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Grossly Unintelligent

05 August 2016

Too much bullishness is never a good thing! For precious metals bulls, it is worth keeping that in mind, with the metal trading near AUD $1800 an ounce this week, up circa $350 in 2016 already.
Short-term, we wouldn’t be surprised to see the metal take a breather here, but with a price rise of over 25% YTD, equity markets volatile, and the cash rate moving lower, it’s no surprise that interest in the sector is skyrocketing.
Evidence of that interest is everywhere, with ABC Bullion last week hosting a conference for over 600 investors in Sydney, whilst the just completed 25th Diggers and Dealers event in Kalgoorlie this week was largely a showcase for all things gold related, with Aussie gold miners dominating the conference agenda.
Another sign highlighting the new bull market for gold is the ever growing number of reports we are seeing written about the metal from the broader fund management and investment community. 

Overnight, we’ve seen bond king Bill Gross “come out” with a sobering note regarding the challenges the global economy faces, noting that capitalism can’t function efficiently in a market so distorted by current monetary policy settings. Gross also commented on the absurd situation created by central bank repatriation of income derived from government bond holdings to their respective treasuries, “creating a situation of money for nothing – issuing debt for free”. Most importantly, in attempting to explain what investors should do, Gross noted that; “I don't like bonds; I don't like most stocks; I don't like private equity. Real assets such as land, gold, and tangible plant and equipment at a discount are favored asset categories”.  
Of those three, gold is easily the most liquid and investable, making it a logical choice in an investment portfolio, a position it appears some Australian based value managers appear to be adopting, with some turning to the metal as a holding in their client portfolios today.
The Gross outlook can be read here in full.
Less you think every fund manager is loading up on gold, fear not, for most are still ignoring the asset class. Indeed the skeptics, and the critics remain – with a few hit pieces on the metal doing the rounds as well.
One in particular that stood out was a recent note by Intelligent Investor. The headline; “Even in bad times, gold is a bad investment”, gives it away that the author doesn’t look too fondly on gold. 

The article gets off to an amusing start, explaining why gold is a supposedly lousy investment by referencing an article written by Jason Zweig, a journalist for the WSJ.
Zweig recently noted that in his opinion, gold was nothing but a “pet rock”, repeating an article title he had used about a year ago, around the time gold was bottoming out in USD terms. 

Bear in mind, this is the very same journalist, who in September 2011, when gold was at a cyclical high near USD $2,000, wrote an article titled; “Is Gold Cheap? Who knows? But Gold-Mining Stocks Are”. 

Gold in USD terms soon began a +40% correction, whilst gold miners fell closer to 80% from around the time that article was published to their lows in late 2015.
We can’t comment on his entire body of work or analysis, but anyone making a decision regarding investment into physical gold based on the musings of Mr Zweig has likely not done too well out of it, and it makes you wonder why the Intelligent Investor author would reference this material.
Moving on from that issue, the article lists three main criticisms of gold, all of which we will address here. 

Issue 1.
One of the reasons gold is a “bad” investment is that, contrary to the commonly held view, gold is actually “poor protection against inflation”, at least according to the author of the article.
Apparently, according to the author, “on a time scale useful to investors – 5, 10, even 40 years, gold is actually a terrible hedge against inflation.”
In our SMSF Trustees and physical bullion report (click here for link), we looked at returns on gold covering 1yr, 10yr, 15yr and 44 years to end 2014 (note gold is up significantly since).
The table below compares those results to inflation over the same time frames.
  1yr 10yr 15yr 44yr
Gold (AUD) 9.0 10.1 8.3 9.0
Inflation 2.5 2.8 3.0 5.6
Source: ABC Bullion, RBA 

As you can see, in every instance, the price of gold has risen far more than inflation. If this is a “terrible hedge” against inflation, then long may it continue.
Of greater bemusement is the fact that the author tried to justify his argument that gold is a “terrible hedge” against inflation by noting that after; “adjusting for inflation gold is still 44% below its peak in 1980”.
We’ve seen some cherry picked data before, but this one takes the cake, for the author has decided to start his “analysis” from the very end of the great 1970s bull market in gold.
It is unbelievable (as in literally not believable) that the author wouldn’t have access to the gold price returns of the 1970s, and how they’d impact any analysis investigating gold’s effectiveness as a hedge against inflation.
The simple truth is that if any investor “lost” money in gold as a result of piling all their dough in after the price had risen over 20 fold in the space of ten years – then it’s not gold’s fault – it’s the investor’s fault, as would buying the top of the NASDAQ in the early 2000s have been, or going long oil when Goldmans were talking $200 a barrel.
The truth is that gold itself does just fine as a protector of wealth or purchasing power, and protection against inflation. That doesn’t mean individuals won’t lose money on it by mistiming their entry and exit points into the metal, something that effects all asset classes, as numerous studies by DALBAR will attest.
Tip 1 to being an intelligent investor, and avoiding the fate of many investors who make rash decisions with their portfolio is to steer clear of rubbish analysis using cherry picked data that is published to make a bullish or bearish argument on any investment topic and asset class. 

Issue 2.
According to the author, gold isn’t a productive asset, meaning an investment in gold is pure speculation. At a very shallow (I mean very shallow) level, there is some merit to this argument, though anyone whose “speculated” that gold will hold its value better than currency in the past 45 years since Nixon closed the gold window has of course seen the value of their holding rise by circa 9% per annum in dollar terms.
At a higher level though – the argument is ridiculous. Gold isn’t meant to be a “productive” asset as the term is commonly understood. Rather, gold is meant to be a highly liquid, zero credit risk monetary instrument.
It does exactly what it says on the tin! 

Issue 3.
Finally – the article references opportunity cost, suggesting that before buying gold, investors should consider which other assets they could invest in, as the other asset classes may grow wealth faster than gold.
Can’t argue with that – so let’s take a quick look around the grounds as it were, at the three other liquid asset classes (equities/bonds/cash) that any investor can easily access
  • Cash: Record low nominal rates globally, with ‘real’ rates near if not below zero. Further easing likely in Australia.
  • Bonds: Have been in a bull market for 35 years. Currently over USD $10 Trillion in negative yielding sovereign debt. Average ‘real’ yield for investment grade credit sub 1%, and closer to 0.50%,
  • Equities: US equities trading at over 25 times cyclically adjusted earnings, circa 50% more expensive than long-term average. Other markets more attractively priced, but none are ‘cheap’, with businesses still reticent to invest, whilst zero rate policy has encouraged buy-backs and high payout ratios, which will limit future earnings growth.
Indeed commenting on the outlook for these asset classes, Bill Gross (in his June outlook) stated that the returns of the past will not be seen again anytime soon, noting that; “You have a better chance of observing another era like the previous 40-year one on the planet Mars than you do here on good old Earth.”
Mckinsey have also recently released research explaining why investors will need to lower their sights when it comes to the returns on financial assets in the coming decades, whilst the GMO 7 year asset class forecast (seen visually below), suggests a portfolio made up entirely of financial assets will likely go nowhere if not decline between now and the early 2020s. 

You can read more about these forecasts here.

Less you think I’m being hyper-bearish, it’s worth disclosing that I’m long all three of the above asset classes, but the warnings of Gross and Grantham shouldn’t be entirely ignored, which is one of the reasons I’m also happy to be long gold.
There are some other points we think intelligent investors should remember when it comes to gold, not least of which is the fact that it remains the only highly liquid asset class that is easily accessible by all investors.
As a final point, the contrarian in me can’t help but be happy to read this “analysis” regarding the supposed drawbacks of physical gold, and the fact that it is still being disparaged as an asset class worthy of investment at all.
For at the end of the day, genuinely intelligent investors know it makes sense to buy assets when they’re unloved.
Until next time
Jordan Eliseo
August 2016

This publication is for educational purposes only and should not be considered either general or personal advice. It does not consider any particular person’s investment objectives, financial situation or needs. Accordingly, no recommendation (expressed or implied) or other information contained in this report should be acted upon without the appropriateness of that information having regard to those factors. You should assess whether or not the information contained herein is appropriate to your individual financial circumstances and goals before making an investment decision, or seek the help the of a licensed financial adviser. Performance is historical, performance may vary, and past performance is not necessarily indicative of future performance. Any prices, quotes, or statistics included have been obtained from sources deemed to be reliable, but we do not guarantee their accuracy or completeness.