Thursday, January 27, 2011

Stocks gain against gold, and that is good news


The above chart plots the daily ratio of the S&P 500 index to the spot gold price. Stocks have been doing pretty well in nominal terms, with the S&P now up 92% from its Mar. '09 low. But against gold, stocks are up only 36% from last year's low. The thing that caught my eye is that since the end of last November, stocks are up 10% while gold is down 5%. Gold is down almost 8% (almost $110/oz) since its early December high. Stocks may be on the verge of a significant upswing against gold, after losing 87% of their value from the highs of 2000 through Mar. '09, as shown in the next chart.


Taking a very long-term perspective and ignoring the impact of dividends, stock prices have only just kept pace with gold prices over the past 83 years. This fact lends credence to those who advocate a gold standard, since it shows that gold indeed holds its value against other real assets over long periods, though of course there have been huge swings from time to time. But if the best that gold can do over time is to match the increase in stock prices, while delivering enormous extra volatility along the way, then gold is not a particularly attractive asset from an investment perspective, especially since it pays not a penny of income and in fact costs money to store. And it's particularly unattractive today, unless you are convinced that the Fed is on the verge of committing a major monetary mistake and/or the U.S. is going to default on its debt obligations.

What are the drivers behind this recent development? That's anybody's guess, of course, but here's mine. Borrowing from observations made by my friend Don Luskin, I think the recent rise in stocks and the decline in gold reflect an emerging sense of optimism regarding the economy. The economy is doing better than expected, and it's not just because the Fed is buying Treasuries by the bushel. As I've noted before, it's hard to find evidence that the Fed's QE2 purchases have resulted in any expansion of the money supply; indeed, it looks like they have only managed to keep the monetary base from shrinking. In any event, with the economy doing better, the need for a QE3 definitely declines, and that in turn means less risk of a possible Fed inflation error, plus less risk of some significant, adverse geopolitical or financial crisis. So the case for buying gold at prices that are quite high on both a nominal and real basis is diminished.

Consider also that the long-term trends in stocks vs. gold prices reflect major shifts in the relative attractiveness of financial vs. real assets. That relationship, in turn, is heavily influenced by monetary, fiscal, and political trends. Stocks collapsed against gold in the 1970s, because the U.S. devalued the dollar, the Fed was way too easy, and presidential leadership (Nixon, Ford, Carter) was weak. Stocks then surged against gold from the early 80s to 2000, because the Fed was tight, inflation collapsed, taxes were reduced by an order of magnitude, and presidential leadership was generally good (Reagan, Clinton). Stocks have been crushed since 2001, as the Fed began pursuing a very accommodative monetary policy, government meddling in the housing and financial markets led to a huge housing boom and bust, and presidential leadership has been at best controversial and less than inspiring.

It may not be obvious yet, and I may be jumping the gun, but I think it's worth suggesting that we may be on the cusp of a new era, characterized by improving fiscal policy (e.g., a reduction in the size of government and reduced tax burdens), a return to more prudent and/or rules-based monetary policy, and better presidential leadership. We've already seen financial assets recover a good deal of what they lost in nominal terms in the past three years, but stocks could still gain significantly relative to gold.

8 comments:

J. Tepper said...

First of all, congratulations on such a top nothc and high quality blog.

One thing you wrote puzzled me. I don't know how any serious observer can write this: "I think it's worth suggesting that we may on the cusp of a new era, characterized by improving fiscal policy (e.g., a reduction in the size of government and reduced tax burdens), a return to more prudent and/or rules-based monetary policy, and better presidential leadership."

I think that is completely and hopelessly deluded. What evidence do you have for that? Presidnet Obama has no plan. Even the Tea Party candidates didn't mention reforming Social Security or Medicare in their rebuttal to the State of the Union address. Both parties are driven by ignorance, arrogance and the crass pursuit of power. If you don't recognize that, you are not cynical enough.

Also, the Fed is in fact monetizing almost 50% of the Treasury's borrowing this year. Currency in circulation is rising and excess reserves are falling while the Fed's balance sheet is expanding. How does that not qualify as money printing? Deficit to expenditure levels for the US governemnt are 40%. We have only seen this in countries where hyperinflation has followed. Clearly Congress has no desire to make adjustments, and the Fed is doing its bidding by monetizing debt. That is the only conclusion available from the evidence. I highly recommend you read Peter Bernolz's Monetary Regimes and Inflation.

Gold is falling because sentiment had been extremely bullish while real rates had risen. Gold tracks real rates. Given that inflation is turning up and the Fed will not raise rates, real rates will fall again. Until the Fed raises rates, gold will do well. I am not a gold bug. Gold is merely a vehicle to short the Fed and their extreme incompetence. I'll happily short gold when the Fed raises rates.

Public Library said...

Your producing a chart for gold covering the period when we broke from the gold standard.

Gold has most likely become more volatile exactly because of the monetary blunders since then...

Scott Grannis said...

You make a number of good points, most of which I've addressed at least a few times in past posts.

Things are undoubtedly miserable/awful/dismal right now, as you say. Obama is clueless, fiscal policy is a trainwreck, the Fed is in uncharted waters, etc. But we've known all that for about two years now. It's old news.

On the margin, I think there is a real chance for change, because the path we are on is unsustainable. We will have to change, and there are bunch of good people in Washington that know this and they are gaining power, while Obama & Co. are losing power. It's all about changes on the margin, and I'd also point out that the market is very good at sniffing out change before it becomes obvious.

For example, I think gold can and most likely will fall well in advance of a Fed tightening, because the market will see it coming.

Benjamin said...

"It may not be obvious yet, and I may be jumping the gun, but I think it's worth suggesting that we may be on the cusp of a new era, characterized by improving fiscal policy (e.g., a reduction in the size of government and reduced tax burdens), a return to more prudent and/or rules-based monetary policy, and better presidential leadership. We've already seen financial assets recover a good deal of what they lost in nominal terms in the past three years, but stocks could still gain significantly relative to gold."

Oddly enough. I feel the same way.

Although I may differ on what "prudent" means for monetary when you are at zero bound, and unemployment is nudging 10 percent, and the CPI suggests we may be in deflation already, unit labor costs are falling, and goods, services, capital and labor can cross our borders at will.

If Japan is prudent, I fear for prudent.

Sometimes it is prudent to go on the offensive.

As for better presidential leadership, bring it on. Maybe we can get Scott to run.

Lori said...

Benjamin,

You had asked previously my age, location, and investment horizon.

I reside in So. Cal. My age is 49. So, my time horizon is right around 40 years.

Any suggestions?

Buddy R Pacifico said...

If gold and equities are equals over time, ex dividends, then dividend paying stocks must be the smart investment. Buy long and hold long equities with consistent cash flow and dividend growth could be a gold mine!

Benjamin said...

Lori-

I think it is a good time to buy SoCal property. I think interest rates will stay low for quite a while. Eventually, that will start boosting industrial and other properties. SoCal real estate always comes back--if you ever spend a winter in anywhere else, you realize why.

I suppose you should maintain a good mix of equities, and that can easily be done through ETFs. I would buy into a domestic broad ETF and perhaps one oriented to the Far East. SPY is a good ETF for domestic.

Bonds don't offer much now, and if yields rise, bonds will go down.

You are still young, so you will live through a couple cycles more. It may be ten years, or it may be 20, but there will be another recession, and the "end of the USA is coming" mood. Load up then.

But really, my advice is free and worth every penny....

brodero said...

How about this...

A median priced existing home
can be bought today for 128 oz....
the all time low was 100 oz. in 1980..the high was 550 oz.....at some point a product that keeps
warm in the winter and cool in summer will have more value that
the shinny metal....