Investing in gold is that you're not really investing in gold. You're investing against the U.S. dollar. It's not that gold goes up, it's that the value of a dollar goes down. Actually, it's even more subtle than that. What you're doing is you're betting against the interest rate on the dollar. I know this sounds odd, but any currency you carry around in your wallet has an interest tied to it. That's essentially what the currency is—that rate—and it's the reason why anyone would want to use it. Gold can be seen as the way to keep all those currencies honest. People mistakenly believe that gold is all about inflation. That's not quite it, but high inflation is usually very helpful for gold. What gold really likes is to see is very low real (meaning after inflation) interest rates. Gold is almost like a highly-leveraged short on short-term TIPs. Here's a good rule of thumb. Gold goes up anytime real rates on short-term U.S. debt are below 2% (or are perceived to stay below 2%). It will fall if real rates rise above 2%. When rates are at 2%, then gold holds steady. That's not a perfect relationship but I want to put it in an easy why for new investors to grap. This also helps explain why we're in the odd situation today of seeing gold rise even though inflation is low. It's not the inflation, it's the low real rates that gold likes. This chart shows the three-month Treasury bill rate minus the one-year inflation rate (low is good for gold, high is bad):
In February, gold took a big hit when the Fed announced it was lifting the discount rate. This isn't the all-important Fed funds rates, but you can see how nervous the market was over the threat of higher real rates. This rule of thumb also tells us that gold can rise very quickly and it can fall very quickly. One Ben and his pals at the Fed raise rates, gold is in for a world of hurt. The history of the price of gold is long boring periods with sharp dramatic spikes. The up part of the spike is fun. The downside, less fun. What's tricky about gold is that it's also impacted by geo-politics. Gold peaked in 1980 shortly after the Soviets invaded Afghanistan. It reached a low point not long before we did the same. The pricing of any commodity can be tricky because commodities are subject to substitution. Let's say that gold, despite its high price, is the cheapest way to make a part for a certain kind of semiconductor. That will drive demand for gold. However, let's say that once gold crosses a certain level, it's no longer the cheapest way to make the part. Maybe unobtanium is a better way to go. That will, in turn, undermine gold's value. It's price impacts its price. This is a major difference between investing in equities and investing in commodities. Stocks are companies, filled with people aiming to make a profit. Gold is just a rock. It just sits there. In 10,000 years, it will still be a rock. My view is that the Federal Reserve will raise interest rates earlier than expected. I don't know exactly when that will be but it will put gold on a dangerous path. For now, my advice is to stay away from gold, either long or short. Safe Harbor Statement: Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints. Nothing in this article is, or should be construed as, investment advice. |
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