David – you posted the below Tweet the other day and you were, in a sense, asking a question.
If you peek at the comments, the gold people didn’t seem happy. I’m going to take a different approach and challenge your thesis. Your thesis is gold is no longer a hedge, but you are also asking a question with that.
Let’s define a hedge for some of the general audience:
To those generalists, you might hedge your wheat production by taking a short position in the futures on it. You plan on making 5,000 bushels. At that rate, you have a profit of x. You place a bet AGAINST your production of 5,000 bushels on the futures exchange. IF you make your 5,000 bushels, you have a profit of x minus the premium you lost for the bet of y. If a flood wipes you out, you lose the profit on your crops, but you win your futures bet minus costs. In a sense – by hedging on the futures exchange, you lock in profit Z. Whether or not you produce – Z is your profit.
Now you may have gold in your portfolio for kind of the same reason. If you have cash in the bank, let’s say $1800, you expect to have a certain purchasing power. Right now, that purchasing power buys one ounce of gold. If the value of that dollar goes down, then it means you need more currency units to buy that one ounce of gold, perhaps $1900 in currency units. If the value of the dollar goes up, then you need less currency units to buy that one ounce of gold. So you can sort of see how gold is on a see saw with currency units.
When you have currency units as your money and you have inflation in the system, you increase your currency units by maybe 1.25%. If you are digging up 1.25% more gold each year, then the value of those currency units to gold would be roughly equal. As luck would have it, our human population increases at about 1.25% per year. One could then suggest that perhaps a normal rate of currency inflation might be 1.25% to account for human population growth as well as meet the level of gold extraction.
This see saw gets a lot more complicated, but let’s just make the argument that over the last 100 years, currency units have increased at a rate of 2% (what the Fed defines as normal inflation) and the gold ounces dug up continue at 1.25% more – and the human population increases at 1.25% more.
Over those 100 years, you could imagine the AVG currency unit PER PERSON would increase. You could also imagine that it would take more currency units to buy an ounce of gold because the rate of increase of gold ounces is not as much as the rate of increase of currency units.
To demonstrate this….
We will take a $20 bill from 1921 and an ounce of gold from 1921 and bury it in a time capsule. At that time, an ounce of gold could buy you a fine man’s tailored suit. Meaning, that suit would also cost you $20 in cash.
I got some stats here on income.
I see the current per capita income about $60,000.
Now, let’s dig up the cash and gold…and see what happens.
What you see now is that the $20 bill is still worth a $20 bill. I was able to get a smoothie over lunch at Smoothie King for about $9.50. So, that $20 bill might be able to buy 2 smoothies. That one ounce piece of gold is now worth $1800. It can still buy a fine suit.
I don’t happen to have the M2 money supply or the US gold supply in 1921 handy, but we can be those forensic CSI guys and extrapolate a few things.
- IF a suit cost $20 (gold) in 1921 and the average wage was $3,269, that means a person then could have bought 163 suits. What you now see today is a fine suit would equal about $1800 if you used the gold measurement. That person’s spending power with his wages of today would then buy 33.33 suits. Meaning, wages of the day in 1921 had about 5 times the spending power they do today. IF we were to equivocate 1921 wages to today using the suit measurement of 163 suits, and a suit cost $1800 today, a wage equivalent today would be $293,400. Or rather, our spending power has been reduced by a factor of 4.89.
- That piece of gold today is worth 90x what it was then, in nominal terms. Give or take, that means the value of the currency unit dropped by 90% over that 100 years.
To add a twist here, let’s say you had put the money in the stock market. The dow is roughly 476 times greater than then. Wow! Well – the idea of putting money into stocks is to GROW your wealth. If you wanted to protect your SPENDING power, then you wanted gold. If you wanted to get RICH, you would buy stocks. Duh.
But here is where gold shines….
- Debasement of currency. See above where the relative value of the dollar has declined by 90% over the last 100 years. This is by my spitball math here. Many reports have it at 97%. If you are thinking that the currency units are increasing at more than 1.25% per year, then you would like to preserve your spending power over that delta. The greater the delta, the more gold I would buy to bridge that gap.
- During stock market declines. Whether you are talking a crash or recession, gold holds relative value better than the stock market. Take a look at Mike Maloney’s Wealth cycles were you are seeing how the dow/gold ratio works. At times in our history, this ratio was 1:1.
This is a relative value. At the bottom there in 1980, it was 1:1. This is where you would take gold and exchange for the Dow. At the peaks, like in 2000, gold was severely undervalued versus the Dow and it made sense to invest in gold then from the stocks.
So while you may have a 476x from 1921 for stocks, it’s about a 90x for gold. Meaning stocks performed 5.29x better than gold. They are different types of assets. I’m not even approaching real estate here as another storage class, but you get the idea:
Over time, cash loses a LOT of value.
Looking at the examples above, if you want to GROW your wealth, invest in businesses. If you want to PRESERVE your wealth, invest in gold. IF you see the stock market going down, you may be gaining a lot of wealth in your gold. At other times of “risk on”, stocks could wildly outperform gold.
OK – but is it STILL a hedge?
David posts the gold versus TIPS chart. Hint – not going to blow smoke up your ass, I don’t know what the TIPS is other than the Treasury Inflation Protected Security. Meaning, I’m an IT manager and have never traded this or played this, but I have seen this chart over the years and understand the concept. And that is, when inflation moves with TIPS, gold does too. This chart goes back 5 years. On a side note, gold has been money for 5,000 years.
As I demonstrated above with gold and the $20 bill, over any period of time, x, there is a decline in the value of currency, y, due to inflation. David has a 5 year chart. If you look closely David, gold significantly outperformed inflation in 2020 and has since been in a consolidation pattern. If I’m looking at this chart – what you see is 3 years of highly correlated performance with 1 year of gold shooting up, with the next year gold coming back and inflation shooting up.
This goes then with the time of x. If you are looking at 1 year, then yes – David is correct, it appears they are moving in different directions. But over 2 years, you saw gold appeared to overshoot expecting the inflation that came later. This overbought condition appeared to lead to a consolidation which then may have gone oversold.
If you look at the math over these 5 years, add up the numbers and average them out, you will find that these are still highly correlated. One year does not a thesis make. Why not?
I would then like to ask you David – if I offered you time travel to 100 years out from now, and you had $1,800 in cash, and I asked you if you wanted to put that cash in the time capsule or exchange it for one ounce of gold and put in the time capsule, what would you pick? Given the demonstration above, I’d assume you would pick the one ounce of gold.
Storing financial energy
I did an entire series on financial energy, which I’d like to write a book about someday, and what David is asking isn’t if gold is a hedge – he’s essentially asking if it’s a store of value that will act as a hedge against risk on. You have to understand what financial energy is, and you also have to understand how to store financial energy.
I put this slide together to understand storing financial energy……
Most people think of cash as money. It is one of three states of storing financial energy.
Within the “money” class, this is what you normally see. Remember, all of the items here store financial energy. Some, like cash, are highly liquid but lose value over time. Some of these items are perishable. Some are commodities like gold and silver that store financial energy over millenia.
The problem here is you see a $20 bill and you think of the current $20 bill. I don’t really believe a $20 bill is money. I believe it is currency – and this currency has no inherent value. It’s only value is that the government allows exchange for it for goods and services.
I believe there is significant time decay in currency. And it’s hard to prove me wrong with that with the example above.
Moving forward – you have times where there are “risk on” and times when there is “risk off” with investing. How do you want to shape your portfolio? This question is actually, “how do you want to store your financial energy for use at a later time”?
If you understand this concept, you then understand how to shape your portfolio. You put financial energy into money (or assets that have value that can be traded), business (actually, you invest in business processes), and property.
What are your objectives with shaping a portfolio? When I worked at Vanguard and was fixing the computer of a Wharton MBA (nice diploma on the wall) she walked me through the big picture stuff when I was 23. Shaping a portfolio is all about risk. Generally speaking, those younger have much riskier portfolio structures because if a 25 year old loses his shirt on a 401k, he has 40 years to recover. If you are 62 and have sizable financial energy accumulated, you are looking to protect it.
This might be why you see the 20 somethings chasing dog meme cryptos while you have the “boomers” holding gold. These are two different entities completely. I even classify non-asset backed cryptos as property, not money. Even die hard bitcoiners will tell you it isn’t money, it’s designed to store value. I would thus think of it as speculating on beach front property. It’s the exact same thing, and IT is the field I’ve worked in for 25 years and have advanced degrees in. It is an address space you are speculating on. It might turn out to go 10x! Or, another shiny beach front community comes up and everyone betting on the first one sells for pennies on the dollar to speculate on the next one. Bitcoin and cryptos are a technology, not money.
I dove into that part because David Lin is on the younger side and can afford to be more speculative with his profile. The last time a recession happened, he may have been in kindergarten and it’s unclear if he has seen the pain of a recession. I’ve been laid of 3 times as a result of recessions. I can tell you when a recession hits, dog meme shitcoins are about the last thing anyone wants. I had to sell my silver trumpet once to make ends meet during one of the recessions. I played in orchestras all through college and grad school at the time and the trauma of selling that was devastating. Meaning, when recessions hit, those without a Benz in the driveway sell everything not nailed down.
So we are in a risk on phase, and have been for a very, very long time. In that environment, you are investing in business processes and speculating on property. Meaning, during these times it MAKES SENSE to unlock the financial energy in your money batteries to sell these assets to buy those that grow your financial energy.
But as those markets start to top and get frothy, a funny thing happens. What you notice is that you can convert some of this high risk fuel to low risk fuel to PRESERVE your wealth. As you start to see the dow/gold ratios increase, and the housing market go bananas, you then may also start to see some selling and profit taking to LOCK IN wealth by converting it to cash (anticipating a risk off event could be happening soon), and then storing it as gold. Or bonds.
To me, it seems cash is about the worst STORE of financial energy there is. I demonstrated that it lost 90% of its value to gold over 100 years. I would not really classify cash as money, it is exactly what it’s supposed to be – a medium of exchange. It appears to be that item that is needed to convert all of this stuff to different battery stores.
David is asking if gold is a store of wealth in a risk off event. The evidence he provided essentially came down to a 1 year period of time, which was completely mitigated by the previous year, if you want to “dollar cost average”. Watching David on Kitco, he appears to have a strong bias for bitcoin over gold. I would contend in his professional career, he has only seen “risk on”. With this, Bitcoin and cryptos are highly speculative assets that have seen incredible gains, but have yet to withstand a risk of recessionary event.
At this time, the markets are toppy. Many feel a recession is imminent. Others feel we have a blow off top coming and then a recession. What I would contend is at THIS time, those with significant profits may start to take some of these profits to lock into the “risk off” battery store – gold. And, by proxy, silver for the every day Joe Sixpack. As we have seen, bonds are another form of “risk off”, but we may see soon that no one outside of the government wants to buy a 10 year for 1.5% when the government tells you their REALLY LOW CPI is coming in hot at 5.4%.
With all of the currency printed the last year, along with all of the cheap debt issued to inflate stocks and assets – it would stand to reason that in the next 12 months we may see a colossal move to lock in financial energy into the oldest risk off asset out there – precious metals.
When you are creating your portfolio, it’s a mix of money (gold/bonds), business (business processes for ROI), and property (real estate can be something you live in, rent out for yield, or speculate on). It is of interest to note that you need to evaluate your own levels of risk when creating your portfolio, but it is also if interest to note where we are in business and wealth cycles. When the relative value of the stock markets and real estate are far overstretched to gold, those with incredible means will lead the pack by liquidating a PORTION of their higher risk assets to thus shuffle to lower risk, but higher preservation.
While gold, stocks, and real estate all have different risk profiles, these also correlate then also with the gains each can get. But also, one must consider a third property to add to risk and yield – preservation.
With the preservation attribute, this is how you STORE energy for long term and PRESERVE wealth. Think of my 1921 stock number up above. Many of those stocks went to 0 in the Great Depression. Real estate ALWAYS goes up? No, it doesn’t. Consider during the Depression, houses were being demolished because the values were too high and people couldn’t pay taxes on it. Look at the GFC in 2008 and how the housing market cratered. Think about buying a great house and within 6 months, a dump is built right out back to smell up your neighborhood, a trailer park in built adjoining your backyard, a sex offender is now registered next door, and crime in your neighborhood is through the roof. These things affect property (speculative) values. Think about gold. In the 1930s, it was confiscated, and then the government arbitrarily changed the value from $20 to $35. Central banks hoard it.
David – I think think you lost this round. Everything above indicates that AS risk off starts to happen, gold will be THE key asset to PRESERVE wealth. As riskier items with tremendous profits are sold into the market, this reduces the values of these things, and this cash will then move from risk on to risk off to increase the bid on gold.
My full slideshow to explain financial energy and how it is stored is located at https://thefinancialenthusiasts.com/tools/ and from there, click on the second one with “gold is the center of the financial universe”. Try clicking here, but I have no guarantee the link will work.