Metals Market Report 11-25-2014

The Mike Fuljenz Metals Market Report

November 2014, Week 4 Edition

Is Gold Still an Inflation Hedge?

Gold rose above $1200 Friday on a pair of major central bank announcements.

In USA Today last Friday (November 21), in an article entitled “Gold’s cheap, but look before you leap,” John Waggoner was skeptical of gold’s role as an inflation hedge. He used these historic examples:

“Gold has a reputation as an inflation fighter, but the data really don’t support that. From 1980 through the end of October, consumer prices have gained 209% while gold has risen 129%. In fact, gold’s performance bears little correlation to inflation. From 1980 through July 1999, the price of gold swooned 50%, to $255 an ounce, while inflation rose 117%. And during the relatively benign period from July 1999 to August 2011, gold soared to nearly $1,895 an ounce.”

He seemingly cherry-picked his dates to make his case. He started his survey in 1980, a peak year for gold. If he had gone back to the full century of currency erosion since the Federal Reserve was born, he could have measured gold vs. inflation after the government’s major changes in valuing gold vs. paper:

  • In 1913, the Federal Reserve was born and so was the Consumer Price Index (CPI), so we can see the results of gold vs. inflation for a full century. Since 1913, gold is up 58-fold (from $20.67 to $1200), while the CPI is up merely 23-fold, so gold has grown 2-1/2 times the rate of inflation.
  • In 1933, FDR forced the sale of privately-held gold and then he revised the gold price to $35 per ounce in early 1934. The CPI is up 18-fold since early 1934, so gold has risen nearly twice as fast (34-fold) from $35 to $1200 – and 58-fold from its $20.67 price paid to American citizens.
  • In August, 1971, President Nixon closed the gold window. Since then, CPI inflation is up 483.3%, while gold is up 3,329%, so gold has beaten inflation by almost 7-fold since then.

It’s a mistake to think that gold tracks inflation each year, or month, or even decade. Gold does not track inflation that closely. Gold is subject to the buying and selling of market traders, like any investment, but over time gold has proven itself to be an inflation hedge AND a deflation hedge, i.e., a currency hedge.

Louis E. Eliasberg – The King of Gold Coins

Louis E. Eliasberg Sr. came to be known as “The King of Coins” after he accomplished a feat many thought to be impossible: Over a period of less than two decades, from 1934 to 1950, Eliasberg assembled the only complete collection of U.S. coins – the only one that contained regular-issue coins of every denomination from every date they were issued and every mint that made them in those years. News of this achievement not only electrified fellow hobbyists, but also impressed the entire nation. It was considered so significant that Life magazine, then required reading for millions of Americans, featured Eliasberg and his coins in a lavish photo layout. Yet, this “King of Coins” didn’t have kingly wealth. He lived comfortably on his income as a Baltimore banker, but his budget for buying coins was not unlimited. Nor was he known as a big spender: Dealer who did business with him found him to be a cautious buyer who took out his checkbook only after careful deliberation. Eliasberg wasn’t even a hobbyist when he started buying coins: He did so as a way to circumvent the Gold Surrender Order of 1933, which required U.S. citizens to turn in their gold coins, but exempted collectible coins. “I realized the only way I could legally acquire gold was by becoming a numismatist,” he explained years later. “So in 1934, to the extent of my means, I started buying gold coins.”

Soon bitten by the hobby bug, he started buying other coins as well, and within a few years he had built a respectable collection. Then, in 1942, came a marvelous opportunity: He was able to purchase outright the outstanding collection of John H. Clapp – in the process acquiring many rare coins he didn’t already possess. That’s when he began thinking seriously of pursuing the impossible dream: a U.S. coin collection with “one of everything.” He prepared a list of coins he lacked and started tracking them down in auctions and dealers’ inventories. “Eliasberg struck me as a gentleman,” one prominent numismatist later recalled. “He was tall, aristocratic, a genius at finance, but he didn’t know very much about coins… He knew more about making money.” His success at making money has become the stuff of legends in the coin collecting community. During the decade and a half it took him to complete his collection, Eliasberg spent less than $400,000. When the collection was sold, at a series of auctions between 1982 and 2005, it realized a grand total of roughly $55 million – more than 100 times what he had paid.

The gold coins he started buying in 1934 not only turned Eliasberg from a numismatic novice into a great collector, but also ended up confirming his status as a very successful investor. In short, even if he had never begun pursuing the seemingly impossible dream of collecting “one of everything,” Eliasberg would have made millions just through his decision to buy gold coins as collectibles.

ETFs: One Big Reason Why Gold Rose from 2001 to 2011 – Despite Low Inflation

Last week, The Wall Street Journal celebrated the 10-year anniversary of the birth of the biggest gold exchange-traded fund (ETF), the SPDR Gold Trust (ticker symbol: GLD) on November 18, 2004. On that date, gold was $442 per ounce and the Dow Jones index was 10,572, so in the decade since this gold ETF was born, gold is up 171% vs. just 68% for the Dow Jones index. In the same decade, the CPI is up only 24.3%, so stocks and gold have both beaten inflation, but gold has risen much faster than stocks.

The gold ETF created a whole new set of gold investors – the paper-oriented stock trader who does not want the hassle of buying and storing physical gold. When the ETF was launched, the SPDR fund held eight metric tons of gold, worth $115 million at the prevalent price of gold at the time. Ten years later, despite massive selloffs in 2013, GLD currently holds $27 billion in gold, or about 700 metric tons.

Gold’s rise and fall were exacerbated by momentum buying by ETF investors. At gold’s peak price in August of 2011, GLD held $77 billion worth of gold (about 1260 metric tons at $1900). For the next 20 months, GLD traders basically held on to those shares, hoping for a recovery. By the end of 2012, GLD held more physical gold bullion than all but four central banks. But in mid-April 2013, there seemed to be an orchestrated ETF selling campaign by large firms, sending gold sharply down for the rest of 2013.

There’s no question that GLD helped push gold prices higher, faster, than it normally would have risen. By the same token, panic GLD selling in 2013 sent gold further down, faster, than it would have fallen in a physical-only market. For better (mostly) or worse (lately), the GLD ETF has transformed gold from a “boutique” investment into the mainstream of investment choices. When gold begins to take off again, it’s likely that these gold ETF traders will follow the momentum of the metal and bet back on board.

One More Error in USA Today

When non-specialists write about gold, they tend to make honest mistakes. Waggoner’s use of 1980 as a measuring rod for gold is a good example. Most mainstream journalists compare gold’s price today to its earlier peak year of 1980. This would be like stock market analysts comparing any stock market recovery to the peak stock prices in early 2000, instead of from the stock market’s recent low in March, 2009.

Author John Waggoner made another honest error when he said “You can always buy gold bullion coins from the U.S. Mint.” No, you can’t. The Mint only sells American Eagle gold (or other bullion coins) to authorized dealers, who may then sell them to the public. He was honorable in admitting to me that he was wrong about that, but he held firm by defending his article for making 1980 the starting point for gold price measurements, since he used the average price in 1980 rather than the peak price of $850. Still, 1980 had the highest average gold price of any year before 2006. To be fair, he could have added:

  • In the last 50 years – since November 1964 – gold is up 34-fold vs. 20-fold for the Dow.
  • In the 15 years since the turn of the Millennium, gold is up 314% vs. 55% for the Dow.
  • In the last 10 years, since the GLD ETF was born, gold is up 171% vs. 68% for the Dow.

The lesson for any chart or date comparison: “I can show you any trend, if I control the start and end.”

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