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There has been much debate on goanet about gold being a good investment today.
To me, the question that needs to be answered is whether the world is headed
towards inflation or deflation. We are obviously in a deflationary phase at the
moment, which would suggest that buying gold is not a good idea in the short
run. But before I discuss this in more detail, let us go back in time to 1990.
After the Japanese bubble burst in 1990, they continued to be in a deflationary
state for about a decade - even with extensive government stimulus packages
that led to Japan's govt. debt finally cresting at 140 of GDP%. This is
currently the highest amongst the major industrial nations. In Japan's case,
much of this debt was funded internally a la its citizens who had (and have)
very high savings rates. It also continued to have trade surpluses during this
period, again alleviating the need for foreign borrowing. As a result, the
impact on its currency was marginal.
It is interesting to compare this to the US. Prior to this crisis, US govt.
debt was around 50% of GDP. It is now headed towards 100% of GDP. This is an
unprecedented increase unless ones goes back to WW2. Furthermore, by most
indications, we are only at the start of a continuing cycle of super large
deficits, which means that this number will probably continue to increase.
Back in WW2, US govt. deficit spending reached over 300% of GDP. If one takes
the current figures it that light and also noting Japan's debt of 140%, it does
not seem to be too bad. However, there are significant differences that do not
make this comparison as straight forward. For one, in WW2, US citizens at that
time had significant savings, which allowed the US govt. to borrow from them.
Secondly, much of the deficit spending was invested to boost America's
industrial base, which effectively supplanted what was being destroyed in
Europe and Asia, all of which put the US in pole position at the end of the war.
The state of the US is worse now. Much, much worse in fact. In the last decade
of supposed US prosperity, the US (public and govt.) primarily used borrowed
money on consumption, wars etc, all of which contributed very little to
technological innovation and industrial growth. Conversely, the rest of world
that fed the US, over invested in production to feed the artificially inflated
US economy. The savings rate of the US public is effectively zero, and in fact,
for a period in 2005/06, it was actually negative. The US has also continued to
run massive trade deficits. This means that much of the US debt borrowing has
had to be funded from overseas investors.
The obvious question is how has the US been able to fund this without impacting
its currency? In fact with the onset of the financial crisis, the US$ has
actually appreciated somewhat against most of the world's major currencies
(with the exception of the Yen).
One key factor is that the US$ is the world's reserve currency. Around 60% of
the world's trade is conducted in US$. This means that nations must keep US$ in
reserve to conduct their daily business with the rest of the world. The rest of
the world currently holds several trillion dollars as part of their reserves.
These reserves are accumulated via trade surpluses (primarily with the US),
purchases of US govt. debt and through net capital inflows into their
economies. One may think of these reserves as IOUs from the US to the rest of
the world. If the rest of the world continues to hold and increase its
reserves, it effectively means that this is borrowed money that the US will
never have to pay back! So far, most nations have had no concerns with
accumulating these reserves for they have continued to have belief in the
intrinsic value of the US economy. Furthermore, in many cases, foreign
governments have continued to buy US$ in order to keep the value
of their currencies down.
Going forward therefore, one must ask:(i) Will the US be able to continue to
fund its deficits? (ii) How will the USD fare against other currencies and
(iii) How will the USD fare against other investment vehicles such as gold.
If there is a god, I suggest you ask it, because, no one can say for sure how
things will progress. However, one can make attempt to make some guesses based
on some macro trends.
WRT to the first question, so far, the US has been able to continue to fund its
deficits. One figure of merit is the interest rate the US govt. pays to borrow
money. It is currently around 0% for its short term debt. This means that
people continue to believe in the US's ability to pay back its debts for the
short term. More importantly, it remains to be seen how its 30 yr bond rate
fares. After declining for much of last year, it has started to increase. This
is not a good sign for the US, but one needs to monitor this for a longer
period to see if this trend will continue.
Connected to this, is the ability or willingness of nations to buy US debt.
Currently, the largest holder of US debt is China. With the onset of the global
crisis, there are some indications that China is buying less US debt, primarily
because it is now using this money to pump up its own slumping economy. Again,
this is not a good sign for the US, specially given that the US is now
projected to suffer growing budget deficits in the next few years.
Taken together, it would suggest that the USD is due for a correction. However,
with much of the rest of the world also in a recession, betting on currency to
currency valuations may be a bit of a gamble. The British economy and the Pound
are pretty much in the tank and face a crisis that is worse than the US (even
larger govt. deficits, bank failures, public debt etc on a % basis). In the
Euro area Germany remains relatively strong (no govt deficits, healthy trade
surplus and high savings - though it too will face negative growth), but this
is tempered by problems in Spain, France and as always Italy. With the rest of
the world, I cannot comment. There may be some currency gains in China, India
and south America viz the USD.
This finally brings to the original question: the price of gold. Again, the
answer to this is whether the US will experience high inflation. In the last
few months, the US has put in around 3 Trillion $ into its economy, raising
govt debt from around 6T (40-50% of GDP) to 9T (70-80% of GDP). In spite of
this, the US economy continues to deflate. Why? The reason for this is that the
banks and financial institutions have used these cash infusions to bulk up
their reserves, rather than inject this money into the active money supply.
If the banks start lending and if the US economy starts recovering, it is
possible that it may then trigger a strong inflationary cycle. If that happens,
we could see a slumping dollar viz gold. In the short run, it is possible that
gold may continue to slump, because of decreasing demand due to the slowing
world economy. Hence it may be a good idea to wait for a little bit and see how
the macro trends play out before jumping in.
In the long run, I continue to remain very bullish on clean energy technologies
(solar, wind). In the short run, however, there is going to be major pain and
consolidation. Based on current trends, we can expect cost parity with dirty
coal technology in between 5-10 years. When that happens, stand back and watch
the explosive growth happen.
Related to this (in the US anyway) is smart grid technology to effectively
deliver distributed energy sources to the grid. Right now for example, many
homes that have solar panels generate surplus energy during the day which then
requires that this energy be stored using expensive batteries. A better
solution would be to allow the homeowner to sell this energy to the grid during
the day (when demand and therefore cost is the highest) and buy back energy at
night, thus completely eliminating the need for expensive batteries. In the US
the problem has been that much of the US grid is controlled by the Federal
government which has not been too cooperative, thus limiting the ability of the
local power networks to use homeowners surplus energy. This is about to change
with the new administration. This is an immediate high growth area.
Another up and coming area in the medium term are companies that are into
battery technology. A big driver for this will be from the transportation
industry.
Finally another growth area to look at is low cost mass water purification
using reverse osmotic membrane technology. Much work is being done to develop
the membrane materials with the aim being to reduce the energy required to
purify the source water. Most projections indicate severe shortages of clean
water in the next few decades. In fact it is already a problem in many poorer
countries, but current desalination technologies are just too expensive.
My bottom line:
1) Currency trades: Some diversification to safeguard against a cataclysmic US$
collapse is a good idea, but too early to predict dollar trends. One predictor
for this is US bond yields.
2) Gold: look for inflation signals. If there is inflation, buy gold/dump
dollar.
3) New technologies: Strong on smart grid technologies in short/medium term.
Strong on solar/wind in medium/long term. Strong on clean water long term.
Marlon
Roland Francis wrote:
> There is a record on Goanet where a person or two have admitted to
> following Mervyn's advice on buying gold which at that time was a
> thousand dollars an ounce. Gold has been below that ever since.
Date: Sun, 18 Jan 2009 18:30:05 -0800 (PST)
From: Mervyn Lobo <[email protected]>
Please immediately produce the post where I advised anyone to buy gold at
$1,000 an ounce, or withdraw your statement.
Mario adds:
I have no idea how gold and Khapris are related.
Anyway, as the only real voice of reason, truth and peace on Goanet, I must
confirm that Mervyn is technically correct, in an "it all depends on what the
meaning of 'is' is sense". I hereby confirm he did not explicitly advise
anyone to buy gold.
The archives will show that what he did when gold hit US$1,000 an oz. was to
issue an excited Off Topic post predicting that gold would go to US$1,650 an
oz. sometime between now and when hell freezes over. He later insinuated that
he had made a lot of moolah by picking the lowest point in gold prices years
ago. As I recall, some other Goanetters expressed some amused skepticism at
the shifting explanations of precisely how this was done.
