Tuesday, November 13, 2013 Hitchhiker's VUE

General Information and Analysis

Gold - Is it an inflation hedge?

In general, many people I talk to including Quants in NY agree that gold is an inflation hedge.  Of that set of people, many seem to believe that gold's price will increase in lockstep with inflation.

While I'm unable to show charts in Google's Blog software, I would like to show you the charts I'm studying.  I think most people would agree there is some inflation in the USA, as the value of the dollar has been crushed in the International trade markets.  (In other words, the dollar has been down.)

If you will take the time, go to stockcharts.com (free) and graph Gold.  Then go to the government site that graphs CPI.  (Yes, CPI is imperfect, and the Federal Reserve is correct in using PPI instead.)  However, CPI measures consumer inflation accurately enough for this comparison.  From 1987 (after a big run up in gold) to 2004, gold went down, turning in 2000.  By 2004 gold was around the same price as it was in 1988 about $420 per ounce.  The CPI however, shows inflation climbing every single year (albeit, the % was up and down, but never reached zero). 

Looking at gold and CPI from 2004 to 2011 (where Gold's top was made), there was a huge uplift in gold, but inflation remained about 2% except in 2009 when CPI went negative.  During that time, gold was inverse to CPI, with gold shooting up to $1800 dollars per ounce while inflation in 2011 was 3.2%; with down and even negative inflation.

Investor's may argue that there were plenty of crises in that time, and that is what caused gold to shoot up.  There is truth in that, but it would be well to point out, crises can be war or other factors that drive gold up.  Crises are not necessarily inflation. 

In the meantime, many gold bugs are suggesting that gold will go to the moon when inflation rises well above the 3% rate as it cannot help but do. 

Ah contraire; investors will dictate price, and fear it appears drive investors to invest in gold; not inflation directly.  Price will be what it will be.

Gold has a place in everyone's portfolio, but do not expect it to be a good precursor to inflation.  In addition, do not expect it to be a good investment vehicle over the next 2-3 years.  Gold is almost certainly driven by human emotions; not by production value.  Even the Russian central bank got caught up in the mania to buy gold, and for whatever reasons gold has collapsed, the fact is, that it has collapsed.  That has put tremendous pressure on the Russian Central Bank to release some of the mineral to stimulate Russian's economy.

What you will find is that when interest rate returns on US short term treasuries are under the inflation rate (which they are not at the moment), then gold becomes a good investment.   However, rates being under inflation happens very rarely.

If we regularly invest in boring productive assets from farm lands to businesses, they will be a better hedge against inflation.  Why is that?  Because they can grow you investment faster than inflation erodes your investment value.

May I submit, then, it is better to look for 600 lb gorillas in the marketplace that hold pricing power and have brand loyalty.  When inflation kicks in (who knows when), they have the ability to raise prices as inflation raises their expenses.  They can make a profit and maintain your investment value.  This is due to the ability to pass along price hikes with little (or no) loss in business volume. 

The result is steady (while boring) profit margins, that result in dividends and even stock appreciation.

What is an example of these kind of stocks?  McDonalds, Coca Cola, and so-on.  They are not the go-go high tech stocks, biotechs, and so-on.  Go-go stocks can make a lot of money in a short period of time, and so can gold.  But those stocks (with a very minor amount of exceptions) are up and valuable, and then collapse in a hurry.

US

I have to go and get my car fixed, and that is a three hour drive to someone who can fix my Honda Pilot. 

The stock market is down overnight.  The S&P 500 futures vs fair value is -7.50 and Nasdaq is -19.30. These numbers change very rapidly, and I've worked on computer algorithms to calculate and invest on the fly in HFT, but for the retail investor, these are only an indication of how the market will open; not what it will do after the open. 

Treasuries (USA) are hovering near their high, and that should be interpreted as "no tapering" anytime soon.  As I say over and over: Price is what it is, and in the short term (day trading) price is basically random.  I imagine traders to be like starlings in flight; they go one direction, change incredibly fast, and flow in waves back and forth. 

Since at 6:00 AM this is overnight trading, the Euro-Area Industrial Production fell, and that is likely leading the DAX lower.  With the DAX heading lower, then overnight USA indexes head lower. 

Wall Street Journal is also reporting that all of sudden worries have entered.  Good grief, they are all worried that the Communist Leaders failed to provide clear policy direction.  Folks, they are Chinese, and they rarely are detailed in anything.  Instead, they are most likely to go slowly as they have done to float the Renminbi.  They will also go slowly in making the market free.  This kind of change is difficult for them, and they go slowly and steadily.

There is no major news that should drive the market lower, and look for the market to chop after opening, while the risk for a major dive in the USA stock market is eminent.  I would take profits in any long term stockmarket investment if I have excellent profits, or I would take out insurance by hedging with options.