Wednesday, July 31, 2013

What is the payoff structure of gold?



In an excellent new post, John Cochrane corrects some of Greg Mankiw's points on gold as an investment, writing:
In any case, Greg shouldn't have phrased the question, "how much gold should I hold according to mean variance analysis, presuming I'm smarter than everyone else and can profit at their expense by looking in this crystal ball?" He should have phrased the question, "how much more or less than the market average should I hold?" And "what makes me different from average to do it?"... 
As Greg points out, gold is a tiny fraction of [global] wealth. So it should be at most a tiny fraction of a portfolio.
Quite so. But even if one would not personally choose to make one-way directional bets on an asset, one might want to specify the asset's full state-contingent payoff structure, for those who do choose to speculate or to use the asset to hedge their idiosyncratic risks.

In other words, when does gold pay off? Cochrane tosses out a possible answer:
There is all this bit about gold, guns, ammo and cans of beans. If you think about gold that way, you're thinking about gold as an out of the money put option on calamitous social disruption, including destruction of the entire financial and monetary system. That might justify a different answer.
This idea is pretty common. But is it true? Would gold really pay off in the event of a calamitous social disruption? I'm really not sure that it would.

The basic idea here is that fiat money's value rests on the stability of governments; remove governmental stability, and people will go back to using gold as money (or at least to using gold-backed money), as in days of yore. If that happened, it would be handy to have stocked up a whole bunch of the suddenly back-in-use medium of exchange.

But I seriously question whether this would ever happen. See, both technology and the structure of governance have really changed since the days when gold was used for money. The assumption that the end of the Recent System (fiat money) would make us revert to the Old System (gold-backed money or gold as money) does not seem well-founded to me.

First of all, gold has always had a lot of limitations as a medium of exchange. Most notably, it is relatively easy to steal. To realize this, all you have to do is look at games like World of Warcraft, Diablo, Dungeons and Dragons, or the original Final Fantasy. In those games, gold is the money, and you often get gold not by doing an honest day's work, but by running around and beating people up and taking their gold. In other words, the entire world of modern fantasy role-playing is a subtle joke on gold's unsuitability as a medium of exchange.

Now in the past, people just sucked it up and dealt with this, spending large amounts of money and effort to guard their gold. But in the modern day, better alternatives are available. In particular, electronic security is cheaper than physical security. It's easier to guard digits than lumps of gold. In fact, in the case of gold-backed money (rather than physical gold money), you'd need electronic security in addition to guards at Fort Knox. Non-gold-backed digital currency is always cheaper to use than gold-backed digital currency.

So if fiat systems collapsed but electronic networks remained intact, it seems to me that we'd move to some sort of Bitcoin-type artificially scarce digital currency, rather than gold. Not Bitcoin itself, but some electronic currency managed by an institution with lots of staying power and respect. I'd put my money on ToyotaBucks.

OK, but what about a calamity so huge that electronic networks collapsed? In that case, wouldn't we have to go back to using physical money?

Maybe, but it wouldn't be gold. In the days when people carried around gold doubloons and whatnot as money, you had a global political system characterized by pockets of stability (the Spanish Empire, or the Chinese Empire, or whatever) scattered among large areas of anarchy. Those stable centers minted and gave out the gold coins. But in the event of a massive modern global catastrophe that brought widespread anarchy, the gold bars buried in your backyard would not be swappable for eggs or butter at the corner store. You'd need some big organization to turn the gold bars into coins of standard weights and purity. And that big organization is not going to do that for you as a free service. More likely, that big organization will simply kill you and take your gold bars, Dungeons and Dragons style.

In other words, I think gold is never coming back as a medium of exchange, under any circumstances. It is no more likely than a return of the Holy Roman Empire. Say goodbye forever to gold money.

So when does gold actually pay off? Well, remember that stories do not have to be true for people to believe them. Lots and lots of people believe that gold or gold-backed money in the event of a global social  disruption. And so when this story becomes more popular (possibly with the launching of websites like Zero Hedge?), or when large-scale social disruption seems more likely while holding the popularity of the story constant, gold pays off. Gold is like a credit default swap backed by an insolvent counterparty - it has no hope of actually being redeemed, but you can keep it around forever, and it goes up in price whenever people get scared.

In other words, gold pays off when there is an outbreak of goldbug-ism. Gold is a bet that there will be more goldbugs in the future than there are now. And since the "gold will be money again" story is very deep and powerful, based as it is on thousands of years of (no longer applicable) historical experience, it is highly likely that goldbug-ism will break out again someday. So if you're the gambling type, or if you plan to start the next Zero Hedge, or if your income for some reason goes down when goldbug-ism breaks out, well, go ahead and place a one-way bet on gold.

The only way gold will never pay off again is if practically everyone reads and believes this blog post. Not much chance of that happening!

97 comments:

  1. So... not quite, Noah.

    Gold has been going down during times of crisis too when you'd think gold-bug-ism should be rising.

    IIRC, from my trading days, 2008 and the beginning of 09 weren't good times for Gold and it was high panic times where the fabric of the world as we know it seemed to hang by a thread...

    In any case, you're right about the problem of saving wealth for a crisis. Even if you wisely accumulate cans of food and simple agricultural tools and such, the only result will be to making you into a target.

    And guns? Well, sure, they're the only realistic investment but you better know how to operate them and have lots.

    My best 'catastrophic insurance' item? Either the outright command of a mechanised infantry battalion/Brigade Combat Team or, in case a life in the Army seems like an excessive price for a deep OTM put option, a grand mutual friendship or mutual interests with the colonel commanding your local BCT.

    And it's been done before. You can look at how Roman citizens of means and wealth fared during the Barbarian Age in Europe...

    Arguably, you won't get the luck of riding off on an emerging religion like Christianity but who knows? Doom cults ought to become popular at this junction in time...

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    1. The popularity of goldbuggism is not perfectly correlated with the probability of social collapse.

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    2. With all due respect, I think that the drop of Gold prices during the 08/early 09 had a lot to do with Indians and Chinese families being less able to indulge in their desire for owning Gold...

      OTOH, you're still not wrong as Indians/Chinese love affair with the yellow metal is but a cultural variant of right-wing American gold-buggism... :)

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  2. OMG, I used to play a Night Elf. Big ears, purple hair, you couldn't miss me.

    Btw, I didn't read this post; I only look at pics.

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  3. I think the other thing that gold does fairly well is to preserve its value over long periods of time - ie several generations. So if you are thinking dynastically, then if you are very rich, and for some reason you want your descendants to also be rich, then it makes sense to keep part of your savings in gold as a hedge for them. Of course, you are then making the bet that intervening descendants won't squander it in some way, just as they might mortgage the land you leave them, or find some way to spend the capital that you leave in trust, but it's a part of a multi-generational insurance policy.

    Of course, I'm not sure that mainstream economic theory assumes that rational actors optimise for multi-generational consumption functions, but I'm sure it's implied in Arrow-Debreu, if only because everything else is.

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    1. I see your point. That gold doesn't oxidize like other metals is a huge advantage. On the other end: Keeping your wealth in corn isn't such a good idea unless you're planning to turn it over before it spoils.

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    2. Nathanael10:54 PM

      That's also what jewels are for.

      Spices were generally worth more, but even spices go bad eventually.

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  4. Up until the 1870s apotheosis of gold, silver was much more important as a medium of exchange. The Spanish empire produced masses of silver coins, which were much more widely used in the world economy than gold coins.

    Silver is about 15 times more common in the Earth's crust than gold. Economic activity had to get up to a sufficient level where gold was a useful medium of exchange. For most of human history, there was enough activity for silver, but not enough for gold, to be the dominant medium of exchange.

    So, enough of a catastrophe is more likely to push us back to silver than gold.

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    1. What about salt?

      (and, yes, I've seen the TV serie Jericho: http://theredbanker.blogspot.com/2013/07/best-tv-series-since-2000.html )

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    2. I can't tell if you're being sarcastic or not.

      I assume you know the history of salt and its importance in early trading.

      But, otoh, it's still easily steal-able and, of course, significantly heavier than silver or gold to carry around in your pockets...

      But, on the other other hand, it would reflect well that, if society was to collapse, we would have a period of barbarism/barter economy before we would have a renewed attempt at currencies, as per your point about the Spanish/Chinese/Roman empire(s)...

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    3. Yes, salt will really be a hugely valuable commodity in the event of a large-scale social disruption.

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    4. I'm thinking bottle caps, ala Fallout.

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    5. But what if it's time to pay the rent, and you come up short because you just had to use some of the rent money to season your French fries?

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    6. Nathanael10:53 PM

      Well, you always have to make a decision between consumption of luxuries and saving!

      Though actually, salt is likely to be relatively less valuable than other spices due to the ability to dissolve it out of the sea. And the seas are rising.

      Start looking at other spices. :-) Popular drugs are *always* good money, whether legal or illegal.

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  5. Anonymous4:58 AM

    In the event of some kind of collapse, my guess is that people who's social model is chiefly informed by Dungeons and Dragons, World of Warcraft, etc, will find themselves uniquely disempowered. Gold or no gold, bits or no bits.

    If you don't understand this, I suggest you google "Knightian Uncertainty", and consider that there are things that others know - many others - and that you do not.

    In the Desert of the Real you will find neither Baudrillard not Nietzsche. You will find only yourself, and then perhaps the straw-men will seem unworthy opponents.

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    1. You're utterly wrong.

      Sure, computer RPGs are primitive (though getting better all the time: http://www.forbes.com/sites/nathanlewis/2013/07/11/video-game-central-banker-knows-more-than-ben-bernanke-and-bitcoin-dreamers-too/) but RPGs in general are a good source of historical information and socio-econo-historical reflection.

      I don't expect to convince you but wanted to set the record straight.

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    2. Anonymous5:36 AM

      Oh, it's not the games which lack fidelity. It's the gamers.

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    3. bjdubbs5:46 AM

      "If you don't understand this, I suggest you google "Knightian Uncertainty", and consider that there are things that others know - many others - and that you do not."


      Nominated for most ironic comment.

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    4. Anonymous6:11 AM

      The risk of getting hit with a sphere is incalculable if you live in Flatland. Not all of us do.

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    5. Anonymous2:09 PM

      Everything about the future is to some degree uncertain.

      That's not an especially compelling reason to, as so many people have done over human history, devote all one's time and all one's resources to protect against an apocalypse that, for most of these people, never arrived in their lifetime.

      Seems like a poor bet, even if you don't know the true risk involved.

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  6. An important addendum to your point is that almost no one owns physical gold anymore, they own electronic claims to gold that is often on other continents - hence the amazingly absurd tale of the late Hugo Chavez trying to ship his gold en masse across the Pacific Ocean.

    When society collapses, those electronic claims to gold will be worth even less than fiat currencies.

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  7. If we're heading to a world mora utopian than dystopian, there's another way gold could pay off — gold as a renewable energy source.

    http://www.greenoptimistic.com/2010/03/31/rhic-gold-ions-energy/#.UfbMdmSxPk4

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    1. You finally found a good fundamental reason to buy gold!! :-)

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    2. I win. If, that is, the technology actually comes to fruition as a viable energy source. Which it may not.

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  8. Anonymous5:38 AM

    My guess is that most people owning physical gold do so in order to transition a monetary collapse, not as a medium of exchange during such a collapse. Gold will always be worth something, as opposed to a collapsed fiat currency. It should be lumped in the category aniques, houses etc, not in the category ammo and cans of beans.
    Orca

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    1. Like anything else, including fiat, gold is only valuable if others are willing to take it in exchange. In the worst of nightmare scenarios I want food, gas and guns. I won't take any amount of gold in exchange for the only thing I need.

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  9. Great post Noah, I never really understood the fetishism of goldbuggery - first of all not enough gold to replace our current monetary system, in the case of sovereign collapse - as you mentioned technology such as bit coin can easily take the helm. And if everything collapses, who's going to protect your gold or your family from unsavoury bandits who not only want to rob but also enslave you?

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    1. Anonymous12:38 PM

      Actually, theoretically there is enough gold to replace our current monetary system, if it is priced correctly. You just have to adjust the price.
      Practically, there is one big problem: is the stated gold supply where it is supposed to be? Don't ask me, ask the FED, which hasn't allowed an audit since 1956.
      Orca

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    2. Anonymous7:46 AM

      But in order to do that, gold would have to be formed into physical tokens (coins?) to act as a medium of exchange - and there are practical limits to that. The tokens aren't going to be be pgysically big enough to be practical for buying your supplies even on a monthly trip to the county dry-goods store.

      In which case, you end up with a multiple (metallic?) currencies - silver, copper, perhaps even iron (and perhaps aluminum.) And that's going to make a mess of whatever legacy technological infrastructure as peoples' houses will be sacked for the copper plumbing and wiring.

      And just think - any smart barbarian will be raiding gold exchanges for the RECORDS of who owns gold or has had gold transferred to them. Those people are going to be the low hanging fruit in an immediately post Federal Reserve world.

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  10. Anonymous7:17 AM

    "So if fiat systems collapsed but electronic networks remained intact, it seems to me that we'd move to some sort of Bitcoin-type artificially scarce digital currency, rather than gold. Not Bitcoin itself, but some electronic currency managed by an institution with lots of staying power and respect. I'd put my money on ToyotaBucks."

    Bad bet. Calamitous social disruption tends to be a drag on auto sales. More likely to be Softbank-notes.

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  11. Anonymous at 5:38 am is right. It's a uniquely American way of thinking that "societal collapse" has to be an all-or-nothing event; either everything is like Peoria, or we're in Mad Max.

    In actual fact, a very likely failure mode is one in which you live in a country where the state, banking system and law and order have broken down, and where all your other stores of value are no longer readily convertible into the medium of exchange (whatever that might be; probably a foreign currency). Gold has some very useful properties in that context - it doesn't depend on an accessible internet connection (telecoms networks do break down and web services can always be blocked). It's recognisable and more or less universally understood and it has a high value density making it pretty easy to smuggle. Gold pays off when your local government (which controls all the legal infrastructure which makes any form of property you can't carry with you yours) doesn't guarantee those property rights any more. Isabella Kaminska on Twitter claimed that in a crisis the value is in productive assets, but 1930s Europe shows that this is definitely not true.

    Nobody ever carried doubloons around and used them as money. They have always been savings instruments and large-value payments instruments. The "Doubloon" Ahab pinned to the mast in Moby-Dick was a $16 coin at a time when the average annual wage was about $500.

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    1. The most obvious example of a failure mode in which you need gold is "the oppressive government won't let me leave the country unless I give them all my assets first" - though actually people in this position in 1930s Europe tended to use diamonds, which are even denser and easier to smuggle.

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  12. A climber on the side of a mountain having moments of doubt about his/her abilities may go into a vortex of panic and "shake off the rock."

    Goldbugs and survivalists are in an analogous position, though unfortunately we are in a sense roped to them.

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  13. Phil Koop8:02 AM

    While it is true that goldbugs often refer to millenarian, global catastrophe scenarios, they cannot account for *variations* in the price of gold because, derp. It is not primarily true that states of the world in which gold pays off are states in which you create more goldbugs.

    Rather, gold is *primarily* used as a hedge against local political change. The hope is not to revert to a pre-fiat medium of exchange golden age (ha ha) but simply to preserve as much of one's ill-gotten gains as possible and escape. Gold is just a relatively portable, anonymous, and universally accepted store of wealth.

    Political disruptions which spur well-connected insiders to accumulate gold may encourage goldbugs by raising prices, but this is an indirect connection.

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  14. What about M0 cash? cold hard currency, both foreign and domestic, in small denominations for food, alcohol, checkpoint bribes, standing in line bribes, etc. the ATMs will be the first to go, the FDIC will have strings attached (no sweets, only whole grain food you little peasants).

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  15. Sounds about right. And, as you point out, the apocalyptic gold fantasies (or your basic Rothbardian argument for gold as the "market" choice for money), fail to realize that it was government that made gold into money.

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  16. I have handled a single gold coin. I am not sure there is anything I could point to that would, to the average guy, say that a coin was gold. Silver is even worse.

    The lack of civilisation loses you everything that confirms gold is gold. Without that infrastructure of trust and confirmation, How many rounds of ammo will you trade for the services of a Doctor?

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    1. Obviously you have not seen the backside of quite a few pawnshops- they still use acid and a stone, along with a file to test gold. Tools that have not changed in centuries.

      Modern fakery has made it more difficult, but technology also fills those gaps.

      BTW- diamonds are really problematic to value, yet I bet you would surely like one!

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    2. Anonymous2:17 PM

      The value of diamonds is also buoyed by artificial supply-constrained scarcity that could dissolve in a societal collapse. So you have something that could face a deterioration in relative value that makes the fake-genuine problem closer to not being worth it unless you have obtained an expertise in detection. Of course, the need for expertise in detection also points out some of the silliness of current relative valuations of rocks and elements, but that is another matter.

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    3. Citizen AllenM: If you have to find a pawn shop to cash in your gold while society is collapsing around you, that's a massive inconvenience, and might not be an option if the pawn shop owners have already fled the country. To repeat Noah's point in the post: a gold-based currency still requires a certain level of infrastructure, so you need a collapse which causes modern infrastructure to heavily collapse but old-timey infrastructure to stick around, which isn't all that realistic.

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    4. Nathanael10:49 PM

      Spices, I tell you. Spices!

      I mean, yes, skills come first, friends come next, and arable land / animals / plants come next, but if you're looking for something that a stupid person can buy and store and not work too hard to maintain....

      Spices and drugs.

      After all, cacao beans were actually money in several civilizations. And they may become quite rare as global warming screws up the agriculture.

      Coffee will probably have similar characteristics.

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  17. Anonymous12:43 PM

    An alternate way of thinking about it: Let's presume that society has collapsed as the goldbugs think it will, where normal commerce has broken down, government-backed currencies are worthless, and individuals are trying to make trading decisions in a government-free barter system.

    If I have a year's supply of food, and you have 300 pounds of gold, who's better off? Given that, why would I trade any amount of my food for any amount of your gold?

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    1. Anonymous2:39 PM

      Because we don't live in one world society. Your countries society may break down and another may be fine. In that case you may want to leave and bring your stored value with you. Gold will be accepted in another country and is easily transported and hidden. A years supply of food will not.

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  18. Gold has the one advantage of always being of value to someone.

    This history of pawnshops shows there is always someone willing to loan local currency against gold and silver:

    http://www.history.com/shows/pawn-stars/articles/pawning-through-the-ages

    While Keynes railed against the barbarous relic, gold is in the very heart of the psyche for so many people. The obsession that is revealed is not pleasant, and to justify that obsession, many resort to the fantasy of the lottery ticket value of gold.

    That lottery ticket value is what gold buggery is selling, where the reality is very few would actually act at the moment to buy something of greater long term value when the relative price of gold skyrockets.

    Gold is static wealth, valued at whatever the market will bear, instantly capable of liquidation anywhere in the world outside of Antarctica. We, as economists, should view gold similar to land, a portable commodity in constrained supply, with some very good uses, but one that has an uncertain return.

    The real fear is not Mad Max, in which case gold would be near worthless, but Argentina or Weimar, when you need hard currency to eat. Is that a valid concern? Perhaps.

    In short, gold, like anything else portable and of value, can be sold almost anywhere, and as a way to hold or move wealth provides that function to people. Look at India, and ask why do they demand so much gold? Because the culture has perfected a model of wealth transfer between and within families that uses massive amounts of gold. How much of this is just cultural momentum, and how much of this is legitimate wealth? Who knows?

    Gold once melted down in the jeweler's crucible is untraceable, totally fungible, and always has some value- instant value.

    And the ring that the jewelry casts, sets some stones in, and is sold again recycles that wealth, indeed endlessly recycles that wealth.

    This has been going on for milennia, and to expect people to change based on an esoteric liquidity preference for ease of transactions is pretty funny.

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    1. agree. gold is a hedge against hyperinflation- or more specifically a currency falling against the US dollar. you can print an arbitrary amount of dollars but the quantity gold is finite. Putting your reichsmarks in gold in 1925 would have been a very prudent decision

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    2. Putting your reichsmarks in any other class of asset would have been prudent.

      But in any non-apocalyptic hyperinflation scenarios, you have better options than gold as a "hedge." Some of them will actually earn a return while you hold them too.

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    3. The 'return' is not watching your holdings become worthless in a couple years

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    4. Land (or any other physical asset) also doesn't become worthless in a couple years in a hyperinflation scenario. Land (and some other stuff), unlike gold, actually do have returns.

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    5. I would point out that unimproved land does not have any return. Gold is like unimproved land- a speculative venture of some value, but that value is uncertain until proved through exchange. Build a business on the land, and it has much more value. Land far away from commercial use or household use does not have much value. Look at agricultural property right now- what is it's value in the USA- especially given how much more food we produce than necessary here in the USA.

      Bubble, or not? Prudent investment at these prices, or speculative folly?

      Right now the concept of return is murky, as we destroy capital through nonuse, and destroy the value of a dollar through low returns, all while encouraging a background level of inflation.

      Of course, the real mismatch is between capital and labor right now- and the fact that capital is removed from actual return through excessive financialization and disintermediation. In short, seeking a return might be fatal to your capital, at which point gold looks much safer- an ounce of gold is scarce and expensive to render out of the earth.

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    6. Gold is "always of value to someone" in the same way that steel is "always of value to someone"; difference being that steel has a use beyond pretty earrings and teeth. The lack of a return also has the important quality (which Noah implicitly makes in the original post, I think) of making gold damn near impossible to value. Valuing a stock, in the abstract, is pretty straightforward-- discounted present value of all future dividends (actually predicting that rightly is easier said than done, but at least there's a fundamental theory behind it). Valuing a bond is even more straightforward-- the difficulty is assessing creditworthiness. Even real estate and useful commodities like coal, food, oil and natural gas depend largely on medium- and long-run supply and demand.

      But gold is pretty unique in that it has exceptionally limited use value-- gold won't power your car like oil, you can't build a house out of it like you can with iron, and you can't eat it. Its price depends PRIMARILY on how many clowns read Zero Hedge and believe what it has to say about gold. While there's speculation in the equity and bond markets, those, in the medium to long run, return to a fundamental value-- if P/E ratios get out of line for stocks, chances are they'll normalize. Everyone and their mother can sell off bonds, but so long as those bonds are held to maturity and don't default, a sell-off is just a nice way to lose a lot of money. But what changes about gold if it moves from $500 an ounce to $1500 besides a self-fulfilling panic? Think of it this way: if Google's fundamentals stayed the same but Google stock lost 40% tomorrow, you could, objectively, say that Google stock is mispriced. If gold lost 90% tomorrow, or gained 90% tomorrow, there's absolutely no way to say that that price would be "wrong". And that's what makes it such a lousy investment for anyone analyzing it as an asset.

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    7. Nathanael10:46 PM

      Well, gold does have a fundamental price determined by jewelry and electronics demand.

      That price is low. Really low.

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  19. Extremely well thought-out and to the point. Bravo, Noah.

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  20. Cochrane:
    "But long-term bonds have a magic property: When the price goes down -- bad return today -- the yield goes up -- better returns tomorrow. Thus, because of their dynamic property (negative autocorrelation), long term bonds are risk free to long term investors even though their short-term mean-variance properties look awful.

    Gold likely has a similar profile. Gold prices go up and down in the short run. But relative prices mean-revert in the long run, so the long run risk and short run risk are likely quite different."


    wow.

    What about Treasury bonds?
    Well, one reason a T-bond price can drop is increased inflation expectations.
    And yes, the nominal return from a T-bond increases after the price drops.
    But the real return does not.

    What asset pricing model is Cochrane using where investors do not care about real returns from bonds, but care instead about nominal returns?
    In exactly what sense are long-term T-bonds "risk-free" to an investor who cares about real returns?
    After declaring long-term bonds to be risk-free, Cochrane states:

    "Gold likely has a similar profile. Gold prices go up and down in the short run. But relative prices mean-revert in the long run, so the long run risk and short run risk are likely quite different."

    Cochrane thinks gold is likely "risk free to long-term investors" as well?
    Really?
    I guess I see his point: gold is gold, and even if you hold it forever, it will still be shiny.


    http://infinite-ignorance.blogspot.com/2013/07/math-is-hard-university-of-chicago-bond.html

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  21. Even though I'm not a goldbug and I support QE and monetarism, gold does serve a useful purpose, one of which is to hedge hyperinflation in emerging markets where converting local dollars into US dollars is not feasible, or carries a high risk of default. if your currency is falling 10-30% a year against the dollar gold will be a very good hedge. The problem is people in America buying gold for the endtimes, the erroneous belief the dollar will be worthless (Peter Schiff's bullshit), or for speculation.

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  22. You're right. Gold can't possibly survive as a currency without government (or other large stable organization) backing. The gold standard wasn't gold coinage: it merely consisted of a faith-backed government printed dollar bill, which the government traded unlimited amounts of for gold at a fixed price.

    And gold coinage won't work either. To get change after buying something off McDonald's value menu, you'd have to chop a standard size 1 ounce coin into 1390 tiny wedges, each one a mere 0.0029 inches at the wide end--about five times the width of a bacterium.

    In reality, gold coinage was never more than a way for the extraordinarily rich to store and transport their wealth. In gold-coinage systems, most market transactions were either barter or used copper coins. To give an idea of scale--in ancient Greece you would use copper coins to buy goods at the market; you use gold coins to purchase the market itself, possibly including all the people in it.

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  23. The main reason to own gold isn't a complete collapse scenario. In a complete collapse, you'd want to own farmland. Instead, it's more like insurance against partial collapse. Not just hyperinflation - what about deposits in Cyprus? If you see as a possibility any situation of partial economic collapse where you think you might lose a lot of money that you put in conventional investments, for whatever reasons, it can make sense to put some of your money in gold in the hope that it will retain a significant value.

    On the issue of protecting gold, let's not forget it's very portable. Sure, you need to be very careful if you were actually carrying it around in your person, but surely that would only happen rarely, if you can't find a better way of taking your gold from A to B. Unless you are fabulously rich and choose to have lots of gold bars, you are likely to own only a few gold coins, and finding secure places to put small things shouldn't be all that difficult.

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    1. Not sure why you think a piece of paper saying you own farmland is more valuable in a total collapse than a piece of green paper saying you own dollars.

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    2. I wish somebody had pointed that out to that old windbag Hershel in Season 2- preferably with a shotgun.

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  24. Anonymous5:25 PM

    For some of us it's enough to observe that (a) gold and silver hold value against inflation over long timescales, and (b) over shorter timescales their price is not tightly correlated with other assets that hold value against inflation. Those two properties alone make them useful as sensible diversifiers for an investment portfolio. The "insurance against social crises" aspect is a bonus.

    Personally I think if there's an end-of-civilization type scenario, gold, farmland and guns are all pointless. Having a lot of friends with guns is helpful, but if you're just another mouth to feed why would they remain your friends? And can you count on them surviving? In really dire times everyone's survival will depend on how USEFUL they are to those grabbing for power. So I would recommend investing in hands-on skills, a brain filled with practical knowledge that will remain valuable.

    ReplyDelete
    Replies
    1. Nathanael10:45 PM

      Gold and silver have declined massively compared to, say, land, over long timescales. They actually do not hold their value against inflation.

      Delete
  25. Anonymous9:27 PM

    Never understood how it's possible to carry 100,000's of g.p.'s without a bag of holding or an encumbrance penalty.

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  26. I think the central idea here is pretty much right; that gold is a bet on an outbreak of goldbuggism-- but I don't know that I see the benefit of holding any amount of gold, period. Most assets, we can predict fairly well how they'll perform under different scenarios. When investors are scared and the economy is in the tank, they buy bonds issued by sovereigns who print their own money-- the US, UK, Japan, and pour out of stocks. When corporate profits are humming, they pour into stocks. When the economy is humming, they pour out of safer bonds and into stocks.

    What about gold? Well, its price spiked in the late 70s for some reason (inflation?), stayed roughly flat for a good 20 years, then started accelerating around 2004. Then lost a good third off its peak recently. Can you explain that? Because I sure as hell can't. So what exactly will gold add to your portfolio besides volatility...? I suppose if you'd poured into gold around 2007, you would've gotten rich. You also would've gotten rich pouring into 10-year Treasuries in 2007. And if you'd poured into stocks in late 2008, you could've made a neat 100% on your index fund just by buying the S&P at the trough. And that was just a bet on the "We're all gonna die" scenario not happening. Compared to gold, which, as you rightly noted, isn't gonna do you much good in the "We're all gonna die" scenario either.

    In that scenario, while Peter Schiff might trade his hunting rifle and can of beans for a gold block, I sure as hell wouldn't...

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  27. Pre-collapse spirits with unbroken seals. Same with packs of cigarettes in cellophane. Those will be currency worth having. Prison is a good model for how it will work. Not much gold trading in Sing Sing, but a fair amount of booze and fags being swopped for goods and services.

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  28. People were starving in post WW1 Germany, and while they did barter for food, the real currency was cigs and schnaps.

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  29. Unanimous11:30 PM

    Most things have value because people know that there are other people who value them. Gold has always been valued by civilisations, and it always will be. It has uses, including for people who like to wear it, and everyone knows it.

    The difference from most things is gold's durability, and this means that one of its uses is as a long term store of wealth. Debt contracts and equity are generally better stores of wealth because either they pay interest or don't vary in value so much over short periods of time. But, gold's short term fluctuations in value lead to another use. Since it lost its link to money in the early 1970s, it has varied roughly inversely with real interest rates. So it can be used as a hedge against drops in real interest rates, and this appears to have been the dominant factor driving changes in the price of gold since the early 1970s.

    Gold can retain value through a period of hyper inflation, as can most things except money and debt contracts denominated in money.

    None of the above are consistent with gold as being a hedge against collapse of civilisation, or a good hedge against hyper-inflation - the opposite in fact. It has no value where the influence of civilisation is not felt, and its value declines with real interest rates which rise dramatically or become practically infinite outside of civilisation, and very uncertain during hyperinflation.

    There are no hedges against collapse of civilisation, but an ability to make friends and keep your head down could be helpful.

    ReplyDelete
    Replies
    1. Nathanael10:43 PM

      You do have to be careful about how you store your spices. But as long as you do that, they are far more valuable than gold. Jewelry demand is quite low compared to spice demand.

      Delete
  30. Anonymous11:37 PM

    If gold is so dumb, why do central banks and the IMF hold so much of it? Do they watch too much Glenn Beck?

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  31. Anonymous12:13 AM

    The Average Life Expectancy For A Fiat Currency Is 27 Years.

    Gold and Silver from thousands of years ago is still money.

    When the Dollar and Euro fail the World Bank or IMF / UN create a Metals backed Global Currency those who own metals will still have wealth.

    If you own paper or digital currency its value is determined on the trust in the currency.

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  32. I believe in what you say. Have been telling the same to gold bugs, but they are always waiting or the impending doom when the world will revert back to the gold standard. They just don't listen.

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  33. Rothosen7:42 AM

    So following his arguement a stable government can print as much as they like. Four major central banks can print as much as it takes to maintain stability. Since there is no reference to a currency's value except other curencies everything is fine. We can monetize a trillion a year as long as the others do as well. I have noticed our government spends millions each year holding on to a quarter billion ounces of this worthless stuff. (accounted for at $35/oz) Why not just send one to every American. We won't object.

    ReplyDelete
    Replies
    1. Nathanael10:42 PM

      A stable government can, in fact, print as much money as it likes.

      If it prints too much, so that you have money chasing goods and services which don't exist, inflation will rise, which may be a bad thing. We are not at risk of this right now.

      This may have happened during the oil shocks in the 1970s -- every dollar printed went straight to buying oil, but there was *only so much oil*.

      There is also the important point that our current government is very far from stable.

      Delete
  34. Gold and silver, i.e. precious metals, pay off when people start to realize that the currency in which they are paid is quickly losing its value. People have me laughing on this blog thinking that land is a better place to put cash in an inflationary environment. While land may be a good asset which will hold its value, you try bringing a few handfuls of that land with you to the market to buy some milk and eggs, and I'll bring a few silver coins, then we'll see which is more marketable. lmao.

    ReplyDelete
    Replies
    1. Anonymous1:25 PM

      On my land I will have cows and chickens to produce milk and eggs which I will then barter for other goods. Good luck trying to eat your gold coins-you may want to save your digestive system the trouble and shove them up your rear end.

      Delete
    2. Good luck trying to buy those cows and chickens with your land. With my silver and gold I can buy whatever I want, including cows and chickens and even land if I so desire. How do you guys not get that?

      Delete
    3. Anonymous3:45 PM

      I don't need luck to sell part of my land to someone who has cows and chicken and is looking for more land to cultivate. I would need luck to get chickens, cows, or land in exchange for something whose main feature is that it is shiny. Unless by social convention, exactly as with fiat currency, people decide to adopt gold as a medium of exchange, gold will be of very little value. How do you guy not get that?

      Delete
    4. Nathanael10:39 PM

      Neil: Imagine I'm the farmer wtih the cows and chickens. I don't want your silver and gold. What can I possibly do with shiny metal? Worthless junk.

      I have cows and chickens. You want eggs and milk, you give me something *useful*.

      Perhaps you have some skills and could work for your eggs?

      Or perhaps you have some spices. It gets a bit boring eating eggs, milk, chicken, and beef.

      If you are seriously hedging against governmental collapse, go for better sources of wealth than stupid shiny metals. Go for spices.

      Delete
  35. I could be wrong, but I've heard somewhere that much (most?) gold is held by central banks. I imagine central banking authority would collapse along with its government, sending these reserves to market and dragging golds value down as well. But would that be enough to break its psychological grip?

    Frankly, I'd sooner believe we'd go back to bartering rather than have a fixed medium of exchange. And I would bet fiat would make a quick comeback in whatever authority emerges subsequently.

    ReplyDelete
  36. Gold pays off when financial repression is high.

    http://alephblog.com/2012/04/06/gold-does-nothing/

    ReplyDelete
  37. Cochrane sez: "But long-term bonds have a magic property: When the price goes down -- bad return today -- the yield goes up -- better returns tomorrow."

    Uh, what? Probably I'm an idiot, but to me this seems to misundrstand how bond prices work on a fairly basic level. When the price falls, the yield increases, of course. But that increase in yield isn’t an increase in the yield you’re getting from holding the asset, or indeed that you'll ever see during its lifetime.

    It’s an increase in the yield you’d have to offer to somebody else in order to get them to take the asset off your hands. So a fall in a bond's price does not do anything to increase the future returns you'll get from holding that bond. I expect I've gone totally wrong here, but can anyone explain why?

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  38. As has often been pointed out, gold is not an investment, it's a religion; and religions keep carrying on very nicely despite the fact the their gods don't exist.

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  39. just look at the premiums on

    gld and slv options

    l like the one's on tza and tna

    better

    ReplyDelete
  40. Gold has always suffered as a medium of exchange because it was so rare. Since roman times the actual gold was monopolized by the wealthy as their trading medium. The vast majority of exchange was in bronze, copper, and silver. China was exclusively silver based as the story of the opium war illustrates as opium caused a depression when it caused massive outflows of silver. The spanish empire was built on Mexican Silver as they became the primary source of money creation of their time, although the economy didn't produce nearly as much as others and the stagnation let the low countries fight the empire into bankruptcy because actual economic production was so much more superior.

    Sign me up for the salt insurance plan as it is the only useful thing that doesn't rot that I can think of that would be needed in a world without refrigeration.

    ReplyDelete
  41. The most important things to remember about gold are that it has steadily declined in value over the past 450 years, there is a lot more of it in asteroids likely to be mined before a young worker reaches retirement than on all of this planet, and fusion may make even these "astronomical" quantities look tiny in the same timeframe. With the Apollo and Gemesis diamond patents expiring in less than a decade, diamonds look worse. On the plus side, we can all have cheap bling.

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  42. However, you only need to go into the developing world to realize that gold has exchange value and acts as a hedge against unstable currencies. It is also a thing of beauty. You would look odd with a dollar note or bond hanging around your neck (at least for now). It may be people's beliefs that drive gold as a medium of exchange but so it is for fiat and efiat.

    ReplyDelete
  43. Anonymous5:19 PM

    Two-thirds of the world's population (India and China) are goldbugs. Always have been and always will be.

    ReplyDelete
    Replies
    1. Anonymous5:23 PM

      Sorry, one-third

      Delete
  44. Anonymous9:30 PM

    If we needed a new financial system it would be designed around credit, double entry accounting and clearing houses. Species and currency are tokens, physical manifestations of credit. Credit would be issued as debt, circulated to be used for transactions, and be returned to cancel the debt. Gold would have no part to play unless it became a token of universal credit.

    I have a ledger from 1880 when small money was tight. Half the transactions were store credit.

    ReplyDelete
  45. Nice analysis. And then you can have a look at some survivalist blogs of people that actually lived through something akin to collapse (I recommend guy named Ferfal) and a pattern emerges:

    1. It is always good to have "hard currency" reserve, like US dollars. This will not save you when shit hits the fan in USA obviously

    2. Then it is equally good to have stockpiles of mundane valuable metal jevelery - gold rings, necklaces etc. Why not pure gold bullions?

    - These are rare enough and nobody will trust you
    - They are suspicious. If you come to a shop trading gold bullion for medicine or groceries, it is likely that you may end up with not so pleasant company after you are out of the shop. If you bring old old gold ring you blend among other desperate people, or even among petty thieves

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  46. Nathanael10:37 PM

    My hedge against the collapse of governments and civilizations?

    Chocolate.

    (Pretty much any popular drug will do, but chocolate is one I actually like.)

    ReplyDelete
    Replies
    1. Jabberwocky8:49 AM

      Heh. Good point. In the event of an infrastructure collapse and dwindling supply, how many people would be willing to barter for something like coffee? I'm guessing a lot.

      Delete
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    ReplyDelete
  48. Isn't the sensible approach to look at the evidence and then try and understand what that is telling us. Instead of saying gold is stupid so ridiculing gold bugs we should see that despite gold being stupid, having a portion of gold in a portfolio of savings improves the Sharpe ratio a lot. You don't need a monetary collapse for gold to fulfill that role. All that needs to happen is for the price of gold to randomly bob about in a way that doesn't correlate positively with stocks and/or bonds. Then having some gold will allow you sell some to top up your stocks and bonds whenever they are cheap and gold is expensive.
    That may illustrate that pet theories about how savings benefit the economy are nonsense but it is backward to stick with the theory rather than make theory fit the facts.

    ReplyDelete
  49. Why does it is important to study the payoff structure of gold?

    Thanks
    William Martin

    PPI Claims Made Simple

    ReplyDelete
  50. Gold backed or fiat, money moves up and down in value; money is not a store of value. Gold is insurance against government collapse, it becomes more valuable when confidence in government declines; it too is not really a store of value. Jim Willie writes that the BRIC nations + Germany are close to unveiling a world 'trading' currency backed by gold -for country level trade settlements only. Martin Armstrong is no goldbug but he says gold as an investments day will come beginning next year. Armstrong's Princton Economics has managed $Trillions, advised governments, he has been a political prisoner... knows what he is talking about from the practical trading side of things.

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  51. Anonymous11:56 AM

    It's been a long time since I've seen a new argument against owning gold, but I gotta hand it to you for your World of Warcraft story. Very original.

    ReplyDelete