What Is Gold Trying To Tell Us?

Posted by urbandigs

Tue Jan 15th, 2008 10:47 AM

A: Who the hell cares about the price of GOLD on a real estate site? Well, sometimes if we take a step back, we can get a clearer picture of what is going on. As more financial firms release updates regarding the mess on their books, and stocks seem to be pricing in a recession, gold is soaring! But not to inflation adjusted highs! You see, gold is typically a safe haven investment that gets plenty of attention when economic times become uncertain. So, to be backwards analyzing, one cold interpret the rise in gold to a deteriorating and uncertain economy, which then could explain why wall street is struggling right now. Add in comparisons to the mid/late 70's stagflation and gold surging, and it paints a disturbing similarity to today's environment.

gold-rises-inflation-fed.jpgAccording to Zeal Gold Investing 101:

The primary reason to own physical gold is to protect a core portion of your portfolio from all kinds of nonlinear contingencies.

We humans generally become complacent as investors and assume that tomorrow will be just like today. History has proven that linear assumptions are one of the most dangerous and lethal errors that investors can make. Even in fairly normal life we are all aware of local nonlinearities including hurricanes, tornadoes, and earthquakes. Financial nonlinearities also abound, such as the implosion of the great NASDAQ bubble in early 2000. Gold is the perfect investment to protect a foundational portion of your portfolio from an inherently unpredictable future.

Owning physical gold in your own possession is like having fire insurance on your house. Gold protects against all kinds of nonlinearities, from the insidious to the geopolitical to the bizarre. Gold protects against insidious nonlinearities like the gradual erosion of paper currency values through inflation. Untold financial havoc has occurred in history because people made foolish linear assumptions that the value of paper currency is sustainable.
Now, Im not telling you to dump everything in your portfolio and load up on Gold stocks or ETF's. The point of today's post is to explain to you that rising gold is on some level the street telling us that they are uncomfortable with the economic environment, expects further rate cuts that will weaken the US dollar, and are seeking a safe haven investment for possible turbulent times. Gold could also rally in major bull markets, but to see what it is doing right now compared to stocks, its clear that we are not in a major bull market. So lets exclude that reasoning altogether. So when did gold last rally huge; IN THE MID 70s WHEN STAGFLATION WAS THE KEY WORD & THE US WAS IN THE WORST ECONOMIC DOWNTURN SINCE THE GREAT DEPRESSION! See this historical chart below showing you the rise of gold in this era of uncertainty and economic distress:

historical-gold.jpg

According to an old US News & World Report article, being sure to put yourself back into time & place when it was written in August 2006:
Ben Bernanke may be facing a nasty relic of the disco era. It's called stagflation. The U.S. economy seems to be experiencing a bout of stagflation. It's a rare, worst-of-both-worlds situation where economic growth and employment stagnate yet inflation rises. In 1974, for instance, the U.S. economy shrunk 0.5 percent and unemployment rose to 7.2 percent, even though prices skyrocketed 11 percent. Oil shocks, loose Federal Reserve monetary policy, and out-of-control government spending have all been blamed for the stagflation. The economic mess culminated in America's worst economic downturn since the Great Depression.
The uncertainty today continues to lie in the credit markets, the financial institutions, and the housing sector. As housing falls, financials lose billions in their toxic asset backed securities on their books, which cripples balance sheets and starts a chain reaction on wall street. You are seeing it right now. As I noted previously here on UrbanDigs.com, we are yet to see significant defaults of alt-a, prime, option arms, credit cards, auto loans, etc.. although we are getting the warning signs! Believe it or not, even those loans/debts were securitized on wall street and what we saw with subprime could very well spread to other areas of debt as well. Thats the uncertainty! Thats why we need a recession to fix these problems; I just don't see any other way.

If the fed acts aggressively by cutting rates, it will re-inflate the asset bubble, not allow the system to correct itself on its own, and will result in runaway inflation as gold will likely rise to $1,500 and oil to $125+. It will also hurt the US dollar as the world's currency. Remember, foreign governments own tons of US debt in the forms of treasuries; if the fed eases aggressively those foreigners may unwind those treasuries leaving us to pay off our deficit at much higher rates!

Right now I am seeing asset deflation (housing prices falling) and commodity inflation (food, energy, gold rising). Not a good scenario any way you slice it and one that puts our fed in a very tough spot! Although its a far line, if you connect the dots it is worthwhile to keep an eye on gold for any clues about how uncertain wall street is. As we all know, wall street sentiment and the positive or negative wealth effect that results, is a strong force to be reckoned with here in Manhattan real estate! Hence, its worth a discussion!

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