Thursday, June 10, 2010

Shut-up, WSJ: Bernanke Puzzled by Gold Rally

The WSJ reports:
“I don’t fully understand movements in the gold price,” Mr. Bernanke admitted. But he suggested it might be another example of investors fleeing risky assets and flocking to assets that are perceived as less risky, not only Treasury bonds, but also ones like gold.
It also might have to do with that quantitative easing (e.g. money printing) thing. Or maybe that competitive devaluation (e.g. fiat currency race-to-the-bottom) thing we are experiencing. We havn't seen major effects in price-levels as a result of the money printing because of both a lack of demand for loans, which has kept the money supply from materially increasing, but that doesn't mean people like it when you indiscriminately print money to buy $2 Trillion of shitty agency paper, Mr. Bernanke. Or, maybe, it's just a bubble.

In case you think you are just so smart buying gold to protect yourself from inflation and stick it to the man, you are not. The collectibles tax on bullion is 28%. That means that if the currency collapses and gold goes up 500% your nominal gain is 360%. If prices increase by 400% in addition to this, your real return is actually -8%.



This is one of the reasons that I don't like gold as an investment. It might be a good store of value before taxes, but it creates nothing in-itself. A better long term store of value would probably be real estate, especially if it produces something useful like a cash-flow or a crop / livestock, or it gives you a place to live. It's also nice that real estate has been getting cheaper while gold keeps getting more expensive.

If the government wants your money, they can and will take it. That stimulus needs to be paid off somehow, whether it is reduced spending or higher taxes in the future as a result of higher debt-service, currency devaluation or higher interest rates for the private sector. Trying to play cat and mouse with the government is swimming against the current, and if you buy gold it's never going to multiply or create anything useful. A scrap-metal recycler with inventories would benefit in an inflationary environment, all while earning profits from value-creating activities (turning waste into raw materials). A backyard with an apple-tree will give you apples and maybe give your kids a place to play tag or hunt for Easter-eggs. Jewelry you can at least wear. What is a heavy shinny gold bar that's locked in some vault going to do for you?

In the end, profits are not always driven by value-creation in the short-term, but it's generally easier and more sustainable to earn profits by creating value, which is really just another way of saying "making things better." And isn't that what this whole "allocation of capital" thing is all about, making the world a (subjectively) better place to live?

Math explanation: Initial gold price: $100. Initial price level 100. Post-increase gold price: $600 ($100 + ($100 * 500%)); Post increase price level 500 ( 100+ (100 * 400%)); Collectibles tax gain: $140 (28% * ($100 * 500%)).

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