Yes, you read me correctly.  Gold, despite recently surging to new all-time highs, is a truly lousy investment.  And this is not just my view; it is the view of Benjamin Graham, the mentor of Warren Buffett and the father of modern investing!  Consider what Graham had to say about the barbarous relic in his classic The Intelligent Investor:

The standard policy of people all over the world who mistrust their currency has been to buy and hold gold. This has been against the law for American citizens since 1935—luckily for them. In the past 35 years the price of gold in the open market has advanced from $35 per ounce to $48 in early 1972—a rise of only 35%. But during all this time the holder of gold has received no income return on his capital, and instead has incurred some annual expense for storage. Obviously, he would have done much better with his money at interest in a savings bank, in spite of the rise in the general price level. The near-complete failure of gold to protect against a loss in the purchasing power of the dollar must cast grave doubt on the ability of the ordinary investor to protect himself against inflation by putting his money in “things.”

Graham wrote these words just before the massive 1970s bull market in gold and other commodities, making his timing extraordinarily bad.  But his logic is still sound.  What kind of investment pays no income…yet COSTS money to store?

And contrary to the claims of the gold bugs — which tend to be based more on political ideology than actual economics — gold is nearly as susceptible to “printing” as paper currencies.  The amount of gold in circulation as coins and bullion is by no means fixed. (Just ask the Hunt brothers what happens when you assume the supply of a precious metal is fixed and you attempt to corner the market…).  New supplies of gold are mined every year, and long-forgotten pieces of jewelry suddenly reappear and find themselves at the local pawn shop when prices get high enough.  (The supply of gold is obviously less expandable than that of paper currencies, but you get my point).

It should also be mentioned again that it was the hated US dollar — not gold — that investors ran to during the 2008 meltdown.

Gold, over the long term, is a terrible investment.  But — and it may surprise you to hear me say this –  I’m not necessarily recommending that investors dump their holdings immediately.  A lot of really BAD investments can make really good trades.  The “dot com”stocks of the late 1990s were investments of such laughably poor merit that you cannot believe today that anyone was stupid enough to buy them.   But as bad as they were, a lot of traders made a pile of money riding them up to the peak of the Nasdaq bubble — if they were smart enough to sell near the top.

Gold may have already peaked, or it may well have another 50% surge left in it.  I have no idea and will not hazard to guess.  It’s impossible to say what gold is “worth” because it has no intrinsic value.  And you never know how irrationally high a bubble will take a given asset.

My advice is this: view gold for what it is.  It’s not an investment.  It’s a highly-speculative trade.  Approach it as a trade, use stop losses, and don’t be afraid to take a profit (or loss, for that matter).  But most of all, don’t believe the hype.  The arguments for gold today are the same ones used in the 1970s (often made by the same people, who never seem to go away). They were wrong then (as the 1980s and 1990s proved) and they are wrong today.

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

You know the drill: stocks up, dollar down.  With investors rediscovering their appetite for risk, the dollar has lost its appeal as a safe haven and has resumed the downtrend it was in long before the financial crisis.  So, a falling dollar only makes sense with a rising stock market.  Or does it?

Check out the chart below, sent to us by Douglas Robinson at RCM Robinson Capital Management LLC.   As you can see, for the past two years, the dollar and the S&P 500 have had a strong negative correlation.   But it wasn’t always that way.

As you can see from the green areas of the chart, there have been several times in recent years in which the dollar and S&P 500 rose and fell in near lockstep.  And if you go back to the 1990s, you’ll see that while US stocks were in a bona fide bubble, the dollar was near all-time highs!

Bottom line: don’t expect the current negative correlation to last forever.  There are limits to how low the dollar can go before it starts to damage the US financial system and stock prices.  We won’t attempt to call a bottom here.  Forecasting currencies is the quickest way to an ulcer or an early heart attack.  But we can say with a fair degree of confidence that we expect the US dollar to be significantly higher against most world currencies a year from now.

And one final note: for all of those rabid dollar bears and gold bugs who are convinced that the dollar and its guardian — the Federal Reserve — are uniquely rotten, consider this: when the world financial system plunged into meltdown in 2008, investors ran to the US dollar, not away from it.  All of the investors — including the world’s central banks — who are currently piling into gold and sending it to new highs should keep that in mind.

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

Hedge fund manager David Einhorn had some interesting comments on the dollar in the recent Value Investing Congress:

When I watch Chairman Bernanke, Secretary Geithner and Mr. Summers on TV, read speeches written by the Fed Governors, observe the “stimulus” black hole, and think about our short-termism and lack of fiscal discipline and political will, my instinct is to want to short the dollar. But then I look at the other major currencies. The Euro, the Yen, and the British Pound might be worse.  So, I conclude that picking one these currencies is like choosing my favorite dental procedure.

This more or less sums up our view at HS Dent.  We agree that the dollar is a horribly mismanaged currency by an irresponsible and self-destructive government.  The problem is…so is every other major world currency!  It’s difficult to make money shorting the dollar when there is no viable option to short against.

Einhorn reaches the conclusion that, since all paper currencies appear to be in a race to the bottom, gold is the direction to go.  We’d tend to disagree with Mr. Einhorn on this count because we believe gold will face some serious headwinds in a deflationary environment — and the bond market is still telling us, in contradiction to the gold market, that deflation is the real concern.

The dollar is a despised asset right now — it is nearly impossible to find anyone who is bullish on the dollar.  This could make the dollar an intriguing contrarian investment.

Should  the stock market roll over in a new bout of risk aversion, the dollar should rally sharply.  But even if risk aversion remains benign, we would expect the dollar’s current weakness to reverse at least marginally in the next year.  Its current depressed value against the euro would appear to be unjustifiable given the economic challenges that the eurozone faces.

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

We are asked quite regularly what we see in store for the dollar.   This is a difficult question because nearly every commentator on the matter has an answer that is, for lack of better words, ideologically motivated.  For whatever reason, people want to love or hate the dollar.  For some, the dollar is a source of national pride…for others an example of everything wrong with what the government has become.  

Our view of the dollar can be explained by tweaking Winston Churchill’s defense of democracy: “Democracy is the worst form of government except for all those others that have been tried.”  

To adapt Mr. Churchill’s words, the dollar appears to be the worst currency in the world…except for all those others. 

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