A Value Proposition

By -

Hi Slope, Gary from Biiwii.com and Biiwii.blogspot.com here again, with something I wrote in 2007 that I think can help settle some of the noise regarding gold, should Tim choose to publish.  I think it is relevant here since Tim often refers to some err, dynamic tension between himself and gold bugs.  🙂

As the rot in Wall Street's dark
alleys works its way from the inside out, from the seediest hedge
funds' leveraged 'investment' vehicles to Main Street's financial
institutions (pensions, 401K's, savings, etc.) gold has taken center
stage, closing above $800 for the first time in its still young bull
market. Fear and anxiety are increasing as the US Dollar falls
further below serious long term support and in this environment,
gold is an emotional conduit through which growing fears of fiat
monetary instability pass. Picture a burning building with a limited
number of exits and a large crowd trying to pile through the door.
Let's call it a… oh I don't know… let's call it a casino.

Gold is the object of many strange and varied perceptions, perhaps
because it is an ancient asset that has always stirred basic human
instincts for wealth, good fortune and even survival. But in light
of the perverted and multi-headed monster we call a financial system
– with seemingly infinite instruments of 'profit' limited only by
the imagination of financial engineers – perceptions toward gold
have become distorted, helped by an enabling Wall Street and
mainstream financial media.

The main point to remember is that gold does nothing; it just sits
there and does not care about the crazy gyrations going on all
around it. But to understand and accept this, casino patrons must
first accept that the metrics they have been schooled in and the
rules they have been taught over the fiat decades to play by are not
applicable. Filling the void that this lack of understanding creates
is a whole host of opinions, many disparaging and/or dismissive.
Others simply attempt to fit this "asset class" into
conventional metrics. The inspiration for this missive was a recent
piece by Brad Zigler called
That Glitters May Not Be So Golden
. Mr. Zigler did not write a
'hatchet piece' on gold but what I find interesting is his and many
other financial media correspondents' analysis of gold as a return
(or lack thereof) instrument.

Gold pays no risk premium as it carries no default risk. But in the
world of financial media-fed perceptions that is a bad thing. No
return you say? No markup? No leverage? Who needs that?! Gold is
about value and nothing more in my opinion. That is why I refuse to
get excited when its fiat currency denominated price goes up and why
I also remain at a normal pulse rate when said 'price' declines
sharply. I do agree that when trading or investing in the gold
miners (as I do) it is important to keep traditional metrics in
mind. But the miners are my casino of choice and I most certainly do
not see the gold miners as gold, a gold equivalent or anything other
than a potentially hugely leveraged play on an enduring asset of

Back in the real world, players are just beginning to get the hint
that the risk they have taken on in the hunt for return in some very
dark corners has come at a price and the price is a massive debit
against the entire system of something for leveraged nothing. Yes,
gold pays no premium but neither is it subject to this debit because
it never went anywhere to begin with.
Is What It Is
(this is the credo by which the website was
created) and as a barometer of global financial sentiment its
exchange value is rising versus a whole host of paper promises not
to mention many hard assets. So what many investors now need is a
sort of 12 step program as they attempt to 'put down the crack pipe'
and come to an understanding that real value has nothing to do with
return (unlike modern portfolio and asset allocation theory) and it
certainly has nothing to do with leverage.

Mr. Zigler's
and my responses:

has raged for some time now about the utility of gold in a
portfolio. Forget, for a moment, the breathless claims of
infomercial touts and
magazine advertisers. Think, instead, of asset class selection.

should anyone add gold—or, for that matter, any asset—to a
portfolio? The answer that comes immediately to many people's minds
is "return." It's the promise of outsized, and often
returns that entices people to call that 800 number in the wee hours
of the morning to get their hands on the yellow metal.

There should be no debate. An asset of
historic value belongs in a portfolio if debt obligations (bonds)
and calls on corporate earnings (stocks) belong there. I agree, the
800 number pitch men are seedy characters capitalizing on fear and
insecurity, but why are they part of the conversation? Have you ever
seen the movie
? The world of stock scams dwarfs that of unscrupulous
precious metals dealers.

isn't the end-all, be-all, however. In the long term, the metal's
price is notoriously unstable. Since gold's price was allowed to
float in 1970, its annualized standard deviation—its price
variance—has been clocked at nearly 20 percent, versus 15 percent
for blue-chip stocks. And in that time, gold's return has only
averaged 8 percent. The S&P 500 earned 11 percent per year.

There is the word "return" again. The reason gold has
under-performed over the measured time frame (minuscule in the
context of history) is because contrary to what some gold bugs may
think, there certainly was upside to the fiat money system. This
upside was manifested in liquidity to build out all manner of
productive enterprise. The United States for example spent the
majority of the 20th century on the upside of this build-out. The
question now becomes 'do we remain on the upside or have the secular
changes beginning in and around 2000 marked a decided switch to the
inevitable payment to the piper (of the debt used to keep the dream
alive)?' If you think there is still productive upside, you will see
gold's 'return' as sub-par. If you believe that secular changes are
at hand, you are looking for that exit door in a crowded casino and
you don't give a damn about return. You want to stay whole.

So what
return can we
from gold? Well, financial theory says you can't expect any increase
in an asset's value without growth prospects. Stocks' expected
return derives from earnings growth. Issuers of corporate securities
can create things and grow. There's a real prospect for a company
trading its shares or warrants to be worth more and more as the
result of management decisions. Gold itself doesn't produce
earnings, and for that reason its expected return can be
approximated as zilch. Nada. Bupkis.

Mr. Zigler is correct. Gold provides no 'return' in the modern asset
allocation theory sense of the word. But in bringing the word
'value' into the equation he again shows how modern portfolio
theorists are trained; no return, no 'growth' = no value
proposition. Gold does not stand at $806 this morning because of its
growth but rather because of its retained value vs. paper
instruments – USD first and foremost – which are coming under heavy
questioning. It should be noted that in the US the stocks of these
growth entities are denominated in USD.

in the price of gold, of course, does occur. History attests to
that. There's just no reason to
it. What influences the price of gold are external, not intrinsic,

It appears Mr. Zigler and I have been watching two different
financial systems over the last several years but I certainly agree
that gold's value is affected by external forces.

He then goes on to write about the gold miners which is my usual
subject matter on the
, so I will just end here this critique of modern portfolio
theory as it applies to gold. I hope it helps shed a little light on
an alternate way of thinking for a few people.

I will leave you with a final thought that I was taught early on in
a school of decidedly unconventional asset theory. Price is price
and value is value. They are not one in the same. Unfortunately that
simple thought has been schooled out of the masses. I have no doubt
that pitchmen of all types will come out of the woodwork to hawk the
golden solution to an awakening public. A fortunate few will keep it
simple however and remember that real value is enduring and real
value is not a pitch. I find value splitting wood at my wood pile. I
find value in jamming loudly on guitar. I find value in Google. I
find value in the air I breathe. I find value in remaining
financially whole. I do not find value in debits attached to an
unpayable black hole.