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Most of Wall Street Doesn’t “Get” Gold – 7 Major Misconceptions about the Gold Market

By Louis Navellier November 11, 2013

There is an unnecessary war of words being waged between fans of the stock market and the “gold bugs” who distrust many paper-based investments. There is no need for this level of conflict. A well-balanced portfolio has plenty of room for a large holding of equities, and a smaller allotment for gold.

Unfortunately, most stock market analysts try to evaluate gold as if it were a stock. From what I read in most of the established financial press, analysts are concerned that (1) gold doesn’t throw off earnings, (2) gold does not pay interest, (3) gold is merely an inflation hedge, (4) gold is a crisis hedge, (5) gold’s rise and subsequent crash resemble a classic “bubble, (6) gold has little or no practical (industrial) value, and (7) shrinking ETF and futures market demand for gold will continue to depress the price of gold.

It’s time to look at these seven assumptions about gold with a mutual respect for both stocks and gold.
#1: Gold Doesn’t Throw Off Earnings. The major misconception here is that gold competes with stocks, which are often measured by earnings. Gold is more of an alternative to cash, not stocks, but if you want to talk about phantom earnings, you can also make the same arguments about America’s most widely-held investment, your own home. There is no formula for evaluating the right price to pay for real estate – whose prices have swung wildly up and down in the last decade. Just because there is no way to value a specific piece of land from day to day, does that mean we should not own real estate?

Stocks are also difficult to value, since quarterly earnings are subject to a wide variety of usually-wrong guesses by analysts. Stocks constantly disappoint or surprise analysts on the upside or downside. There is no way to predict any stock’s future performance, so maybe the earnings argument is a red herring.

#2: Gold Doesn’t Offer Interest: These days, your cash earns about 0.25%. The Fed’s target rate for short-term interest rates is (and will be) 0% to 0.25% for the foreseeable future. If you want to go out a little longer on the maturity curve, the two-year Treasury note currently returns a microscopic 0.3%. Overseas, the euro now earns 0.25%. This is gold’s major competition. Since the Federal Reserve has said that it will maintain its super-low short-term interest rate policy until at least mid-2015, gold will earn only slightly less than bank CDs or short-term Treasury bills, so interest becomes a moot point.

#3: Gold is an Inflation Hedge (and there is little or no inflation). A recent Wall Street Journal article is typical when it says that gold is down because “inflation remains subdued, dimming gold’s allure.” While global policies of monetary expansion will likely lead to more inflation, in time, the main point to remember is that gold does not “track” inflation, but is a long-term hedge against paper-currency value erosion. From Roman times to the present, an ounce of gold could always buy a good suit of men’s clothes. Today, an ounce of gold could buy a man a full wardrobe – suit, shirt, ties, and a nice pair of shoes. Gold does not track inflation month to month, or year, but it does beat inflation over a lifetime.

#4: Gold is a Crisis Hedge, but it has not responded well to recent global crises. Kathy Kristoff, writing in the October issue of Kiplinger’s Personal Finance magazine, says that she avoids gold since “no one can provide a good formula for evaluating the right price to pay. Gold is essentially a hedge against fear. When people become worried about the economy or the value of their currency, they bid up gold’s price. But are they $500-an-ounce concerned or $2,500-an-ounce terrified? I know of no logical way of making that call, so I simply stay away.” She is wrong for making gold so one-dimensional, but she is right in saying that gold mostly reacts to severe crises, not everyday run-of-the-mill global unrest.

#5: Gold is a Bubble Investment. The Journal says “gold has lost its luster” and it has “lately…been a dud.” Just what do they mean, lately? Since its peak in 2011, or for the year-to-date, gold is down, but if you want to compare gold’s performance to stocks since mid-2013, the precious metals beat stocks. From June 30 to November 1, 2013, silver rose 17.7% and gold rose 11.1%, vs. 9.3% for the S&P 500 and 4.3% for the Dow. In the five years after the global crisis of September 2008, silver rose 110% and gold 77%, doubling the S&P 500 in the same five years, so there’s no sense in viewing these investment classes as an either/or choice. A balanced portfolio includes a lot of stocks and a modest gold position.

#6: Gold is Inherently Worthless. Gold has been deemed by most civilizations as a superior form of money for thousands of years. Aristotle outlined the four key criteria for money (in shorthand: Durable, portable, divisible and intrinsically valuable), with gold holding superior advantages in all four categories. In writing about gold, the Journal doesn’t exactly say that gold is “worthless,” but they did write: “No one knows how to value gold…gold doesn’t generate cash flows. That makes the shiny stuff worth only what the next investor will pay for it.” That’s a negative way of expressing gold’s chief asset value: Gold is the only asset that does not rely on another person’s promise to pay. In other words, gold has no counterparty risk. With stocks or bonds, investors must evaluate if the underlying company can meet its debt payments (or scheduled dividend), or whether the company might even declare bankruptcy.

#7: Gold ETF Demand is Down: Articles about gold in the financial press invariably focus on declining gold ETF sales or short interest in the futures market. These paper gold investments can indeed wag the dog, but the vast majority of gold demand is for physical metal. Over 60% of demand comes from Asia (primarily China and India), but even in the U.S., physical demand is rising this year. The U.S. Mint just announced that 2013 sales of U.S. American eagle gold coins surpassed total 2012 sales as of November 1, so they have sold more gold eagle coins in the first 10 months of 2013 than in all 12 months of 2012.

Due to a flat supply curve – with under 2500 tons of newly-mined gold coming on market each year – this battle between short-term paper gold traders and long-term physical gold accumulators will likely continue, putting gold in a $1200 to $1500 trading range, giving us breathing space to build a position.

A More Balanced View of Gold

In their November 2-3, 2013 weekend review of the gold market, the Wall Street Journal concluded that “a small allocation to gold won’t kill an investor’s portfolio, but experts say you should think twice before leaning on it heavily.” The authors don’t define what “small” or “heavy” mean, but a round 10% position in gold has protected portfolios from paper erosion over the centuries. Gold provides portfolio balance, plus price appreciation in decades like the 1930s, 1970s and 2000s, when stocks were fading.

Gold is an alternative to global paper currency debasement and a portfolio diversifier. With a modest position in precious metals, investors can improve their overall portfolio performance while reducing their risk. Navellier Gold is dedicated to helping you accumulate gold at the lowest possible cost.