It's Not a Crash...

When prices are still up 45% (SLV) and 26% (GLD) over the past 12 months, I would call it a correction.

That's not to say it doesn't have risk to the downside (see Gold Prices Can Go Down).

Source: Yahoo Finance

Gold Prices Can Go Down

FT Alphaville asked if this two day decline in the price of gold was the Kiss of Death for Gold?, while Nouriel Roubini compared the recent run up to the Nasdaq bubble. Others simply noted that the two day decline gets prices all the way back to where they were... last week.



Expect more pressure over the next few days as the CME Group ups margin requirements to match the recent run up in the price of gold. Per Bloomberg:

CME Group Inc. raised the margin requirements on gold trading at its Comex unit for the second time this month, after prices surged to a record above $1,900 an ounce and then plunged today by the most since March 2008.

The minimum cash deposit for borrowing from brokers to trade gold futures will rise 27 percent to $9,450 per 100-ounce contract in the speculative Tier 1 category at the close of trading tomorrow, Chicago-based CME said in a statement. On Aug. 11, the increase by the exchange was 22 percent to $7,425.

I am in Nouriel Roubini's camp in that I do believe the gold run (i.e. bubble) will pop in impressive fashion, but I am not ready to claim that moment is about to occur when gold continues to make new highs each month. As I said back in March 2009:

I've learned my lesson with the Internet Bubble (and recent housing bubble) that most people are illogical and invest based on fear (sometimes fearing loss, sometimes fearing they will miss out on the next big thing) and money can be made even if the premise makes absolutely no sense in the long run. As long as fear reigns supreme and equity markets remain volatile, there will be plenty of people convinced gold is the only "safe" investment.

My expectation is that eventually the golden bubble will run its course and come crashing back down to earth. If the economy gets worse, people will realize you can't eat the stuff and investors will sell their stakes to pay for necessities. On the other hand, if the economy recovers, investors will have much better opportunities with their capital… as I mentioned Tuesday, asset inflation, especially in precious metals, serves no economic purpose in the long run.

Source: Yahoo Finance

Gold Model Still Rockin'

Updated version (the charts only) of my October 2010 post On the Value of Gold:

I've been a gold bull for a while now (see my post Ready to Ride the Golden Bubble from March 2009), but my rationale was more behavioral in nature. But now, Crossing Wall Street has a fascinating post on a possible model (or at least a framework) for the price of gold, which indicates we are nowhere near the peak.

I highly recommend reading the full post as it provides a nice background for why the model may work, but to the magic formula:

Whenever the dollar’s real short-term interest rate is below 2%, gold rallies. Whenever the real short-term rate is above 2%, the price of gold falls. Gold holds steady at the equilibrium rate of 2%. It’s my contention that this was what the Gibson Paradox was all about since the price of gold was tied to the general price level.

Now here’s the kicker: there’s a lot of volatility in this relationship. According to my backtest, for every one percentage point real rates differ from 2%, gold moves by eight times that amount per year. So if the real rates are at 1%, gold will move up at an 8% annualized rate. If real rates are at 0%, then gold will move up at a 16% rate (that’s been about the story for the past decade). Conversely, if the real rate jumps to 3%, then gold will drop at an 8% rate.

I wanted to see for myself, so I took Eddy's model and updated real T-Bill rates with historical T-Bills rates and historical CPI figures going back to 1951, then sized it so the output matched the current price of gold (this was not resized in the updated post).

And while he is not trying to explain 100% of gold's movement, but rather the factors that drive that movement... the result in itself is rather impressive to say the least.

Log Scale

His six takeaways (summarized):

• Gold isn’t tied to inflation, but rather tied to low real rates (not always one in the same)
• When real rates are low, the price of gold can rise very, very rapidly
• When real rates are high, gold can fall very, very quickly
• Gold should not (and does not) have a long-term relationship with equities
• Low rates are likely to last for a long period of time
• Gold price is political; central bankers can crush the price if desired (i.e. raise rates)

Data Source: Measuring Worth

Breaking Down the GLD / SPY Model

I've been researching and analyzing a number of rotation / momentum strategies of late (details potentially to follow), which is one reason why I was so interested in the recent GLD / SPY Rotation Strategy posted by Michael Gayed over at The Big Picture. In a nutshell the strategy attempts to follow rolling monthly momentum to allocate between gold and the S&P 500. He concludes:

Of course, past performance is not indicative of future results, but the simple binary decision of being either long SPY or long GLD depending on which is outperforming the others does seem to suggest alpha can be generated.

While I am not nearly as willing to suggest the framework works (and if it does, it doesn't necessarily work in the manner described), I did think the framework was interesting enough to take a deeper dive.

First of all, let's outline the strategy:

• Using end of day values for Gold (ETF GLD) and the S&P 500 (ETF SPY), create a price ratio by dividing GLD by SPY
• If the ratio is greater than the 20 day moving average of the ratio, then allocate to gold; otherwise to the S&P 500

I was able to closely match the results:

What I Like

Before I dive into the issues I have with the analysis, here is what I like...

I like that while the strategy was only allocated to gold about 50% of the days, it still tracked the performance of gold with a correlation of .70 on a monthly basis. That is pretty staggering. Why do I like that? Because it opens up the possibility that it closely tracks gold when gold outperforms and may track equities when equities outperform.

Issues

That said, here are my main issues with the model:

• The data set is very limited
• The data is from a period in which gold significantly outperformed equities

If you were to have asked me prior to seeing the analysis if I was interested in a model that involved gold and equities that outperformed equities over the past 6 1/2 years, my response would have been a very easy no. Unless the model shorted gold, it would have been just about impossible NOT to outperform equities over that time frame (gold is one of the top performing asset classes since 2004; equities one of the worst).

As a result, I would have been much more interested in hearing about a model that outperformed gold over this time, rather than consistently underperform over its history (20.7% annualized returns vs. 17.9% annualized returns), without much of a reduction in volatility (21.1% vs. 20.3%).

Deeper Dive

Keeping those limitations in mind, lets dive into the idea that gold is a good momentum strategy. The below chart summarizes the performance of the model based on different periods of exhibited "strength" in the model as defined by the level that the GLD / SPY index was above its 20 day moving average and the corresponding one day forward average return in the price of gold and the S&P 500.

An interesting observation is that the only level that gold did not outperform was when the GLD / SPY index was greater than 10% above the 20 day moving average (note that this was less than 2% of all trading days) and GLD / SPY outperformed most when the GLD / SPY index was more than 10% below the 20 day moving average. This:

1. Indicates the GLD / SPY index outperformed the S&P 500 because gold in most instances outperformed the S&P 500
2. The model actually shows gold and S&P 500 exhibit mean reversion at extreme levels

Update:

I was able to find Gold prices going back to 1992 (the inception of the SPY) over at USA Gold and recreated the model using Gold rather than GLD. The results don't seem too promising prior to the beginning of the gold rally that started in 2001.

Source: Yahoo Finance

Relationship of the Day

I can't take credit for this (saw it in the background on CNBC), but thought the relationship was interesting (it goes back to at least the beginning part of the decade, but I pulled the data for the ETFs which only go back to 2006).

Source: Yahoo

The Impact of QEII

On September 21st, the FOMC signalled a new round of quantitative easing with the following:

The Committee will continue to monitor the economic outlook and financial developments and is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate.

An interesting theory from James Bianco (via The Big Picture) as to why we perhaps shouldn't be surprised that the positive impact of QEII has been outside the Treasury bond market (even though they are targeting $600-$900 billion in Treasury purchases).

Over the last several weeks we have repeatedly mentioned the Federal Reserve’s portfolio balance theory. In a nutshell, this theory states it does not matter what securities the Federal Reserve buys with newly printed money (QE2). The market will arbitrage this new money into the market that it thinks will have the most impact.

With that theory in mind, lets take a look at one relationship that seems to have diverged since the announcment of QEII... the rather strong relationship (outlined here) between gold and Treasuries.



Source: Yahoo

The Remarkable Gold Run Continues

Btw- a great post by Kid Dynamite which provides details of how the gold ETF (GLD) works here.

Source: USA Gold

Gold over the LONG Run

A follow up from last week's post "A View from the Gold Perspective", the chart below shows the price of consumer goods / services in gold terms since 1800. As I mentioned in my previous post (and can be seen below):

The Great Depression was a deflationary environment as the dollar was backed by gold. Today, rather than deflation in dollar and gold terms, we have a disconnect between the dollar (slight inflation) and gold (massive deflation) in terms of goods / services.

Source: Minn Fed / Measuring Worth

A View from the "Gold Perspective"

A reader of Crossing Wall Street blog responds to Eddy's gold model post (which I looked into here) and puts everything in terms of gold, rather than dollars. Note that this is just a portion of that response and I recommend readers take the time to read the whole thing and think about it as it puts everything in a very different perspective. That response:

First, the dollar derives its value from its relationship to gold. So instead of the dollar price of an ounce of gold, it should be thought of as the gold price of a single dollar. (For instance, the current of gold price of single US dollar is presently about 1/1345th of an ounce of gold)

Second, on this basis, the relationship is somewhat clearer: when the purchasing power of an ounce of gold rises (i.e., when an ounce of gold commands more dollars) interest rates will be low; and, when the purchasing power of a an ounce of gold falls (i.e., when gold commands fewer dollars the interest rate will be high).

In other words... gold doesn't rise in dollar terms when real interest rates are low (or negative), but rather interest rates are low because their is no demand for the dollar in gold terms.

A View from the "Gold Perspective"

Under the assumption that Gold IS the only real currency (it has the huge benefit that it cannot be depreciated - an ounce of gold in year 1 is an ounce of gold in year 2, year 3, ... year 100), then the recent run up in gold is not appreciation relative to the dollar, but rather the US dollar has seen a severe depreciation relative to real currency (i.e. gold).

But, if the dollar is collapsing, then why aren't prices of goods and services jumping?

Perhaps (bear with me, this perspective is new to me) we happen to be in a severe deflationary environment in real currency (i.e. gold) terms, offset (intentionally?) by a devaluation of our fiat currency to prevent a collapse in the price level of goods in $$ terms. This devaluation may be saving the economy from falling into a deflationary spiral if not pursued (our economy has a lot of hard assets that are used as collateral for dollar loans. A drop in the assets value would be extremely destructive as the value of these loans would fall if the price of the collateral was allowed to fall, which would cause asset prices to fall further... rinse - repeat).

The Great Depression was a deflationary environment as the dollar was backed by gold. Today, rather than deflation in dollar and gold terms, we have a disconnect between the dollar (slight inflation) and gold (massive deflation) in terms of goods / services.

Below is a chart of headline CPI (i.e. purchasing power of the dollar) vs. gold CPI (purchasing power in gold terms). Since the consumer price index began in 1947, goods / services cost ~900% more whereas goods / services cost 70%+ less in gold terms.



And a year by year comparison of CPI in dollar terms and gold terms shows the economy went "gold deflationary" during the telecom / Internet induced recession early last decade.



Still getting my head around this, but any comments are more than appreciated...

Source: Measuring Worth / BLS

On the Value of Gold

I've been a gold bull for a while now (see my post Ready to Ride the Golden Bubble from March 2009), but my rationale was more behavioral in nature. But now, Crossing Wall Street has a fascinating post on a possible model (or at least a framework) for the price of gold, which indicates we are nowhere near the peak.

I highly recommend reading the full post as it provides a nice background for why the model may work, but to the magic formula:

Whenever the dollar’s real short-term interest rate is below 2%, gold rallies. Whenever the real short-term rate is above 2%, the price of gold falls. Gold holds steady at the equilibrium rate of 2%. It’s my contention that this was what the Gibson Paradox was all about since the price of gold was tied to the general price level.

Now here’s the kicker: there’s a lot of volatility in this relationship. According to my backtest, for every one percentage point real rates differ from 2%, gold moves by eight times that amount per year. So if the real rates are at 1%, gold will move up at an 8% annualized rate. If real rates are at 0%, then gold will move up at a 16% rate (that’s been about the story for the past decade). Conversely, if the real rate jumps to 3%, then gold will drop at an 8% rate.

I wanted to see for myself, so I took Eddy's model and updated real T-Bill rates with historical T-Bills rates and historical CPI figures going back to 1950, then sized it so the output matched the current price of gold.

And while he is not trying to explain 100% of gold's movement, but rather the factors that drive that movement... the result in itself is rather impressive to say the least.



Log Scale



His six takeaways (summarized):

1. Gold isn’t tied to inflation, but rather tied to low real rates (not always one in the same)
2. When real rates are low, the price of gold can rise very, very rapidly
3. When real rates are high, gold can fall very, very quickly
4. Gold should not (and does not) have a long-term relationship with equities
5. Low rates are likely to last for a long period of time
6. Gold price is political; central bankers can crush the price if desired (i.e. raise rates)

This last point intrigues me. There is so much capital wasted (i.e. invested) in gold that my question is what would happen if central bankers did just that and raised rates?

The common thought (mine included) is that would kill the economy as we do live in a "credit economy" (i.e. there are lots of assets that are priced based on cheap credit, such as housing). But what if that forced capital away from gold and into goods and/or services that actually benefitted someone / something in the economy?

Data Source: Measuring Worth
Model Data (column K): Google Docs

Gold as a Percent of Equities / Fixed Income

Paul Kedrosky's Infectious Greed with the post Gold is Way Under-owned Compared to Other Times When the World Sucked:

Thought-provoking table from Cembalest at JP Morgan comparing gold’s capitalization as a percentage of bond and equity market capitalization during other periods of market nihilism/strife/awfulness/madness.

The table is recreated in chart form below to show the relative holdings (in percent) by market cap ($) between equities, fixed income, and gold globally in 1982 and at the end of 2009.



Interesting to note that along with gold being held at a much lower percent in market cap terms, but the level of debt outstanding relative to equities and gold is right about where it was in 1982.

Gold ETFs Exploding

Commodity Online provides details of the massive flow into gold via ETFs:

Investors have been stocking up on gold in the face of sovereign debt issues in Greece and other countries. Combined exchange traded fund gold holdings reached a record 59.11 million ounces by 6 May, up 943,686 ounces in one week.

59.11 million ounces / 32,000 ounces in a tonne = ~1850 tonnes of gold in ETFs.

How much is that? A LOT.

Below is a chart detailing the eleven largest holders of gold; nine central banks, the International Monetary Fund and ETFs.



Absolutely wild considering the first Gold ETF was launched in 2003. And Business Week details that it isn't only private investors diving into the metal:

Central banks added the most gold to their reserves since 1964 last year amid the longest rally in bullion prices in at least nine decades, data compiled by the World Gold Council show.

Combined holdings rose 425.4 metric tons to 30,116.9 tons, an increase worth $13.3 billion at last year’s average price, according to the data. India, Russia and China said last year they added to reserves. The expansion was the first since 1988, the data from the London-based council show.

Central banks, holding about 18 percent of all gold ever mined, are expanding their holdings for the first time in a generation as investors in exchange-traded funds amass bullion as an alternative to currencies.

So... are you ready to ride the golden bubble?

Source: IMF

The Scale of Hedge Fund Gold Purchases

In case you missed it... early last week The Reformed Broker detailed the incredible amount of gold that hedge funds (in this case Paulson & Co.) have accumulated in a very short period of time:

John Paulson of Paulson & Co, the legendary hedge fund manager who made tens of billions betting on the mortgage crisis between 2007 to 2009, likes gold. He really likes it. He likes gold more than a friend.

To most market participants, this is not news, but here’s something you probably didn’t know: Paulson owns more gold than several major countries! Combined!

Retail investor (and more recently this hedge fund) support has made gold a one way bet for much of the past 6+ years. Thanksgiving's Dubai debacle however provided a glimpse into how quickly this may potentially all come to an end. Per the FT Alphaville:

Gold had at one stage dropped as much as 5 per cent as it responded to safe haven flows into the dollar. The precious metal has since recovered to trade about 3 per cent lower at $1,155.80.

Commenting on the sell-off, Davies — who had moved his fund to its maximum 50 per cent under weight gold position:

“It happened so quickly, I’ve never seen a quicker paper liquidation in gold ever.”

Don't fret... gold has snapped back / stabilized and now is once again within striking distance of new highs (chart below per Kitco).



Regardless of what is or is not a justified price for gold, the only thing that matters is the next price that a buyer or seller is willing to transact. And while I continue to expect to see a one-sided trade, when that one sided trade ends, it has the potential to get real ugly, real fast (though I think we are still a long ways away) as this "tonnage" hits the market.

Anyone Ready to Ride the Golden Bubble?

Gold is now up more than 4% over the last two trading days and showed strength during last week's equity and commodities sell-off. BUT, looking at the below chart, it is possible that "we ain't seen nothing yet".



As I detailed back in March, I have been "Ready to Ride the Golden Bubble", not on logic, but on the frenzy.

I've learned my lesson with the Internet Bubble (and recent housing bubble) that most people are illogical and invest based on fear (sometimes fearing loss, sometimes fearing they will miss out on the next big thing) and money can be made even if the premise makes absolutely no sense in the long run. As long as fear reigns supreme and equity markets remain volatile, there will be plenty of people convinced gold is the only "safe" investment.

So if the train is leaving... is anyone else on board?

Gold Exposure... Gold or Gold Miners?

Gold has been on a tear (though nobody seems to know why... hatred of all currencies has been one answer), up $70 the past two months alone.



Which has brought the opportunity in gold miners to the front section of the paper. WSJ reports:

Gold companies' shares soared Wednesday amid a sharp rally in gold prices, and one analyst said the strong performance of larger companies was a reversal from earlier in the year.

Gold prices reached their highest point in nearly three months as the U.S. dollar weakened and participants bought in a flight-to-quality bid based on economic uncertainty and concerns about the stock market. Most-active December gold gained $22, or more than 2.3%, on Wednesday.

Burchell said his firm is positive on the gold sector and believes the metal has come out of its summer hibernation period. Summer months are traditionally weaker for gold prices. He added gold behaved better than expected this year, but was range-bound throughout the summer. Burchell said Wednesday's increased share prices were in part a reaction to Tuesday's weakness, adding that investors see the "specter of inflation" down the line, leading them to speculate in gold as a hedge against that inflation.

Jefferies & Co.'s Mike Dudas said gold and gold stocks can find some money in the recent weakness in financial stocks as investors look to gold for more stability. Gold prices had been quiet recently and were looking to break one way or the other and certainly did so on Wednesday, he added.

So gold or gold miners? Since 2006, the metal has significantly outperformed the goldmining index (GDX) by 30% and at times by more than 170% over a 12-month period (mining stocks were CRUSHED post Lehman Brothers collapse, while the metal held up).



So do I find value in gold? In the fundamental value of the metal... No. BUT, in the story... YES. As long time readers know, I am Ready to Ride the Golden Bubble.

I am currently playing this through the options market with vertical call spreads (buying in the money calls, offsetting some of the cost by selling out of the money calls) on the metal itself (ETF GLD). BUT, with all the liquidity sloshing through markets, my guess is that miners themselves may have some cheap financing available to lever up their exposures.

Anyone have any thoughts?

Source: Yahoo Finance

Update: To be clear, I am still heavily short oil, thus consider this a hedge (and not an outright position) on my commodity short.

Oil Spike a Result of Dollar Weakness? Not Necessarily

In my post about the run up in the price of oil, I received the following comment:

Dollar weakness was left out of all of those explanations. Since the quantitative easing program hit high gear around March 19th, the price geometry has been constructive (minus one correction mid-rally -- few, if any rallies go straight up). Graph the dollar index or euro-dollar trade against a crude oil chart. You will see significant pressure of late due to concerns of firming inflation on the forward curve.

Since March 19th the Euro is up "only" 1.7% against the dollar (all of which took place the last two days). And while I do agree that a strong or weak dollar can and will impact the price of oil over the long run, I don't necessarily buy it as a reason in the short run. One reason, if the oil rally were due to a decline in the dollar, oil wouldn't have outperformed a "better" store of value (i.e. gold) over that same time frame.

Gold / Oil Ratio; May 2006 Index = 1

In looking at the chart above, we see the two were extremely correlated until the global economy blew up last Fall and gold outperformed by a factor of 4. Oil has shown a strong comeback since that time. And since that March 19th quantitative easing date?

• Oil is up 10%
• Gold is flat

What I do find as an intriguing theory is that in "uber-real" terms (i.e. the price of gold), oil overshot to the downside. Thus, while oil has rallied rather significantly over the past three months, it is just mean reversion from this oversold territory.

*Note the above chart is inexact as it uses the ETF's GLD and USO as representatives for gold and oil respectively (I am working from home ahead of the long holiday weekend - i.e. no Bloomberg).

Update:
Could this be another reason?

Golden Bubble Cont'd (Part II)

Another case for gold entering bubble territory. Tim Iacono at Seeking Alpha with the details:

To me, it's just fun to watch their stash grow as inventory at the world's most popular gold ETF passes holdings by central banks all around the world. Switzerland, you're next! Soon, GLD will be number six in the world and then it'll be a long way to go in relative terms to catch Italy at almost two and a half thousand tonnes but, at the rate they're going in 2009, that'll happen by this fall. Then it's just a chip-shot away to surpass France.

With net assets of over $33 billion, GLD is already the second largest ETF in net assets according to Yahoo! Finance behind only its SPDR brother SPY at about double that figure. Somehow, it seems like that gap might narrow rather quickly over the next year or so.

Ready to Ride the Golden Bubble

First the chart, then my explanation…

People seem to forget this, but all bubbles start with a seemingly strong premise. In the case of gold it's that the printing press is going wild, thus gold should strengthen relative to the dollar. This makes sense to a degree. The Internet DID change the world, but Pets.com didn't become a worldwide leader in pet accessories; oil SHOULD have increased in price due to a global economic boom, but at $145 / gallon businesses failed and people stopped driving; financial innovation DID allow many first time buyers the access to finance a new home, but someone making $20,000 a year should not be buying a $1,000,000 house.

In other words, a great story can explain why the boom begins, but it doesn't justify the price if it becomes outlandish. As money pours in and the bubble gets larger, investors pour in more money. Gold has been a similar story as the shiny metal formerly used in jewelry vs. 401k's has become exceptionally self-feeding as gold has been one of the few asset classes that has shown strength, attracting new capital.

The following are a few reasons why I believe gold may be entering the next bubble:

1. The same people that argued gold is a BUY BUY BUY because of inflation are now coming up with well-articulated reasons why gold is a BUY BUY BUY because of deflation. I personally don’t have a clue how deflation or a decrease in credit can possibly be good for gold.
2. Pre-house bubble pop, everywhere you looked there was housing TV show this (i.e. Flip that House), housing seminar that, become a realtor this. Now there are "gold guys" preying on frightened investors' 401k’s, infomercials about gold coins, and the Internet sensation CASH4GOLD.
3. Gold serves no useful purpose, to my knowledge, outside of a minor uses in electronics / dentistry and major uses (at lower prices) in jewelry. I say "at lower prices" because gold is already to being replaced by cheaper metals in jewelry (the demand for gold jewelry was down 35% in the fourth quarter) and the existence of CASH4GOLD means people may be net sellers of gold in jewelry (I personally like to picture a frightened investor selling all their prized jewelry out of fear, only to take that cash and invest it in gold out of fear of inflation).
4. The wildest thing to me is that in most cases this investment is not in bars you can actually see (the value in gold is supposedly its beauty), but in an ETF where you see its value in your account statement. (In addition: if you think the financial system is melting... don't put your money into an ETF).

After all that you’d think I’m shorting gold? Well, I actually am in the short-run (The Financial Ninja read my mind with his post regarding that opportunity), but I am ready and waiting for gold to make new highs to reverse my positioning with expectations that this bubble train is far from over. I've learned my lesson with the Internet Bubble (and recent housing bubble) that most people are illogical and invest based on fear (sometimes fearing loss, sometimes fearing they will miss out on the next big thing) and money can be made even if the premise makes absolutely no sense in the long run. As long as fear reigns supreme and equity markets remain volatile, there will be plenty of people convinced gold is the only "safe" investment.

My expectation is that eventually the golden bubble will run its course and come crashing back down to earth. If the economy gets worse, people will realize you can't eat the stuff and investors will sell their stakes to pay for necessities. On the other hand, if the economy recovers, investors will have much better opportunities with their capital… as I mentioned Tuesday, asset inflation, especially in precious metals, serves no economic purpose in the long run.

Gold... Has It Really Stored Value?

In response to yesterday's inflation adjusted S&P 500, we were asked:

Could you present the same plot but with inflation-adjusted gold overlayed on the data? It would be interesting to see if stocks really do outperform over the long-term...

Over the past 34 years, the price of gold is only 25% higher in real terms.



Compare this to yesterday's chart to equities... (note this is back one more year than the chart for gold... I can't dig up that last year of gold data), which shows equities returned 400% in real terms over the past 35 years.



And the following chart combining the two 10-year rolling periods...



Surprised?

You shouldn't be... asset inflation (whether via gold, housing, or commodities) serves no long-term productive purposes... only increased productivity creates actual economic value. Thus, the movement of capital towards productive resources (i.e. what equities, fixed income, and bank loans are intended to do) is the only type of long-term investment that really creates broad economic value.

Using an extreme example: Imagine if all the wealth in the world simply went to buy assets (to be more extreme, lets pretend it all went to gold and was in turn stored in a vault). There literally would be no global economy.

Fun with Gold

Update: These ARE NOT charts of cumulative or relative return. They simply show how many ounces of gold were required to buy the S&P 500 or a home at each point in time against how much the S&P 500 or a home cost in dollars. The post doesn't say the word 'return' once and for any snap shot of cost at any point in time, rental earnings, dividends, or opportunity cost are irrelevant.

So, we all know housing and equity markets have been hit hard after many years of gains... in dollars that is. How would each market look in terms of the hardest of currencies... gold (note that October dates were used as that is the last Case-Shiller print and the long-term trend is what I was looking for).

The housing market is interesting. From 1987-1997 the housing market went nowhere in dollars, but started to see the beginning signs of the boom, in gold, beginning in 1997. From 1998-2005, we saw a bubble form in both dollars and gold, but that's where we see a huge divergence. Gold rallied hard starting in 2005, "predicting" the fall. It now takes roughly the same amount of gold to buy a home as it did back in 1997... dollars are another thing altogether.




The equity market is even more interesting (to me). Since 1994, the S&P 500 has roughly doubled in dollars. In gold, the market has gone... well nowhere.