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« Jim Grant on "The Bullion Puzzle" | Main | Investors Too Pesimistic on Aiful (and Takefuji, for that matter)? »

October 05, 2007

Sesit: Gold is a Bad Hedge

I don't offhand know all that Sir John Templeton thinks of gold bullion. I do recall an interview with him years ago where he pretty much dismissed the idea of the metal as a good long-term investment, citing that it earns no return.

My guess is that Templeton would buy gold mining stocks if they were deemed undervalued.

Anyway, I recalled Templeton's remarks when reading Michael Sesit's latest Bloomberg piece this morning.

Sesit doesn't buy the idea that gold is a safe-haven:

Here's why. Gold reached a record high of $850 an ounce in January 1980. If since then the spot price of bullion kept pace with U.S. inflation as measured by the consumer-price index, gold would now be selling for $2,119.84. Instead, it stood at $732.05 in London trading yesterday, only about a third of what it should be if it were truly an effective inflation hedge.

History shows that since 1988, the correlation between bullion and U.S. inflation expectations is just 36 percent, according to Goldman Sachs Group Inc. That means the price of gold rises and falls with inflation expectations 36 percent of the time. The relationship between gold and U.S. consumer-price inflation is less, at only 23 percent. And the metal's correlation with U.S. core inflation, which excludes food and energy costs, is even lower, at 7 percent.


Many people a lot smarter than me -- Jim Grant is one -- are bullish on gold (see my previous post). So we can argue this stuff all day long (not my idea of a good time).

But I do think gold can make sense as a short-to-intermediate term investment. I posted before that I owned the Central Fund of Canada (closed-end fund holding gold and silver bullion) before launching Controlled Greed.com. This was back when gold was rough US $270 an ounce and the Central Fund was trading at a slight discount.

I later sold the position at a nice profit. I could've made more by holding longer -- but selling too soon is a chronic mistake of us value guys, you know.

I can also see gold bullion making sense as a quasi form of insurance. This gets to the idea of someone setting a fixed percentage of their assets being in the form of gold -- and sticking to that number religiously. It takes discipline and I hasten to add that I am not doing this.

Remember, I don't own any gold or gold mining stocks at this time.

For the most part, I agree with Sesit (and I imagine, Templeton): to beat inflation over the long term, achieving capital appreciation in the form of stocks is the way to go.

All we have to do is find the right stocks. ;-)

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Comments

You make a very logical case for not owning gold as a hedge. However, gold's value as a hedge was never really steeped in logic, just a misguided perception. What's wrong with taking advantage of that misperception and buying gold as a way to take advantage of a weak dollar?

Walter: It's fine for someone who knows currencies. My game is that of a long term investor (who will invest in foreign stocks), so when I think of currencies is from the angle that they balance out over time.

But what you suggest is fine. Please understand, I am not for or against gold. I've owned it in the past and may again in the future. I find the subject interesting because people I admire greatly, like Jim Grant, are bulls on the metal.

I would like to add that gold prices can be skewed by central banks dumping their gold position. This is often done in concert among several central banks to maintain a set rate. Central banks can also manipulate their holding record by entering into swaps agreement. As Buffet said, once the tide recedes, we'll find out who's been swimming naked.

I challenge you to see that gold is indeed undervalued at ~$760. The fed will continue to dump liquidity and debase further to bail out the subprime mess. Social security, medicare, medicaed and all of the other entitlement programs out there will mean either 1) more taxation or 2) reduction in payment (unlikely) or 3) payment by printing more money which means further debasement.

Buying gold is not buying insurance. It is value investing. You get more value from what you paid. As a bonus, owning gold is having true economic freedom.

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