Gyroscopic Investing

I was wondering if someone could point me in the direction of data, charts, etc that shows the correlation between inflation and gold prices?

I am curious because I definitely believe that Harry Browne's idea of owning gold as a hedge for inflationary periods was sound at the time. However, I worry that now since people can trade gold so much easier through ETFs and other non-bullion sources it may not be as useful in the role HB envisioned. I am curious how strong the correlation between gold and inflation actually is nowadays.

And if gold is responding to other factors instead of inflation, are there any other possible assets that could also fill the 25% of the portfolio designed to protect against inflation? (I know TIPS are suggested by some but generally considered unsuitable for the PP)

To understand gold prices in the US and elsewhere you need to also understand some about financial/world history, gold standards, etc.. Often it is the case that big spikes in gold were seen around serious events (like big wars). It is also the case that big spikes in gold happened when a currency suddenly runs into problems. By suddenly I mean inflation well above market expectations. This can sometimes happen very quickly or be dragged out over years. Low inflation has never been good for gold, but expectations of high inflation have been.

Realize too that the Gold ETF didn't create a gold market. The ETF is there and popular because there is a market demand for gold. I suspect that even without Gold ETFs we could have seen rises in gold prices simply because of US domestic and foreign spending behavior the past 10 years. Historically it has been the case that welfare and warfare have been inflationary. The 2008 Real estate crash may have caused a pause into deflation territory, but the markets still seem to think that inflation is going to happen. Maybe they're wrong. If so, gold could fall in price.

Gold can and will respond to inflation and to threats to the dollar. I doubt you'll find any asset that has the history of surviving inflation comparable to gold. TIPS are in no way a suitable replacement in the Permanent Portfolio strategy for gold.

Here is an updated table on gold prices:

http://www.finfacts.ie/Private/curency/ ... tprice.htm
http://www.nma.org/pdf/gold/his_gold_prices.pdf

Realize that under a gold standard the price is going to appear low. This is because gold was a legally fixed ratio to the paper currency. A $20 gold coin was about one ounce of gold. A $20 bill meant there was about one ounce of gold payable to the bearer by the Treasury. Gold was money and paper was the same money under the gold standard.

In the above chart you see the stable gold price from nearly the founding of the country until around 1933 when FDR stole the gold from US citizens and broke the gold standard. Then it wobbled around at the Bretton Woods price for another 30 years or so. By 1971 the gold standard was broken and gold allowed to float. That's when the fun begins. The gold price shot up to make up for decades of price controls. Then in the latter part of the decade the inflation was still going on and the gold price escalated. It hit an inflation adjusted high of around $2200 in 1981. When inflation dropped to the low single digits the price corrected and stayed there for years. But with the expansion of govt. spending starting in 2001 it started going up again as the markets anticipated a falling dollar in response.

This link is more interesting because it shows the "official" price vs. NY market price:

http://measuringworth.com/gold/

Put in 1800-2009 and you can see what the US Govt. said it was worth and what the markets did. You can spot the big problems the US has had by the market price of gold (early 1800s, civil war era, FDR's gold theft of 1933, Bretton Woods failing late 1960s). The markets are very efficient at pricing in problems in a currency. The price of gold reflects the collective wisdom of everyone participating.

I used the gold returns from the periodic table + BLS inflation stats to examine the relationship between gold returns and inflation.  From 1972-2010, there were 15 years when inflation exceeded 4 percent.  In eight of them, gold went DOWN.  In some of those years, the degree to which gold lagged inflation was substantial.  What's more, the year 1980 seems to mark a turning point of some sort, since most of the lag years are after 1980. What do you think of this and how might it affect our view of gold as an inflation fighter?


Gold Performance when Inflation Exceeds 4 Percent

Year///Inflation Rate %///Gold Return %///Gold Up?///Gold Lag (%)///Gold %Gain Beyond Inflation
1991 4.25 -10.43 No -14.68 --
1990 5.39 -1.86 No -7.25 --
1989 4.83 -3.23 No -8.06 --
1988 4.08 -15.59 No -19.67 --
1984 4.3 -19.52 No -23.82 --
1982 6.16 14.49 Yes -- 8.33
1981 10.35 -32.87 No -43.22 --
1980 13.58 14.73 Yes -- 1.15
1979 11.22 125.65 Yes -- 114.43
1978 7.62 36.47 Yes -- 28.85
1977 6.5 22.15 Yes -- 15.65
1976 5.75 -5.58 No -11.33 --
1975 9.2 -27.62 No -36.82 --
1974 11.03 72.02 Yes -- 60.99
1973 6.16 71.24 Yes -- 65.08

TBV,

Many consider gold to be the "Canary in the coal mine" in the sense that gold tends to pre-react to inflation and fiscal problems.  Gold went up insanely fast in the 70's, and did so as well in the 2000's.  When wars, fiscal fears and/or oil shocks rear their ugly head, gold skyrockets.  This is important as stocks/bonds are very sensitive to those types of events.

Also, as far as its place in the PP, it's important to note how well gold has done during some of the worse stock downturns in the past 48 years.  Gold and LT treasuries, as a pair, have done an insanely good job of bouncing when stocks drop sharply in a calendar year.  That action is huge, and much more important to the returns and lack of volatility in the PP than simply tracking CPI inflation year by year (which cash tends to do extremely well).

As a side note, if there's anything I've been skeptical of for years, it's gold.  I'm not an Austrian (economically) nor am I a gold bug historically. I, personally, see no intrinsic value in a shiny yellow metal with few industrial uses, but I can't argue with thousands of years of history and its ability to bounce when fear strikes.

I find that its weakness during good (even with light inflation) times is actually a strength, because that whole time you're buying it up at a discount, and then it explodes when you need it to.

Real estate, on the other hand, relies on heavy leveraging to deliver the returns that it does.  TIPS have fraud written all over them.

Gold isn't an inflation hedge.

It is an uncertainty hedge.

Stocks happen to hate uncertainty and that is one of the reasons that gold and stocks go so well together in the PP.

Gold can be an inflation hedge, but it's real role is much more fundamental--it's a place people go when they are scared.

Yes, MT. 

When people start to question the value of homes, leather furniture, new cars, nice clothes, green paper with dead presidents printed on them, fancy vacations, new electronics, and small creature comforts all financed often by credit, and therefore question the value of the stock market of companies that creates all this stuff, people will turn to things they know has basic intrinsic value (we'll assume that gold having intrinsic value for thousands of years is enough evidence, despite what some, including myself, would argue about its theoretical intrinsic value).

In your home, this will mean food, basic shelter, basic transportation, basic utility-creating items, and for your portfolio, this will mean something that can hold value despite the madness, instability and unease of the outside world.  This is part of the reason gold ended up in 2008 instead of down drastically like almost every other commodity.  It's value isn't based on prosperity and consumption and expansion like oil and copper, it's based on fear and instability.

Gold rises when real interest rates are negative.  Gold falls when real interest rates are positive.  TBV, gold fell after 1980 despite high inflation because The Fed got ahead of it by raising rates high enough to turn real rates positive again. 

People like to point out that gold is wacky because the U.S. has had tame inflation for the last 10 years.  Much of the world imports our inflation through dollarization and currency pegs.  There is most certainly inflation and real rates have been negative for a long time.  The U.S. enjoys (rightfully or not) the benefits of seigniorage to the rest of the world.

moda0306 wrote: ...despite what some, including myself, would argue about its theoretical intrinsic value)

The intrinsic value is that it works very well as money.  It wasn't until I read Friedman's "Free To Choose" that I really understood that "money" is just any thing that people use as a medium of exchange, instead of bartering.  Throughout history people have used paper bills, metal coins, salt, tobacco, livestock, and other goods as money.  An ideal money has certain properties: durable, divisible into smaller pieces, impossible to counterfeit, rare enough that a large value fits in a small space, etc.  Gold scores well on all these counts.

Using money instead of barter makes economic transactions vastly more efficient, so people seem to value things like gold that are an excellent form of money but are otherwise nearly useless.

Wonk wrote: Gold rises when real interest rates are negative.   Gold falls when real interest rates are positive.

I think this raises the issue of cause and effect, and I would say that a situation where real interest rates are negative suggests a sick underlying economy, sort of like a severely malnourished person being fed candy bars at 3 hour intervals. 

This underlying sickness of the economy translates itself into a vague sense of uncertainty that manifests itself quite elegantly in the price fluctuations of gold.

If you asked the malnourished person if his overall sense of uncertainty was mitigated by the every-3-hour candy bar routine, he would probably say yes, a bit...but not completely.  Over time, the every-3-hour candy bar routine would probably begin to wear thin, and his sense of uncertainty would begin to rise in spite of the candy bar fix.

There is a nexus among the modern human psychological state (particularly its conception of individual freedom), the tendencies of political and financial structures toward entropy, and gold that I struggle to translate completely and accurately into words, but once I detected this nexus, it became impossible not to see it (and suddenly I saw it everywhere throughout history and all around me in the present).  I think it was an understanding of this intuitive and subtle inter-connectedness that formed the basis of HB's feelings toward gold.

Armed with the insight described above, it becomes very easy to sincerely hope that the price of gold will fall (since it would signal an institutional structure that is sound), while understanding clearly what a secular bull market for gold represents (and its significance goes far beyond inflation).  Part of the beauty of the PP is that its design incorporates all of these factors and wraps them in a fairly inconspicuous package.  It's a bit like a family sedan with a nuclear reactor under the hood. 

When one says that gold is a vote against existing institutions, he has said a great deal in very few words.

KevinW,

All those other items you mentioned that were used as money DO have an intrinsic value outside their money value.  I respect gold immensely for what it does for the portfolio, but to me it seems like circle logic to say gold is money because it has intrinsic value because it is money... on and on.  

I probably should read up more on it, but despite the fact that I understand its thousands of years of history as a currency and having some sort of value in the minds of men, I still can't explain to myself why 1 ounce of gold is worth all the "crap hit the fan" assets I could buy with $1,300.

One of my questions would be, at what price would gold have to come down to, in todays economy, to actually be used for something other than luxury goods.  I'm sure there's a gradual scale, but I'm curious.  I completely understand that monetary metals behave differently than industrial-use metals, so I don't need that lecture... I just have this nagging skepticism of gold while simultaneously adoring what it does for the PP in the real world.

moda0306 wrote: I completely understand that monetary metals behave differently than industrial-use metals, so I don't need that lecture... I just have this nagging skepticism of gold while simultaneously adoring what it does for the PP in the real world.

Your skepticism is the "wall of worry" that gold must climb in order for its price to rise.

That skepticism is always in the process of rising or falling.  Currently, the skepticism has been falling for 10 years.  Prior to that, it had been rising for 30 years.

The ironic thing about the "no intrinsic value" argument about gold is that the same argument could be applied much more persuasively toward stocks (especially those that pay no dividend).  What is a share of stock?  It's a meaningless abstraction (a share of stock is not a claim to any underlying assets or cash flows of a company).  The only value of a share of stock is what someone else is willing to pay you for it.  

Show me a stock certificate from the top firm in the world in 1900, 1800 and 1700 and I will show you an interesting historical relic with no value other than as a souvenir.  Show me a gold coin from 1900, 1800 and 1700 and I will show you something with value that is virtually unchanged from the date it was issued.  Which has more "intrinsic" value?

Remember, we are not interested in some abstract notion of intrinsic value that resides outside the human mind.  We are dealing with assets that we want to own because other humans will value one or more of them at all times.

Thanks very much for all of your replies!!

Having just created my own permanent portfolio, I am impressed with the long-term performance of Harry Browne's 4x25 approach.  The radio shows and now craigr's podcasts have reinforced for me the soundness of the approach.  However, while I was catching up on the podcasts, I listened to the exchange between craigr and Rick Ferri regarding the utility of gold.  Ferri's notion that the market had already driven up the price of gold in anticipation of inflation (and thus leaving ---in his view-- little extra protection if inflation does hit) was a bit unsettling.  My review as shown above confirmed that HB's explanation of gold's role in the four basic economic scenarios created the impression (for me) that gold's central role was as an inflation fighter.  Apparently, it sometimes is and sometimes isn't.  However, stepping back a bit, one finds that different portions of the portfolio can jump in when inflation bites and returns need a boost.  Aside from that, crises, fear and uncertainty (with or without inflation) offer perhaps a more fundamental arena for gold to outperform.  Craigr's advice to Ferri about not evaluating gold "in isolation" sounds truer than ever. Each part of the portfolio has strengths, but the synergy of the whole package is the real prize.

TBV wrote: Ferri's notion that the market had already driven up the price of gold in anticipation of inflation (and thus leaving ---in his view-- little extra protection if inflation does hit) was a bit unsettling.

My question for Ferri--and others of his ilk--would simply be "how do you know?"

If he is just speculating, then I would say his perspective is just one more voice in a world of people telling different stories.

The PP is about getting away from the need to figure out which one of the Rick Ferris of the world you are supposed to listen to.

moda,

In addition to the excellent points Kevin and MT mentioned, I'll add that the "why gold" question can be answered pretty easily and in a non-circular way: because everything else sucked as a form of money by comparison.  Gold was chosen to be money because other forms of money were eliminated--not because gold was anointed in some way.  Most commodities eliminate themselves from becoming money because of their consumption in addition to failing one or more of the qualifications Kevin listed.

MediumTex wrote:

TBV wrote: Ferri's notion that the market had already driven up the price of gold in anticipation of inflation (and thus leaving ---in his view-- little extra protection if inflation does hit) was a bit unsettling.

My question for Ferri--and others of his ilk--would simply be "how do you know?"

If he is just speculating, then I would say his perspective is just one more voice in a world of people telling different stories.

The PP is about getting away from the need to figure out which one of the Rick Ferris of the world you are supposed to listen to.

It's ironic that a guy who makes his living pimping passive investing can have such a strong opinion on the value of an asset he understands nothing about.  Asking Rick Ferri about gold is like asking a proctologist about brain surgery.

Gold rises when real interest rates are negative.   Gold falls when real interest rates are positive.  TBV, gold fell after 1980 despite high inflation because The Fed got ahead of it by raising rates high enough to turn real rates positive again.

http://www.tradersnarrative.com/long-te ... -1513.html

Edit: was having some problem with other chart, here is a replacement.
http://goldprice.org/30-year-gold-price-history.html

These charts do not show strong negative correlation between real interest rates and gold. Can you elaborate a bit?
I could not find I way to supper impose the two charts.

moda0306 wrote: All those other items you mentioned that were used as money DO have an intrinsic value outside their money value.  

What is the intrinsic value of a $100 bill?  If your conception of "money" requires it to have intrinsic value, paper currency completely sucks.  You WANT what you use for money to be useless (like paper money is and gold nearly is), but you also want monetary value to be intrinsically related to an "amount" measurement that can't be faked (like weight).   Gold is perfect - rare but not too rare, easily divisible, doesn't decompose, and completely useless (well, not really, but you get the point).

rickb wrote: What is the intrinsic value of a $100 bill?

Come to think of it, what is the intrinsic value of anything?

Even something like food has differing levels of intrinsic value based upon how much food a person has and how hungry he happens to be when the time comes to decide the intrinsic value.

Let's not kid ourselves, the valuation of anything by people is based on a lot of very subjective factors.

If your conception of "money" requires it to have intrinsic value, paper currency completely sucks.  You WANT what you use for money to be useless (like paper money is and gold nearly is), but you also want monetary value to be intrinsically related to an "amount" measurement that can't be faked (like weight).   Gold is perfect - rare but not too rare, easily divisible, doesn't decompose, and completely useless (well, not really, but you get the point).

Gold really is a marvelous tool for that purpose.  The fact that there was plenty of it around (or maybe I should say just enough) as humanity was moving into its modern civilized configuration with an organized division of labor probably just sealed the deal.

One thing we know is that money of some kind will always be necessary as long as there is a division of labor.  The question then simply becomes what form the money will take.  After trying countless different configurations, I don't think that any fiat currency is really workable over more than a short period of time (simply because sovereign entities backing them come and go in such an unpredictable and chaotic manner).  If the only real option we are left with is some medium of exchange the supply of which isn't easily manipulated (and otherwise meets alll the requirements for "money"), then the list becomes very short and it seems obvious that gold would be at the top of that list.  Silver is, however, a strong second.

Even under a gold standard, however, you still find the practice of issuing notes based upon gold deposits, and the issue of reserve requirements quickly arises, which then leads to the issue of who decides the reserve requirements, which leads to fluctuating reserve requirements, which eventually leads to mass redemptions in response to a panic....so I don't think there is any real "steady state" option available.

"Commodity Money" tends to have intrinsic value: gold, silver, copper, salt, peppercorns, large stones (such as Rai stones), decorated belts, shells, alcohol, cigarettes, cannabis, candy, barley, etc.

...and then of course, on the other side of the spectrum, there are "Bitcoins".

One of the challenges of using a metal/commodity when minting coins in fiat currencies, is that the perceived intrinsic value of the metal/commodity can often become greater than the face value of the coin itself. Despite the efforts of legal tender laws, governments are constantly finding ways to reduce the intrinsic value of the minted coins. Even the composition of the penny has changed over time due to the higher perceived intrinsic value of copper. in the 1870s, 1-Yen coins were a gram of gold — now they are aluminum.

See Gresham's Law: http://en.wikipedia.org/wiki/Gresham%27s_law

rickb wrote:

moda0306 wrote: All those other items you mentioned that were used as money DO have an intrinsic value outside their money value. 

What is the intrinsic value of a $100 bill? 

At least we're getting somewhere here... $1 Billion pieces of green paper and a shiny yellow metal that's maliable both seem to me to have pretty limited intrinsic value... meaning something that can directly add quality to my life independent of some kind of mutually understood collective value placed on it that nobody truly understands.

So let me get this straight, if you don't want your currency to have too much industrial value, then what are you left with?  Because to me, a currency, with absolutely no other value isn't valuable at all.  So what, historically, was the value people saw in gold?  A luxury item.  Let's just call it what it is, right?  Enough wealthy people, for thousands of years, have actually wanted a nice shiny yellow maliable metal for luxury purposes, but on top of it all it has all those currency traits.  Question, if gold was a puke-green color, would it have held the same value over the last several thousand years?  Additional question: What if yellow goes out of style?  Just to be clear, I'm completely sold on the PP and gold's function within it.  I am just trying to throw some questions/ideas out there for people to chew on a bit.

moda0306 wrote:

rickb wrote:

moda0306 wrote: All those other items you mentioned that were used as money DO have an intrinsic value outside their money value.  

What is the intrinsic value of a $100 bill?  

At least we're getting somewhere here... $1 Billion pieces of green paper and a shiny yellow metal that's maliable both seem to me to have pretty limited intrinsic value... meaning something that can directly add quality to my life independent of some kind of mutually understood collective value placed on it that nobody truly understands.

So let me get this straight, if you don't want your currency to have too much industrial value, then what are you left with?  Because to me, a currency, with absolutely no other value isn't valuable at all.  So what, historically, was the value people saw in gold?  A luxury item.  Let's just call it what it is, right?  Enough wealthy people, for thousands of years, have actually wanted a nice shiny yellow maliable metal for luxury purposes, but on top of it all it has all those currency traits.  Question, if gold was a puke-green color, would it have held the same value over the last several thousand years?  Additional question: What if yellow goes out of style?  Just to be clear, I'm completely sold on the PP and gold's function within it.  I am just trying to throw some questions/ideas out there for people to chew on a bit.

Well, let's take a look word, "intrinsic." Intrinsic doesn't mean something that can directly add quality to your life. The definition of intrinsic is:

• 1) belonging to the essential nature or constitution of a thing <the intrinsic worth of a gem> <the intrinsic brightness of a star>
• 2) originating or due to causes within a body, organ, or part <an intrinsic metabolic disease>

The intrinsic value of gold has more to do with the fact that it's the most naturally rare, stable and exchangeable element known to man. It's best explained in this NPR article.

Yeah, I think the definition of intrinsic can have different levels of meaning... my philosophy class tested that word's meaning to the n'th degree.

So if gold had all of the exact same qualities that it has, which I'll admit make for a perfect currency given the standard characteristics, then you come to the next question: ok, it's rare and has all these great qualities.  What kind of value should be attached to that? 

Historically, I always wonder how much of that is luxury value (which is ok, but it's important to me to work through the logic/math here).  So that's where I got the puke-green color exception.  Instead of gold being a "gold" color, if it were puke-green or some disgusting looking color, one would wonder whether it would have become a currency or not?

MT... any insight on that?

moda0306 wrote: Yeah, I think the definition of intrinsic can have different levels of meaning... my philosophy class tested that word's meaning to the n'th degree.

So if gold had all of the exact same qualities that it has, which I'll admit make for a perfect currency given the standard characteristics, then you come to the next question: ok, it's rare and has all these great qualities.  What kind of value should be attached to that?  

Historically, I always wonder how much of that is luxury value (which is ok, but it's important to me to work through the logic/math here).  So that's where I got the puke-green color exception.  Instead of gold being a "gold" color, if it were puke-green or some disgusting looking color, one would wonder whether it would have become a currency or not?

You are correct that the pleasing color does affect its value. It's "shine" is also a very important factor as well. Since the beginning of time, artists have sought out the best materials for creating their art work. The best marble, the best metals, the best paints, etc. Because gold is such an awesome element and has a very naturally attractive color, it is the perfect element to preserve and create artwork. If you create art, and want it to be timeless (i.e. last forever), you choose gold as your medium. That's a very big deal. Color is part of that historic artistic value, and shouldn't be discounted as a simple feature. And the more beautiful the coin is, the less likely someone will want to melt it down. Beauty is powerful.

Nature has a funny way of matching the complementary wavelengths of light (i.e. beautiful colors) with beautiful things. Rarely do you see ugly colors in nature.

My initial logic towards gold was, "Why on earth would I want to have a luxury item when the world is falling apart all around me... that's exactly when luxuries don't matter."  Immature, but probably quite common.

I do have a whole new respect for it at this point, and your guys' insight is really amazing to hear.  Sometimes I get in a mood where I just don't like it, then MT does a post in Olde English/ Yoda speak and his words alone remind me what gold truly represents.  Funny, my initial post was to tell the TC why gold is the only thing that works in the portfolio, then I get in a back-and-forth arguing that it has no intrinsic value.

Interesting conversations, gentlemen.