Not All Gold Bugs Wear Tinfoil Hats

Gold has had some reputational issues since reaching a record high in 2011. The thesis at the time was that a massive expansion of the money supply via the Federal Reserve’s quantitative easing program would spark hyper-inflation, making hard assets more attractive than financial assets. Hyper-inflation never came to pass, which helps to explain why the price of gold tumbled almost 50% over the following four years.

We still don’t have very much inflation, and yet there is renewed interest in gold with prices reaching their highest since early 2013 at about $1,440 an ounce. There are a lot of reasons to like gold. One is that gold tracks fairly closely with budget deficits. The highs of 2009-2011 roughly corresponded with the large deficits that reached 10% of GDP during the Obama administration, which included the stimulus spending during the Great Recession and a sharp depreciation in the value of the dollar.

This time there is a sense that the deficit problem is large and intractable. The Congressional Budget Office forecasts the deficit will more than double to 8.7% of GDP by 2049. Also, there is open discussion of things such as modern monetary theory, or MMT, which would be about the most gold-bullish development imaginable.

Gold is the closest thing that we have to an objective store of value. Many disagree, saying there is nothing objective to gold’s value, since it generates no cash flows. That’s not the point. The point is that there is a finite amount of gold in the earth’s crust, there is growing evidence that we have mined most of it, and aside from traveling to an asteroid, we aren’t going to produce much more. (Full disclosure: I have positions that would profit from rally in gold and the shares of gold mining companies.)

The cryptocurrency promoters argue that Bitcoin is an objective store of value, and they are somewhat right, since there can only be a certain number of coins in existence. But Bitcoin has some technical complications that gold does not, such as what happens if the power goes out? I have argued for years that tangible things you can pick up and touch are considerably more valued than lines of computer code. Time will tell.

But the biggest factor affecting gold prices recently has been the proliferation of negative-yielding debt. There are about $13 trillion of negative-yielding bonds in the world, and a shiny rock that yields nothing – but, admittedly, has some storage costs - is actually high-yielding in comparison.

Those who advocate the investment merits of gold are often labeled as “gold bugs,” which has become a somewhat derisive phrase, associated with conspiracy theories and tinfoil hats. But in the current political and economic environment, there are real intellectual reasons to think about gold other than hysteria over hyper-inflation due to money printing.

The hysteria over inflation due to money supply growth was pretty widely accepted in 2009, including by me, but it was the fear of inflation that drove people into gold, which worked out, and put options on 30-year bonds, which didn’t. In other words, gold can move on fear. It can move on fear of deficits and it can move on fear of MMT -- even if those fears are never realized. Markets are occasionally irrational, but that doesn’t mean there aren’t opportunities to profit from the irrationality.

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