The 10th Man

A Guidebook to Investing in Gold

June 11, 2015

“A gold mine is a hole in the ground with a bunch of liars standing next to it.”

I started investing in gold in 2005. Not a bad time, right?

Here’s why I started: I was the ETF trader at Lehman Brothers at the time. A couple of guys came by to talk about this crazy idea they had about a gold ETF. I think one was from the World Gold Council and the other was from State Street. The WGC guy brought along a 10-ounce bar of gold. At the time, it was worth almost $6,000.

The ETF was SPDR Gold Shares (GLD).(* Please see disclosure below)

I ended up buying GLD, because I’m a trader. Trading stocks is what I do, so it’s easy for me to buy something with a ticker. I didn’t even know you could buy physical gold. It was 2005 or 2006, so I’m not even sure if the online bullion dealers were up and running yet. If you wanted to buy gold, you’d have to be in the know, go to some hole-in-the-wall coin dealer, get your face ripped off.

I have owned GLD since. And along the way, I learned a lot about investing in physical gold, and I bought that, too.

But that’s not the interesting part.

I Loathe Gold Culture

One of the things I figured out as I was starting to invest in precious metals is that a lot of the other guys investing in gold and silver were… not the kind of guys I really wanted to hang out with. Neckbeard McGoldbug. You know the type.

I’m talking about the ridiculous conspiracy theories, the bizarre politics that are so far right, they’re left. The hatred toward banks. I still don’t understand it. These are supposedly right-wing guys who found themselves on the same side of most issues as Matt Taibbi and Elizabeth Warren. The apocalyptic outlook, the relentlessly bearish views, the outright refusal to participate in one of the biggest (and most obvious) stock market rallies ever.

I am allegedly a right-wing guy—and I’ll own it—but I am not that.

The other thing I discovered about these guys is that it’s useless to try to sell newsletters to them. They don’t believe in intellectual property.

So part of my gold investing career has been figuring out what I am and what I’m not. I guess you could call me a classical liberal and monetarist who takes a keen interest in gold.

Freeze It, Personalize It, Polarize It

As the gold rally crested and rolled over, the mainstream financial media really started to go after the gold bugs. They were super annoying on the way up, and the (mostly liberal, Keynesian) pundits were crushing them on the way down. It’s gotten to the point where the only people left buying gold are… Neckbeard McGoldbug, and they’ve been thoroughly maligned for it.

If you recall, the whole idea was that quantitative easing (printing money) was going to create a lot of inflation. Plus, the budget deficit was about $1.8 trillion at the time, so we would have to monetize the debt. It was a pretty good argument. And it worked for years.

Then it stopped working.

The inflation the gold bugs predicted never happened. It was the biggest hoax perpetuated on investors, ever. So the beatdown from the Keynesians continues to this day, on Twitter, on blogs, in the news.

But maybe the gold bugs weren’t wrong—just super early.

I’m Not an Economist, But…

I do remember this from a class I had: the quantity theory of money.

MV = PQ

I’m sure this looks familiar to many of you.

So M, the supply of money, has gone way up:

But V, money velocity, has gone way down:

Given constant Q (quantity of goods), P (price) remains pretty much unchanged.

So we will eventually get our inflation—if money velocity turns around and heads higher.

There aren’t any good theories as to why money velocity continues to plummet. At least, I haven’t read any. I think we will have a similar inability to predict when it rises.

This is overly simplistic, but I’m a simple guy.

Gold Is/Is Not for the Long Run

There are people who say gold should be x percent of your portfolio in all weather. I get it. It tends to be negatively correlated with other stuff, so it reduces the volatility of a portfolio.

And as long as central banks are doing what they’re doing, the long-term case for gold is pretty much intact, recent price action notwithstanding.

But let me tell you this. If central banks ever got religion and pulled a Volcker and hiked rates to the moon, it would be a remarkably bad time to hold gold.

On the other hand, throughout history, there have been times where people were very sad that they didn’t own gold. I talk about one of them here.

It’s very real, and the history of fiat currencies is also quite sad.

I am the furthest thing from an alarmist. I don’t think the dollar, or the euro, or any other currency is going to collapse, at least not imminently.

But I also think the Fed doesn’t want to raise interest rates, possibly ever.

The ECB is printing, and you have the prospect of direct monetization.

Japan is just insane.

Even Sweden is printing money.

And I can see a scenario where Canada, Australia, and Norway are all doing it too.

So: if the whole world is printing money, I’m okay with being long gold.

But in 2015, you really shouldn’t care about what people think.

*Disclosure: at the time of this writing, Jared Dillian was long GLD, SLV, and physical gold and silver.

Jared Dillian
Jared Dillian

 

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Comments

Mike Leach

June 24, 2015, 10:32 a.m.

Agreed.  Most long-term charts (10 years or more) should be on a semi-logarithemic scale.  While perhaps not concave, the M2 chart would at least be flatter, particularly at the end, and show that the increase in money supply to be more gradual.  At the same time, the velocity chart should also be semi-log, and it would similarly be flatter, indicating that the decline in the velocity of money, while real, is not quite as sharp at it appears.

benjamin.t.roberts@wellsfargo.com

June 12, 2015, 9:37 a.m.

I’ve enjoyed your plainly spoken insights for a while now, and have also wondered about the declining velocity of money.

Since my education was in aerospace engineering, my suspicions are that it has been related to the recapitalization of the banks (their leverage ratios are at recent historic lows), and some consumer deleveraging as well.  That is, perhaps some of the issue is that M2 is comprised of both “active” money and credit (i.e. money circulating in the economy) and “dead” money and credit (e.g. money that isn’t actively circulating).  I seem to recall that “velocity” is actually a derived figure, rather than a measured one (i.e. V = P * Q / M2).  Since capital for some banks has increased from 2-3% (or maybe 5-6% on the high end, IIRC) to 9-13%, I wonder how that plays into the determination of “velocity”.

It seems to me that some useful macro insights could be obtained if one were able to separate out the sources and magnitudes of the differing monetary flows.  QE3, for instance, may have largely gone toward offsetting the reduction of credit and the recapitalization of banks, and thus had relatively little direct effect on the economy (apart from psychological).  New regulations or policies (or their removal) could then be reasonably reviewed according to their predicted and observed effects on these differing pools of money.


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