Wednesday, October 13, 2010

Is Better to Go Long Gold Versus Equities?

I hate asking such a thing after seeing gold rise $25 today.   However, the question is a valid one in my view.

As the Fed steers the Titanic straight into the QE iceberg one must seriously begin asking themselves if they want to be in hard assets over stocks.

After all, the dollar will almost assuredly see further tankage once further easing is announced.  This will then place further pressure on the consumer as the bare necessities begin eating up more and more of their disposable income.

As we saw after the commodity bubble in March of 2008, equities down the line are at high risk of getting slaightered as the our purchasing power dries up.

It's important to realize that stocks are pretty much priced for perfection at this point because the the Fed's threat of quantitative easing has created high demand for stocks as traders try and front run the Fed's actions.

The problem here is stocks are not being bought for earnings or fundementals.  They are being bought based on pure speculation that the Fed will save us if the economy does not turn around. 

Essentially, the Fed has created a false sense of security for investors which is a very dangerous precedent.  I am sure they are thrilled to see all of this bubble blowing.  Ater all, their jawboning is designed to try and lure investors back into taking risk.

In their eyes, the only way to escape this Great Recession is to grow out of it.  The problem here is there is no way to grow out of this nightmare because our foundation is built out of sand.

None of the real issues have been dealt with: 

  • The trillions of dollars of losses still remain on the banks balance sheets. 
  • Our government continues to run massive deficits as they try and fend of this financial collapse. 
  • The bailouts that add to our deficits have not been stopped.
  • The fraud that has created this mess has turned into one giant cover up.
  • Foreclosuregate continues to grow like a cancer without a cure throughout the banking system.
Essentially, nothing has been fixed.  As a result, nothing is going to change because the real problems have not been dealt with.

What did Einstein say?:  "The definaition of insanity is doing the same things all over again and expecting different results."

Have Investors Had Enough?

This is what has me concerned.  When I look at certain areas of the market you have to wonder if the market is trying to send a message to Washington that they are sick and tired of watching this trainwreck. 

Some signs of this are clear:

  • Gold is hitting new highs on an almost daily basis. 
  • The Yen(which is currency of a country that's more bankrupt then we are) is now sitting at 15 year highs against the dollar.
  • Central bankers are beginning to back away from our treasury debt.
The only positive thing that's working right now for Wall St is stocks but does that really matter in the grand scheme of things?  After all, they are priced in US dollars. 

You have to ask yourself:  If the dollar continues to lose it's purchasing power are you really growing your wealth if the market goes up?

This is why I asked the gold question in the headline of this post. Before I start here let me state that this is not investment advice.  It's just how I see things right now.

So why gold over stocks?  Well, first of all, there has been a strong correlation between the way gold and stocks have been trading(especially in the last week): 

Here is the S&P over the past few weeks:

And here is etf GLD which tracks gold:

What I like about the gold versus stocks year to date is it's been less volatile and it has also performed better.  Gold is up over 20% versus the single digits seen in the S&P.

What's more attractive to me when it comes to gold is the current economic climate.  You have every tailwind possible for the gold trade.  We have tremendous amounts of fear, lack of confidence in the US dollar, and plans by the Fed to cheapen the currency even further.

To be fair, stocks get help from some of these tailwinds as well.  The problem here is when it comes to valuations or more importantly real wealth.  The risk to equities is two fold in my book:

First:  You have stocks priced for perfection in an environment where the cheapening dollar is going to hamper consumer spending.  This will eventually be realized in bad earnings.

Secondly, if stocks go up(and thats a big if moving forward), you are increasing your wealth in a currency that is losing it's value.  As a result,  your real growth in wealth relative to the drop in the value of the currency could actually be a net negative.

Think about it this way:  If stocks rise 8% but the cost of living in inflation adjusted terms rises by 10% during that same period have you really gotten anywhere?

The Bottom Line

Let me be the first to say that I am not suggesting that you sell all of your stocks and buy gold.  What I am trying to do is make a point that having all of your assets priced in denominated dollars is very risky when you look at the world we currently live in.

Inflationary and even hyperinflationary panics have been seen throughout time.  They can also hit very rapidly which is why you need to be prepared for them.  Art Cashin was actually talking about the risks of hyperinflation today.

Folks, risks that were unthinkable a few short years ago are now real.  The impossible has now become possible.

Foreclosuregate has only heightened the level anxiety out there and the market is acting extremely unstable. 

If you are long you might want to think about adding gold to your portfolio because they are both headed in the same direction.

The key advantage of owning gold is if the financial world panics and stocks fall off a cliff, gold will hold up much better than your equity positions because it will be one of the first places money runs to hide.

The one downside to the gold trade is the risk that the Fed does a 180 and realizes that they must raise rates in order to fight inflation and stabilize the bi-polar market.

This of course would lead us into a deflationary collapse so the risk here is minimal in my view because the Fed does not seem to be able to accept such an outcome.

These are certainly unprecedented times and as I always preach:  Diversification is a must and that includes diversifying out of the US dollar.

Disclosure:  No new positions taken at the time of publication.


RGB said...

Hey Jeff,
this may be a silly question, perhaps even an ignorant one. How does one respond to the folks who claim that a weak dollar means nothing to those who are remaining in the U.S. and not traveling or purchasing anything abroad? aside from the obvious, that imported goods become insanely expensive, what is the real detriment to American citizens of a weak, if not collapsing dollar. Thanks for your blog, it remains one of the best out there. RG

Jeff said...



You could answer this in many ways but the easiest argument against this idea is oil. Oil is used to make everything manufactered or consumed. Every consumer product needs oil in order to be produced. Every car needs it. You need it for heat etc etc. The list goes on and on. Same thing goes for food commodities. Wheat is used everywhere. Also keep in mind if a farmer can sell it abroad for twice the price he is not going to be a nice guy and sell it here using our toilet paper currency.

Thanks for the support!

Anonymous said...

fed is foolin the big boys... they would rather play with their heads than J6P. make the big money think its gona be QE; but its gonna be deflation.

out of nowhere, and in everyones faces.

big drop, blood in the streets, sudden collapse.

will be fun to watch.

Jeff said...


That's pretty much what happened in the early '80's with Volker.

I hope we see the same thing today. I bought downside protection in case we see the Fed pull the trigger.

It will be a sight to behold.

For now the dollar is getting crushed!

It appears the FX traders will be relentless until they get their way at this point which is exactly what you described.

The plot thickens!

Anonymous said...

"The one downside to the gold trade is the risk that the Fed does a 180 and realizes that they must raise rates in order to fight inflation and stabilize the bi-polar market."

The other downside to the gold trade is the sheer quantity and diversity of those pimping it. Glen Beck - buy gold ads. Preachers telling theif flock to buy gold - suburban housewife gold parties - etc. etc. It has all the hallmarkes of a speculative bubble.

Dont get me wrong, I think inflation hedges are a good idea, but not gold (really anything but). Id much rather look toward something that is largely ignored by ma & pa investor and has a better chance of being driven by fundamentals. Lumber, wheat, copper - whatever - just something that wont attract fringe elements of society (there are no such thing as "potash bugs").

Anonymous said...

Anon2 I was going to say the exact same thing. I feel gold is way beyond a fundemental story & is being bubbled up by speculation traders & the typical small investors chasing returns (which typically get burned on these thesis). I am much more excited about buying commodity ETFs that are focused on grains,water etc. things that are a vital to exist. As a all in one portfolio diversifer I like the ETN DJP to get commodity exposure which also has metals as well.

flipdippy said...


Dollar down,
producer prices up,
food production costs waay up,
unemployment claims up up,
discouraged job seekers, too many to count.

iThings for everyone, S&P 1202 here we come!

Anon, people have been saying don't buy gold for years now, look where we are now. No offense, but the market has spoken. I hope we get a solid correction (15-30%) soon so I can take all my trading money and plow it into gold, silver, and other metals.

Jeff said...

Great points

The speculators are definately driving this up.

I don't think J6P owns a lot yet. I ask a lot of friends if they own gold and most of them don't.

There are other hard assets to own for sure.

I don't think gold drops too far because there are too many people waiting for a pullback to get in.

Anonymous said...

JSP is priced out of gold; not even a factor here.

gold is better than real estate for this; real estate and stores of value like land will lag this run up; unless they are path of progress type developable properties.

housing? to quote Mr T... "deeead meat."

housing as we know it is gone. there is no way to determine what the prices will be.. if based on liquidity, look out below.

it will be deflation, this is a head fake; its aN 'all in' type gambit, manipulation to try and spur buying into the markets..

when it starts falling; the only equity will be short positions. and the fundamentals and circumstances of the market will insure those shorts keep the boots on the neck of the market.

forget the runup happening now... its a fraud cover up.

but i think gold is for real, because it is being bought internationally, including china increasing their reserves, perhaps to legitimize their own type of co-Op currency (with Fr?) to rival the anglo system.

Jeff said...

Well Said!