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Iron Capital Insights

  • Iron Capital Insights
  • September 9, 2009
  • Chuck Osborne

All That Glitters Isn’t Gold

We are in the midst of a new gold rush. Gold briefly went over $1,000 per ounce and is still hovering at those levels. Everywhere you look, you find someone pushing gold and other “inflation hedges” as they preach the gospel of runaway inflation.

There is one minor problem with their gloom and doom inflation talk:  we are actually experiencing deflation. Prices, as measured by the consumer price index, are lower today than they were a year ago; as of July 31, consumer prices were down 2.1% over the last year. Producer prices, as measured by the PPI, were down 6.8%. We are experiencing deflation, and the price of gold should be going down, not up.

The argument for future inflation is compelling. The Federal Reserve has been flooding the system with money in an effort to fight deflation and to avoid financial collapse. Congress and the current administration are on a record-breaking spending spree. This path, if we continue down it, will lead to inflation. The question is when.

As reported in today’s The Wall Street Journal, the money supply in the U.S. is actually shrinking. M2, a measure of the money supply that includes timed deposits such as CDs, has shrunk 4 weeks in a row at a 12% annualized rate. That is a deflationary signal.  However, put aside these inconvenient data and pretend for a second that the runaway inflation is already here. Is gold really the best place to be? What is the true value of a bar of gold?

The problem with gold as an investment is that it has no real value. It does not grow, it does not pay a dividend, and it has no real practical use. If you buy a bar of gold and bury it in your backyard, 20 years from now when you dig it up, you still have the same bar of gold and only a hope that someone will be willing to pay more for it. If, instead of gold, you had buried a share of a company 20 years ago – let’s say Research in Motion, maker of the Blackberry – you would have buried a little-known maker of two-way pagers and dug up a global giant in telecommunications.

Companies are dynamic. They don’t just change in price, they change in value. While the initial onset of inflation may hurt companies, a prolonged inflationary environment helps. The best hedge against long-term inflation is actually equity ownership in companies with the power to pass price increases on to customers.  Those who are chasing gold at $1,000 per ounce are most likely making a big mistake.

Chuck Osborne, CFA
Managing Director