Marc Faber: Gold is Dirt cheap.

Faber is not a stupid guy.

Your friend igor@rivinfinancial.com has shared a link with you. Marc Faber: Gold is "Dirt Cheap" — Price Could Reach $10,000 per Ounce | Daily Ticker - Yahoo! Finance http://finance.yahoo.com/blogs/daily-ticker/marc-faber-gold-dirt-cheap-price-could-reach-130058708.html Eleven years into a gold bull market, Marc Faber publisher of the Gloom Boom and Doom report still doesn't think gold is in a bubble. Joining us via Skype from in Chiang Mai, Thailand Thursday, Faber told the Daily Ticker's Aaron Task there are fundamental reasons why gold, already nearly 30% higher for they year, [...] Read the full story

Very well put

I
David Stockman: Rick Perry Is Right, the Fed Is “Totally Wrong” | Daily Ticker - Yahoo! Finance
http://finance.yahoo.com/blogs/daily-ticker/david-stockman-rick-perry-fed-totally-wrong-151724790.html
============================================================
Yahoo! Finance http://finance.yahoo.com/

More on inflation

This is a continuation of the last post. After looking at it, it seemed to me that the interpretation of the chart was a little oversimplified, and that was because the numbers had changed so much over the 18 years of the study that log scale would be more enlightening. No easier said than done (OK, a little easier said). Here is the same graph in log scale:

In this form, it seems clear that (other than some cyclical behavior) there was essentially no commodity price inflation from the beginning of the study (January 1993) until the end of 2001 --  beginning of 2002 (also known as the Dot Com crash). In those nine years, a conservative saver seems to have actually increased the purchasing power of his bank account quite considerably (by around 50%, in real terms). During that golden age (which we can call the Age of Clinton), there was a combination of the peace dividend, considerable technological innovation, a gridlocked government which actually managed to run a surplus, and fairly conservative fiscal policy. The chart below shows prevailing money market rates, which are closely tied to Fed Funds:

You will note that the "Greenspan put" coincides almost exactly with the end of the golden age (marked somewhat more memorably by the terrorist attacks of 9/11/2001). The massive money printing, did not wait to make itself be felt: tgold prices rise at a 1.5% a month clip -- the log scale graphs are amazingly linear (the F statistic, which shows the strength of the trend, is around 5000), commodity basket prices rise somewhat slower (1.1% a month clip), with more variability. During this period (the last ten years, approximately), our hapless saver's money market account gains around 20% in nominal dollars, but loses around 70% of its commodities purchasing power. Being no fool, our saver decided to invest her hard-earned dollars in real estate, but imagine her dismay when that investment did about as well (or poorly) as her neighbor's money market account (the graph below shows the change in the Case-Shiller index versus the Money Market account. You will see that nominally, Case-Shiller outperformed the money market account by around 15%, but all of that and more was eaten up by transaction costs, property taxes, and so on. I am only viewing housing as an investment, so am not counting the savings of rent or the mortgage tax deduction.

Since the move into housing was borne of desperation with the performance of the simpler ways of saving, it is not at all surprising that the returns are similar, though as we all know, the disruption caused by the fact that real estate investment is very far from risk free (as everyone now knows) has been rather considerable.

It is always harder to determine causality than correlation, so the graphs by no means prove that that monetary policy caused the end of the Golden Age of Clinton and the implosion of our savings, but they do provide some food for thought, I hope.

What is inflation really, or what's the use of gold?

Those who have read this previous post probably (and understandably) wonder how reasonable the Alternative CPI measure is. After all, it seems to indicate that our cost of living has increased almost four-fold since 1993, which seems rather steep (mostly since for only very few of us has our income increased four-fold in the same period). There is no question that the official numbers are seriously gamed (see this note, or this), but that, in and of itself mean that the alternative numbers are right. My personal view is that the Alternative CPI measure is more a measure of inflation (that is, the debasement of the dollar) than the actual CPI growth -- the latter tends to be smaller than the former, since the money-printing is offset by technological progress, which causes computers to drop from $6000 in 1981 to $150 at Walmart in 2011 (the latter computer also being several orders more powerful), and your car's fuel consumption to go from 8mpg in the 1960s to 40mpg today.

A good proxy for inflation is, however, provided by prices of commodities (still not perfect, since exploration and mining also have made considerable strides), and since a representative basket of commodities is rather cumbersome to hold, a good proxy for one is gold -- indeed, gold is almost miraculously convenient -- it is compact, it does not degrade, and it saves you from buying shares of oil tankers parked off Singapore.

The above seems counterintuitive (after all, we have all heard of the gold bubble, but [relatively]  few of us have heard of the the wool, rice, natural gas, or any one of the many other possible commodities bubbles. Well, luckily for us, the IMF maintains a commodities price index, so we can compare and contrast. Here is the requisite chart:

Some explanation might be in orer: The very smooth red line shows how many dollars you would have were you to invest $1 in a money market account in January of 1993. The almost-as-smooth green line shows how many of those dollars you would need according to the Alternative CPI computation to purchase a basket of goods worth $1 in Jan 1993. The jagged purple line shows how many of those dollars you would need to purchase however much gold you could buy for a dollar in January of 1993, while the really jagged light blue line shows the same for a dollars worth of a commodity basket. The conclusions, at least to me, are:

• The Alternative CPI seems, as advertised, to be a good measure of inflation (and is, therefore, a bit of an overestimate of the actual price inflation).
• There is no gold bubble (a conclusion also drawn in a previous post from other data).
• Gold (in addition to its compactness) is a better gauge of monetary inflation than the commodities basket (witness the huge volatility in the latter starting in late 2007  or, for that matter, just in this May.
• The red line (your risk free return) was added just to make the chart more depressing. Unfortunately, it has achieved its goal brilliantly.

Your dollars at work, continued

To add some color to the previous post, we can compare how the returns of our instruments of choice, to wit:

• FXA (corresponding to Australian Dollar money market fund).
• FXE (corresponding to a Euro money market fund)
• FXF (corresponding to a Swiss Franc money market fund)
• GLD (corresponding to physical gold)
• SPY (corresponding to the S&P 500 with dividends reinvested)
• IWM (corresponding to the Russell 2000 with dividends reinvested)

Perform in terms of constant (constant purchasing power, that is) dollars. This is not as easy as it seems, since the Bureau of Labor Statistics CPI index, which would be the natural measure of inflation, has come under considerable criticism for "gaming" the numbers, starting in roughly 1981, when the methodology for measuring inflation was changed. Luckily for us, the dilligent folks at Shadow Government Statistics (I highly recommend their web site for a wealth of data, and discussion of the related issues) have measured inflation using the more reasonable-seeming pre-1981 methodology. Their data has helped us to produce the comparison charts below. First, an omnibus comparison (the two thick lines correspond to the "Official" BLS numbers and the "Alternative" CPI measurements):

You will note that over the last five years, the S&P 500 barely holds its own even in using the BLS numbers, while the Russell 2000 beats them only modestly. If you use the "Alternative" deflator, you will find that the US equities markets perform rather pathetically, gold has performaed quite well,which could mean one of at least three things: 

1. Gold is overvalued
2. Inflation is expected to pick up even more
3. Our time series does not go back far enough, and gold had been somewhat undervalued before 2006

the Swiss franc has suffered mild inflation (losing around 3% a year over the last five years), while the Australian dollar has kept its value (if you count the interest the money market account pays).

The next chart summarizes what I had just said above, by expressing returns in alternative constant dollars (where the thicker lines are the S&P 500 and the Russell 2000):

Finally, everyone wants to know how the other (antipodal) half lives, and now we express our cost of living and returns of financial instruments in terms of the Australian Dollar:

The thick light blue line is the (alternative) CPI. Apparently, an Australian saw the price of gold peak back in late 2008, and it has been fairly constant later. The Australian who travels to the US frequently has apparently found that it has not gotten more costly over the last five years, and, if he is wise, he would not have invested in the US equities markets (which would have lost him 20% of his money). More interestingly, neither would he have invested in the Australian Equities market (dark blue thick line -- the MSCI Australia index, with dividends reinvested, as represented by the EWA ETF), which, while outperforming the US markets, did worse than keeping the Ozzies in a money market fund. Strange,  but, seemingly, true.

Your dollars at work, or the new Argentina.

This post was inspired by recently reading Jeff Augen's (in many ways disappointing) book Trading Realities". Augen comments that the moves in the US stock markets can be largely explained by currency fluctuations. I decided to investigate the relationship, and rounded up the following ETFs (all of which are preferable to "raw" instruments, since they keep track of dividends and such, and all have a rather low expense ratio:

• SPY -- a proxy for the S&P 500 (with dividends reinvested.)
• IWM -- a proxy for the Russell 2000 (with dividends reinveste)
• GLD --  a proxy for physical gold (notorious for not paying dividends)
• FXA  -- a proxy for the Australian Dollar (pays interest, roughly equal to the Australian Central Bank overnight rate).
• FXE  -- a proxy for the Euro (pays interest, just as, though not as much as, the Ozzie)
• FXF -- a proxy for the Swiss Franc (pays interest, as above).

The newest of these instruments have been around since 6/26/2006, so I picked that date as the start of my study, while 5/20/2011 was the end. First, I wanted to compare the returns of all the six instruments, and produced the following graph:

This was a bit of a shock: you will notice that while gold is the master of all it surveys, buying and holding (in a money market account) the Ozzie or the Swiss Franc produced a better return than investing in the US stock market (large or small cap). Even buying and holding the Euro did as well as the S&P 500! The most depressing thought for those of us investing money in hedge funds is that the simpleton buying and holding FXA (let's not rub it in by talking about gold -- we have time enough for that below) would have outperformed the majority of hedge funds over the same period.

But more shocks were to come. The charts below show how well a European, a Swiss, or an Australian would do investing in the US stock market, compared to a compatriot who decided to keep her money in a mattress:

The above graphs, especially the last two, surprised me: notice that the US equity markets start a precipitous decline in mid-2007, have a V-shaped dip reaching its nadir in early 2009, but do not ever recover beyond October 2010 level (to the present day). This is less true when the comparison is made with the Euro, but this just goes to show you that the Euro is almost as weak a currency as the USD. The conclusion seems inescapable: the recovery (at least of the equity market) is completely fake, and is caused entirely by Bernanke's helicopters circling overhead.

The last part of our analysis can be entitled:

What Gold Bubble?


Let us see how investing in the US markets would have done compared to your retro gold-hoarding neighbor:

The short (and unsurprising) answer is: terribly. Just as in the ancient joke, the way to make a kilo of gold in the stock market is to start out with two kilos. What, however, is much more (to me) surprising is that the collapse (in gold terms) started in 2007, and ever since (again) October 2010 the US equity market has actually maintained parity against gold, although the same cannot be said about the US dollar. Our final chart drives the point home. The chart shows the performance of gold when measured in the four currencies of this study (US dollar, Euro, the Swiss Frank, and the Australian dollar):

If you look at the chart carefully, you will see that gold peaked against the "hard" currencies in late 2008, and since then has been quite flat in both Swiss Franc and Australian Dollar terms (REALLY flat for the last year or so). So, there is no gold bubble currently (there might have been one leading up to 2008, but it was not really a bubble, since it had never popped. At worst, there was a mini-bubble in late 2008, which deflated and than reflated). What there appears to be is an ongoing collapse of the dollar, with no sign of abating.

What to do?


Other than getting very depressed...  The good news is that with the exception of the Australian Dollar, the other instruments described in this post are almost uncorrelated to the US equities. While I would not touch the Euro with a barge pole (I believe that it is fundamentally as weak as the US dollar),  and since the AUD has much better fundamentals than the swiss franc and gold, I see no downside in holding some mix of the the three (FXA, FXF, GLD, or the underliers) to at least diversify away some of the US equity (or currency) risk.