Revisiting Gold and Investment Wisdom by Navin Doshi (December 2003)

Last year while reflecting on the uncertain economic times we’ve been facing, I recommended buying gold and selected emerging market or lower grade bonds. In 2002 Gold was selling at $310 per ounce. Today as of last week it was selling around $395 an ounce which is over a 27 percent rise in value. You could have put your money in a bank and received around one percent interest on it, which is not a desired return. For some investors, a 27 percent return on an investment may not be so spectacular. However, if we had invested in gold stock index, XAU, and companies who deal in gold mining stocks, perhaps most would consider the return to be spectacular. The Gold Index has gone up over 40 percent since last year. The bonds of Telephone Argentina (symbol: tar) rose from below $5oo to over par yielding 11.825 % interest per year and a capital gain of over 100%. The key, however, is to know the wisdom of the investment advice. Today I would like to talk about gold and wisdom of investment because I think both are very valuable assets.

Is there an opportunity to invest in gold? When I am talking about investing in gold, it includes all other precious metals like silver and platinum. Are there other opportunities for investment? The answer to both questions is “yes.” But before I explain why, I’ll preface my thoughts by saying that, in these uncertain economic times, the better investments today are in emerging market currencies, emerging market bonds, and hard assets that include commodities, real estate and precious metals.

To begin with, the US Dollar is losing value against foreign currencies. This is partly because the market is being flooded withUS currency to inflate the dollar. At the same time US ten year Bonds are paying about four percent. On the other hand emerging market Government bonds are paying around 9 percent. The fact is, most foreign currencies are rising in value compared to the US dollar. This is because the US Fed is increasing the money supply or the dollar liquidity faster than the liquidity of other currencies. As a result, I do see a convergence of the interest rates of US government bonds and emerging market bonds. The trend has been established and one way to play this trend is to buy the stocks of the banks in Asia and Latin America. Other investment themes include buying value based high yield energy stocks and growth stocks. Please note that there are always exceptions and contradictions.

With regard to the greenback, for centuries, the US dollar was collateralized by gold. The gold standard helped demand and supply of money to remain in equilibrium. The result was a stable price in terms of dollar which was tied to the unit weight of gold. First major negative effect of this occurred under FDR, who during the depression, depreciated the dollar by fixing the dollar at 35 dollars an ounce of gold which was lowered from its previous 20 dollars an ounce. As a result, the money supply in the US increased by 75 percent and the value of the US dollar dropped by over 40 percent. Though FDR didn’t remove the gold standard for US currency for foreigners, he did make it illegal to own gold by Americans.

Historically, governments have never let go of their power over the money in their country. Part of the motivation for this is to insure against economic downfall. Rulers or governments want an “elastic currency.” Recently at a talk at the Milken Institute, I asked Raghuram Rajan, a recently appointed economist of IMF and a professor at the University Of Chicago School Of Economics, if the US would ever go back to the gold standard. He replied emphatically “no.” Professor Rajan explained in essence that Government will not let go an instrument (elastic money) that helps them get reelected. The FED is pumping money into the US economy to create growth. A few months ago Alan Greenspan explained that he didn’t want the US economy to go into deflation. In fact the money supply doubled during the last eight years in the US. That translates into an annual dollar growth rate of nine percent. Since the GDP for the same period averaged at 2 percent, the inflation rate comes out to be about 7%. This number is certainly much higher than what we’ve been hearing coming out of Washington.

Nixon became unpopular because of the Vietnam War and the Watergate scandal, but many proponents of the gold standard feel his real crime was removing the US dollar from the gold standard in the 1970’s. Since the Nixon presidency, our middle class in the United States has been shrinking year after year. During the Nixon years, even with one wage earner in the family, you still saw an average family with 30 to 40 percent discretionary income. During the Reagan years America went from one wage earner in the family to two wage earners to maintain our standard of living. Today discretionary income is minimal in the US. During Reagan and the last years of President Clinton the stock market was paying big dividends, but both parents were working in US households.

There is an incredible budget deficit. The US also has huge debts to other countries. One way to reduce the pain of debt is to devalue the dollar by printing more dollars and inflating the economy. The net worth of America has been estimated to be about 50 trillion dollars. Our current account deficit is about 500 billion dollars. This is the money America over spends every year. The implication of this exercise is that we are transferring our wealth to other countries at a rate of one percent a year.

There is an expression “inflate or die” in economic circles. There has to have an economic growth to keep the growing population employed. Like a rocket trying to escape earth that needs to reach a minimum speed to do so, so too our economy needs to be kept afloat before everything crashes down around it. Another analogy here is that the universe is always expanding. If the universe stops expanding, then it starts contracting and could collapse into a black hole. Our economic growth is mainly due to the consumption more so than manufacturing. With companies like Costco and Wal-Mart, which are basically distribution portals for manufactured goods from China, the US economy has become more service oriented rather than production oriented. We may be building a huge “black hole” if we ever have to face the reality of what’s really going on. The middle class will continue to shrink as manufacturing jobs disappear from America. The paper currency will continue to expand. It is therefore a no brainer, as Richard Russell would say, to invest in gold today just based upon the law of demand and supply.

Now, we may also be duplicating the 1970’s when we inflated the economy, went off the gold standard, invested in a massive South-East Asian War called Vietnam, and saw rising oil prices and gas lines because of Middle Eastern conflicts. Does this sound familiar? From 1970 to 1982 the Dow fluctuated in the range of 600 to 1000. In 1980 it was 800 and gold had jumped in value around $800 per oz. Currently in the first decade of the 21st Century the Dow Jones index went down from a high of about 12000 to the low of about 8000 and could continue to fluctuate around 10000 going into the next decade. Like in the 1970’s the gold price could skyrocket. At present, selling at nearly 400 dollars an ounce, gold is at the highest it has been in the last seven years. Yes, the price of gold could go down to 380 or so. However, in the long run, it should keep rising as long as the interest rate is lower than the true inflation rate.

We need to look into the history of Germany in 1919 right after WWI. It is a sobering history lesson how the German government debased it’s currency by printing and flooding the economy with its currency. For one thing, the entire savings of Germany’s middle class was wiped out, 25 percent of its children were under nourished. Thousands had tuberculosis. Many died of starvation. Crime was up. Money was worthless. Money was worthless because there had been a collapse of the currency which meant an end of trade with other nations. Thus, entered the Nazis, who used this chaotic situation to gain power and turn Germany into another war machine. We know the rest of the story.

Zimbabwe is another example of what inflation can do to the currency. In the last 20 years we’ve seen their currency go from being equal to the US dollar to now finding their one dollar note of less value than the tissue paper. So in Zimbabwe it is cheaper to clean ourselves with the Zimbabwe one dollar note than the tissue paper. As I mentioned earlier, the US dollar has no collateral like gold behind it. But if the value of the US currency begins to drop sharply, foreign nations who have considerable US bonds and currency may change those US dollars into gold. Many Asian countries are already doing this. It is as if they know “the emperor has no clothes.” Some foreign countries can opt to change US dollars for US assets like real estate, US corporations or even high tech stocks. Because the US is still one of the better capitalistic countries, with a powerful and creative work force, these other assets are not a bad trade off. However, some are now feeling with the post 9/11 psych, the US government is becoming too intrusive. The recent business scandals on Wall Street and the incidents of top American CEO’s manipulating corporate earnings have made some feel the country is sliding into corruption. The Patriot Act that has been enlisted by the Department of Homeland Security after 9/11 is very controversial and many academic scholars are saying it is fundamentally unconstitutional. Still even with changes in attitude by the American government, people want to be employed in this country. People want to live the good life in America. But by making Wal-Mart China’s 8th largest trading partner in the world, is the American economy really on the road to long term recovery? I’m not so sure.

Let’s look at a time in history where gold was in oversupply to ponder this last question. Remember, the supreme law of economics is the law of supply and demand. At the beginning of the 16th Century during the Spanish and Portuguese periods of New World Exploration gold was actually flooded into the World markets. When the Spanish discovered gold in South America, they mined it with slaves from Latin America and Africa and brought their new wealth back to Europe. It was as if the Spanish seemed to have a money press in their basement. But rather than developing an economy with their new gold, the Spanish lived “high on the hog.” Instead, they became world consumers. It didn’t last long. They spent their money fighting wars. After a disastrous loss to the English in 1588 where the Spanish Armada was sunk, Spain fell into a slump. The small easily movable gun boats of the British took down Spain’s big fleet a little like guerilla Al-queda taking on massive American military forces. Put simply, after their defeat, Spain for the next 400 years remained a poor man of Europe.

Today the US is the big spender, thanks to the world where the dollar has been accepted as the world currency at least for last 50 years. We do not know how long it is going to last. But is America developing its economy at the same time, or is it just living high on the hog like Spain in the 16th Century and becoming nothing but a consuming nation? Could America be headed to the same fate as Spain? Or is the US moving back to a similar scenario of its economy in the 1970’s when the Dow dropped to around 330 in inflation adjusted dollars? People lost 2/3 of their wealth, thanks to the market, the inflation, wage freezes and all sorts of hardships.

Alan Greenspan has said that the argument against deflation is that if there is a severe downward pricing pressure, then businesses could go under and bankruptcies would be prevalent. This is poisonous for a nation’s economy since it could degenerate into a depression similar to the one that occurred in1930’s. That’s why the Fed sponsored inflationary trend is anticipated. In spite of this trend, the US is still the destination of choice of most people in the world to do business. For most immigrants, including California’s new governor, Schwarzenegger, America was and is still the dream place to come. In fact, through America’s door of immigration come some of the world’s most entrepreneurial and productive people. This has been important for America’s historic economic growth and success. Still, America’s economic growth since being removed from the gold standard, is perhaps more shaky than we want to admit.

Back in the 70’s, the US could not make its fiscal obligations, so President Nixon took us off the gold standard. America also pressed other nations to do the same. Switzerland argued against it in the UN but they were humiliated by the US. Thirty-five years ago even America’s Fed Chairman said that gold and economic freedom were inseparable. Gold is the only currency that politicians cannot print or control. In fact gold often spells freedom for people. In his book, The Gold Wars, author Ferdinand Lips states the gold wars are being fought by rulers and governments trying to manipulate gold. He claims that the rising oil prices globally have really been caused by the inflated US dollar which is the key currency in buying and selling oil. Because the US Dollar is no longer backed by gold other nations question its legitimate value according to Lips. In many ways, gold can be the only protection of property rights citizens have. Like liberty, gold never stays where it is undervalued. Throughout history, whether it was Lenin, Hitler, Mussolini, Mao, or FDR, all these leaders banned the ownership of gold. Why? If you control gold you can control a country’s money. Lenin had said that the best way to destroy capitalist system was to debauch the currency and with inflation, governments can confiscate, secretly and unobserved, the property and wealth of their citizens. Removing the gold standard of an economy is one of the steps in that scenario.

This all brings me to my final points about “wisdom” and its relationship to gold. As the emerging markets are going up and the US dollar is going down, consumption in America is up and productivity is down, it is important to listen to the “old timers” when it comes to sound business advice. Asians, specifically Chinese and Japanese are big savers. With lots of money saved, the speculation is what they will do with it. Time will tell. In the meantime, what are all the economic pundits saying about advice on your money? I feel it is important to listen to the “old timers. What are the old timers saying? John Templeton says stock valuations are too high right now. He anticipates a long bear market and advises us to be very cautious. Warren Buffett had almost never considered investing in foreign currencies, but has now started to do so. We do know that we are going through an information revolution, but a lot of that information is not of much use. For example, Nassim Nicholas Taleb, a mathematician, says that most information is just noise. He refers to the fact that one has to sift through so much garbage to find any advice that is even really worthwhile. In other words, everyone is too busy doing the “here and now” to really reflect on long term gains of good investment advice. Perhaps, the best quote from Taleb on advice of an old timer is this: “For an idea (from an old timer) to have survived so long across so many cycles is an indication of its fitness.”

Basically the new information is being claimed to be better than the old. But is it really? So much advice is now a “dime a dozen.” However, I’m not alone in saying gold is a good investment right now. Professor Ravi Batra, a well known economic professor at SMU, Dallas, also agrees with me that gold is a good investment along with hard assets. The rational reasoning is that gold rises in time of fear. But how do we determine if we are in a time of fear? Fear is not the only reason that makes gold go up in price. Another reason gold should go up is that money flows where it is treated the best. Today banks pay very little interest so money is not really flowing there. The inflation rate and interest rate affect the price of gold. In the 70’s, the gold price exploded because the inflation rate was a lot higher than the interest rate paid by the bank.

To make sense of information you need wisdom. It takes decades of experience to derive wisdom from information. Information can be received almost instantaneously. The lessons of history shows, that the multitude of un-distilled information needs to be turned into wisdom employing the experience of old timers. Who will survive are not necessarily those who appear to be fittest. Seasoned investors like Buffett and Templeton who have been exposed longer to the ups and downs of the market are more resistant to failure and more likely to survive.

There is one more investment theme that needs to be considered. Currently we have a memory explosion in computers. Few years ago some technology gurus thought computers of the future would be a small inexpensive box hooked up to a massive master big computer filled with information. They were wrong. The trend today is personal computers with large memory banks to hold massive amounts of information. What we have discovered is that people want freedom with their computer. It is a little like the failure of rapid transit in Los Angeles that never seems to succeed because LA drivers ultimately want the freedom of driving. Now, if you see the wisdom of the current trend in computers, you will see why I believe companies investing in hard drives for computers are companies to invest in. We’re already seeing the Disney Company planning to sell large DVD boxes with 100 to 150 of their movies on them. Consumers will be able to own these boxes and they’ll contain all the information you need at your fingertips. Another box might contain all the paintings, sketches and art work of a particular artist you are studying. So you see, the bigger the memory and the more compact, the better the computer.

In conclusion, we must learn from history since it helps to provide wisdom. We do know that successive administration has supported greater world trade. Reputable economists believe that there is no alternate path but to follow the current course. We, certainly, do not want to follow the path of the pre-Nazi era Germany or the 16th century Spain. We hope that the US policy makers are navigating the most prudent path for America. I think it was wise King Solomon who gets credit for saying “wisdom is even more valuable than gold.” Given our current economic times, I think wisdom and gold are both great investments. However, we exist in nature that follows Einstein’s relativity, implying that there is nothing absolute, every thing in nature changes including wisdom.

“To prefer paper (money) to gold is to prefer high risk to lower risk, instability to stability, inflation to steady long term values, a system of low grade performance to a system of higher, though not perfect, grade performance”

William Rees-Mogg, Former Editor, columnist of Times of London.

“Unchecked money and credit expansion eventually hurts the nation that practices it. It is harmful because it depreciates the value of the monetary unit, raises everybody’s cost of living, imposes, in effect, a tax on the poorest, wipes out past savings, discourages future savings, redistributes wealth and income wantonly, encourages and rewards speculation and gambling at the expense of thrift and work, undermines confidence in the justice of a free enterprise system, and corrupts public and private morals.”Henry Hazlitt, former editor, economic section of New York Times and a Newsweek columnist.

“There can be no other criterion, no other standard than gold. Yes, gold never changes, which has no nationality, and which is eternally and universally accepted as the unalterable fiduciary value par excellence.” Charles De Gaulle, French President.

“U.S. government has a technology, called printing press that allows it to produce as many dollars as it wishes at essentially no cost. By increasing the number of dollars, the government can reduce the value of dollars in terms of goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation”. Current Fed Governor, Ben Bernanke.

“We know Mr. Bush wants to be re-elected; over the next 12 months, he and his lackeys at the Fed and the Treasury, will only take policy measures that are designed to keep the public happy with ‘circus and pane’. Such policies can give investors the illusion of wealth as asset markets appreciate, while the loss of the currency’s purchasing power is hardly noticed….” Dr. Marc Faber, a publisher of the investment news letter and the member of the Barron’s round table.

“Truth, like gold is to be obtained not by its growth, but by washing away from it all that is not gold.” Leo Tolstoy.

By Navin Doshi (December 2003)
(Mr. Doshi is a financial market trader, writer and a philanthropist)

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