Someone pointed out that the $859 million GLD position was in the form of call options; I missed that (don't go through filings late at night!) So the increase in the 13F portfolio from $1 billion to $2.2 billion is largely not 'real'; just an increase due to the reporting of the notional amount of the underlying GLD represented by the call options.
That's still heck of a lot of gold, but the exposure is a bit different than owning GLD outright.
Sorry for the error, and thanks for the heads-up!
Showing posts with label GLD. Show all posts
Showing posts with label GLD. Show all posts
Wednesday, May 30, 2012
Duquesne Family Office: Druckenmiller Likes Gold
This is not a blog that tracks the buys and sells of hedge funds or anything like that, but I just stumbled on this so I thought I'd post it. (Of course, a hedge fund manager liking gold is hardly breaking news, but...)
We all know Stanley Druckenmiller; he needs no introduction (if you do, just google him and there is plenty of short articles about who he is). He ran the Quantum Fund (Soros' Fund) and then his own hedge fund Duquesne Capital (which he actually started before joining Soros and continued to run during his time there) but closed down Duquesne in August 2010.
I noticed that websites that track hedge funds dropped his investment activities as Duquesne Capital no longer files 13F's. Well, that makes sense as it no longer exists.
But I did notice by chance that Druckenmiller started filing a 13F again but this time as "Duquesne Family Office LLC". So this is his own money.
I find this interesting for a couple of reasons. Of course, Druckenmiller is one of the all-time great traders/investors, so it's always interesting to see what he is up to. But what is really interesting now is that he is doing a lot of the work for the family office himself. His colleagues at Duquesne Capital left to start their own hedge fund (which Druckenmiller invested $1 billion in according to one article).
So the 13F stocks show what Druckenmiller himself really likes. It's not his other portfolio managers' picks. These are *his* picks.
You will notice that it's a much smaller list than what they used to file as Duquesne Capital. That makes sense.
Anyway, here is the 13F that was filed in May for the portfolio as of March-end 2012 (Look up Duquesne Family Office at sec.gov). See table below.
It is a small portfolio in terms of number of stocks and there are many familiar names in there. It sort of feels right to me as I feel like I can get a sense for why these stocks would be interesting; Wells Fargo is a great bank, YUM Brands is a great way to get exposure to China without having to deal with Chinese companies/fraud etc..., Chipotle is just recreating the fast food business, American Express is a transaction driven high return on capital business (paid on number of transactions, not loans outstanding etc.) etc...
SPDRs!
But then here's the whopper: 5.3 million shares of GLD, the SPDR Gold Trust. As of March-end 2012, that position was worth $859 million. The total U.S. equity portfolio on the 13F is $2.2 billion, so that's a whopping 40% of the portfolio invested in gold. Einhorn has 10% of his assets invested in gold. 40% is pretty big.
[Correction (added later): The GLD position is in the form of call options and the $859 million is just the notional amount; I didn't notice that the first time I looked at the filing. ]
As of September 2011, Forbes had Druckenmiller's net worth at $2.5 billion or so. So this $2.2 billion portfolio constitutes most of his wealth. Given that, this 40% exposure to gold is pretty big.
This is not like some billionaire that files a 13-F, but the U.S. equity portfolio is only 10 or 20% of his net worth or anything like that. It looks like this is a substantial portion of Druckenmiller's wealth is represented here. Of course, we don't know the real exposure as Druckenmiller probably has futures and options positions that won't show up here. We have no idea what his S&P 500 index futures and gold futures positions are. Also, I am leaning on Forbes' estimate of his net worth too and I have no idea how close those are, never having been a billionaire with net worth estimated by them.
And here's the other puzzle. The first filing the family office made was in February of this year and there is no GLD position there. Here it is:
13-F for Duquesne Family Office LLC filed on Feb 9, 2012 for Quarter ended Dec 31, 2011
[ Correction: Since the GLD position is just the notional amount of the call option, the above is irrelevant; there was no addition in the dollar value of the portfolio. ]
We all know Stanley Druckenmiller; he needs no introduction (if you do, just google him and there is plenty of short articles about who he is). He ran the Quantum Fund (Soros' Fund) and then his own hedge fund Duquesne Capital (which he actually started before joining Soros and continued to run during his time there) but closed down Duquesne in August 2010.
I noticed that websites that track hedge funds dropped his investment activities as Duquesne Capital no longer files 13F's. Well, that makes sense as it no longer exists.
But I did notice by chance that Druckenmiller started filing a 13F again but this time as "Duquesne Family Office LLC". So this is his own money.
I find this interesting for a couple of reasons. Of course, Druckenmiller is one of the all-time great traders/investors, so it's always interesting to see what he is up to. But what is really interesting now is that he is doing a lot of the work for the family office himself. His colleagues at Duquesne Capital left to start their own hedge fund (which Druckenmiller invested $1 billion in according to one article).
So the 13F stocks show what Druckenmiller himself really likes. It's not his other portfolio managers' picks. These are *his* picks.
You will notice that it's a much smaller list than what they used to file as Duquesne Capital. That makes sense.
Anyway, here is the 13F that was filed in May for the portfolio as of March-end 2012 (Look up Duquesne Family Office at sec.gov). See table below.
It is a small portfolio in terms of number of stocks and there are many familiar names in there. It sort of feels right to me as I feel like I can get a sense for why these stocks would be interesting; Wells Fargo is a great bank, YUM Brands is a great way to get exposure to China without having to deal with Chinese companies/fraud etc..., Chipotle is just recreating the fast food business, American Express is a transaction driven high return on capital business (paid on number of transactions, not loans outstanding etc.) etc...
SPDRs!
But then here's the whopper: 5.3 million shares of GLD, the SPDR Gold Trust. As of March-end 2012, that position was worth $859 million. The total U.S. equity portfolio on the 13F is $2.2 billion, so that's a whopping 40% of the portfolio invested in gold. Einhorn has 10% of his assets invested in gold. 40% is pretty big.
[Correction (added later): The GLD position is in the form of call options and the $859 million is just the notional amount; I didn't notice that the first time I looked at the filing. ]
As of September 2011, Forbes had Druckenmiller's net worth at $2.5 billion or so. So this $2.2 billion portfolio constitutes most of his wealth. Given that, this 40% exposure to gold is pretty big.
This is not like some billionaire that files a 13-F, but the U.S. equity portfolio is only 10 or 20% of his net worth or anything like that. It looks like this is a substantial portion of Druckenmiller's wealth is represented here. Of course, we don't know the real exposure as Druckenmiller probably has futures and options positions that won't show up here. We have no idea what his S&P 500 index futures and gold futures positions are. Also, I am leaning on Forbes' estimate of his net worth too and I have no idea how close those are, never having been a billionaire with net worth estimated by them.
13-F for Duquesne Family Office LLC filed on May 14, 2012 for Quarter ended March 31, 2012
And here's the other puzzle. The first filing the family office made was in February of this year and there is no GLD position there. Here it is:
13-F for Duquesne Family Office LLC filed on Feb 9, 2012 for Quarter ended Dec 31, 2011
Again, this is a nice, small (in terms of number of names), manageable portfolio of stocks.
First thing I notice is that Apple is here but not in the later filing, so Druckenmiller sold his Apple shares in the first quarter during that Apple frenzy. I haven't tracked back old Duquesne Capital filings, but I think they've owned Apple for a long time.
Also, he owned JP Morgan as of the end of 2011 but was out by the end of the first quarter. Did he dump it because he was hearing on the street about the whale and what Dimon would eventually call a tempest in the teapot and then later an egregious mistake?
The other thing, of course, is the GLD position. It's not there. So did he just buy gold in the first quarter of 2012?
The problem with these hedge funds is that you never know what their futures positions are from these filings and there are no futures 13-F's (that I know of).
So it's possible that Druckenmiller had physical gold in storage at the Fed, had a big futures position he kept rolling or whatever. And for whatever reason, he converted that into SPDRs. This is certainly possible.
That would explain the other thing I notice; the grand total of the portfolio is $1.075 billion in the December 2011 quarter filing but $2.2 billion in the March-end 2012 filing.
Since the 13-F is for only U.S. listed equities, there could be a lot of reasons for this. It could be as simple as the above gold position conversion into an 'equity' position. It could be due to sales of foreign stocks (that are *not* in the 13-F's) and purchase of U.S. equities (which *are* in the 13-F).
It could also be that he took some money back from people he had run some of his money, but there is no proof of that. But if he had assets managed by others, that would not show up in the 13-F. So that is certainly a possibility. It could be any of the above reasons (or another reason I didn't think of). If I let my imagination run wild, it almost looks like he just yanked a billion or so out of a macro fund he invested in and just put it in GLD's instead. But that is probably not what happened. It just sort of fits, but we really have no idea what is going on here (other than that he likes gold).
Anyway, this post is neither here nor there, but I thought it was a little interesting. I am a fan of Druckenmiller, even though I haven't really followed too closely what he has been doing over the years (except reading about him in the papers). And I normally don't look so closely at 13-F's and try to "diff" the filings from one period to the next.
Again, this is just something that I stumbled upon, and I think it's sort of a gem in the sense that we get to take a peak at the "pure" Druckenmiller; what he likes with his *own* money doing his *own* thing (and not his staffs), and not under pressure to perform from clients. It's like peaking into someone's PA (personal account), and that's always fun to do.
Thursday, March 22, 2012
On Gold and Inflation
I typed this up in late February and just found it as a 'draft' in my blogger. I thought I posted it already but didn't. So here it is:
So Buffett has a nice tutorial on investing in the most recent letter to shareholders (2011), available for free at the Berkshire Hathaway website.
He says that gold is just an object and doesn't produce income; that he'd rather own farmland, several Exxon Mobiles and $1 trillion of spare cash rather than own all the gold in the world.
Of course, this has gotten some of the predictable responses. I've even read some investment managers respond emotionally and angrily to Buffett's views on gold. That he just doesn't get it, that he is so smart but just has no clue about gold etc...
Well, first of all, when people respond with anger and emotion, it's usually not a good sign. Most people wouldn't care what others think of their investment ideas. That is the most important part of succussful investing; being able to think independently. Not seeking others who agree and dissing people who disagree etc... As Benjamin Graham says, you are right not because people agree with you, but because your facts and analysis is correct.
So when people respond emotionally and with anger when Buffett calls their favorite investment idea just a 'thing' and not a good investment, this tells me more about gold and the people who favor it.
This is not too dissimilar to what happened in the late 1990s too. People said Buffett just doesn't get it. I heard the same thing. People were even telling *me* that I should know better since I work in finance and deal with stocks that this internet thing is for real. I too faced anger and ridicule when I said most of these internet stocks will go to zero or at least down 90% or some such.
People really got mad when I said that. I do remember that well. I knew then that I was going to be right.
People who are confident and right don't care if others disagree with them. In fact, most of my best investments were the ones people would look at me incredulously. One of them went up 20-fold; someone called it just junk. Another one was a 10-bagger and my broker came back to me with the buy ticket and asked me, "Are you sure you want to buy this? Did you read the newspaper this morning? I don't thnk it's a good idea".
Making the right trade is always going to be hard. People are always going to disagree with you. If you are upset that the whole world agrees with you but one or two prominent people say it's a bad idea and that bothers you enough to write about it, that's a big problem to say the least!
Anyway, I already talked about gold and how I think at these levels and this level of sentiment and the inevitability in the bulls' eyes that it must go higher (in every conceivable scenario) it's not such a great idea.
But let's get back to the simple question. What about inflation? Yes, the Fed is going to keep printing as will other central banks around the world. Doesn't this make gold a must?
Well, let's think back for a second.
I found this great data at the Coca-Cola website and thought I'd use it as an example of what I always talk about.
Let's say that back in 1919 you were worried about inflation. In fact, the Fed was just created in the world looked like it was going to print a lot of money every time something bad happened. The world looked just as unstable then as it does now. In fact, it looked worse. You were looking at another world war in the not too distant future.
If you had predicted in 1919 what was going to happen over the next 90 years, you would have wanted to own gold. Almost certainly. Even I would agree.
What was on the agenda for the next 90 years?
Well, we had World War II. The boom/bubble bust and great depression. We had the cold war. We had FDR and socialism. We had the U.S. going off the gold standard. We had high inflation in the 1970s.
It was certain that the value of the dollar was going to go down by 90% or more.
Of course, knowing all of that, most people would opt for gold.
So let's say you bought gold at $20.67/ounce. Over the next 90 years, you would've been happy to see your gold get up to over $1,700. All your predictions came true and you made a nice return on gold.
How about another person that had the same view, but decided to buy a stock?
This person in 1919 would have seen that despite the problems, the U.S. has a great system that will work well over time, and if you own a piece of a good business, you should do well.
So this person buys a single share of Coca Cola at $40/share.
If this person reinvested dividends for the next 92 years until the end of 2011, what do you think the value of this stock would be?
$9,270,325
Yes, that's not a typo. A $40 investment in a single share of Coca Cola stock turned into $9 million! Compare that to an investment in gold. A $20.67 investment turns into a whopping $1,700.
OK, OK, you say. But who'da thunk Coke woulda been such a hit? You coulda invested in a company that went bust.
Fair enough. But we know that if you just owned the stock index, you also would have returned 10% or so per year. (I didn't check specific end points, but I think it's safe to say that stocks returned 10%/year in the 20th century). So a $20.67 investment in stocks would be worth $132,882 in 92 years. Not quite $9 million, but way better than $1,700 (that gold would be worth).
So what's the point? The point is that yes, gold will hold it's value over time on an inflation basis, but it's still just an object.
When you own a piece of a business, and it's a good one with good products, they should have pricing power. When you have pricing power, you just raise prices as the value of the dollar goes down. If it's a good business, you can grow it too over time so the value of the business grows.
So there are many levers to increase the value of the business.
Gold just sits there. A business is a group of people working hard, full time every single day trying to increase the value of the business, and they can change and adjust as circumstances change. Gold can't do that.
This is why businesses increase in value over time more than commodities, and this is what the inflationist gold bugs totally miss and why Buffett says what he says about gold (versus producing assets).
So Buffett has a nice tutorial on investing in the most recent letter to shareholders (2011), available for free at the Berkshire Hathaway website.
He says that gold is just an object and doesn't produce income; that he'd rather own farmland, several Exxon Mobiles and $1 trillion of spare cash rather than own all the gold in the world.
Of course, this has gotten some of the predictable responses. I've even read some investment managers respond emotionally and angrily to Buffett's views on gold. That he just doesn't get it, that he is so smart but just has no clue about gold etc...
Well, first of all, when people respond with anger and emotion, it's usually not a good sign. Most people wouldn't care what others think of their investment ideas. That is the most important part of succussful investing; being able to think independently. Not seeking others who agree and dissing people who disagree etc... As Benjamin Graham says, you are right not because people agree with you, but because your facts and analysis is correct.
So when people respond emotionally and with anger when Buffett calls their favorite investment idea just a 'thing' and not a good investment, this tells me more about gold and the people who favor it.
This is not too dissimilar to what happened in the late 1990s too. People said Buffett just doesn't get it. I heard the same thing. People were even telling *me* that I should know better since I work in finance and deal with stocks that this internet thing is for real. I too faced anger and ridicule when I said most of these internet stocks will go to zero or at least down 90% or some such.
People really got mad when I said that. I do remember that well. I knew then that I was going to be right.
People who are confident and right don't care if others disagree with them. In fact, most of my best investments were the ones people would look at me incredulously. One of them went up 20-fold; someone called it just junk. Another one was a 10-bagger and my broker came back to me with the buy ticket and asked me, "Are you sure you want to buy this? Did you read the newspaper this morning? I don't thnk it's a good idea".
Making the right trade is always going to be hard. People are always going to disagree with you. If you are upset that the whole world agrees with you but one or two prominent people say it's a bad idea and that bothers you enough to write about it, that's a big problem to say the least!
Anyway, I already talked about gold and how I think at these levels and this level of sentiment and the inevitability in the bulls' eyes that it must go higher (in every conceivable scenario) it's not such a great idea.
But let's get back to the simple question. What about inflation? Yes, the Fed is going to keep printing as will other central banks around the world. Doesn't this make gold a must?
Well, let's think back for a second.
I found this great data at the Coca-Cola website and thought I'd use it as an example of what I always talk about.
Let's say that back in 1919 you were worried about inflation. In fact, the Fed was just created in the world looked like it was going to print a lot of money every time something bad happened. The world looked just as unstable then as it does now. In fact, it looked worse. You were looking at another world war in the not too distant future.
If you had predicted in 1919 what was going to happen over the next 90 years, you would have wanted to own gold. Almost certainly. Even I would agree.
What was on the agenda for the next 90 years?
Well, we had World War II. The boom/bubble bust and great depression. We had the cold war. We had FDR and socialism. We had the U.S. going off the gold standard. We had high inflation in the 1970s.
It was certain that the value of the dollar was going to go down by 90% or more.
Of course, knowing all of that, most people would opt for gold.
So let's say you bought gold at $20.67/ounce. Over the next 90 years, you would've been happy to see your gold get up to over $1,700. All your predictions came true and you made a nice return on gold.
How about another person that had the same view, but decided to buy a stock?
This person in 1919 would have seen that despite the problems, the U.S. has a great system that will work well over time, and if you own a piece of a good business, you should do well.
So this person buys a single share of Coca Cola at $40/share.
If this person reinvested dividends for the next 92 years until the end of 2011, what do you think the value of this stock would be?
$9,270,325
Yes, that's not a typo. A $40 investment in a single share of Coca Cola stock turned into $9 million! Compare that to an investment in gold. A $20.67 investment turns into a whopping $1,700.
OK, OK, you say. But who'da thunk Coke woulda been such a hit? You coulda invested in a company that went bust.
Fair enough. But we know that if you just owned the stock index, you also would have returned 10% or so per year. (I didn't check specific end points, but I think it's safe to say that stocks returned 10%/year in the 20th century). So a $20.67 investment in stocks would be worth $132,882 in 92 years. Not quite $9 million, but way better than $1,700 (that gold would be worth).
So what's the point? The point is that yes, gold will hold it's value over time on an inflation basis, but it's still just an object.
When you own a piece of a business, and it's a good one with good products, they should have pricing power. When you have pricing power, you just raise prices as the value of the dollar goes down. If it's a good business, you can grow it too over time so the value of the business grows.
So there are many levers to increase the value of the business.
Gold just sits there. A business is a group of people working hard, full time every single day trying to increase the value of the business, and they can change and adjust as circumstances change. Gold can't do that.
This is why businesses increase in value over time more than commodities, and this is what the inflationist gold bugs totally miss and why Buffett says what he says about gold (versus producing assets).
Friday, February 3, 2012
Gold Standard?
I already wrote about what I think about gold here and here and that's actually more than I want to say about it, but since there is more talk again about going back to the gold standard, I thought I'd make a couple of quick comments.
I actually don't care too much about this topic as I think a gold standard will never happen. I think once people really think this through, they will realize that it is impossible to implement, and even if they did they will quickly realize that it won't work.
This "let's go back to the gold standard" argument is basically just a big protest against congress and the 'unelected' power of the Fed (and other central banks around the world). (As an aside, I find it interesting when congressmen criticize the unelectedness and unaccountability of the Fed as if we would be better off if congress controlled the printing presses and as if congress holds themselves accountable in any way for anything).
The argument, quite simply, is that congress and the Fed are out of control. We need to control the process of money creation. By linking money to gold, this will take away the Fed's power to create phony money (which leads to bubbles) and things will be O.K.
So, the problem is basically the Fed. And the answer is, abolish the Fed, tie the dollar to gold. Simple.
As with so many things, these 'simple' solutions are rarely simple. Early in the 20th century, I think, people found a way to get rid of white blood cells as they learned that this is the cause of pain. Well, they got rid of the pain but then the patients died too. Why? Because the white blood cells were responsible for fighting infections; this is what caused the pain. By eliminating the pain, they eliminated the patient (unintended consequence). This story is just off the top of my head so I'm sure I got things wrong, but you get the point.
So let's look at some key points about the gold standard argument:
Inflation and out of control debt growth happened because we went off the gold standard
I find this argument to be backwards. People point to 1972 and then the explosion in inflation after that and point to the delinking of gold from the dollar as the cause of this inflation. My view (but I'm no economist) is that the U.S. had underlying inflation and debt growth that made the gold standard unsustainable. This is why the U.S. had to get off the gold standard (or run out of gold, or plunge into a depression etc...).
The situation got to a point where it became unsustainable. So for the first argument against going back to the gold standard, one answer is that we can try for a while but it won't last as it didn't last before.
You can control price or quantity but not both
A gold standard is quite simply a price control and as a free marketer, I tend to think price controls don't work. Whether it's Nixon's WIN (whip inflation now) or currency fixing or Russian-style price control, it won't work.
If you control price, then you can't control quantity and vice versa.
If we go back to a gold standard, then we will have no mechanism to smooth out economic fluctuations. Many will argue that with a gold standard, we won't have the booms and busts that we've had in the past 30 years.
Wrong.
One of the biggest bubbles and bursts, even to date, is the 1929-1932 bubble and depression and as far as I recall, we were on a gold standard. There were no derivatives. There were no hedge funds. There were no CDO's and CDO-squareds. The booms and busts pre-Fed in the 1800s are far harsher than what we've seen in the 20th century since the Fed was created. Depressions were deeper and lasted longer.
I don't know how the mechanics of a gold standard would work, but it may lead to a ban on owning gold. This, again, I am hugely against. I don't even like gold, but I dislike even more government control over asset ownership. Restrict guns? Yes, I can dig that. But gold? Nope. That makes no sense.
If the economy takes a dip and the Fed can't create money, then we may very well enter a deep recession or depression. That would create calls for devaluation of the dollar or the abandonment of the gold standard. At that point, like in 1972, you will create huge disruption as the system that was built on it is shaken to the ground.
This is similar to what is going on in Europe right now; many economists say that Greece would not be in such a bind if they weren't tied to the Euro. As a Euro member, they have no control over the value of their currency. Now a debt restructuring is the only way for Greece to get out of it's bind. So instead of a 50% depreciation in the currency over time (which is totally manageable as we have seen in the U.S. many times), they will have to cut government bond principle by 50%, basically overnight. Many holders of these bonds were European banks that had zero capital set aside against them as they were presumably risk-free sovereigns. And this is creating a bank crisis in Europe. So much for price fixing.
What if Greece was not linked to the Euro? Banks would probably have had foreign exchange hedges against their Greek bond holdings so whatever problems they have wouldn't have been a 'shock' to the system.
This is the reason why Greece is in so much more of a bind than Japan, even though Japan has more debt; Japan can print their own currency, Greece can't.
Now if we go to the gold standard, things will look fine for a while, just like Greece looked fine for a while. And just like Argentina looked fine for a while when they tied their currency to the U.S. dollar, and just like Asian countries looked fine for a while when they too had their currencies tied to the U.S. dollar (until the 1997 Asian crisis).
These 'fixed' prices are very misleading. It makes things look good in the short run, but imbalances increase over time until it becomes unsustainable and blows up. Just like gold prices/U.S. dollar in 1972, Asian currencies in 1997, Europe now etc...
All of these crisis events were preceded by a long period of 'calm' and stable prices/currencies.
If the price control is not working in Europe now (Greece etc...), I don't understand why people will think it will work here in the U.S.
Do we even have enough gold?
Again, I don't know what the mechanics would be of a new gold standard, but the dollar will have to be backed and convertible into gold to some extent for the link to be 'true'.
So the question is, how much gold does the U.S. even own? A quick look on the internet shows that we own around 8,134 tons of gold or 262 million ounces. That sounds about right. At $1,700/ounce, the U.S. owns $445 billion of gold.
How much debt does the U.S. government have outstanding? $15 trillion. Of that, foreign governments own $4.5 trillion. China owns $1.2 trillion.
So what if China balks at the U.S. dollar, sells the treasuries for dollars and demands gold in exchange? We don't have enough gold in this country to ship to China.
(By the way, people seem to think that a gold standard will also stabilize the balance of payments around the world. But again, I think history disproves this. I think what happens is that when someone starts to run out of gold, they start a war and steal gold from another country, or they just go off the gold standard (as has happened repeatedly in the past))
What would happen to the U.S. dollar if we went on the gold standard?
The other thing that I don't think gold standard fans really think about is what would happen to the U.S. dollar if we went on the gold standard. Imagine if the dollar was backed by gold back in 2000. When the dollar rises even 10% against other currencies, people complain about the U.S. becoming uncompetitive globally.
What will happen if the U.S. went on a gold standard? Would the dollar not appreciate at an incredible rate?
There is a case study, and that is Switzerland. I think they were the last to go off the gold standard and that was because their currency became too strong, threatening their domestic industry (which depended on exports).
What would happen to what little U.S. manufacturing we have left? Would exporters be happy with such a situation?
So then we have to all go on the the gold standard together around the world. We have a case study in that too: Bretton Woods. How did that work out? The Japanese yen was fixed at 360 yen/dollar for decades until the Bretton Woods fixed exchange rate system collapsed.
Again, some claim the world went nuts because we abandoned Bretton Woods. But my view is that we didn't abandon it because we wanted the world to go nuts, but we abandoned it because it became unsustainable. Massive changes in economies around the world made these 'fixed' rates totally unrealistic and unreflective of reality. (This kind of reminds me of China now; they are still fixed to the U.S. dollar, but many suspect that changes in the Chinese economy over the years make this current fixed rate completely unreflective of reality. Which leads to the question, who should then set and reset exchange rates over the years to adjust for these changes in economies? A currency board? The IMF? Not. I would advocate letting the markets decide, in real time, 24-hours a day. And same with gold prices).
This is what would happen too, again, if the world went on a global gold standard.
You can point back to the Euro as exhibit A in this example too. Fixing exchange rates, taking away the ability for some to control the quantity of money etc... won't work. It just creates other imbalances that sooner or later makes the 'fix' unsustainable and it blows up with a louder sound than if you allow market forces to send signals so that people can react to problems over time, instead of overnight.
So,
Anyway, I am not an economist or commodity/gold specialist. These are just my thoughts on the subject. And yes, I know there are many, many people way smarter than me calling for a gold standard so many will disagree with the above. But again, these are just my thoughts and observations on the subject.
I actually don't care too much about this topic as I think a gold standard will never happen. I think once people really think this through, they will realize that it is impossible to implement, and even if they did they will quickly realize that it won't work.
This "let's go back to the gold standard" argument is basically just a big protest against congress and the 'unelected' power of the Fed (and other central banks around the world). (As an aside, I find it interesting when congressmen criticize the unelectedness and unaccountability of the Fed as if we would be better off if congress controlled the printing presses and as if congress holds themselves accountable in any way for anything).
The argument, quite simply, is that congress and the Fed are out of control. We need to control the process of money creation. By linking money to gold, this will take away the Fed's power to create phony money (which leads to bubbles) and things will be O.K.
So, the problem is basically the Fed. And the answer is, abolish the Fed, tie the dollar to gold. Simple.
As with so many things, these 'simple' solutions are rarely simple. Early in the 20th century, I think, people found a way to get rid of white blood cells as they learned that this is the cause of pain. Well, they got rid of the pain but then the patients died too. Why? Because the white blood cells were responsible for fighting infections; this is what caused the pain. By eliminating the pain, they eliminated the patient (unintended consequence). This story is just off the top of my head so I'm sure I got things wrong, but you get the point.
So let's look at some key points about the gold standard argument:
Inflation and out of control debt growth happened because we went off the gold standard
I find this argument to be backwards. People point to 1972 and then the explosion in inflation after that and point to the delinking of gold from the dollar as the cause of this inflation. My view (but I'm no economist) is that the U.S. had underlying inflation and debt growth that made the gold standard unsustainable. This is why the U.S. had to get off the gold standard (or run out of gold, or plunge into a depression etc...).
The situation got to a point where it became unsustainable. So for the first argument against going back to the gold standard, one answer is that we can try for a while but it won't last as it didn't last before.
You can control price or quantity but not both
A gold standard is quite simply a price control and as a free marketer, I tend to think price controls don't work. Whether it's Nixon's WIN (whip inflation now) or currency fixing or Russian-style price control, it won't work.
If you control price, then you can't control quantity and vice versa.
If we go back to a gold standard, then we will have no mechanism to smooth out economic fluctuations. Many will argue that with a gold standard, we won't have the booms and busts that we've had in the past 30 years.
Wrong.
One of the biggest bubbles and bursts, even to date, is the 1929-1932 bubble and depression and as far as I recall, we were on a gold standard. There were no derivatives. There were no hedge funds. There were no CDO's and CDO-squareds. The booms and busts pre-Fed in the 1800s are far harsher than what we've seen in the 20th century since the Fed was created. Depressions were deeper and lasted longer.
I don't know how the mechanics of a gold standard would work, but it may lead to a ban on owning gold. This, again, I am hugely against. I don't even like gold, but I dislike even more government control over asset ownership. Restrict guns? Yes, I can dig that. But gold? Nope. That makes no sense.
If the economy takes a dip and the Fed can't create money, then we may very well enter a deep recession or depression. That would create calls for devaluation of the dollar or the abandonment of the gold standard. At that point, like in 1972, you will create huge disruption as the system that was built on it is shaken to the ground.
This is similar to what is going on in Europe right now; many economists say that Greece would not be in such a bind if they weren't tied to the Euro. As a Euro member, they have no control over the value of their currency. Now a debt restructuring is the only way for Greece to get out of it's bind. So instead of a 50% depreciation in the currency over time (which is totally manageable as we have seen in the U.S. many times), they will have to cut government bond principle by 50%, basically overnight. Many holders of these bonds were European banks that had zero capital set aside against them as they were presumably risk-free sovereigns. And this is creating a bank crisis in Europe. So much for price fixing.
What if Greece was not linked to the Euro? Banks would probably have had foreign exchange hedges against their Greek bond holdings so whatever problems they have wouldn't have been a 'shock' to the system.
This is the reason why Greece is in so much more of a bind than Japan, even though Japan has more debt; Japan can print their own currency, Greece can't.
Now if we go to the gold standard, things will look fine for a while, just like Greece looked fine for a while. And just like Argentina looked fine for a while when they tied their currency to the U.S. dollar, and just like Asian countries looked fine for a while when they too had their currencies tied to the U.S. dollar (until the 1997 Asian crisis).
These 'fixed' prices are very misleading. It makes things look good in the short run, but imbalances increase over time until it becomes unsustainable and blows up. Just like gold prices/U.S. dollar in 1972, Asian currencies in 1997, Europe now etc...
All of these crisis events were preceded by a long period of 'calm' and stable prices/currencies.
If the price control is not working in Europe now (Greece etc...), I don't understand why people will think it will work here in the U.S.
Do we even have enough gold?
Again, I don't know what the mechanics would be of a new gold standard, but the dollar will have to be backed and convertible into gold to some extent for the link to be 'true'.
So the question is, how much gold does the U.S. even own? A quick look on the internet shows that we own around 8,134 tons of gold or 262 million ounces. That sounds about right. At $1,700/ounce, the U.S. owns $445 billion of gold.
How much debt does the U.S. government have outstanding? $15 trillion. Of that, foreign governments own $4.5 trillion. China owns $1.2 trillion.
So what if China balks at the U.S. dollar, sells the treasuries for dollars and demands gold in exchange? We don't have enough gold in this country to ship to China.
(By the way, people seem to think that a gold standard will also stabilize the balance of payments around the world. But again, I think history disproves this. I think what happens is that when someone starts to run out of gold, they start a war and steal gold from another country, or they just go off the gold standard (as has happened repeatedly in the past))
What would happen to the U.S. dollar if we went on the gold standard?
The other thing that I don't think gold standard fans really think about is what would happen to the U.S. dollar if we went on the gold standard. Imagine if the dollar was backed by gold back in 2000. When the dollar rises even 10% against other currencies, people complain about the U.S. becoming uncompetitive globally.
What will happen if the U.S. went on a gold standard? Would the dollar not appreciate at an incredible rate?
There is a case study, and that is Switzerland. I think they were the last to go off the gold standard and that was because their currency became too strong, threatening their domestic industry (which depended on exports).
What would happen to what little U.S. manufacturing we have left? Would exporters be happy with such a situation?
So then we have to all go on the the gold standard together around the world. We have a case study in that too: Bretton Woods. How did that work out? The Japanese yen was fixed at 360 yen/dollar for decades until the Bretton Woods fixed exchange rate system collapsed.
Again, some claim the world went nuts because we abandoned Bretton Woods. But my view is that we didn't abandon it because we wanted the world to go nuts, but we abandoned it because it became unsustainable. Massive changes in economies around the world made these 'fixed' rates totally unrealistic and unreflective of reality. (This kind of reminds me of China now; they are still fixed to the U.S. dollar, but many suspect that changes in the Chinese economy over the years make this current fixed rate completely unreflective of reality. Which leads to the question, who should then set and reset exchange rates over the years to adjust for these changes in economies? A currency board? The IMF? Not. I would advocate letting the markets decide, in real time, 24-hours a day. And same with gold prices).
This is what would happen too, again, if the world went on a global gold standard.
You can point back to the Euro as exhibit A in this example too. Fixing exchange rates, taking away the ability for some to control the quantity of money etc... won't work. It just creates other imbalances that sooner or later makes the 'fix' unsustainable and it blows up with a louder sound than if you allow market forces to send signals so that people can react to problems over time, instead of overnight.
So,
- Gold standard won't work because it's a price control. Price controls don't work.
- Gold standard may require limitations on individual ownership of gold; I am against this sort of government control over harmless assets
- We didn't go off the gold standard to mess up the world, we went off the gold standard because it was unsustainable (due to our irresponsible behavior, which proves that a gold standard will not prevent that)
- If we went back to the gold standard, it will be unsustainable just like all other price fixes proved to be unsustainable in history (Bretton Woods, gold standard, Euro, Asian currency link to U.S. dollar, Argentina currency link to U.S. dollar and currency board)
- If we behaved, the gold standard might work. But if we behaved, we don't need a gold standard. If we have a gold standard and misbehave, we will just have another 1972 at some point in the future.
Anyway, I am not an economist or commodity/gold specialist. These are just my thoughts on the subject. And yes, I know there are many, many people way smarter than me calling for a gold standard so many will disagree with the above. But again, these are just my thoughts and observations on the subject.
Wednesday, January 25, 2012
Gold: Interesting Chart
So, I was flipping through some annual reports, catching up on the ever increasing pile of stuff to read. Occasionally, something comes out and grabs me and I have to investigate. The great thing about annual reports is that you learn all kinds of things reading them, not just about the company.
This chart came from the 2010 annual report for Barrick Gold, (or I suppose it's just called Barrick now) in the letter to shareholders section written by chairman and CEO Peter Munk.
He said that there is a lot of talk of gold in a bubble and showed this chart to prove that gold is not in a bubble. He said that in 1980, gold rallied 250% in a single year and that gold recently has done nothing close to that. The gradual rise in gold prices over the past decade has been orderly and not at all bubble-like.
I thought that was interesting for sure. But I still couldn't get over the parabolic-ness and one-decision-ness of the gold story so I decided to take a quick look at other bubbles in the past.
This, "gold is not in a bubble because there hasn't been a blowoff" argument vaguely reminds me of the housing bubble. Yes, housing prices are up a lot in the recent past, but they are not up like other bubbles in terms of magnitude. Yes, it's expensive but it could get more expensive, just like Japan did; we are nowhere near where Japan was etc...
Well, anyway, let's take a quick look at this.
This chart came from the 2010 annual report for Barrick Gold, (or I suppose it's just called Barrick now) in the letter to shareholders section written by chairman and CEO Peter Munk.
He said that there is a lot of talk of gold in a bubble and showed this chart to prove that gold is not in a bubble. He said that in 1980, gold rallied 250% in a single year and that gold recently has done nothing close to that. The gradual rise in gold prices over the past decade has been orderly and not at all bubble-like.
I thought that was interesting for sure. But I still couldn't get over the parabolic-ness and one-decision-ness of the gold story so I decided to take a quick look at other bubbles in the past.
This, "gold is not in a bubble because there hasn't been a blowoff" argument vaguely reminds me of the housing bubble. Yes, housing prices are up a lot in the recent past, but they are not up like other bubbles in terms of magnitude. Yes, it's expensive but it could get more expensive, just like Japan did; we are nowhere near where Japan was etc...
Well, anyway, let's take a quick look at this.
There is no question that compared to the 1970s, gold has done nothing and is not bubblish at all. But I have to wonder if this is a good comparison as gold prices were pretty much fixed for most of the 20th century; the delinking of gold from money caused a catch up in prices to make up for 50, 70 or more years of inflation.
This is certainly not the case now as gold has been freely traded for a long time.
Other bubbles that people use as benchmarks is the 1929 stock market bubble, maybe the 1987 crash as a minor bubble, the Nikkei 1989 bubble and of course the 2000 U.S. stock market bubble.
I'm way too lazy to do accurate work here, but just from eye-balling and grabbing quick prices off the internet, I came up with an approximate five year and ten year price change in these respective bubbles.
Here is what I got:
Price change over
Five years Ten years
1929 stock market bubble (DJIA): 4x 6x (actually from 1918 low)
1987 stock market bubble (DJIA): 3x 3x
2000 stock market bubble (S&P 500) : 3x 4.4x
2000 NASDAQ bubble: 6x 11x
Nikkei 1989 bubble: 4x 6x
Current Gold: 3x 7x
(to September 2011 high)
So looking at it this way, it does look to me like it is in line with other big bubbles. Again, I would think that the 1970s-1980 gold bubble may not be much of a comparable due to the extraordinary event that preceded the delinking (fixed gold price).
If we compare the recent gold price trend to other big bubbles, it looks pretty much in line. The 7-fold gain in gold prices in the past decade exceeds the gain in stock prices in both the 1929 stock market bubble and the Nikkei 225 1989 bubble and easily beats the 2000 stock market bubble.
In any case, I am not a big fan of gold at this point for the reasons I stated in my post back in October 2011 and I still think it is too much of an 'inevitable' investment;
- great historical track record in five and ten year periods that validate the bull story which is...
- the inevitability of central bank easing, almost perpetually due to weak economies and debt problems; money printing can't and won't stop, therefore gold prices must go up
- even if the central bank scenario proves false and the economy picks up steam, that would lead to inflation so therefore gold prices must go up
- So therefore heads I win, tails I win and, again...
- recent price performance confirms and validates above scenario (and gold sure beats the heck out of stocks and other assets on a five and ten year basis!)
- and we have all learned from the financial crisis that we can't have too much stock holdings or else we can lose money so we must diversify into other asset classes, like... [drumroll] gold!, because of the (go back to first bullet point)
So when the above self-reinforcing cycle is in effect and the chart looks parabolic (I am parabolic-phobic), and people tell you that in almost any scenario gold prices has to go up, I just lose interest in it.
Would I short it? Heck no. Am I convinced gold prices must crash or go down? Absolutely not. Can gold continue to go up? Of course!
When the bull case is that we are nowhere near the 1980-type of bubble and in order to make decent returns, such a bubble has to recur, it sort of sounds more to me like a gamble than a rational investment.
There are a lot of people way smarter than me that like gold and that's great.
For me? Nah. I want to own something that is unloved, hated, despised, and cheap. Gold right now seems almost the exact opposite.
Notes
Here is the 'rough' data I used for the above analysis just for future reference:
Nikkei 225 Index:
December 1979 6,570
December 1984 10,000
December 1989 40,000 (never got to 40,000 but that's what I used. Sue me!)
Dow Jones Industrial Average:
August 1977 860
August 1982 900
August 1987 2700
1918 low 66
1924 90 (eyeballed chart, so not very accurate)
1929 high 382
S&P 500 Index:
March 1990 340
March 1995 500
March 2000 1500
NASDAQ Composite:
February 1990 430
February 1995 790
February 2000 4700
Gold:
September 2001 270
September 2006 744
September 2011 1900
Tuesday, October 11, 2011
Ungold!
Gold has done really well the last decade or so and more and more people are talking about the inevitability of gold as a wealth saving asset (protection against inflation, monetary pump-priming etc...).
However, a lot of what we hear today sounds a lot like Howard Marks' first-level thinking (see here what that means). Central banks can't be trusted, money-printing and inflation is inevitable etc...
If the economy tanks, they will have to print more money so gold will go up, or if the economy recovers, then inflation will go up and so will gold. Either way, gold is going to go up.
The sentiment these days seems to be the exact opposite of the late 1990s. Back then with gold under $300/ounce, everyone loved stocks. In fact, if you didn't own stocks, valuation be damned, then you won't be able to afford retirement. Don't believe me? Look at stock returns in the past five, ten and twenty years (in 1999/2000, all those periods showed 20%+ returns, I think). Gold? Garbage. Greenspan has everything under control. With the advanced economic models in use at the Fed, the economy will never tank and inflation will never go out of control. Even central banks were dumping the gold they owned. Who needs it?
Result? High stock prices, low gold prices.
Where are we today?
We seem to be at the exact opposite point today. Gold can do no wrong. If your portfolio has no gold in it, you will never be able to retire, or even make any money. Stocks? They don't work. Stocks are not good long term investments. Proof? Look at what stocks have done in the past decade! Nothing! Flat! Look at what gold has done in the past ten years. Answer? Own gold, of course.
This seems really silly but this is what almost everything I read seems to say, and many of the very same publications that told us to buy stocks in 2000 if we wanted to retire on schedule are telling us to buy gold, gold stocks and other commodity related things because, sorry, stocks just doesn't cut it anymore.
Oh, and what are central banks doing? Buying gold! Uh oh.
OK, OK. I am not really trying to call the top in gold here or anything like that, but if I had to bet, I would bet that a good active stock manager will easily outperform gold over the next five to ten years.
Are value investors wrong?
Here's the other thing that I seem to read alot. People are saying that old folks like Warren Buffett just don't get it anymore. They say he is totally wrong about gold. That he is a fool for buying bank and other stocks. That he should own gold if he had any brains left. He just doesn't get it (remember the last time they said that? Yup. It was in 1999/2000; he is an old, has-been that just doesn't get it (because he doesn't own tech stocks)).
But first of all, is he wrong? I have never, ever heard Buffett make a call on gold prices, ever. So how can he be wrong? He can be wrong if he said gold will go down and it goes up. But he never said that. What he has said over and over is that gold is just not his thing. He likes to invest in things that produce cash flows and where intrinsic value can be calculated so he can pay a discount to that intrinsic value.
There is no cash flow or intrinsic value for gold that I have heard of. And that's Buffett's only point, really. He has said he would rather own all the farm land in this country, ten Exxon Mobils and a trillion dollars of cash for what gold is valued at; gold doesn't produce cash flow, but the other assets do.
It's not a prediction on where gold prices will go, which he would admit he has no idea about.
A similar scenario was happened in the 1970s; it's a good thing he didn't latch onto the gold thing and dump his stocks. I think the key, as usual, is sticking to what you know. If you know how to value businesses and know a little about the stock market, you will do much better than owning gold.
It just seems that there are so many experts on gold these days, even some former value investors. And the funny thing is that they are all saying the same thing and nobody seems to have any more information that anyone else; it all sounds very first-level thinking. It even feels like some are editorializing with their portfolios.
Gold Standard?!
People seem to love gold so much that many people are even calling for a gold standard now to take away the power of printing money irresponsibly.
On the surface, this sounds like a good idea. If we link the U.S. dollar to gold, then the Fed can't just print more money and keep on devaluing the dollar, and we will never have a Zimbabwe moment.
However, this misses a crucial point. I don't think a gold standard would work at all. Why? Because a gold standard is basically a price control and I don't believe price controls work. History shows that price controls don't work, period.
We can control either price or quantity, but never both. If you control price, then the economic adjustments will occur through quantity. This means that in the economy if we can't ease money, the economy will suffer; that means unemployment will go up.
The U.S. is proof that a gold standard is unsustainable. The U.S. and much of the world was on a gold standard and they went off of it for a reason: It was unsustainable. If Nixon didn't delink the U.S. dollar from gold in 1971, the alternative was for the U.S. to default (run out of gold).
This was partly due to big spending by the U.S. government, of course. But did gold prevent this irresponsible overspending? Nope. The fact is that it didn't, and the U.S. had to go off the gold standard. Politicians will spend. The public will demand it. If the gold standard ties the hands of the government, people will demand a delinking from gold. Otherwise the economy may plunge into a deep recession or depression which would then cause a delinking or devalation of some sort as FDR did back during the Great Depression. Do we really think politicians will allow constituents to be crucified on a cross of gold? I think not.
Fixed exchange rates are similar to the gold standard. It is basically a price control, and therefore it is ultimately unsustainable over time.
This is why the 1997 Asian crisis occurred. Asian countries linked their currencies to the U.S. dollar, but this was unsustainable. Many thought that the currency link will provide stability as excessive foreign exchange volatility was disruptive.
Well, when you fix the price, then adjustments occur in quantity. And that often means economic pressures. When the pressures on the economy build up, the price control becomes unsustainable, and when that cracks, all hell breaks loose.
This happened in the U.K. too in the early 90s. The British tried to keep the Pound within a certain range of other European currencies. The British had to raise interest rates to keep the Pound within the valuation range and also had to intervene (in the foreign exchange market) . This put serious pressures on the economy (higher interest rates are not good for the economy) and this was ultimately unsustainable.
The exact same thing is happening now in Europe. To promote stability, Europe adopted a single currency. But that's sort of like a price control. They locked in the foreign exchange rate and fixed it for every country in the Euro. This too was unsustainable from day one.
In the old days, a country like Greece would have adjusted to problems by a cheapening currency. The Greek central bank would print more money to pay down debt, and the market would lower the value of the Greek Drachma. This is now impossible. The banks would have been able to hedge away their Greek sovereign risk by using foreign exchange forward contracts and swaps. In the pre-Euro world, I would guarantee you that the European banks would have hedged their Greek sovereign exposure by using foreign exchange forwards and swaps and European banks would be in much better shape.
In a single currency Euro world, that is impossible. The Greek economy can't adjust itself through foreign exchange rates or anything like that.
It has gotten to the point where Greece will either have to leave the Euro, or they have to default. Either one will be very disruptive to the European banking industry. The European banks are in crisis largely because of this artificial 'link'; they were allowed to lever up on this illusory stability and now that the fan gets hit, the problem is much worse than otherwise (if they didn't force these price controls).
The other point people don't realize is that if you go back to a gold standard, you basically fix the price of gold. A crucial point in that case is that you lose a very important price signal.
When gold prices are free to be set by the market, it sends off a very important price signal to everyone that can serve as a warning.
Some also say that a gold standard would be similar to legislating public government spending. Some argue that that would be enough; to mandate limits on government spending and debt. This would have the same effect as a gold standard.
Again, we can point to Europe. This is basically how the EU decided to solve this problem. In order to become a member of the European Union, you had to have a government debt to GDP of below a certain amount and a government deficit of less than a certain amount.
And yet we have the problems of Greece, Spain, Portugal, Italy etc...
Oops, that didn't quite work either. If things get worse in Greece, the public will demand getting out of the EU, or the Germans will demand they get out of the EU, or they will demand they kick Greece out.
You can't really force things by fixing prices or legislating limits. The only possible solution is for responsible behavior by the governments. If they can act responsibly then a fiat currency system can work fine. If not, no amount of legal limits, gold standard or any other thing like that will help matters.
I think the people calling for a gold standard have things backwards. We are off the gold standard now because we couldn't sustain it; things didn't get bad because we got off of it. Their arguments make it sound like things got bad because we went off the gold standard, but I argue that it got bad enough so that we couldn't sustain it. If we go back to the gold standard, that will happen again for sure. Free markets that can give price signals are far better than fixed prices where imbalances can really build up invisibly until they blow up.
Anyway, that's just my opinion.
Subscribe to:
Posts (Atom)