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Wednesday, July 28, 2010

The Peculiar Allure of Gold: Part 1.1

Some time recently, we discussed here some of what seems to drive the price of gold.While all of the other arguments for owning gold are generally a pile of crap, I had noted that over time there did seem to be an inverse relationship with the value of the dollar under most circumstances. However, I would note of late that it seems that even this relationship has broken down.

This is a simple picture (click on it to enlarge):

What you are seeing there is a 3-month chart of the ProShares US Dollar Bullish Fund (UUP), which has leveraged bullish bets on the US dollar vs the SPDR Gold Trust (GLD) which tracks the price of gold. You might note that there is a positive correlation between the dollar and the price of gold. Wait... what?

Well, maybe for the past three months gold has been a bet against the Euro while over the long run it is a bet against the dollar while also being an inflation hedge while also being a crisis hedge while not doing a particularly good job reflecting any of those relationships! I think there is a simpler reason for the decline of gold recently and that is that as it is clear that there is no risk of accelerating inflation, probably the number one reason scared little Glenn Beck listeners have been hoarding gold has been undercut severely. By the way, bashing on Glenn Beck is not in violation of this blog's no political discussions rule since Glenn Beck's insanity transcends ideology. He gives investment advice and it is damn bad advice at that.

For instance, while things have gotten rough over the past few months and U.S. deficits are in the stratosphere, surely you wouldn't want to invest in worthless pieces of paper like U.S. Treasuries and instead would want the safety of gold, right? Wrong. Very wrong. Stupidly wrong.

TLT, our long term treasury proxy, kicked the hell out of GLD over the past three months while stocks, represented by SPY here, suffered as we all know. It is interesting to note that some gold bulls had maintained that stocks and gold must necessarily rise together because... um... well because they said so, that's why. Never mind that this is a relationship that has never really held except for brief periods when it seems to out of pure coincidence. Recently stocks have rebounded more sharply than many give them credit for while gold has been in a trudging decline.

Gold currently is trading in such a peculiar way that it is helpful to think about the following. Currently, gold is not trading in accordance with any clear rational relationship to, well, anything. If the rationale for investing in an asset is not clear, then you should not invest in it. I can easily spell out why equities are good buys at present levels based on well accepted empirically derived relationships. Gold, it is not so easy unless you truly believe that we are about to undergo a period of 10%+ inflation, which I do not and the markets do not either except for the gold bugs who are always and everywhere trapped in a particularly pernicious insanity.

It may well be that gold gets foisted to new highs by irrational markets, but I would wager that in the next five years gold will be beaten by just about everything, including housing.

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