The economist John Maynard Keynes once famously dismissed gold as a “barbarous relic.”
Keynes was actually referring to the gold standard.
But his inflammatory description reflected his heartfelt sentiment about gold.
Nevertheless, gold has maintained its unique status as both a commodity and a store of monetary value.
Gold is the ultimate safe-haven investment when the stock and bond markets head south.
Everything that is bearish for stocks — political instability, inflationary fears, a falling dollar — tends to be very bullish for the yellow metal.
All three of these factors helped propel gold prices to one of its greatest runs ever.
Since 2001, gold rose from $250 per ounce to a high of $1,900 an ounce in 2011. That’s a massive 660% increase.
Along the way, gold prices hit numerous all-time highs. That made “gold bugs” seem like the smartest guys in the room.
That’s all changed in recent years.
In the past five years, the price of gold has been flat while the S&P 500 is up over 50%.
More recently, the price of gold has suffered one of its sharpest declines in years. Over the past three months alone, the price of the yellow metal has slid nearly 12%.
Gold dropped to $1,131.85 an ounce on Friday, Nov. 7, its lowest level since April 2010.
Jim Rogers once predicted that gold will never fall to $1,000. That level looks increasingly precarious.
I think gold will see $1,000 sooner than it will see $5,000.
All of this has put the gold bugs on the defensive.
A case in point is the University of Texas and local hedge fund guru Kyle Bass.
Back in April 2011, Bass advised UT to take delivery of nearly $1 billion worth of gold bars. That decision has cost the university $250 million in cash — so far. And that doesn’t include another $500 million in foregone profits had the endowment just stuck to investing in the S&P 500 Index.
A Less Than Golden Future
Nor does the near future for gold look any better.
Gold faces the proverbial “perfect storm” of circumstances likely to keep prices in decline.
First, the U.S. economy has not imploded. Gross Domestic Product expanded by a stronger-than-expected 3.5% in the third quarter, and unemployment now is below the 6% level.
Second, hyperinflation never happened. Gold bugs are not yet replacing the collectible 100 trillion dollar Zimbabwe notes they carry around in their wallets with the U.S. dollar equivalent. Today, the specter of deflation is much more of a threat than inflation.
Third, interest rates are likely to rise. Last week, the Federal Reserve ended its quantitative-easing (QE) program. It also indicated that strong economic growth and the improving labor market could mean higher interest rates as soon as 2015. This also has fuelled the rally in the U.S. Dollar Index, which recently hit a four-year high.
When the dollar appreciates, commodities priced in dollars weaken, as it takes fewer dollars to buy them. That puts additional pressure on the price of gold.
Given the perfect-storm scenario tamping down gold prices, it’s no wonder that investors are fleeing the golden hills.
Global holdings in exchange-traded funds backed by the yellow metal have dropped to their lowest level in five years.
Last year, when investors rushed for the golden exits, Asian bargain hunters in the physical gold market came in and bought gold at what were then seemingly bargain prices.
This year, however, Chinese buyers have been conspicuous by their absence. Retail gold consumption fell by one-fifth in the first nine months of the year compared with the same period last year, according to the China Gold Association. Having been burned last year, Chinese investors are understandably reluctant to catch a falling gold knife.
Here’s the uncomfortable truth…
Gold is a speculative asset, in the purest sense of the word. Its price is driven almost purely by sentiment. Gold pays no interest. In fact, it costs you money to store it. And you can’t really model the financial value of an asset that does not pay any income.
That’s why George Soros — himself a huge critic of the global financial system — could make billions betting on gold, after exiting it at much higher price levels than today, even as committed gold bugs get stuck holding the bag.
But for me, the most compelling argument for not owning gold comes to us from investor Warren Buffett.
On May 7, 2012, Buffett told CNBC:
“When we took over Berkshire, it was selling at $15 a share and gold was selling at $20 an ounce. Gold is now $1,600 and Berkshire is $120,000.”
Since that statement, gold has fallen to $1,131 and Berkshire shares have risen to about $215,000.
Not that a mere 200x difference in returns would ever convince a gold bug.
Gold bugs love to point out that you can still buy a nice suit with the gold coin, just as you could in Roman times.
But you could also buy a nice townhouse in Sarasota, Florida, with a single share of Berkshire.
Which would you prefer?
Of course, if a meteor is heading toward planet Earth, all bets are off. The guys in the Montana hills with the gold bars will have won the investment sweepstakes.
But otherwise, if you are still blinded by the religious-like fervor of gold bugs, it’s time to ditch your golden faith, embrace the truth — and make gold a barbaric relic of your portfolio’s past.
In case you missed it, I encourage you to read my e-letter column from last week about the reasons behind Japan’s quantitative easing announcement. I also invite you to comment in the space provided below.