Send an Email
Favourite Sites
  • Whitney Tilson
  • Recommended Booklist

  • Favourite Blogs
  • Calculated Risk
  • Reflections on Value Investing
  • "The market can remain irrational longer than you can remain solvent" - John Maynard Keynes

    Wednesday, September 03, 2003

    Why Gold will keep going up.... for a while

    Historically currencies were tied to a precious metal and were exchangeable for that metal. Pounds sterling were actually exchangeable for sterling silver and at various times US dollars have been exchangeable for a set amount of gold. This provides some "reality" to the money that we exchange. Without currency being tied to hard assets, the only thing that makes it work is the assumption that the next person will accept your cash. Money that is not tied to hard assets is called "fiat", there are many problems with fiat currency not least of which is the country can print more money beyond any reserves of gold/ silver etc that they have. Back in the days when currency was tied, a country had to have most of the hard asset stored somewhere safe to exchange for currency if required. The amount of money in circulation could grow as the government received more taxes as the economy grew. Today any country can print more money leading to inflation.

    The problem world wide today is that many of the largest economies do not want their currency to appreciate relative to other currencies. As the US dollar appreciates it becomes more expensive for other countries to purchase our goods and therefore our economy is hurt, not a good thing during a recovery. China and the US are a prime example. China is deliberately holding their currency down relative to the US dollar. At the same time the US is attempting to hold it's currency down relative to other currencies. In the end there is only one way that all currency's can be deliberately undervalued. The mechanism they must use is to print more money and use it to buy hard assets such as gold. As the Chinese currency appreciates against the dollar, the Chinese print lots more money and buy gold or other hard assets with that money, including US currency (creating demand and driving the US dollar up). This additional supply of Chinese currency reduces the price. Now China just buying US dollars would make the US dollar appreciate. The US would retaliate by buying Chinese currency and nothing much is gained. Both countries, however, can buy some real assets with their newly printed (worth less) money. This has to lead to significant inflation in the medium term. Fortunately for the governments they should be able to sell their gold at the inflated prices maintaining the real value (after inflation), which was the point of pegging currencies to gold historically. The average person, though, does not have a big gold reserve to cash in when his dollars are worth 50c in today's currency.

    The Chinese refusal to devalue the Yuan is a pretty hot news item at the moment. The US treasury secretary is over there at the moment trying to convince them to devalue; he is very unlikely to succeed. With economies worldwide needing massive liquidity to get out of their recessions this is a reasonable short term move. It is almost guaranteed, though, that countries will overshoot the mark and significant inflation is likely one to two years out.

    How can you trade off this? Well I strongly recommend that you do not hold any fixed interest securities of duration longer than 2-3 years to maturity. Treasury Inflation Protected Securities (TIPS) are a great way to avoid the loss of value of your assets, as is being short treasuries. American businesses will continue creating real value and will grow beyond inflation, it is always relatively safe to be invested for the long term in an S&P 500 index fund. I don't recommend buying gold as in the end it has no intrinsic value aside from it's scarcity. Remember stocks have returned $462,502 dollars since 1801, Bonds 1,070, Gold 1.19 and Cash 0.07.

    Comments: Post a Comment

    << Home


    April 2003   May 2003   June 2003   July 2003   August 2003   September 2003   November 2003   January 2004   February 2004   March 2004   April 2004   May 2004   June 2004   July 2004   September 2004   October 2004   February 2005   March 2005   April 2005   May 2005   June 2005   July 2005   August 2005   September 2005   December 2005   April 2006   May 2006   June 2006   January 2007   December 2007   February 2008   April 2008   May 2008   June 2008   July 2008   August 2008   September 2008   October 2008   November 2008   December 2008   January 2009   April 2009   May 2009   July 2009   August 2009   September 2009   October 2009   January 2010   February 2010   April 2010   July 2010   August 2010   October 2010   November 2010   January 2011   February 2011   April 2011   June 2011  

    Disclaimer and Disclosure Analyses are prepared from sources and data believed to be reliable, but no representation is made as to their accuracy or completeness. I am not paid by covered companies. Strategies or ideas are presented for informational purposes and should not be used as a basis for any financial decisions.
    To reduce Spam click here for my email address.

    This page is powered by Blogger. Isn't yours?