100% Cash, Ready for the Crash

[scorpioncapital]

From Nov 18, 2016, Buffett's comments,

 

"WB:  Interest rates are to asset valuation as gravity is to matter.  It will take a lot of movement in interest rates (similar to Paul Volcker in 1981-2) before stocks are too high.  The interest rates on 30 year Treasury bonds have declined from 14 ½ % to 2 ½ % from 1982 to 2016.  Recently, the 30 year Treasury moved from 2.6% – 2.8%.  Stocks are cheap if long term rates are at 4%, four to five years from now.  “We are buying more shares than selling everyday unless interest rates move appreciably higher”.  A profitable trade would be to short the 30 year bond and go long the S&P 500 (assuming no margin calls)."

 

I don't get the impression here that he's in a holding pattern or building cash at Berkshire other than a temporary process between new investments.

[Rainforesthiker]

I guess for those who are in cash in a way they are betting market will go down and get in time to buy back in before it goes up again. This is why I will miss Buffett he is such a good market timer.

 

Yes, he is one of the best at market timing.  Through his entire career he has built cash in rising/high markets, and put it to work in low markets.  Over and over.

 

If you think Buffett is a market timer, then you really do not understand Buffett.  Buying at attractive prices is not market timing.

 

oh, I understand Buffett plenty.  Its all semantics.  He is a market timer.  He tells lay persons not to do it, but he has done it repeatedly.  You can call it what you want.  I calling selling all your stocks near market tops market timing.  He is damn good at it.

 

I tend to view this a little differently.  I think the reality is more that Buffett is extremely disciplined, and in his younger days he would sell stocks of individual businesses when those businesses exceeded his calculation of intrinsic value.  So in the later stages of a bull market he likely would have sold everything he owned, since all of those stocks were above intrinsic value.  This would look a lot like market timing to an outsider, and has the same effect, and perhaps it even is a form of market timing depending on how you define it.  But it is more a collection of many micro decisions rather than one big macro call. Similarly, he was disciplined enough to not buy when he could not find stocks selling well below his estimation of intrinsic value.  Again, this would look like market timing - as holding cash waiting for the market to turn.  But again it is more a collection of micro decisions than one big macro call.  The end result is the same.  To the extent Buffett could be called a market timer, I think it is his extreme discipline, patience and ability to tune out the crowd that enabled it.

[rb]

From Nov 18, 2016, Buffett's comments,

 

"WB:  Interest rates are to asset valuation as gravity is to matter.  It will take a lot of movement in interest rates (similar to Paul Volcker in 1981-2) before stocks are too high.  The interest rates on 30 year Treasury bonds have declined from 14 ½ % to 2 ½ % from 1982 to 2016.  Recently, the 30 year Treasury moved from 2.6% – 2.8%.  Stocks are cheap if long term rates are at 4%, four to five years from now.  “We are buying more shares than selling everyday unless interest rates move appreciably higher”.  A profitable trade would be to short the 30 year bond and go long the S&P 500 (assuming no margin calls)."

 

I don't get the impression here that he's in a holding pattern or building cash at Berkshire other than a temporary process between new investments.

I agree with the previous poster. WB is being very crafty with his words. For years now there have been the same answers. The future is bright. Stocks are higher now than in the past. Stocks will be higher in the future. We're buying. Blah, blah, etc, etc

 

In that interview he said they're buying more shares that they're selling. Sure, but by how much? If you look at their investments in 10-Qs and 13-Fs they're not really swelling. Meanwhile cash is building up at Berkshire like crazy. So if stocks are cheap why isn't he buying? We all know that WB isn't shy on loading up when stocks are cheap.

 

By moving past his words and looking at his actions. You get to the truth... that stocks aren't really cheap and there's not a lot of deals out there. But he's not gonna say that publicly. Instead he'll keep talking about how bright the future is.

[rb]

I tend to view this a little differently.  I think the reality is more that Buffett is extremely disciplined, and in his younger days he would sell stocks of individual businesses when those businesses exceeded his calculation of intrinsic value.  So in the later stages of a bull market he likely would have sold everything he owned, since all of those stocks were above intrinsic value.  This would look a lot like market timing to an outsider, and has the same effect, and perhaps it even is a form of market timing depending on how you define it.  But it is more a collection of many micro decisions rather than one big macro call. Similarly, he was disciplined enough to not buy when he could not find stocks selling well below his estimation of intrinsic value.  Again, this would look like market timing - as holding cash waiting for the market to turn.  But again it is more a collection of micro decisions than one big macro call.  The end result is the same.  To the extent Buffett could be called a market timer, I think it is his extreme discipline, patience and ability to tune out the crowd that enabled it.

So basically tomatoe/tomato

[Tim Eriksen]

I guess for those who are in cash in a way they are betting market will go down and get in time to buy back in before it goes up again. This is why I will miss Buffett he is such a good market timer.

 

Yes, he is one of the best at market timing.  Through his entire career he has built cash in rising/high markets, and put it to work in low markets.  Over and over.

 

If you think Buffett is a market timer, then you really do not understand Buffett.  Buying at attractive prices is not market timing.

 

oh, I understand Buffett plenty.  Its all semantics.  He is a market timer.  He tells lay persons not to do it, but he has done it repeatedly.  You can call it what you want.  I calling selling all your stocks near market tops market timing.  He is damn good at it.

 

I tend to view this a little differently.  I think the reality is more that Buffett is extremely disciplined, and in his younger days he would sell stocks of individual businesses when those businesses exceeded his calculation of intrinsic value.  So in the later stages of a bull market he likely would have sold everything he owned, since all of those stocks were above intrinsic value.  This would look a lot like market timing to an outsider, and has the same effect, and perhaps it even is a form of market timing depending on how you define it.  But it is more a collection of many micro decisions rather than one big macro call. Similarly, he was disciplined enough to not buy when he could not find stocks selling well below his estimation of intrinsic value.  Again, this would look like market timing - as holding cash waiting for the market to turn.  But again it is more a collection of micro decisions than one big macro call.  The end result is the same.  To the extent Buffett could be called a market timer, I think it is his extreme discipline, patience and ability to tune out the crowd that enabled it.

 

Exactly (except maybe for the line the end result is the same, because only 2 or 3 times in 60 years has it "looked" the same).  Buffett's decision process is micro or bottom up.  Market timing is macro or top down.  Buffett has made it clear with smaller sums he would be fully invested at all times because he believes he can always find something attractive.  If we have the time and ability that is what we should do too.  If someone has the ability but lacks the time to make micro calls, or vice versa, then logically they probably don't have the time or ability to make macro calls either.  That person is better off over the long term indexing or buying BRK than they are market timing. 

 

[original mungerville]

Interesting way to handle things.  I have never been anything but fully invested for 20+ years. 

 

But I have to say that things are getting lofty now.  It feels alot like 2007, summer and fall, just before the Bears Stearns mortgage funds blew up.  Markets were overvalued then but not terribly overvalued.  Markets today are aguably way more overvalued on nearly every metric than they were in 2007.  PE; PB; Market cap to GDP.  People will justify this by saying that the discount rate is low, but its appearing to be more volatile lately. 

 

In 2007, the housing bubble had been going full force for years.  There was a vague sense that it was not going to end well.  Today, everyone has run debt up to huge levels.  The US at all levels of government is in excess of 30 Trillion.  At the federal level the debt has gone from 10 to 20 T in 8 years:  thats 7% per year increase against < 2% inflation.  And that is just the US.  Excepting a few countries here and there debt levels have been skyrocketing.  And interest levels cant be lowered to service the debt.  If interest rates do in fact rise, somehow against the backdrop of all this debt, then debt payments are going to rise.  That I believe is the achilles heel. 

 

In summer 2008 the runaway mortgage crisis was 'contained' and there wasn't going to be any contagion.  Government is going to tell you that debt levels are manageable, and maybe they are, until they aren't.  And against this backdrop the worlds biggest economy just elected a tax and spend liberal/conservative? who wants to run up more debt.  And the US isn't alone with huge debts.  My province has record debt... CDN households have record debt.  You cant buy a car, a house, or anything else, when you can no longer service existing debts due to interest rate increases. 

 

And then there is simply the long duration without a bear market, and recession. With each passing month we get closer and closer.  And the longer we forestall it, the worse it wil be.  This time there wont be any V shaped capitulation driven by quantitative easing because government is out of money.  The 'backtracker' will be deep into government spending just to stand still. 

 

Lets just say I have become much more cautious these last few months and have been deleveraging and hedging.  I walked into the 2008, and 2009 redux, unaware of how fast, and how badly things can unravel.  Add to all this: there is no real good value to be had anywhere right now.  That should be signal enough for us.

 

So how does it end...when every developed world government and/or its financial sector is so leveraged up - including China - the #2 global economy? That is what I have been asking myself now for a number of years. Do the debts just keep growing and growing to feed our debt-fueled economic system? Obviously not, something will give and the question is what and when. I don't see how these debts get repaid, they will elect to inflate them away or move to a new global monetary system (the alternative is default).

 

And so I end up thinking you need some precious metals for protection - and the miners are quite cheap given the brutal depression-like (ie down 80-90%) bear market they went through from 2011 to early 2016. So I think a neutral portfolio (say for my mother-in-law) is 85-90% cash/ short-term bonds and 10-15% silver, gold, and miners. Or for a value investor, a neutral portfolio is long individual value picks, some hedging to get to neutral or cash-like, and then incorporate the 10-15% precious metals.

 

Does that make any sense to you? Or do you somehow think these debts can be repaid?

 

 

[scorpioncapital]

Check out the book, Dying of Money (https://books.google.com/books/about/Dying_of_Money.html?id=p5x5Cu4zuaoC) it answers all these questions and more about inflation

 

Btw, the author's name is Ronald Marcks, and has an interview here - http://www.financialsense.com/contributors/jens-o-parsson-ronald-marcks/dying-of-money-interview

http://www.financialsensenewshour.com/broadcast/insider/fsn2013-0607-marcks-tyo2583.mp3

 

This is what he wrote in 2013 -

 

"Jim: You know, one of the things I learned in your book, the ability of savers in Germany to hold marks enabled the government to mask the underlying effects of inflation. This storage factor of investors saving marks kept them from being immediately dumped into the market. In many ways, just like today where you have Americans that are holding Treasuries or buying Treasury bonds—a lot of money has gone into bond funds—do you see a lot of similarities between what was happening in Germany and what’s happening today?

 

Ronald: Oh, very much so. In fact, I think it’s even worse now than it was in Germany. I did some calculations on the present state of affairs. The money supply has increased by 4.85 times since the end of 1979 and prices have only increased by 2.32 times, which means that there’s a latent inflation of about 109%, by these calculations. That inflated money, I would say, is mainly in the debt markets because you find that even Federal debt securities are pretty close to zero percent interest, which is very contrasting to the situation you had in the past when outbreaks of inflation were occurring. Interest rates when higher than 10% for instance. So, that’s where I think the money is that’s been pumped out and the question is, when does that money start to come back from debt securities into goods."

 

And this: http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/7909432/The-Death-of-Paper-Money.html

 

"The crucial passage comes in Chapter 17 entitled "Velocity". Each big inflation -- whether the early 1920s in Germany, or the Korean and Vietnam wars in the US -- starts with a passive expansion of the quantity money. This sits inert for a surprisingly long time. Asset prices may go up, but latent price inflation is disguised. The effect is much like lighter fuel on a camp fire before the match is struck.

People’s willingness to hold money can change suddenly for a "psychological and spontaneous reason" , causing a spike in the velocity of money. It can occur at lightning speed, over a few weeks. The shift invariably catches economists by surprise. They wait too long to drain the excess money....

 

He contends that public patience snapped abruptly once people lost trust and began to "smell a government rat". Some might smile at the Bank of England "surprise" at the recent the jump in Brtiish inflation. Across the Atlantic, Fed critics say the rise in the US monetary base from $871bn to $2,024bn in just two years is an incendiary pyre that will ignite as soon as US money velocity returns to normal."

 

Isn't this what has happened with Trump and the delay since 2008 almost play by play?

 

One of the lines from the book I thought was great, "Persons incautious enough to become holders of

money wealth [cash] should beware that the announced intention of Keynesian economics was to effect their

extinction"

 

So it's a bit scary that what we have today could be worse than some of the scariest inflations in history.

 

I just don't understand two ideas -

1. If inflation decimates P/E ratios due to higher rates, but

2. Rates go up so financials and good assets - hard or soft - such as an operating business with pricing power become more valuable

 

How is #1 and #2 not a contradiction? Either a good asset behind the shares has increasing value because the value of money declines or it has decreasing value due to contracting P/E ratios.

Is the reconciliation of these concepts basically the roller coaster? You pump up the stocks to a very high level and so even when they fall it still is more than one's purchase price many years before the inflation process began? I would think that if this is the case, nobody would fault an investor for trying some market timing instead of watching as this contraction happens and they lose all their unrealized gains.

[wachtwoord]

The P/E ratio of a good business may be decimated but if the E in that equation goes up faster (due to strong pricing power in an inflationary environment) than the P/E factor goes down stock prices will still go up (in non-normalized terms).

[thepupil]

scorpion,

 

I think your number 2nd propositions should read

 

2. Good assets, such as an operating business with pricing power, are possibly able to raise price and maintain their real earnings power over time.

 

Then the two statements aren't contradictory. You may discount the increased earnings using a higher rate because of inflation. Whether or not the good asset increases or decreases in value (nominal or real) depends on how it was valued at time 0, which is not known. If we assume KO  has pricing power and is a good business, and it's earnings will increase at the rate of inflation, whether or not it goes up in value depends on the rate at which earnings are discounted at time 0 and time 1. If it starts at a PE of 30 and that goes to 12, it's obviously a much different story than if it starts at a PE of 18 and that goes to 12, holding the increase in earnings from inflation constant.

[scorpioncapital]

Interesting, so let's say $30 of cash over some period - longer or shorter depending on the virulence of the inflation, becomes $10.

 

All things being equal and no growth,

 

Let's say at time 0 a good business had $1 of earnings and was valued at 30x or $30/share.

After some time of inflation, the business has $3 of earnings and is valued at 12x or $45/share.

 

An uphill battle as we can see, an investor might not be faulted too much for selling at $30 and waiting a couple of years instead of treading water for meagre returns. (if the above occurs over a decade it's like 3% per year + dividends if any). Or he might do nothing, not sure which move is best here.

 

On the other hand, that $30 cash is now worth $10. So it does seem owning the business even at a contracting P/E you have at least $45 instead of $10 even though your real rate of return is very low.

 

I'm sure there are other implications here related to when to buy/sell/wait. Many of us have not lived through an inflation like Germany or US in the 70s.

 

I see lots of gold bugs, art buyers, commodity owners making the argument that this is the best thing to own in an inflation but the gist of the argument I get is that these assets merely keep up with inflation. So that $30 put into it is maybe $30 at the end. It sure beats getting out $10 but it does little for achieving a return on top of that. I wonder if there is a business that can maintain a decent return, say 10%/year in the face of declining P/Es - perhaps one that is already cheap right now, like IBM under 10x earnings. How much more can that contract?

 

Also things are *not* equal, high growth might also counteract these forces.

Do we know if real growth rates are also decelerated in a large inflation?

GARP seems the most prudent. I'm not a fan of 'pure' value - whatever that means - because to me GARP is the only value. What some call value I call 'cheap because future prospects and management are dull'  ;D

[Jurgis]

scorpion, in your scenario, you should be careful to either express everything in constant-time-moment-A dollars or specify which things are time-moment-A dollars and which ones are time-moment-B dollars. I get impression that you are mixing the two which might be confusing you and other people reading your example. E.g. $30 in cash at A becomes $10 in constant-time-moment-A dollars at B. It still remains $30 in time-moment-B dollars. Then when you say $30 in KO at A becomes $45 at B, is $45 in time-moment-B dollars or time-moment-A dollars?

[scorpioncapital]

I think the future dollar value is $30 vs $45, but both will buy - when the inflation seeps into day to day prices as opposed to capital market inflation what $10 or $15 might buy before the inflation. Is that right?

 

It really does seem it's an uphill battle no matter what you own. Is growth our only saviour? I mean, that stock that did $1 before and does $3 now and is re-rated to 1/2 P/E, must it grow much more, to like $4/share @ 15x or $60 to double your capital (buys $20 before the inflation while the cash is worth $10)?

 

I did read some people believe tech companies (if you can pick the winners) will do well in an inflation because of the higher growth rate but it seems the growth rate is really supreme for everything. If inflation is a headwind for growth you have to really work very hard at cost containment and raising prices (if you can) to achieve your goals. I can see how the new environment could be very challenging for a large segment of mediocre companies. Is this what Buffett meant in that article from the 70s when he said that only a good company is protection against inflation? The other companies may do even worse than things like gold, commodities, real estate, art, which themselves may only keep up plus a small return depending on how you pick your spots?

 

Seems frugality and cost containment is the flip side of pricing power. A company that has neither is dead. One that has both is very good and one that has one or the other is somewhere in the middle. I was thinking to start a thread of companies that are frugal which will go a long way to 1/2 of the equation. We know Berkshire is not wasteful but what other CEOs/companies have a fanatical devotion to keeping costs down while growing? Or is it a structural issue, a tech company has to be less fanatical because it's swimming in a better, cleaner pond?

[rb]

For all this talk about inflation and metals there sure doesn't seem to be a lot of correlation between the 2.

 

Edit: new cleaner chart

[rb]

Interesting way to handle things.  I have never been anything but fully invested for 20+ years. 

 

But I have to say that things are getting lofty now.  It feels alot like 2007, summer and fall, just before the Bears Stearns mortgage funds blew up.  Markets were overvalued then but not terribly overvalued.  Markets today are aguably way more overvalued on nearly every metric than they were in 2007.  PE; PB; Market cap to GDP.  People will justify this by saying that the discount rate is low, but its appearing to be more volatile lately. 

 

In 2007, the housing bubble had been going full force for years.  There was a vague sense that it was not going to end well.  Today, everyone has run debt up to huge levels.  The US at all levels of government is in excess of 30 Trillion.  At the federal level the debt has gone from 10 to 20 T in 8 years:  thats 7% per year increase against < 2% inflation.  And that is just the US.  Excepting a few countries here and there debt levels have been skyrocketing.  And interest levels cant be lowered to service the debt.  If interest rates do in fact rise, somehow against the backdrop of all this debt, then debt payments are going to rise.  That I believe is the achilles heel. 

 

In summer 2008 the runaway mortgage crisis was 'contained' and there wasn't going to be any contagion.  Government is going to tell you that debt levels are manageable, and maybe they are, until they aren't.  And against this backdrop the worlds biggest economy just elected a tax and spend liberal/conservative? who wants to run up more debt.  And the US isn't alone with huge debts.  My province has record debt... CDN households have record debt.  You cant buy a car, a house, or anything else, when you can no longer service existing debts due to interest rate increases. 

 

And then there is simply the long duration without a bear market, and recession. With each passing month we get closer and closer.  And the longer we forestall it, the worse it wil be.  This time there wont be any V shaped capitulation driven by quantitative easing because government is out of money.  The 'backtracker' will be deep into government spending just to stand still. 

 

Lets just say I have become much more cautious these last few months and have been deleveraging and hedging.  I walked into the 2008, and 2009 redux, unaware of how fast, and how badly things can unravel.  Add to all this: there is no real good value to be had anywhere right now.  That should be signal enough for us.

 

So how does it end...when every developed world government and/or its financial sector is so leveraged up - including China - the #2 global economy? That is what I have been asking myself now for a number of years. Do the debts just keep growing and growing to feed our debt-fueled economic system? Obviously not, something will give and the question is what and when. I don't see how these debts get repaid, they will elect to inflate them away or move to a new global monetary system (the alternative is default).

 

.......

 

Does that make any sense to you? Or do you somehow think these debts can be repaid?

We in the US at least there's been quite a bit of deleveraging in the household and private sectors. So you can look at the gov't debt increase as the gov't stepping in to control the deleveraging process so you don't have a complete economic meltdown. But that's neither here nor there.

 

The answer to your question is that no, the gov't doesn't need to repay those debts and probably never will. Nor does it have to inflate the debt away. This level (or even much higher) of debt is totally serviceable.

 

Also it's helpful to think of what's actually happening in the economy. The US gov't debt isn't a magical thing that just appears or disappears. On the other side of the US debt there are massive amounts of savings that are lent to the gov't. If something were to happen to that massive pool of saving it will probably take the shape of an investment boom. But even that would have a marginal effect. Also if you have an investment boom (think factories not stocks) the gov't has a larger tax base and the gov't borrowing needs decrease. In addition if you move away from a demand constrained economy the gov't can easily pass a tax increase.

 

The math gets really complicated when you start giving away tax cuts like Oprah gives away cars. But you figure that a lot of those money will go into the savings pool and will be available for the gov't to borrow. So no, I don't think that we're at risk of a gov't debt crisis in the US unless the American are really hell bent on creating one for themselves. You can't get good data out of China, so God knows what's going on over there.

[Jurgis]

I think the future dollar value is $30 vs $45, but both will buy - when the inflation seeps into day to day prices as opposed to capital market inflation what $10 or $15 might buy before the inflation. Is that right?

 

It really does seem it's an uphill battle no matter what you own. Is growth our only saviour? I mean, that stock that did $1 before and does $3 now and is re-rated to 1/2 P/E, must it grow much more, to like $4/share @ 15x or $60 to double your capital (buys $20 before the inflation while the cash is worth $10)?

 

If you assume huge inflation (3x loss of purchasing power) and huge PE contraction (30x to 12x) then yeah, most of options are not very attractive.

[original mungerville]

"I just don't understand two ideas -

1. If inflation decimates P/E ratios due to higher rates, but

2. Rates go up so financials and good assets - hard or soft - such as an operating business with pricing power become more valuable"

 

#1. is why I think precious metals also make sense to own as part of a portfolio rather than only stocks. At a minimum, gold becomes your old cash position in an inflation. In a "risk off" phase of an inflation there should be tons of demand for gold rather than cash. Gold is an investment in monetary disorder which we seem to have at this point.

 

The p/e of precious metals miners should not contract in an accelerating inflation as the earnings growth would be levered to accelerating revenues. Earnings should grow faster than the inflation and so the p/e should not contract, it should expand for the period when earnings growth is greater that the inflation/discount rate.

 

I don't know, given the debt levels and the money printing, I feel more comfortable with 15% of a portfolio in gold, gold miners and silver rather than just traditional stocks and cash.

[rb]

"I just don't understand two ideas -

1. If inflation decimates P/E ratios due to higher rates, but

2. Rates go up so financials and good assets - hard or soft - such as an operating business with pricing power become more valuable"

 

#1. is why I think precious metals also make sense to own as part of a portfolio rather than only stocks. At a minimum, gold becomes your old cash position in an inflation. In a "risk off" phase of an inflation there should be tons of demand for gold rather than cash. Gold is an investment in monetary disorder which we seem to have at this point.

 

The p/e of precious metals miners should not contract in an accelerating inflation as the earnings growth would be levered to accelerating revenues. Earnings should grow faster than the inflation and so the p/e should not contract, it should expand for the period when earnings growth is greater that the inflation/discount rate.

 

I don't know, given the debt levels and the money printing, I feel more comfortable with 15% of a portfolio in gold, gold miners and silver rather than just traditional stocks and cash.

The point I was trying to make is why do you cling to the idea that gold is related to inflation if data doesn't support it? See chart I've attached.

 

It actually turns out that surprise! the price of gold is more related to its real world applications and mining costs rather than inflation. When you take those things into consideration a better investment will probably be physical gold rather than the miners if you want to go that route. Just be mindful that you're actually investing in gold mining costs not in an inflation hedge.

[original mungerville]

"gold is related to inflation if data doesn't support it? See chart I've attached."

 

From your chart, gold does well in periods when inflation is really high (1970s) which is what I was referencing when I said "an inflation" (I wasn't talking about controlled 2% inflation periods, and certainly the CPI is probably not the best measure, I was talking about significant inflations) and it does well in periods when material money printing is required (last 16 years) to sustain a debt-fuelled global economic/financial system - ie it does well when the monetary system is under pressure. 

 

"It actually turns out that surprise! the price of gold is more related to its real world applications and mining costs rather than inflation."

 

What are you talking about? The chart you provided shows a bull market in the 70s due to inflation, then a bear market in the 80s through 2000s because Volcker jacked interest rates so much in the early 80s that real interest rates were significantly positive breaking the back of the gold price. Then several central banks sold significant amounts of their gold by the early 2000s (eg, Bank of England) marking the bottom in the gold price just when financial assets were peaking (ie stocks). Gold then started to rise as Greenspan's put on the bursting Nasdaq sent real interest rates to lows, inflated the housing and finance bubble 2002-2005 which then burst by 2006 through 2010 requiring lower interest rates and asset purchases (ie money printing) by Bernanke. China inflated their financial system as the financial crisis took hold and just kept levering up. They have had a huge creation of debt in their financial system in the last 15 years, and especially the latter part of that. Bernanke's strategy went global - Europe adopted it as well. That is why gold has been increasing significantly since 2000 in $US terms. And very significantly in almost every other currency.

 

"Real world applications"? Jewelry demand has some impact. Gold price is driven by investment demand including central bank buying, selling, leasing, and the gold derivatives market. Mining costs provide a long-term floor as is the case for any substance which is mined. Real interest rates have an impact. Monetary stability has an impact. Sentiment and prospective views on monetary stability have an impact (which is why gold can also do well in deflations).

 

If you think "real world applications" and "mining costs" drive the big moves in the gold price, you are mistaken.

 

[rb]

"gold is related to inflation if data doesn't support it? See chart I've attached."

 

From your chart, gold does well in periods when inflation is really high (1970s) which is what I was referencing when I said "an inflation" (I wasn't talking about controlled 2% inflation periods, and certainly the CPI is probably not the best measure, I was talking about significant inflations) and it does well in periods when material money printing is required (last 16 years) to sustain a debt-fuelled global economic/financial system - ie it does well when the monetary system is under pressure. 

 

"It actually turns out that surprise! the price of gold is more related to its real world applications and mining costs rather than inflation."

 

What are you talking about? The chart you provided shows a bull market in the 70s due to inflation, then a bear market in the 80s through 2000s because Volcker jacked interest rates so much in the early 80s that real interest rates were significantly positive breaking the back of the gold price. Then several central banks sold significant amounts of their gold by the early 2000s (eg, Bank of England) marking the bottom in the gold price just when financial assets were peaking (ie stocks). Gold then started to rise as Greenspan's put on the bursting Nasdaq sent real interest rates to lows, inflated the housing and finance bubble 2002-2005 which then burst by 2006 through 2010 requiring lower interest rates and asset purchases (ie money printing) by Bernanke. China inflated their financial system as the financial crisis took hold and just kept levering up. They have had a huge creation of debt in their financial system in the last 15 years, and especially the latter part of that. Bernanke's strategy went global - Europe adopted it as well. That is why gold has been increasing significantly since 2000 in $US terms. And very significantly in almost every other currency.

 

"Real world applications"? Jewelry demand has some impact. Gold price is driven by investment demand including central bank buying, selling, leasing, and the gold derivatives market. Mining costs provide a long-term floor as is the case for any substance which is mined. Real interest rates have an impact. Monetary stability has an impact. Sentiment and prospective views on monetary stability have an impact (which is why gold can also do well in deflations).

 

If you think "real world applications" and "mining costs" drive the big moves in the gold price, you are mistaken.

Look if you're right and I'm wrong I'd love to learn more. But please provide some data to back up the argument, not just commentary.

 

If gold is related to inflation then why doesn't it correlate to inflation indexes? CPI isn't a good measure which is? PPI? GDP Deflator? Why is monetary base a better measure than money supply? Actually it doesn't correlate that well to monetary base either. What up with that?

 

Regarding real world applications. Actually more than half of the gold mined (I think about 60%) goes to real world applications. Mostly jewellery, electronics and automotive. 

[original mungerville]

Wow man. There is no point continuing this discussion. I did not say it correlates well to controlled inflation. You assumed that is what I meant. I then explained in my last post that that is not what I meant. Yet you still insist it was what I meant. Gold went up nicely during the high inflation in the 70s as per my last post.

[rb]

Wow man. There is no point continuing this discussion. I did not say it correlates well to controlled inflation. You assumed that is what I meant. I then explained in my last post that that is not what I meant. Yet you still insist it was what I meant. Gold went up nicely during the high inflation in the 70s as per my last post.

Well if you don't want to continue the discussion that's your prerogative. You can take your toys and go home.

 

But i wasn't trying to be facetious or anything like that. Yes gold went up nicely in the 70s and inflation was higher in the 70. But as you say gold went up nicely in the 70s. In fact it went a hell of a lot higher than inflation. Then inflation continues (yes at a more regular pace) and gold crashes then fluctuates. In the 90s we still have inflation (subdued kind) and gold trends toward a bottom. Then in the 2000s we still have subdued inflation but gold spikes up.

 

Yes gold went up nicely in the 70s and inflation was high in the 70s but so what? Does anything that went up nicely in the 70s is related to inflation? Yea that's a bit of snark but it has its place sometime. It's just if something is related to inflation I expect that it would have a correlation to inflation. Otherwise what are we talking about.

 

Regarding the gold miners just look at their stock price compared to the price of gold. They have to be the only type of companies where the price of their product goes up a lot but their value doesn't.

 

I'm sorry if all of this is offensive in some way. But I'm not trying to be offensive. I'm just looking at data.

[original mungerville]

"Yes gold went up nicely in the 70s and inflation was higher in the 70. But as you say gold went up nicely in the 70s. In fact it went a hell of a lot higher than inflation. Then inflation continues (yes at a more regular pace) and gold crashes then fluctuates. In the 90s we still have inflation (subdued kind) and gold trends toward a bottom. Then in the 2000s we still have subdued inflation but gold spikes up.

 

Yes gold went up nicely in the 70s and inflation was high in the 70s but so what? Does anything that went up nicely in the 70s is related to inflation? Yea that's a bit of snark but it has its place sometime. It's just if something is related to inflation I expect that it would have a correlation to inflation. Otherwise what are we talking about."

 

I explained why gold crashed through the 1980s and 1990s in a bit of detail (there is too much for this thread) and those factors have nothing to do with regular pace inflation. The point is a whole bunch of other factors drive the gold price to a greater degree when we have regular pace inflation - see my previous post. Gold went a whole hell of a lot higher than inflation in the 70s which is why you want to own it if you think rampant inflation is coming back - and the gold miners - which brings us back to the beginning of this thread.

[maybe4less]

IMO, gold seems to correlate (inversely) with real interest rates rather than inflation. Low real interest rates means there is less opportunity cost to holding gold, whereas cash may have a significant opportunity cost if real rates are negative.

 

This explains why gold did well in the high inflation period of the seventies (inflation was close to nominal rates and even higher at certain points),  why gold hit a low in ~2000 when real rates hit nearly 7%, and why gold did well coming out of the recession with real rates approached 1% (inflation was running near 3%, but nominal rates were very low). Gold has declined since then as inflation has decreased and with Fed starting to raise nominal rates.

[original mungerville]

IMO, gold seems to correlate (inversely) with real interest rates rather than inflation. Low real interest rates means there is less opportunity cost to holding gold, whereas cash may have a significant opportunity cost if real rates are negative.

 

This explains why gold did well in the high inflation period of the seventies (inflation was close to nominal rates and even higher at certain points),  why gold hit a low in ~2000 when real rates hit nearly 7%, and why gold did well coming out of the recession with real rates approached 1% (inflation was running near 3%, but nominal rates were very low). Gold has declined since then as inflation has decreased and with Fed starting to raise nominal rates.

 

Yes, I agree with you - real rates are a big driver (the gold price also seems to correlate well with the expansion of central bank balance sheets which some academics argue create negative nominal rate equivalents in practice). If because of the large debts globally the Fed now remains behind the curve on interest rates (ie if Fed keeps real interest rates negative as they are currently), then gold will do well. If real interest rates are significantly positive, gold will not do as well going forward. I just don't see how we get the latter without major major asset market declines in the US and globally.

[AzCactus]

History doesn't repeat itself, but it does rhyme.

 

---Mark Twain