In our blog post of March 22, 2013, entitled “Your Money and Your Life,” we said that the U.S. Congress, the Department of the Treasury, and the Federal Reserve are pursuing a policy of debasing the U.S. dollar. The continuous debasement of the U.S. dollar propels a long-term upward movement of the dollar price of real assets—that is assets such as precious metals, petroleum, and shares of companies that are called “real” in contradistinction to paper money created by the state.
According to the U.S. Consumer Price Index the purchasing power of a dollar in 2013 is the same as six cents ($0.06) in 1933. 1 Over that 80-year period beginning in 1933 deliberate dollar debasement has raised the price of real assets in dollar terms. For example, our prior blog post said that the price of gold is up from an ounce to ,600 an ounce (as of late March 2013) 2 and the price per barrel of crude oil is up from $1 to $93. Gold is no scarcer in 2013 than in 1933.
Between August 2001 and August 2011 the price of gold in U.S. dollars rose 633%, from $256 an ounce to $1,876 an ounce. That sensational increase in market price started relatively gradually, with a 75% rise from August 2001 to August 2005. Entrepreneurs in the financial service industries sought to take advantage of the heightened interest in precious metals by creating new financial “products” to sell to the public, such as the ETFs (exchange traded funds) for gold and silver started respectively in 2004 and 2006.
Since August of 2011 the U.S. dollar price of gold is down about 25% with about two-fifths (40%) of the 25% decline occurring in the five weeks beginning March 22, 2013. Rises and falls of such magnitude are part and parcel of the stock market, but Americans had not experienced in recent years such downside volatility in the market for precious metals.
Contemporaneously the stock market is rising—doubling off its lows reached at the nadir of the stock market crash of 2008-2009, a crash that was part of the financial crisis that erupted in 2007-2008. The recent decline in the price of precious metals is a shock to those Americans who only recently began to consider precious metals as an alternative to fiat money dollars and debt securities denominated in dollars, especially since the stock market has been rising while precious metals prices have been falling.
Accordingly, we reproduce here some words of wisdom on this subject—gold price downside volatility—from Darren Pollock and David Horvitz of Cheviot Value Management, LLC (Cheviot). That firm was co-founded in 1985 by Frederic G. Marks, author of the prior post entitled “Your Money and Your Life,” and proprietor of the website of which it is a part. These comments are quoted from communications by Darren and David to Cheviot clients including the firm’s most recent newsletter, which can be viewed at http://cheviotvalue.com/ 3
Since 2007 the number of Americans unemployed is higher by 97% at 13.2 million, the prior twelve months’ Federal deficit of $975 billion is up tenfold compared with the 2007 figure, total U.S. debt outstanding climbed by 82% to $16.4 trillion, and, sadly, the number of impoverished Americans is 33% higher than six years ago. The labor participation rate (the percentage of those working out of those who would like to work) is at a 34-year low. This rate is far more accurate in portraying the health of the employment market because, unlike the unemployment rate, it does not ignore the millions of Americans who have ceased to look for work.
In its latest 10-year projection, the Congressional Budget Office (“CBO”) predicts for the next few years a rather optimistic scenario of strong economic growth, plus low rates of interest and inflation to lessen—yet still not eliminate—the annual U.S. deficit. Interestingly, the CBO’s ten-year projection a decade ago, in 2003, was for a cumulative surplus of $2.3 trillion. What the U.S. experienced instead was a cumulative deficit of $7.1 trillion.
How can anyone realistically expect the U.S. to grow its way out of debt, given that during its heyday of economic expansion, the U.S. debt nearly tripled from 1991 to 2007 and today’s debt is far larger at $16.8 trillion? Even the CBO, whose prior predictions were far too optimistic, expects the debt level to climb above $26 trillion by 2023.
Throughout economic history, countries in this predicament have had a few choices.
1. Attempt to grow out of the debt.
2. Employ austerity measures to eliminate deficits.
3. Default on the debt by overtly paying creditors back less than face value on their debt, a policy that is akin to an economic act of war that would crush the value of the U.S. dollar
4. Dramatically increase inflation to lessen the burden of existing debt outstanding. Eureka! This cheapening of fiat money, such as the U.S. dollar, and increase in inflation is gradual and hard to see. Compared to the currency devaluations which occur regularly in other countries, the covert path of inflation is the financial equivalent of carbon monoxide. It is silent, colorless, and odorless.
With the Fed suppressing interest rates and monetizing billions of dollars’ worth of U.S. Treasury debt every day, stocks have levitated. “It is very artificial. If you give me a trillion dollars, I’ll show you a good time too and a lot of people are having a good time,” stated expert investor Jim Rogers in a March 28th CNBC interview. “I’m somewhat skeptical because I know it’s going to end badly.” After prices have risen, the average stock investor wants to get in. Not Rogers: “There are better places to invest than [where prices are reaching] an all-time high.”
Boston-based research firm, Dalbar, Inc. studies the behavior of owners of mutual fund shares and analyzes the discrepancy between the returns earned by individual shareholders compared to those of the underlying mutual funds to which the individuals commit their funds. Dalbar found that aggregate returns for the shareholders of mutual funds lagged far behind the performance of the mutual funds themselves. Dalbar proved unequivocally that when viewed collectively, individuals—lay and professional alike—buy high and sell low.
The Dalbar study showed that market participants’ behavior revealed regular patterns. Periods of high returns caused increased buying, whereas relative or absolute poor recent performance spurred selling. Whether they know it or not, fear and greed guide the decisions of many market participants, including professional money managers. This lures them into committing their funds to the market more heavily near market tops and withdrawing near bottoms.
Naturally, this emotionally driven activity is one of many sure ways to poor results. The inclination to think of what has happened instead of what might or will happen is a natural human tendency. And these are actions repeated in every market cycle, of every decade, throughout market history. Countless market participants fell prey to what we named “the Dalbar effect” in the years just before the 2000 market crash and again before the 2008 implosion. While market participants clamored for all things tech, telecom, and dot-com ahead of the 2000 wreck, so too were professional and lay persons attracted to anything related to housing stocks and emerging markets (among others) in advance of the 2007-2009 market crash, the greatest crash since the early 1930s. Indeed, greed can dull one’s desire to heed the lessons of financial market history.
Conversely, fear often prevents market participants from holding on through turbulent periods.
Today’s market is the antithesis of what occurred at the depths of the 2008-2009 bear market. Few people wanted to buy then; nearly everyone wants to buy now. The stock market is there to provide us with the opportunity to buy or sell. It is not there to direct us by its often wild behavior. As Warren Buffett wrote in 1988, “Our marketable equities tell us by their operating results—not by their daily, or even yearly, [stock market] price quotations—whether our investments are successful. The market may ignore business success for a while, but eventually will confirm it.”
Even though gold has outperformed most other asset categories during the past decade (notwithstanding its recent price decline), it remains an unloved asset. It has performed well because gold gains relative value when the quantity of money is increased at a rate faster than that of the underlying economic growth. At such times, the U.S. dollar—given that it has not been backed by any quantity of precious metal since 1971—is debased. This eventually fosters price inflation throughout society. While some prices in the economy are already rising (land and property prices are levitating in large part as a function of cheap borrowing costs and the threat of future inflation), many daily prices of goods are not dramatically higher. This is because consumer and producer price inflation follows currency debasement with a lag.
The meager austerity measures in expenditures of the U.S. are doing little to reduce the federal deficit or U.S. debt levels. But they are causing the economy to slow materially. This should lead to continued monetary creation (i.e., debt monetization and currency debasement) by the U.S. Federal Reserve, like other major central banks globally. Japan, all of Europe, the U.K., etc. all face similar problems.
Market historian and investor Jim Grant shared this insight recently: “There’s a distinction to be drawn between a panic when the cause is really the structure of the marketplace and a crash in which the collapsing asset class portends something about the future . . . It seems to me what is intact at this time is the determination of central banks to print their way out of trouble which is terrifically bullish for gold in the long term. So I remain bullish [on gold], though chagrined.” 4
There have been major market events throughout history that told us only something about market behavior itself—and nothing about the future. Think of the October 1987 crash in stocks. Market prices fell precipitously in one day but the underlying economy was no different. For those with fortitude, it was a buying opportunity. At the time legendary value investor John M. Templeton stated that the underlying economy was no different, that the companies he owned were little changed, and that he was setting out to make consistent purchases of the very securities that had lost nearly one quarter of their market value that week. A maxim of John M. Templeton is that “The time of maximum pessimism is the best time to buy.”
Those with a sense of history may see much now that is reminiscent of the 1970s, when despite ongoing monetary debasement the price of gold experienced bouts of selling. The Federal Reserve was employing aggressive monetary policies in the wake of the 1973-1974 bear market for stocks. This helped propel stocks higher and, by 1976, market participants were too positive on the economy to find any value in gold. Gold declined dramatically, reaching a bottom on August 25, 1976. However, less than a year later it had nearly doubled and over the ensuing four years, it climbed by more than 700%.
And it should be noted that the monetary policies of the Federal Reserve in the 1970s were quite restrained in comparison with those of the Fed today, and the amount of monetary debasement then was miniscule compared to what the Fed is doing at present.
- See the CPI Inflation Calculator of the federal Bureau of Labor Statistics at http://www.bls.gov/data/inflation_calculator.htm ↩
- Actually the late March 2013 price of gold was around ,550 an ounce ↩
- Frederic G. Marks is no longer involved in the operations of Cheviot. The firm’s business is being carried on capably by Darren Pollock and David Horvitz. ↩
- Quoted from interview at http://www.bloomberg.com/video/gold-prices-may-be-falling-on-momentum-grant-says-~lfBNvoMQTezFJZ9ZTUzUw.html ↩