Monday surprised many investors when gold fell over 9% in one day, ending the day down over 20% year-to-date. Gold futures with a February 2014 expiration fell as much as 10%, and other precious metals saw declines at or near double digits. With some analysts dismissing the fall as panic selling, others warned that gold’s days are numbered. Several high-profile analysts and investors have attacked gold in recent weeks, with George Soros and Goldman Sachs both saying that the metal was set to fall in the near term. The analysis earned scorn and derision from several market participants, the most vehement can be read on any number of blogs across the internet.
For investors looking to make money, this vehement response is difficult to process. With the more hysterical blogs predicting an apocalyptic global conspiracy with Soros named as an active participant, it’s easy for a fair-minded investor to dismiss the most fervent defenses of gold as idealogical hysteria. More crucially is the fact that gold, regardless of its intrinsic value, has been a prominent element of a certain political ideology that is extremist, hyperbolic, and apocalypse-inclined.
Economically, gold is a great hedge against inflation, and bouts of quantitative easing from the U.S. Federal Reserve have encouraged gold-bugs to double down on their love for the metal since 2008. And, indeed, double-digit annualized returns seemed to prove them right.
There is only one problem: this run-up was happening at a time of deflation (in the case of 2009) or near-zero inflation (in the case of every year since). The low inflation environment of developed economies that we’ve seen since 2008 has emboldened Keynesian economists and caused a run-up in bonds–the total return of TLT has been an annualized 9.5% since 2009, as inflows into bonds to protect against deflation caused bond funds to climb higher and higher.
The fact that gold (an inflation hedge) and bonds (a deflation hedge) are both up so strongly since 2008 demonstrates that the traditional theories behind investment theory–commodities go up in inflationary periods and bonds go down, and vice versa for deflationary periods–needs to be adapted to the liquidity trap that most developed nations have found themselves in since the crash of 2008. It also suggests that seeing these developments politically might satisfy a sanctimonious thirst for justice, it will not yield the best returns.
Stocks Have Won
While the right-wing inflation hawks have earned an impressive return in a metal-focused investment strategy and Keynesian investors worried about deflation have done well with bonds, stocks remained king. The SPY total return from January 1st, 2009 to date is a hair over an annualized 14%, blowing both bonds and gold out of the water.
Whether stocks will continue to outperform gold and bonds is an open question, and an interesting one. But a good answer will not be found by resorting to ideological talking points, as gold-bugs looking at the value of their gold holdings are hopefully realizing as gold continues to fall. Instead, the question of what value is, how it is created, and why certain assets either retain or create value would yield much better results.
Savvy investors will now look at gold as either an undervalued asset with global demand that exceeds its current and inefficient market price, or as an overvalued asset now undergoing a decline after a bubble. Either way, the attitude to gold should be made based on fundamentals and not on a political belief of what is good or bad public policy, and indeed right or wrong ideology.