Look Who is Joining the "Uncivilized" Gold Investors

Scott is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

There seems to be a disparity between Ben Bernanke's recent actions and the rhetoric in which he engaged over the past year.  2012 was a year in which many debated whether "QE-3" would be forthcoming.  It was only early April 2012 that Bernanke came out with his statement indicating that he has "no appetite for more quantitative easing."  To a cynic, this might appear as a carefully chosen phrase to -imply- there would be no further QE - without technically saying there would be no further QE.

By the amount of high profile, public attention the Federal Reserve gave to the price of gold, a case could be made that Bernanke was fighting a war on gold.  The daily headlines containing Bernanke's rhetoric were always coupled with how it affected the price of gold.  Why would the Fed be obsessed with the price of gold?  The prices that we pay at the grocery store for a gallon of milk, a loaf of bread, ice cream or even soft-drinks are not splattered on the front page of every website and newspaper in the way that the bellwether ounce of gold is. It's easy to palliate the rising price of oil by blaming it on factors like demand, weather and even Somali Pirates; but gold is regarded by many as a "smoking gun" that is not easily explained away.

There was not just a disparity between rhetoric and actions by Bernanke. Friends of the administration came out publicly insulting gold investors, seemingly in hope of attaching stigma to owning the precious metal. Warren Buffett and George Soros regularly offered anti-gold rhetoric seemingly to help the cause. Buffett's long time partner Charlie Munger called gold investors "uncivilized."  Uncivilized?  Seriously?  Why insult people to that degree for their personal investment preferences?  George Soros declared to the media that gold was "the ultimate bubble" - remarkably near the time he was accumulating tens of thousands of shares in the SPDR Gold Trust ETF (NYSEMKT: GLD).

Exhibit A. Soros described gold in January last year as "the ultimate asset bubble."

Although, Soros seemed to have a change of mind after his benevolent warnings to the public...

Exhibit B. According to Bloomberg News (August 16, 2012): "Soros Fund Management bumped up exposure to SPDR Gold Trust to 884,000 shares".

That's a great deal of money to be putting into a bubble.  Let the reader decide why Mr. Soros would be buying gold by the ton after publicly calling it "the ultimate bubble."  Perhaps unfortunately, many seem to have opted to embrace George's words, rather than his later deeds.  As is typical, the crowd is seeking refuge in what may actually compound their pain and hasten their financial pain.  An example of such behavior can be seen in recent headlines immediately following the QE 3 announcement:

The Federal Reserve's latest all-in, open-ended bond-purchase policy is shaking the nerves of investors thinking about the potential inflation effects of all that additional money in the financial system.
That's boosted iShares Barclays TIPS Bond fund (NYSEMKT: TIP) - an exchange-traded fund focused on Treasury Inflation Protected Securities. Rising interest in the fund indicates more demand for protection from inflation. (Marketwatch.com)

This might be funny if not for the potential implications.  This strategy could possibly compound the problem. The inflation exists because government cannot afford to pay its bills and is therefore increasing its debt obligations. The TIPS issued by the US Treasury ostensibly to protect buyers from inflation actually - increase - the federal government's obligations even further - because - of that inflation.

The Problem with comparing key Global Currencies as a measure of "Strength"

Instead of looking at the unbacked paper currencies of the world on a macro level, the market and especially the media have focused on which fiat currency is the "strongest" against one another. Following is an example of recent headlines from the past week regarding US Treasuries:

Treasuries Rise 6th Day on Europe Concern, Slowdown Signs - Businessweek‎  - Treasuries rose for a sixth day as European leaders clashed on ways to curb the region's debt crisis and economists said data on ...

Treasuries Rise; 10-Year Yield Falls 2 Basis Points to 1.69% - Bloomberg‎ 

Treasuries Rise as Euro Falls; Most US Stocks Retreat - Businessweek‎

These typical headlines serve as a distraction. They allow the media and anyone else who cites them to use relative language to describe the US Treasury, the Dollar and the Euro.  As they see-saw back and forth, it is a specious view which takes the focus off of how the currencies fair against items containing intrinsic value. Instead, they focus on how the two fiat currencies and downgraded debt instruments compare to each other while acting as though one is healthy or "strong" because it exceeds the value of another on a given day.

Following is what I believe to be a better analogy of the Euro versus the Dollar:

The Titanic is often metaphorically used to describe the current economic situation of the US because the reason it sank was a monumental example of arrogance that could have been avoided.  Instead of emphasizing the reason it sank, which has been done repeatedly by many, I will proffer a Titanic metaphor that compares the -manner- in which it sank to the gradual sinking of all fiat currencies.

As was memorably demonstrated in the contemporary blockbuster produced by James Cameron, we can recall the doomed passengers all scrambling to the opposite end of the sinking ship. One can visualize from the picture below, the passengers including the fictional character portrayed by Leonardo Dicaprio - hanging on for dear life to the railings as it went vertical.

Although they were doomed nevertheless, it was human instinct for the passengers to stay alive as long as they could by running to, although temporarily, to the end that was rising - upward - above the water as demonstrated below:


<img src="/media/images/user_13823/titanic_1_large.jpg" />

Recent theories postulate that the steel of the Titanic may have been defective, causing the ship to break in half before it went totally vertical as in the film; however, one thing is certain.  Whether the ship went totally vertical before sinking to the bottom of the sea, the entire ship did sink in the process, making that theory entirely academic.

The point of the analogy is that the only way to survive what appears to be coming out of this pending debacle is to be among the fortunate in the lifeboat.  In case it isn't clear, gold, the currency to which the world reverts throughout world history - is a lifeboat.  If you are playing with treasuries thinking that they will outlast the Euro, you are running to the opposite end of a ship that is doomed to sink and you are embracing the herd mentality that reflects human nature.

Billionaires and Nations position themselves

We are now learning due to public filings and news reports that billionaires and world leaders are buying heavily into gold.  Even our "former" enemies are stockpiling gold, which is a bit troublesome when contemplating the "golden rule" in that context.  Vladimir Putin has joined the ranks of those dramatically augmenting a large gold position.  The September 10th headlines proclaimed to an ambivalent public:
Double Down: Vladimir's Putin Billions Into Gold In Anticipation of Global Upheaval

"In the last seven months alone the People's Republic of China has added more gold to their reserves - over 500 tons… Russia's President Vladimir Putin has been aggressively investing into the precious metal over the last five years - spending some $500 million monthly as he diversifies his country's assets out of Dollars and Euros. Currently, 9% of Russia's reserves are held in gold. This, of course, begs the question: why?"

The Chinese government not only has stockpiled gold, they have encouraged their citizens to do so as well. Prosperous though their citizens appear, the communist regime is still in charge.  In communist regimes, people are the property of the state.  This means the physical gold their government urged them to buy is the government's gold and can be taken from their subjects by that government at will. Taking that into consideration means we may be grossly underestimating the amount of gold the Chinese government actually owns.

When the fiat currencies of the West finish their ongoing collapse - the oppressive governments that own gold - may be in a much better position than governments of the West including the US.

Many are concerned about "confiscation" which certainly is not without precedent in America.  Our government could conceivably make a move to abscond with the gold owned by the private sector and the citizenry under the guise of protecting us against the regimes.  After all, how can our virtually bankrupt government compete when the communists have ownership all of that gold, all of that wealth - while America's gold is owned by private citizenry?  In a situation where our government has to "lay off" our military due to trillions being spent on entitlement programs, one can see the writing on the wall of another impending confiscation attempt as in 1933.

This warning is not intended to advocate what this prodigal government may well attempt, but rather to serve as a warning to those who have the discernment not to be long Treasuries (or any fiat based instrument) to prepare now for that day.

Always Diversify (including among types of gold holdings)

Anytime I am asked what is the "best way" to buy gold, I always recommend diversification. There are several popular ways to buy gold including buying physical gold through various dealers as well as through ETFs and even shares of companies that mine the metal. When I write about the miners or the SPDR Gold Trust , which I do own, I am certain that I will receive many comments and e-mails warning me that it is "just paper" and not real gold.

I find it to be an interesting argument and not totally without merit.  As one who is an ardent proponent of diversification, I have long recommended the use of both the ETF and tangible gold as a part of an overall hedging strategy.

Although long gold since 2004, including GLD, I am not what one would call a "gold bug" as gold is not the only thing in which I invest. Some of the zealots have argued that "GLD is just paper gold." Well, in many cases I could say the same thing about their gold coins. Unless they only have a few gold coins to their name or are brave enough to have their life's savings buried in their back yard - many of them have their gold in safety deposit boxes at banks and such locations.

Well, that safety deposit box is theirs for a leased term according to a piece of paper and a key the bank has lent to them. When they walk out of that bank, all they have to represent their gold is "paper" because someone else is keeping the metal for them. I guess using their logic, that makes their receipt a derivative for gold. Similarly, by virtue of my owning shares of GLD, my share of gold bars are held in London vaults of HSBC Bank USA NA (See #10 of FAQs). 

I wrote that in jest but many of the concerns about the gold held for the ETF could be applied to the bank safety deposit box.  If one is worried about the government confiscating the gold held in those London vaults, they should probably worry about the government shutting down the bank and plundering their safety deposit boxes when it comes to a crisis of that magnitude.

I do not mean to knock gold coins. I think investors should own physical gold coins and have them in diversified locations.  I also like the SPDR Gold Shares (GLD) for their liquidity.  It is one fast and easy way to trade in gold for a portion of one's holdings on the way up (and investors can write options on them).

 


I own a position in SPDR ProShares Gold ETF (GLD). The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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