Six reasons gold will keep falling


As this piece is being written, the price of gold continues to tumble, and we wish our new readers to know that we are not simply jumping on a convenient bandwagon. We have argued that gold’s price was likely to fall many times this year, including here in January, here in February, here in May, and, most recently, here in June. While we have pointed out possible ways in which investors might profit from this directly (shorting GDX, buying DUST), it must be allowed that we much more frequently point to opportunities in stocks.

We who advocate investing in the stock market as the most sensible and most likely rewarding long-term investing strategy available have a great deal to keep track of. That the stock market indices rise and fall each day is the least of it: money rotates from one sector to another, technologies emerge or are made obsolete, exceptional CEOs somehow create profits or losses in industries which, for everyone else, are producing the opposite. But for those advocating instead the purchase of gold, there is, at the end of the day, only one thing that matters. On one single number—gold’s current price—all their hopes must rest. Perhaps that is why they say, with grueling predictability, the same thing every day.

One gives up hoping that anyone will ever count the number of times they have been wrong in the past twelve months and be driven by humility and decency to announce that they never really knew what they were talking about in the first place. Hence, it is not to them that we now address ourselves, but to those who, having followed them this far down the rat-hole, may be wondering if perhaps there are logical flaws in the arguments they have been hearing for the past year predicting an imminent and dramatic rise in the price of gold.

There are, of course, as the tumbling price of gold proves, and sharp witted readers will no doubt have spotted some already. Still, we’re happy to point out what we see as the most egregious errors that gold enthusiasts are making today.

Argument: The U.S. government is manipulating the price of gold.
I eagerly await the day I see Ron Paul appear on TV wearing a T-Shirt that reads “You don’t have to be a paranoid conspiracy theorist to buy gold—but it helps!” Nearly all gold enthusiasts argue from time to time—and some nearly every day—that selling in the gold market is somehow unnatural and must be the result of a deliberate strategy to lower the price of gold on the part of the U.S. government and whomever the U.S. government actually answers to. (This last varies from source to source. Frequently represented are: The Illuminati, The Bilderberg Group, The Chinese, The Trilateral Commission, and others, including some, which we will not here repeat, based on racial or religious bigotry.)

Of course, the U.S. government is itself long gold, and we have not yet heard a convincing, or even sensible, motivation for why the government would want to erode the value of one of its own holdings. One senses from a few pundits, however, that there is no need for an explanation, since the whole corrupt system obviously exists just to persecute the pundit himself, and those who follow his advice. In their cases, we add to the charge of paranoia the charges of narcissism and messiah complex.

This preponderance of wackos in the gold-bull camp may be the single greatest argument in favor of selling gold. Before moving on, we add that this argument may look like a paper tiger. If we saw such an argument, and didn’t read what gold-bull pundits had to say each day, we might assume it was just that. It isn’t. If anyone reading this doubts that large numbers of (somewhat) respected financial analysts could truly have descended into conspiracy theory, we ask only that you read the full analyses of a few well known gold-bulls before responding.

You’ll be amazed.

Argument: Gold performs as well or better than stocks in the long run.
This argument can be made to appear true, but doing so requires the proponent to define the nature of the long-run by examining only a very convenient slice of it. The long-term superiority of gold is shot down rather convincingly here by Matthew O’Brien in a recent piece in The Atlantic. It seems that gold was a horrible investment between the years of 1500 AD and 1965 AD. It seems that any pirate who captured a Spanish treasure galleon in 1500 would have been well advised to sell immediately, as by 1965, that golden booty would have lost 80% of its value.

Argument: Gold’s value cannot possibly drop below its production cost.
Why would $1,290 per ounce be a natural bottom for a commodity that traded at $890 per ounce just five years ago, and $390 per ounce just five years before that? Gold supporters think they know the answer. Apparently gold mining has grown continuously more difficult, and as a result, no mining company can now profitably produce gold if it sells for less than $1000 per ounce. This production cost has been proposed as a sort of dead-man’s line by gold enthusiasts—a level below which the price of gold cannot fall, lest the very logic of capitalism—produce at one price, sell at a higher one—be inverted. While being right on the particulars, supporters of this argument have managed to reach exactly the wrong conclusion.

Scarcity increases the price of a commodity because it limits the utility of the commodity to a few, but it is the utility of the commodity that gives it its value and ultimately determines the price. Phrased another way, this is to say that the monetary value of anything is whatever the market is willing to pay for it. In the case of gold, or any metal, those who choose to buy the metal owe nothing to those who dig for that metal in the earth, and are in no way bound to consider the going forward viability of mining when determining whether any particular price warrants buying or selling.

Gold has been overpriced, and as a result, it has been over-mined. As its value continues to tumble and the illusion that it provides safety shatters, necessity-selling and panic-selling will both increase until, at some point, the inevitable result of gold’s overpricing will become clear: the world has been drastically oversupplied with gold. After that, there may be no such thing as a profitable gold mining venture for some time to come.

There was once an economic theorist who held the opposite to be true: that a thing’s value was, in a fundamental way, determined by the number of man-hours it took to produce it (taking into account also the number of man-hours it took to produce the machines necessary to produce it, the tools necessary to produce those machines, etc.) His name was Karl Marx, and his theories have been out of fashion in capitalist circles for some time. Still, if gold enthusiasts insist his theories need to be reconsidered, I won’t stand in their way. I will point out how ironic it is, however, that enthusiasm for gold is so often erroneously described as being a product of right-wing ideologies.

Argument: The fundamentals are strong.
The fundamentals of gold are its chemical properties (low reactivity), its atomic number (79), its atomic weight (197), and its appearance (shiny!). The fundamentals of gold are eternal and unchangeable; anyone who claims otherwise has either lost sight of the real meaning of the word or simply chosen to ignore it.

As an investment, gold has other fundamental properties as well: it earns nothing, produces nothing, creates nothing and engenders nothing. While other forms of investment seek to grow their own value, gold provides no output whatsoever, but requires the input of resources to store and guard. Monetarily, gold is endothermic, and it always will be. From the point of view of a fundamental investor, this is a gruesome state of affairs.

Argument: This is a technical bottom.
If charting worked for anything, it would work for gold, though the same could be said of bitcoins, or any other investment for which there is no fundamental value on which to base price. It doesn’t, though, except, occasionally, in the extreme short term. At present, there is no clearer example of how thoroughly it does not work than gold. Again, you may need to read some historical analyses from gold enthusiasts before fully embracing this truth, nevertheless, if you do, you will find that gold has been at a convincing technical bottom on nearly every day that it has ever lost value—ever.

Argument: Quantitative Easing drives the real value of gold.
This one misconception is at the very core of the current gold bubble. In its simplest terms, the argument holds that there is a fixed ratio of value between cash and gold, so if the total amount of cash is doubled, its value against gold is necessarily cut in half. This idea is so simple that can be explained by almost anyone to almost anyone else, so seductive that sophisticated, educated, and otherwise reasonable people gamble everything they have on it, and so wrong that we don’t know whether to laugh at it as a self-mocking farce or cry for the very real pain that is now causing, and will most likely continue to cause, to its adherents.

The value of money is theoretical; it always has been and always will be. On the other hand, the value of coffee, of cereal grain, of milk, of gasoline, of paper, of textiles, of labor, of a fine cigar… these are real. And in defiance of the theoretical drop in the value of money, none have risen in price dramatically over the past five years. So the question gold enthusiasts should be asking is not “Why is gold worth more money today than it was before?” but “Why is gold worth more coffee than it was before? Why is it worth more milk? Why is it worth more gasoline, more labor, more cigars?”

Why, in short, did the value of these things not skyrocket in response to the debasement of our currency? And whatever the reason was, why would it not hold equally true for yellow, shiny rocks?

Julian Close

Julian Close

Julian Close became a stockbroker in 1995. In his 20 years of market experience, he has seen all market conditions and written about every aspect of investing. Julian has also written extensively on corporate best practices and even written reports for the United Nations. He graduated from Davidson College in 1993 and received a Master of Arts in Teaching from Mary Baldwin College in 2011. You can see closing trades for all Julian's long and short positions and track his long term performance via twitter: @JulianClose_MIC.

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