Conversations with Dr. Gold
They say that copper is the only metal with a PhD in economics, because it has such an excellent record in forecasting future business activity. Much has been made recently about Dr. Copper and his preliminary diagnosis of an impending recession, but what many don't realize is that the king of metals -- gold -- also has a PhD. However, if Copper's doctorate is in economics, Gold's expertise is more along the lines of philosophy, and his degree has been awarded by the world's oldest, most venerable of schools: the school of hard knocks.
Dr. Gold still teaches at the school of hard knocks -- the same old classes that have been in session since the dawn of civilization. Dr. Gold lectures on the subjects of beauty, value, responsibility, and the rule of law. One of his most popular courses -- offered regularly -- is on the subject of inflation. Dr. Gold is a kind and patient teacher, repeating his lessons again and again for beginning students, never tiring but unmercifully strict. He will never fail to pull cocky young upstarts who think they they know better back into line -- sometimes quite violently.
I had a few conversations with Dr. Gold this weekend at the Boston Public Library. Many people don't know it, but most big city libraries subscribe to a number of excellent market letters. Boston Public has over 20, and every couple of weeks I like to go down and catch up with what some of the great market thinkers are thinking. Nearly all of these thinkers are long-time students, in one way or another, of Dr. Gold.
Richard Russell is an old timer. His January 24 Dow Theory Letter is a great one. He details how much investing has changed since he began, just after the War when the memory of Depression was still fresh in people's minds. Back then, nobody wanted a stock unless it payed a dividend - almost the complete opposite of today. I'll have more to say about that in future articles (sign up here to be notified) But of particular interest was Russell quoting another old timer, Ian McAvity on one of Dr. Gold's many lessons:
Think of the Dow as a tradable ETF. In August 1929, your grandfather sold one unit of the Dow and bought 18 and 1/2 ounces of gold. Three years later, when the Dow/gold ratio bottomed at 2:1, he sold those 18 ounces of gold and bought back 9 units of the Dow with the proceeds.
Those nine units reached another peak in 1966, when the ratio hit 28:1. Now your father exchanged those 9 Dow units for 252 ounces of gold. In January 1980, the ratio got to an almost unprecedented 1:1, so he converted those 252 ounces of gold into 252 units of the Dow.
Come 1999 with the ratio at an unprecedented 43.85:1 level, the prudent family converted those 252 units of the Dow into 11,050 ounces of gold! No trades were based on the price of gold or the level of the Dow...It's just a simple question of how many ounces of gold is the Dow trading for in the market. This little fable started with 1 unit of the Dow at a peak in 1929. Two tops, two bottoms and five trades later, its 11,050 ounces of gold in 70 years.
Which would you rather have today? 11,000 Dow points, or 11,000 ounces of gold?
Of course it is just a story, but as Russell points out, it shows the importance of relative valuation, patience, and -- for lack of a better word -- the fashions of investing. Fashions come and go among investors, so don't get too attached to a trend. Once upon a time (back in Russell's early days) it was bonds and dividend stocks that everyone wanted. Later it was growth stocks, then real estate. But sooner or later, old styles come back into fashion. They always do.
Another lesson from Dr. Gold comes by way of December's Elliott Wave Theorist on the Silent Crash. This one was not available at Boston Public, but you can download the entire report and watch the video edition for free until Thursday. In this report, Robert Prechter points out that the nominal Dow peaked at 381 in September 1929, and today it is hovering somewhere around 11,500, a 30X increase over 77 years. Not bad, right? But amazingly, measured in gold, the recent Dow high's are actually right about where they were at their 1929 peak! Unbelievable but see for yourself:
It took 18.5 ounces of gold to buy the Dow on September 3, 1929. On May 10, 2006, it took 16.5 ounces of gold, so it is actually cheaper. Now, you might think this is just an academic comment, but it's crucial to understand that there has been very little net manufacturing growth in the United States over that period. It's hard to believe, but it's being masked by tremendous credit inflation supported by the Federal Reserve and carried out by the banking system.
Or as Dr. Gold would put it: One dollar won't buy what it did in 1929, but one ounce of gold (about $20 at the time) sure will (about $650 today)! This is an incredibly important chart, and there are others that go along with it showing the hidden destructiveness of unchecked credit creation and the likely outcome.
Along these same lines, Dan Amoss, in the February issue of Strategic Investment, has some interesting teachings from Dr. Gold via a story about the current "Goldilocks" economy. As the Goldilocks scenario goes, Chairman Ben supposedly has the US economy running "just right," just like Goldilocks, who broke into the three bears' house and ate the bowl of porridge that was "just right." (huh?) But Amoss notes that the Goldilocks story has a tragic ending. When the bears come home and find her sleeping in their house, they kill young Goldilocks, rip her to shreds and eat her (or just scare her and chase her away, depending on who's telling the story). After all, she has no right trespassing in their house and eating their food, even if she is just a naive little girl. That's how things go in the school of hard knocks. Apparently Goldilocks wasn't one of Dr. Gold's better students.
Amoss goes on to say:
Taking this metaphor to a more plausible conclusion -- the Federal Reserve has broken into the house, sat in the chairs, ate the porridge, and slept in the beds of every individual saver of US dollars. This institution constantly injects new floods of cash into the banking system by "monetizing" government liabilities (mostly Treasury bills). With each new dollar created, the value of each existing dollar held by savers declines in value.
This is part of the story that is being told by the chart above. The Fed is apparently another one of those upstart young students that Dr. Gold is going to have a word with one of these days...
But there is more to the story: Only two of the Dow's original 1929 components remain in the index today. The rest have either shriveled up and been kicked out of the Dow, been acquired by foreign or domestic companies, or have simply disappeared. Poof. Bankrupt. Gone. Many of today's industrials are not even industrials at all. Can you honestly call American Express, AIG, Citigroup, JP Mogan, Disney, McDonald's, Coke, Home Depot and Wal-Mart "industrial" stocks?
|1929 Dow Components vs. 2007 Dow Components|
American Tobacco B
General Electric Company
General Motors Corporation
General Railway Signal
Sears Roebuck & Company
Standard Oil (N.J.)
Texas Gulf Sulphur
National Cash Register
American International Group
Honeywell International Inc.
International Business Machines
Johnson & Johnson
J.P. Morgan Chase & Company
Procter & Gamble
The only two that remain from '29 are GE and GM, and it is questionable how much longer GM will last. The changes to the index reflect the changing nature of the US economy. Chrysler for example, a member of the '29 Dow, is now owned by a German company and just today announced that it will lay off 10,000 American workers and close at least two more US plants. As American manufacturing has crumbled, the US has moved increasingly towards a service economy, with special emphasis on financial services. Four of the Dow's current 30 stocks are financial services firms. In the long run, the question still remains -- at least in my mind -- if this kind of a service-based economy can create real wealth, or is it all just shuffling paper? Warren Buffett said it another way, "If you get in early on a chain-letter, you may make money, but no wealth is created."
Speaking of Buffett, let's pop on over and read a few pages of the Intelligent Investor, by Benjamin Graham (most certainly available at your local library). Remember that Graham was Warren Buffett's mentor, and Buffett calls this the greatest investment book ever written. A few of the most important insights found in the book include (from the introduction):
- The market is a pendulum that forever swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes them too cheap). The intelligent investor is a realist who sells to optimists and buys from pessimists.
- The future value of every investment is a function of its present price. The higher the price you pay, the lower your return will be.
- The secret to your financial success is inside yourself. If you become a critical thinker who takes no Wall Street "fact" on faith, and you invest with patient confidence, you can take steady advantage of even the worst bear markets. By developing your discipline and your courage, you can refuse to let other people's mood swings govern your financial destiny. In the end, how your investments behave is much less important than how you behave.
The last point very critical. Dr. Gold couldn't have said it better himself. Don't take anything on blind faith. The best (some say the only) education comes the hard way, from the school of hard knocks. The next best way is to study history, putting special emphasis on the teachings of Dr. Gold.