Forget the Gold Bulls... and the Gold Bears
Gold cratered Friday and then again yesterday, hitting a two-year low on fears that troubled European countries will have to sell their reserves to cover the cost of increasingly expensive bailouts.
The sell-off took the metal below the important $1,400 psychological threshold. Gold bulls are now proclaiming that this "correction" represents an excellent new entry point before the next big rally.
Gold bears, on the other hand, claim this is only the beginning of a more serious pullback.
Who should you believe?
No investment is more misunderstood than gold. And the prognosticators are often just as confused as their followers. For example, how many times have you heard gold bugs insist that this metal is "the ultimate inflation hedge"?
That's like calling the Titanic the ultimate luxury liner.
Between January 1980 and August 1999, for example, gold lost 68% of its value - before accounting for inflation.
Bear in mind, this whopping loss didn't just occur in the low-inflation '90s but in the hyperinflationary '80s. How any sober-minded person can call something that loses two-thirds of its value over two inflationary decades "the ultimate inflation hedge" is a bit of a mystery.
Sorry... It's True
Yes, gold held its value much better than paper currency over this period. But what didn't?
Stocks, bonds and real estate were better inflation hedges than gold over that period... as was hiding your cash in a mattress.
Undeterred by history and the facts, gold bugs often insist that runaway government spending will cause a new round of hyperinflation and a new bull market in gold.
That's possible. But it also ignores the fact that the gold market - like the stock market - discounts what can be reasonably known. That's why bullion prices soared before inflation became a problem in the 80s - then promptly sold off as inflation reared its ugly head. This could well happen again.
And here's even worse news for true believers.
Uncle Sam's free-spending ways - while irresponsible and grossly unfair to future generations - may not result in higher inflation after all.
Take Japan, for example. It was the world's second-largest economy for the past two decades. Its government debt as a percentage of GDP was far larger than ours. (Even today, it is more than 200%.) Yet note that Japan didn't have an inflation problem but rather the very opposite: deflation.
Could the U.S. follow in the same path? Perhaps.
We can't know. And, perversely, even if we could know, history shows us that still wouldn't tell us how it would impact the price of "the barbarous relic."
In short, gold is the ultimate speculative asset class.
Unlike stocks, you can't value it on sales, earnings, cash flow or price-to-book value. Unlike bonds, you can't judge it on credit history, coupons or yields-to-maturity. Unlike real estate, you can't value it on rental income or tax benefits.
This decorative metal is only worth what someone is willing to pay for it.
That means someone who claims to know where gold will trade in the future either isn't too bright or isn't too honest. Or both.
So take my advice. Own gold and gold shares. They can be - note: can be - a valuable hedge against economic or political chaos, as well as a play on rising prosperity (since gold's unique properties will keep it in demand).
But if your portfolio is overloaded with gold based on someone's cockamamie "world economic view" or "future inflation forecast," think hard. As historian David McCullough likes to say, "There is no such thing as the foreseeable future."
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