Tuesday, March 17, 2009

Gold is very expensive

When priced against real assets.  

I know the gold bugs – and there are many of them – compare the amount of gold in existence (160 thousand tonnes being the total ever mined) with the amount of nominal money (including bank deposits etc) in existence.  Gold adds up to $4.7 trillion at $950 per oz – nominal money maybe 60 trillion.

They thus assume that gold must go up.  

I am not going to approach that argument – because much of the cash really is trash (or should be trash after we have got through throwing it out of helicopters).  

What I want to note is the widespread headlines that maybe 50 trillion dollars of nominal wealth has been “wiped out” in this crisis and that something between 150 and 200 trillion remains.  The official figure for the total US household wealth about 51 trillion.  I don't have a number for the whole world – but just under 200 trillion is a reasonable guess in total – the US being just under a quarter of global activity – and having slightly more expensive equity markets than most the rest of the world.

Now does anyone really believe that the store of gold in vaults is worth over 2% of all tangible assets everywhere?  Seriously?    

Gold may be cheap against nominal assets in which case you would be better off holding gold than US Treasuries.  But I can't believe you would be better off holding gold than diversified timberlands or other real assets.  Unless of course the world degenerates into total war and all your timberlands burn down.

I know the gold bugs will hate this idea – because it harks back to the argument against gold – which is that it has no intrinsic value.  We spend a lot of money (and kill a lot of birds with cyanide) to dig gold out of the ground only so we can bury it again with expensive guards on the vault.  

And I am not bullish on nominal assets.  Long Treasuries at very low yields look like a very bad bet to me.  But maybe now is the time for lowly levered real assets.  

Even better is highly levered real assets – but where the debt is very long dated and cannot be called and has no covenants attached.  You get to be long the real assets (good) and short the nominal assets (also good) without the financial crisis risk of being called on the debt (very bad). Candidates for that (rare) category highly desired.


Post script - looking at the comments in the email most people are giving me assets where the asset value has not been marked down appropriately (lots of real estate for instance) or where there are problems rolling the debt (most assets).

I am being pretty picky.  I want an asset appropriately priced for NOW as if it were non-leveraged - but with huge leverage and with NO DEBT ROLLS at all.  If it requires a debt roll I am not interested.

Leverage is death if you need to roll it.  But long dated debt that you do not need to roll for 20 years - that is wonderful.  That is effectively short treasuries.  


Advant Guard said...

Are the real yields on Treasuries low? Last year you could have bought 10-year treasuries yielding 4%, but headline CPI was 5%, resulting in a -1% real yield. But now the 10-year note is yield is 3%, but the headline year-over-year CPI is 0.0%, resulting in a 3% real yield.

Now if you believe that this current recession is just a normal everyday inventory-driven recession and inflation will quickly return to 3%, that 3% yield looks stupid.

But if the recession causes a shift in attitudes towards debt and leverage, resulting in demand anchoring on a lower baseline and inflation being minimal, 3% real return looks pretty good.

Anonymous said...

Interesting data summary.

“Now does anyone really believe that the store of gold in vaults is worth over 2% of all tangible assets everywhere?”

Moreover, why should the velocity of gold be the same as the velocity of nominal money?

Anonymous said...

There are a number of real assets out there, many with explicit inflation linked returns (water pipes, toll-roads etc). Most of these are geared around 60%, some of these even have long dated (20 years average) debt with a good fixed component. But (borrowing from a previous post of yours) if you were that worried about inflation, dont you still make more money shorting treasuries?

Anonymous said...

In the mid-1990's I once sat on a plane next to a mining engineer who had just spent the summer working at a gold mine in the US west. She told me about the cyanide problem but went one further: she explained that it was illegal to permit a bird to die from the cyanide, so the company stationed men around the periphery of the heap with shotguns to shoot the birds dead as they approached the heap. Kept the deaths nice and legal.

John Hempton said...

The regulated assets are not much good because of regulated returns.

Ditto the toll roads - they fail because they cannot cope with the intermediate funding points.

Anonymous said...

I suppose this is the converse of "preaching to the choir" but any confirmed goldbug would think 2% of assets would be a substantial underweight.

To your enquiry, I'd guess what is wanted are low levered and term funded property holding companies, to the extent the debt is enough to crush the equities valuation without actually crushing the equity. Successful identification of same often amounts to exceptional skill at falling knife-catching.

I saw this afternoon (US) where Bill Ackman finds himself in more control of GGP than he might like. Am not sure if his thoughts were along these lines or no. The debt, at least, is not long in that instance.

Anonymous said...

Ok, per your postscript, you'll be needing operational leverage rather than financial. 20+ year capital structures are hard to come by, but firms with stable nominal operating margins - implying a locked effective cost of capital - hmm. Will require more data than available in a Chicago pub.

Neil said...

Hong Kong real estate investment trusts are worth a look. They are conservatively geared, many have deep pocketed major shareholders, HK prices did not hit all time highs this time around, they have great yields and an interesting forex dynamic (HKD is pegged to USD but on a PPP basis will substantially appreciate with a long time horizon).

Buffett made the same point about gold versus businesses on CNBC a week or two ago (he must have borrowed the idea from you :) ).

Matthew said...

On gold I'd add two things. There aren't 160,000t in vaults, and whilst much of the non-gold-vault is recoverable with time and money, your comparision is probably overflattering to gold as a % of all tangible assets.

Further, I've not done the sums, but given gold mine output has risen slower than global real GDP, and the price slower than inflation, since the late 70s/early 80s (even excluding the 1980 spike), whilst asset prices presumably are still that much higher (???) then that share of tangible assets must be still be lower than at the last such time of economic and financial stress (ie the long-run trend is down).

Anonymous said...

Doesn't fill the bill in all respects, but that sounds vaguely like Berkshire Hathaway. I suppose a fund manager buying that stock would be cheating a bit.

Anonymous said...

Intersting post. Three questions:
(1) How big is global wealth? If the US is a now a quarter of output US Wealth is probably more than a quarter of global wealth (Isn't wealth some form of saved output?). I have seen a UN estimate tagging global wealth at ca 125tn.
(2) Based on risk return caracteristics is a 2% allocation to Gold efficient? What are the implied returns from such an allocation?
(3) Seeing latest flow of fund data US net worth is ca 60tn or 20'000 per person, 2% of that is 400US$ at 950 per ounce or ca 12g of gold per head. Does not sound like much? A wedding ring is already a few grams.

Anonymous said...

Two observations:

-the relevant figure is not gold as a percent of net worth but gold as a percent of assets. If total non-financial U.S. debt is $35tr and net worth is $60tr then assets are $95tr. This calculation simply recognizes that the leverage in our economy is at record levels.

-I share your view: oh, please deliver onto me all manner of unlevered real assets with no refinance risk. What? Having trouble coming up with any? Okay, I'll settle for well managed currencies with Central Banks not given to wild experiments and polities happy with taking their medicine when necessary. What? Again no suggestions? Well, lets see...that leaves what as an alternative?

John Hempton said...

David Pearson is right. Its very hard to find the real asset with no refinance risk.

And it is hard to find the good currency.

Gold is almost everywhere an inferior investment to a business of high quality purchased at a low price.

But it is an easier investment than the above too.


Anonymous said...

Know you hate it but...
Life assurance? Levered but the liabilty profile of a life co is the closest thing I can think of to what you are talking about re refinance risk

Anonymous said...

if you have enough patient money, can you find a real asset, or an asset which generates cash flows on a real asset, and offer to refinance their credit with patient capital? you could structure it so that you get some debt and some equity.

Anonymous said...

"If total non-financial U.S. debt is $35tr and net worth is $60tr then assets are $95tr."

Net worth accounts for all assets on a net basis. No non-financial debt is held by entities whose corresponding liabilities or equity are not captured in the measure of household wealth. Adding $ 35 trillion is double counting.

Anonymous said...

I agree since when is debt wealth? On a net basis it should cancel out no? I own a bond but the comp owe me money. Net no wealth?

Anonymous said...

brazil is one of the few countries with positive real interest rates and relatively low personal/corporate leverage, therefore i like the currency a lot more than my native GBP. a lot of petrobras' debt is long-dated and in USD.....

px_ said...

4 reasons why I don’t agree...

1. value of currency due to it’s limitless supply is deflationary - as the dollar loses purchasing power, upward inflationary pressure on costs occurs – the end result is you need more $ to purchase the same amount of gold

2. in addition to the above, gold has historically provided a safe (read stable) form of exchange and therefore as countries take on more debt, gold reserves offers some peace of mind – two recent examples would be Russia’s recent purchase of gold to add to its gold/foreign exchange reserves (following on their stated policy to increase gold reserves to 10% of holdings), and the increasing investment surge in Gold ETFs

3. you assume that gold has no value/use other than investment – in 2008 new mine global output was approx 2450 tonnes – the industrial demand was 430 tonnes and jewelry demand was 2137 tonnes – though jewelry can double as a form of investment, it is by no means considered the most direct route for such and therefore should not be seen as such – that means there was a greater demand for gold for non-investment purposes than there was output – this not including the additional demand of approx 1100 tonnes for investment purposes

4. owning real assets (such as Timberlands) has some value, though no single asset has the global recognition that gold has, and unless we are to deteriorate to a barter economy, the fluctuating prices for other assets would be most likely be more volatile

Anonymous said...

seems like the point is, gold is very expensive relative to alternative investments. so it loses out on a relative basis, even though it looks very attractive according to various obvious measures and theories that exist in a vacuum. capital will flow inexorably to the best value. gold is at a 9 year high. stocks at a 13 year low. that's the most compelling fact for me. gold is the worst kept secret in the investment world, and is wildly over-discovered. Relative prices matter when it comes to investment.

Anonymous said...

I just surprise about your analyzing, what The Fed supposed to do now is to change the slogan of 'In God We Trust' with 'In Gold We Trust' .. sorry, just kidding

Anonymous said...

Did you get a cease and desist?

Unknown said...

Insurance company float has the characteristics of long-term, non-callable debt if it's obtained by a growing or stable company. If it's raised at a combined ratio of less than 100%, the interest rate is effectively negative. And if that float is invested wisely, you have what you're looking for. Fairfax Financial (FFH) is the best company I've found along these lines. Market cap is $4.4 billion with $11.5 billion in cash, giving an enterprise value of -$5.3 billion. Run by the best investor this side of Buffett. I'd really like to hear what you think.

Unknown said...

"Even better is highly levered real assets – but where the debt is very long dated and cannot be called and has no covenants attached."

Argentine GDP Warrants. You get paid a coupon = real GDP performance over a hurdle every year for the next 25yrs or so.

Highly Levered: I think we can all agree that Argentina fits this category.
The debt is long dated - the bulk of the debt matures in 20ish years, but servicing costs rise in the next 1-2...an issue no doubt.

The bulk of GDP is linked to ag. commodities - so another link to real asset performance.

problem is the credit and fx exposure to the coupons. But if real assets do well in the next year these issues diminish. if cashflow problems persist for the sov. you kiss your warrant prem good bye.

a real asset with loads of leverage...and high probability of default. but your exposure can't be called, just defaulted on.

Anonymous said...

The author is very confused when he says:

“Now does anyone really believe that the store of gold in vaults is worth over 2% of all tangible assets everywhere?”

Does anyone believe that all the paper that money is printed on today is worth even one thousandth of "2% of all tangible assets everwyhere?

Most money isn't even printed, it's just bits on bank computer disks. None of that is relevant though.

The value of money is the confidence that someone will give you something valuable for it. If that confidence is shattered, it's not worth a thing. And it's nearly impossible to restore confidence once it's systemically destroyed.

Around the world, the value and confidence in banking systems and their fiat currencies is being undermined at at a faster and faster pace, yet more and more problems keep popping up. Central banks can only print paper and hope.

Bernanke or Obama can create paper money with words, but they can't create more gold by any means. It's that simple. Gold cannot be undermined the same way.

Gold has limited intrinsic value, apart from the cost of extraction. It's value is as a form of money.

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