I have History on My Side, What do you have?
Looking around at the investment world today, I am struck by how hard it is for adults to face the music, to look at the world for what it is. Denial, prevarication, obfuscation, dissembling, happy-talk, whatever you call it -- but it looks as though many grown adults refuse to accept reality. For me, as someone who believes in the power of history, I have seen this before -- many times -- but not personally. Instead I have seen it in other eras and ages. And with Jesse Livermore-- the great Wall Street investor who ultimately took his own life -- I too believe that “the game does not change and neither does human nature.” I believe that I have a much more useful tool to work with than economic modeling, accounting expertise, or mathematical prowess when I read or talk to people dispensing financial advice. I believe I have history on my side when I tell people to buy precious metals.
A Well Worn but True Cliché: He Who Has the Gold Makes the Rules
History teaches that human beings are frail, fickle, prone to extremes of euphoria and pessimism, and often love to claim that their era is better than times past. History is filled with people who claimed that their time was different (and it wasn’t), and that they could escape the mishaps that have plagued earlier people (and they couldn’t). Above all, history teaches humility.
Most people don’t bother remembering that the conventional wisdom among British stock speculators in 1720 was that shares of the South Sea Company could never go down, that the untold riches of the New World would make the ludicrous price of the shares seem worthwhile, and that no one other than Isaac Newton himself held his stock in the company as it subsequently lost more than 80% of its value (the equity market in Britain took nearly a century to recover). Fast forward 140 years to the American South, where cotton planters were convinced that cotton could never go down, that it was OK to have leveraged positions in land and slaves, and, later, that Confederate bonds were the way to go. No one in the South saw defeat coming, no one saw the collapse of cotton, or the Union’s emancipation of slaves. Overnight, men worth 100,000 dollars (multimillionaires today) lost literally everything. This story repeats again in Weimar Germany in the 1920s, where many German investment managers told their clients to keep their money in the Papiermark even as that mark lost 99% of its value, and as the price of gold in Papiermarks went from around 100 to something around 1 trillion per ounce. (And you thought 1300 dollars was expensive for gold!). People should remember Vietnam in the 1960s, where gold was the one thing the refugees had to trade with American military officials after war and the communist government ravaged even other “tangible” Vietnamese assets like farms and houses. I think some people may have already forgotten how in Argentina less than ten years ago, people who held American dollars domestically got taken to the cleaners when the Peso collapsed 75% and the government converted all domestic dollar bank accounts into pesos (so much for the magnanimity of government).
In each of these cases, those strange people who held on to shiny little metals called gold and silver survived and even prospered to help not only themselves but their family and neighbors. This may also be why central bankers, for the first time in decades, have stopped selling their gold and are rumored to be strong buyers. How interesting.
Relearning the Obvious: The Role of Precious Metals in History
The reasons people throughout history have turned to precious metals are many, and it is amazing that these reasons need to be repeated after 2008, but so it goes with the conventional financial media and brokerage firms. Gold and silver are easily divisible and standard in composition, nearly indestructible, and they are not generally seen as a necessity of life (such as oil or grains), so there are fewer qualms regarding hoarding them. Gold in particular is especially portable- a million dollars fits in a relatively small box. (Gold is getting even more portable in dollar terms by the day, if you catch my drift.) For these reasons, if you are a central banker or someone managing billions (now trillions) of dollars and you want something that is outside the banking system, that cannot be devalued by fiat, that is easy to physically take delivery of and is indestructible, you would turn to precious metals- not bulky and perishable items such as oil barrels or farmland (though they are far better than paper).
Gold and silver are also far more inelastic than other commodities, meaning that when a bunch of demand comes into these markets, you cannot just go out and mine more gold or silver. New mine supply probably only increases the overall supply of gold by less than 5% in any given year- if even that. There are fewer ounces of gold than there are people on earth- and many fewer above-ground ounces of silver (not a widely known fact), even if there are supposedly many more ounces of below-ground silver. For all of these reasons and others, precious metals form their own asset class, similar to, but different from other commodities because of their scarcity and their history as currency. You would think that most financial advisors would at least recommend some sort of reasonable allocation (10-30%) to the precious metals sector, either in bullion form, or with mining shares. You might think so, but you would be wrong. Legendary investor Jim Rogers recently reported most hedge fund managers at a conference admitted to him they did not own one ounce of gold (I find that a little hard to believe, but on second thought, maybe not.) In fact, investment managers not only fail to recommend a decent allocation to precious metals, but as a rule they deny that precious metals are a distinct asset class from other commodity investments in the first place! To me, this borders on tragic.
So many commentators on various (unnamed) cable news stations say gold has no productive value, that it is a bubble, and, of course, that they don’t own it (or so they say). I would remind them that perception is reality with all “investments”- many of which are simply numbers on a computer screen. These commentators will tell you with a straight face that stocks are the way to make money off of new industries, new technologies- ignoring the fact that most investors made no money in the last decade, even while CEOs made off like bandits. They also ignore the fact that stock market in Germany and Japan in the 1940s more or less went to 0, even while people needed tangible assets, whether oil, liquor, or metals. Stocks are no replacement for tangible assets! These same aforementioned commentators will call 2% dividend yields on stocks a screaming buy, and they will tell you that high yield debt offers great long term value, even when consumers are trying to get rid of debt, not take on more. And these commentators look at gold and silver, which have been in a raging, ten year bull market, and they look into the TV camera genuinely puzzled. They are not alone- Ben Bernanke himself recently said that he didn’t understand why gold was going up. Really? I am not sure what is worse: Bernanke not knowing why gold is going up, or him lying about it. I am actually starting to feel sorry for these people because I bet they sense that something is wrong with their world but quickly bury the emotion. Many of them may have a small hunch that a way of life died in 2008, and that the 0% interest rate offered by the Federal Reserve means that debt saturation and debt aversion is reaching levels perhaps not seen in modern human history- but these financial elites probably feel that this negative talk is better left unsaid. Better not to scare the “sheeple.”
Among supposed “safe havens” and “tangible assets,” precious metals will outshine
But try as they might to repeal history, history will win out, and a whole generation of people will be brought back to respect the humbling lessons of the past. You see, trees don’t grow to the sky, and neither does debt. We are on the back end of the unwinding of not simply a housing bubble, or a tech bubble, or a credit card bubble: we are on the back end of a bubble in debt itself. Of course, the real unwinding has not begun yet -- that will come in the sovereign debt market, which for the time being is offering good returns, as it has for nearly 30 years. But again, trees do not grow to the sky. Debt still saturates everything. Take the example of bonds and residential real estate. Residential Real Estate is a form of debt. You read that correctly-- I believe it is no longer a hard asset. How many people do you know pay 100% for their homes in cash? You think people never did this in the past? Wrong- read Robert Schiller, among others, on the history of real estate. Before the 1950s, you generally had to pay at least 50% down for a home, in many cases you paid for your house in cash. 100% down. And if banks were to extend you a loan they would practically send a private eye after you to verify your financial worth. A novel concept, no? But over the past few decades and especially during the last ten years, you might as well call real estate, debt estate. It will not provide the kind of inflation protection people think it will, because real estate during the Baby Boom era was a play on credit expansion, and was not a store of value. Productive farmland is a different story, of course, but is anyone recommending buying farmland? Well I just did, but I would bet that too is a minority position. Of course, real estate has already begun to deflate; not so with bond prices. They are still in bubble territory, trying to repeal history and grow to the sky. Likely, it will take a collapse in this last, perceived safe haven of fixed income to push the crowd into precious metals.
The general absence or underinvestment of the retail investor is one of the more frustrating aspects of this bull market in precious metals. This is all the more frustrating given how retail investors have seen stock portfolios get hit twice with 50% declines in the last decade, and in many areas, they have seen an implosion in real estate values, a now heavily leveraged asset which destroyed many families’ balance sheets. They lost everything. The retail investor has endured the added insult of 0% interest rates on their bank savings, which means there is no opportunity cost of pulling money out of the banking system and into tangible assets. So, in theory, I would have thought the public would have turned to precious metals long ago. Because to me, at least in my mind, every time someone loses their home and realizes they were duped by the something-for-nothing world around them, they should become a gold bug. Every time someone loses their job because multinational corporations believed it made more sense to send that job overseas than to keep it at home, they should become a gold bug. Every time someone looks at Wall Street and sees the market drop 1000 points in a matter of minutes because someone with a “fat finger” pushed a wrong button, they should become a gold bug. Every time someone looks at Washington, D.C. and sees mainly bipartisan, self-interested corruption, they should become a gold bug. Every time someone realizes that we as a society need to take our medicine and accept austerity, that we need to audit (or abolish) the Federal Reserve, or try to find out how much gold really is in Fort Knox, they should be well on their way to becoming a gold bug. Every time someone realizes that Bernard Madoff was more than a criminal-- he was a metaphor for a fraudulent fiat currency system-- they too should become a gold bug. The fact that more retail investors have not embraced precious metals perhaps speaks to their participation in the last bubble still left: that in long-term debt, a bull market going on 30 years strong.
Precious Metals as Peaceful Civil Disobedience
But I see trouble ahead there too. What happens once the Fed has to acquiesce to the market and let interest rates rise, because it has failed to bring down unemployment after seeing its ultra-accommodative policies set off an inflationary price spiral? (Something that seems likely in my mind) This will be the end of the bond bubble, regardless of all the talk about Quantitative Easing II. And this will be the beginning, the moment of realization by the masses, that they have been badly misled by self-interested leaders in the media, financial industry, and government. They will turn to the two things that have always been currency: gold and silver. (This time they might also turn to palladium, platinum, and gemstones).
Moreover, the public will buy gold and silver not for a quick profit, not to try to game the system, and not because they want to buy more SUVs or McMansions. Instead they will buy precious metals out of a sense of moral imperative. This is where the game changes. This, I believe is the most powerful motivation to purchase something. For most it will no longer be about investment performance, or whether or not the government heavily taxes precious metals, or attempts confiscation. Buying precious metals will be seen for what it is: peaceful civil disobedience against a system that has backfired on many Americans (even if Americans were complicit in the process). And once the public buys their gold after being burned for the last time in fixed income investments, for example, the public will hold on to gold whether it is 5,000-- 15,000 -- or a million dollars an ounce. Because they will have come to believe that you would no sooner sell your gold (and silver), than you would sell you life raft when you have just jumped off the Titanic.
And when your investment advisor looks at you like you are crazy for trying to buy precious metals, you turn right around and ask them: I have history on my side, what do you have?
