Shayne McGuire: The Early Innings of a Gold Boom
My new friend Shayne McGuire is director of global research at Texas' $115 billion Teacher Retirement System, which means he oversees a vast portfolio of high-grade bonds, Blue Chip stocks, and cash. Not the kind of environment that's usually hospitable to atavistic assets like gold. Yet he recently published a book -- a very good book -- titled "Buy Gold Now", in which he explains his belief that the dollar, U.S. bonds and many stocks are headed south, while gold is going to the moon. Here he is on why this will happen and how best to play it:
DollarCollapse: You're a rarity: A mainstream money manager recommending gold, an asset that usually does well when bonds, your pension fund's mainstay, do badly. Why?
Shayne McGuire: On the surface, gold makes sense in today's environment. Gold does well when both bonds and stocks are doing badly, when there is insufficient compensation for the risks inherent in owning either asset class. In the 1970s, gold did very well in part because the stock and bond arenas were mine fields. Investors found that pulling money out of financial assets made sense. Simple as it sounds, the concern was with staying away from things that were going down, and this collective concern pushed gold up as more investors bought it, as is occurring today.
Gold fared poorly during the 1980s and 90s in part because there were high yields in the bond market, which rewarded investors moving into that arena during periods of stock market turbulence. But today, a 10-year Treasury bond pays investors less than a 4% yield, a level below inflation, which is beginning to rise again. Who wants a negative return? On the other hand, the stock market's volatility has doubled in the last year and returns are negative. Now that a recession is on the horizon, gold makes more sense to more people each day and the market is tiny: a small amount of interest is making gold and other precious metals surge in value.
At a deeper level, there are a great many other reasons why gold continues to rise and why I believe we are in the early innings of a gold boom. The dollar, about which we could talk for hours, continues to plunge and there is a multiplicity of reasons why the greenback should stay weak, most notably the monstrous size of our national debt (government and private). The derivatives market, which was negligible 20 years ago, just passed the half quadrillion mark in size, and we know -- based on the questionable record of banks' risk management systems -- that this is something to be concerned about. (LTCM, a single hedge fund which had two Nobel prize-winning PhDs helping call the investment shots, nearly brought the global financial system to its knees a decade ago. But back then the hedge fund industry was half the size of today's, and the derivatives market is more than six times the size then, and several times larger than world GDP.)
Furthermore, there are strains on supply, as the mining industry struggles to increase production, and there are signs that central banks may begin to slow down their sales of gold after decades of dumping. Clearly, to this last point, there has not been a free market in gold. Perhaps we will soon discover gold's real value, and I think it's not cheap. Clearly, central banks have impeded a truly free market in gold. In the years ahead we will discover gold's true value, and I think it's several thousand dollars higher than what we see today.
I think it makes sense to believe that more and more investors will come to appreciate the value of something tangible that you can hold in your hand, a store of wealth that had been unchallenged for thousands of years until the last 30 or so.
DC: How have your colleagues responded to your coming out for gold?
SM: Judging by their interest in my book, I am surprised at how well many have responded. This was unexpected. Any MBA holder, who has been taught to value almost any asset, hits a stone wall when faced with gold: it pays no dividend or coupon, and without deriving a cash flow, the basis of most assets defined as being financial, there is no conventional way to determine its dollar value. Ultimately, it's just a rock, right? I wrote my book with this question in mind: how can I convince friends with MBAs, who have never thought seriously about owning gold (and often mock its owners, like me!), that a polished rock could climb in value into the thousands of dollars? I was encouraged to learn that several of my colleagues, who eat, sleep and dream about finance, have decided to buy gold.
DC: Are the problems that have made gold such a good thing to own fixable, or will we have to go through a currency crisis followed by an economic collapse?
SM: I have no crystal ball, so I can only talk about what makes sense to me. The credit explosion (the way up the hill) could only have occurred if there had been credibility in the U.S. dollar, which is ultimately backed by the strength of the mammoth U.S. economy. A smaller economy never would have been able to accumulate debt equivalent to more than 300% of its GDP, as we have today; its currency would have collapsed, as has happened dozens of times in emerging markets in just the last twenty years.
For decades, up until very recently, concerns about the dollar were ultimately silenced by the verdict of the market: collectively, the investment world felt that the dollar could not fall -- despite ever-climbing deficits -- because it is the world's currency: all of the powers that be -- central and private banks and all governments -- would ensure its safety. Japan, Europe, and the newly strengthened emerging markets have accumulated dollars to prevent its collapse and there is a collective sense that they will continue to do so. But now that the value of U.S. assets is in clear decline and the U.S. economy is decelerating more rapidly than any economy I can think of, the credit bubble has been punctured severely.
In 1933, President Roosevelt told the nation that national assets had fallen below the level of national debts in value after the 1920s credit bubble exploded. Today our assets (at least on paper) are worth substantially more than what we owe, but I know that quite a few people noticed in 2006 when a St. Louis Fed paper asked the stunning question "Is the United States Bankrupt?" Many of the Great Depression's problems were exacerbated by the dollar's strength: FDR was not able to weaken it even as he tried! Today, we have the inverse situation: all of the world's major central banks are accumulating dollar reserves in a frantic effort to keep the dollar from collapsing.
I have lived through two currency collapses (in Mexico) and I hope we will be able to prevent one. But the outlook is not good. Currency collapses are always caused by excessive debt, and no nation has ever accumulated more than we have. Our debt is larger than global GDP, and that is without including the tens of billions in unfunded federal liabilities.
DC: How will we know when the dollar has bottomed and gold peaked?
SM: That is a very tough question because we have never faced a scenario like today's. Former Fed Chairman Paul Volker smothered the gold rally in 1980 with double-digit interest rates that compensated investors for holding bonds during inflationary times. Today, the Fed stands ready to print money and keep interest rates in the low single digits and is ignoring inflation, at least for now, as they deal with the credit crisis.
I think gold will have peaked when the rewards offered for holding traditional assets are sufficient to compensate us for surging risks. If we consider that gold peaked when an ounce of the precious metal was near the value of the Dow Industrials index, then perhaps gold needs to rise at least ten-fold or the Dow needs to fall quite a bit.
Gold is the most underowned major asset class; it is almost completely absent from the vast majority of major funds in the world that exceed $100 million in value, of which there are hundreds if not thousands. Today, these funds can invest in gold with the click of a mouse and a great many of them are beginning to do so. The global asset market is worth around $140 trillion. If one percent of that moved into the miniscule $5 trillion gold market -- less than 5% of which actually trades each year -- gold's value would skyrocket. Lacking a P/E or some other conventional investment metric with which to measure its value, I think gold will rise as high as the market will allow it, and I think we will have a speculative craze, just as we had with the Nasdaq. I think $10,000 an ounce is possible. But who can say what the limit is for an asset that has no P/E? Obviously, there will be a time to sell, but I think that is years in the future.
DC: In the meantime, what kinds of gold should people be buying?
SM: I think, as has happened many times before in human history, people will once again become increasingly concerned about the value of paper assets -- receipts representing some questionable value -- and will look toward physical gold and the rare coins market, in particular. I think the rare coin market could outperform the bullion market in the years to come and I tried to make an argument for this in my book. I prefer physical gold over ETFs and my three favorite coins are Buffalo one-ounce gold coins, pre-1933 Liberty gold coins, and -- if you'll allow me to throw in silver -- Morgan silver dollars.
DC: Okay, speaking of silver, how does it fit into your framework?
SM: I personally like silver a lot, but it is a more speculative investment. If you want to bet on a dollar crash, this is a good way to do it. But caveat emptor. During the summer of 2006, silver fell around ten percent in a single day, a very painful thing to watch. Gold is far more stable: on a very bad day, it could fall three percent.
There are more industrial uses for silver, which makes the metal vulnerable in a recession. However, silver is used up in industrial production, meaning that each day there is less silver around, while virtually all the gold that has been mined and refined in world history is with us today.
Although China still has stockpiles of silver that it uses to control prices to some degree, the U.S. Treasury finally has sold off the remainder of the enormous stockpile it has accumulated in the 1930s. Today it holds zero. Hence, central banks cannot interfere in the silver market the way they do in the gold market. This is why I think silver has been so strong of late: hedge funds and other investors have realized that, say, a sudden announcement that the IMF is dumping silver could never happen, as just occurred with gold.
DC: Will we ever use gold as money again?
SM: Only if the dollar collapses and takes the Euro down with it.