to prepare for the end of the world. It's to prepare for the growing public distrust of paper. As the public comes to realize the Ponzi scheme nature of the Western Banking system - wherein debt crises are papered over with more and more debt, and the banking class grows richer and richer while everybody else languishes, the distrust for paper understandably grows.
This doesn't mean the world collapses. It means that paper investments are looked upon with ever increasing distrust. Right now, as I write, the bullion premium over the spot price is widening. It has been widening for many years. During periods of intense deleveraging, the bullion premium tends to blow out.
Paper gold, including GLD and CEF are perfectly good tracking stocks. I use them myself with great confidence. For now. At some point if accounting problems are discovered there, those prices too can collapse while the price of bullion soars.
Final note. I use the terms lever, and delveraging a lot. What does this mean? Leverage is essentially taking on risk in order to boost your returns. Risk is taken on by going into debt in order to buy more. It's that simple. Our entire fractional reserve banking system is built on the principle of going into debt to boost returns. I won't go into the history of the Fed here, but the basic idea of the Fed is that in good times the banks will make fantastic profits because of leverage. In bad times the Fed will bail them out with tax payer money. They always win. We always lose.
In Peter Bernstein's fantastic "The Story of Risk" he puts forth the argument that risk awareness and risk management is what has made the modern economy so wonderfully productive. He also posits that Trust is the engine that makes the entire system run. When risk is perverted by a system that rewards triumph and bails out failure - Trust is lost.
Do you trust your banker? Do you trust your broker? Do you feel they have your best interests at heart? Or do you suspect they're just trying to make a buck off you? These are the most vital questions in determining the health of the economy - which it to say in determining the health of risk assets. All paper assets are risk assets.
When trust is lost investment turns away from risk. Gold bullion is the ultimate risk free investment. It's that simple.