Bitten by the Gold Bug
by John Mauldin, Mauldin Economics
I wandered as an innocent bystander into the world of investment newsletter publishing in 1981-’82. Back then it was a world inhabited to a great extent by “gold bugs” of one variety or another. The investment newsletter world was in its infancy, and I was something of a direct-mail wizard, brought in to weave my magic with mailing lists and fluid copy. You can’t write effectively about something you don’t know, so I plunged in head first, learning all about Austrian economics and the problems of fiat money.
I was soon a partner in what was then a small research and publishing house called the American Bureau of Economic Research, founded by Dr. Gary North. He inoculated me with reams of material on the case for gold and free markets – things I had not learned in college! I had never heard of Ludwig von Mises or Friedrich Hayek (whom I later got to meet in Austria, but that is another story).
I attended my first New Orleans Conference back in the early ’80s. It was then a rather large gathering of people (4,000 or so) who wanted the US to go back on the gold standard. Remember, it had been only a little more than 10 years since Nixon led us down the path to a fiat currency.
It is hard for younger generations to imagine now that it was once illegal to “hoard gold.” Franklin Roosevelt issued Executive Order 6102, which required all persons to deliver on or before May 1, 1933 all but a small amount of gold coin, gold bullion, and gold certificates owned by them to the Federal Reserve, in exchange for $20.67 (equivalent to roughly $370 today) per troy ounce. Owning gold would remain illegal until President Gerald Ford signed a bill which went into effect on December 31, 1974, re-legalizing the owning of gold. Gold began trading in 1975, just in time for the inflation of the late ’70s.
A gold bubble soon developed, which popped (or imploded, depending on your view) in 1980 with the coming of Fed Chairman Paul Volcker, who broke the back of inflation. But that did little to dampen the enthusiasm of the gold crowd. They were still remembering the very recent past.
A young man in a wheelchair, James (Jim) Blanchard, influenced by Ayn Rand and other laissez faire economic writers, had formed the National Committee to Legalize Gold in 1971. He saw gold ownership as a fundamental human right, a hedge against government mismanagement of money, and the first essential step down the long road to monetary integrity. He hired a biplane to tow a sign saying “Legalize Gold” over President Nixon’s 1973 inauguration.
In 1975, after gold became legal, Blanchard organized a conference in New Orleans for his fellow gold enthusiasts. He was expecting 250 people, but 750 showed up. By the time I arrived at the conference in the early ’80s, it was packed with a bevy of characters straight out of central casting – colorful, often funny, but very serious about the subject of gold and free markets. The memory of the inflation scare in the ’70s was still quite fresh, and inflation was still very high. I got to meet and become friends with some of the true intellectual leaders of the free-market world. (I was the “marketing guy” back in those days, still absorbing and learning.)
Gold was seen as an inflation hedge, a currency hedge, and a shield against government iniquity in the form of deficits and monetization. I will admit I took the bait – hook, line, and sinker. I became an unabashed gold bug. By 1986 I was writing a newsletter on gold stocks. “Research” back then consisted of running up a large telephone bill and buying all the subscriptions to newsletters on investments and gold stocks I could get my hands on.
By 1986, gold was again in a bull market, having seen a dip below $290 in March of 1985, from its blow-off high of $850 on January 21, 1980. All the charts show gold dropping in 1980, but few remember that gold actually closed up $30 for the year at $589.75. Picking natural-resource stocks was not all that hard in a bull market, but avoiding the Vancouver gold bandits was not as easy. You really had to know who was involved in any gold stock you invested in. Information was not as easy to get as it is today.
For personal and business reasons, I had to stop writing the letter and sold it to another established writer. I remember telling my readers that, since I was selling the letter, it was likely that gold would be in a bull market for years to come. As it turned out, though, it was a good time to exit.
I started writing again for a general audience in late 1998, but I did not turn bullish on gold until 2002, when I turned bearish on the dollar. Gold had been in a 22-year bear market and during that time had been anything but an inflation hedge – or a hedge against anything, for that matter. But the supporters of gold held fast to the party line. I still understood the reasons for investing in gold, but some of the data simply did not support the reasons.
Time to Buy, or Sell?
So let’s get this out of the way. For quite some time I have not been a gold bug. There are times to be bullish on gold as an investment, and I have been (as in 2002), but as of this moment I do not see gold as having the potential it did in 2002. But if that is the case, then why am I still buying gold every month?
I am going to draw freely on a very solid paper by my friend Dr. Campbell Harvey of Duke University. Cam and I have communicated since the early part of the last decade. He did the original research on the correlation between the yield curve (the relationship between long-term and short-term interest rates) and recessions, which I learned he had done after I quoted others who had not acknowledged his work. We have since compared notes on numerous topics. He sent me his writing on gold last month, and I now share it with you.
Sidebar: the yield curve is not currently predicting a recession. But interest rates are obviously a manipulated market. It will be interesting to see if we can have a recession with a positively sloped curve. This to me would be just another clear danger signal that monetary policy is no longer working.
Back to gold. Here is a summary from Campbell’s abstract:
“Gold objects have existed for thousands of years but gold has only been an actively traded object since 1975. Gold has often been described as an inflation hedge. If gold is an inflation hedge then on average its real return should be zero. Yet over 1, 5, 10, 15 and 20-year investment horizons the variation in the nominal and real returns of gold has not been driven by realized inflation. The real price of gold is currently high compared to history. In the past, when the real price of gold was above average, subsequent real gold returns have been below average.
“As a result investors in gold face a daunting dilemma: (1) ignore the past and seek inflation protection by paying a high real gold price that almost guarantees a decline in the future inflation-adjusted purchasing power of gold or (2) embrace the past, avoid gold and run the risk of a greater decline in the future purchasing power of other assets relative to gold if inflation surges. Given this situation, is it time to explore ‘this time is different’ rationalizations?
“We show that new mined supply is surprisingly unresponsive to prices. In addition, authoritative estimates suggest that about three quarters of the achievable world supply of gold has already been mined. On the demand side, we focus on the official gold holdings of many countries. If prominent emerging markets increase their gold holdings to average per capita or per GDP holdings of developed countries, the real price of gold may rise even further from today’s elevated levels.”
Campbell shows us that gold has been erratic as an inflation hedge. Sometimes it is and sometimes it isn’t, depending on what time period you look at.
Want to go back beyond 1975? The real price of gold is well above it long-term average in terms of inflation. Look at this next chart.
Of course, this assumes you believe official inflation statistics. If my health insurance costs are a measure of inflation, then gold is barely keeping up. Not to mention the costs of private school tuition and colleges. (I paid my first private school bill in 1980 when Tiffani started the first grade. And now my youngest, Trey, is in his final year of high school. Can you believe a 15x rise in private school costs? Gold is also trailing badly on that front!)
