In “The Hidden Dangers in Safe Havens,” New York Times August 19, by Paul Sullivan, the case is made that buying Treasuries and gold could disappoint investors seeking to avoid risk in stocks. I have been long precious metals (and mining) since autumn 2008; I don’t think I am a genuine gold bug or care if you call me one, and I hope that whoever is buying Treasuries continues to do so. Let me explain.
Despite the ostensibly enigmatic demand for Treasuries, which has pushed the closely watched 10-year Treasury's yield down, below 2% briefly (and its price up; there’s an inverse relationship), I tend to agree with Mr. Sullivan and the individuals he interviewed about the perils of buying Treasuries, if anything for the risk of inflation, if nothing else, for settling for such low yields (even when holding to maturity, as some are claiming they’ll do). Real inflation, like what is published at Shadow Stats and what you and I pay at the grocery store or the pump (two things the Fed conveniently does not consider to be a part of “core inflation”), in fact makes yields on most Treasuries effectively negative!
I suppose if one had a some figurative money to invest but was plain scared of volatile markets, that one could park it in something short-term (i.e. Treasuries, money market, or CD) just so that the principal could be earned back in full and maybe also a little interest. Obviously in street price terms they’ve lost at least a little purchasing power. Yes, they’re guaranteed their money back by virtue of the “printing press,” in the same way that some have argued the U.S. didn’t deserve the S&P downgrade from AAA status. However, it costs money to run that press and the more money there is floating around, the chances are the pricier goods and services will be.
Meanwhile, there may be some upside price action in Treasuries, but they are already trading at/above par. Let’s agree that price upside is limited and should something stinky hit the fan, then there could even be downside – unless one either holds to maturity (but you know that your purchasing power is eroding) or unless those printing presses stay on (electronic account crediting or mechanical production, it doesn’t matter). See the NYT article for a good discussion of potential downside rates. To make matters worse, this hypothetical person with some money to invest must reinvest soon, too. Risk everywhere. What’s an investor to do? Buy gold? But shouldn’t people be selling it to those guys on TV?
Speaking of gold, I find the argument dubious that it is overvalued, whether based on price alone, or the fact that it has no yield, or that it is not exactly consumed in large quantities. These arguments were made in the NYT piece, are made often in the mainstream media, and are in no shortage amongst investors and traders alike. Journalists (in the U.S.) are either not allowed to publish anything about the eroding value of the dollar and its link to monetary policy, or have unfortunately fallen for the mocking of gold bugs and the claim that gold is merely a “tradition” (i.e. the holding of it as "just another asset by central banks" as Mr. Bernanke recently put it; Google the following terms and note the nonexistence of mainstream coverage: "gold just another asset a tradition bernanke"). And the same goes for growth investors likely disinterested in gold because it doesn’t have a version associated with it (no iGold 5 hitting the market in 2 weeks 8 hours and 52 minutes … sorry Apple) and value investors shunning it because Buffett says so and since there’s no practical use or yield. Ironically, value investors should have been buying metals big time in the late-2008 to 2009 rout.
Hopefully the shrewd reader of this article has already discerned something about yield. Treasury yields are illusory unless you have a way of earning a lot of money otherwise, outpacing real inflation, to offset the purchasing power you are losing in your Treasury investments. Ironically, with the upside of Treasuries limited theoretically by a 0% yield, gold in fact has at least an equal yield to some Treasuries. Yes, there are costs associated with storing gold, or one pays an expense fee with a gold fund, but bond funds have expense fees, too.
Some key differences between gold and Treasuries are that the former is in limited supply, while the latter technically has an endless supply; gold (and silver) has a couple thousand years serving as a store of value, while Treasuries have a much more short-lived history and have fixed maturities. The intrinsic value of gold holds its own, as gold is likely recognized and accepted around the world without question, except for possible instances of counterfeit or fake gold. Treasuries, however, are not backed by anything but a promise, and there is no telling how many more will be issued. I much prefer a guaranteed store of value over a promise, especially considering the growth rates discussed below. That is not to say that the popular metals ETFs aren’t without their issues, but more on that later.
Consider that since 1971, when President Nixon closed the window on exchanges of dollars into gold, the price of gold has increased over 50-fold per ounce ($35 -> $1,850), while a barrel of oil, which was apparently around $4 back in 1971, fetches about $83 today (WTI; Brent is $110) after its recent sell-off, or over a 20-fold increase. The S&P 500 index has risen by 11 to 12-times ($100 -> $1,125).
A similar rise can be seen in the growth of the money supply as reported by the Fed, from a base of around $800 billion in 1971 to now more than $9 trillion (using M2; M3, the broadest measure of money supply was no longer published after 2006). The growth is closer to 18-fold using an estimate of M3 at $15 trillion per Shadow Stats. By comparison, the U.S. population increased by about half between 1970 and 2010, while world population doubled. For a look at some measures of credit growth, see “Credit Growth Driver Economic Growth, Until it Doesn’t,” at the Daily Reckoning.
I would like to note that I’m long precious metals via the Vanguard Precious Metals and Mining Fund (VGPMX). I began with a 15% allocation within my retirement fund and have since increased it to 20%. VGPMX charges a 0.27% expense fee. Its trailing dividend yield is 4.3% -- gold may not yield anything itself but miners that are profitable can pay dividends.
Curiously, VGPMX is down about 10% year-to-date compared to gold’s (GLD) 30% return and silver's (SLV) +38%; VGPMX has more than doubled from its trough, similar to GLD, but both fall short of SLV’s four-bagger. There are plenty of articles on Seeking Alpha discussing undervalued miners, which is what is holding back VGPMX.
I am content with VGPMX since I’m restricted in my retirement fund investment options. Dividends from VGPMX, should they continue at over $1/share, are appreciated in the meantime and going forward. We shall see if the gap between miners and actual metals’ returns is narrowed. My timing with SLV has also been fortuitous, though even more rewarding, since I bought at $12 versus a recent $41. I sold half of my position at $24.50 – I’m not a fan of the CME/COMEX’s decisions to arbitrarily (and effective-immediately) raise margin requirements and thus I sold, partially due to the doubling of my position, the CME’s moves, and concern about future intervention.
Anyway, similar to VGPMX, I’m also content here to let SLV run. It’s worth mentioning that I would have been more willing to add to my SLV position on some of the heavy sell-offs if it weren’t for the risk of intervention and reports I have seen doubting that it actually holds the physical silver it claims to; I see a similar situation with GLD. In the event of a repeat of 2008 and failing financial institutions, I’d rather not have too much exposure to a fund that may be subject to the credit risk of its sponsor.
Lastly, my reference at the outset of hoping that buyers of Treasuries continue to do so (keeping the 10-year at the 2% level), is a matter of strategic self-interest. Banks have not gone under and some have profited quite handsomely (at least bankers themselves have been paid) thanks to privileged borrowing capacity with the Fed. Discussion of privilege is beyond the scope of this article, but let it be said that as long as rates remain this low, it is wise for an individual to consider such things as refinancing mortgages or buying real property/assets. Companies are once again buying back their stock and some are taking advantage of low borrowing rates. I am not necessarily a fan of borrowing for buybacks, but clearly when long-dated debt financing can be obtained at very favorable rates it may be a wise use of capital. I’d much prefer companies be hiring workers as evidence of a recovering economy, but how much can we blame companies for being cautious on hiring and capex, while opportunistically repurchasing stock….
In the current environment, I am comfortable keeping my gold/silver-related holdings (add to metals/mining fund; maintain SLV), avoiding Treasuries, maintaining exposure to value (equities) and higher-yielding corporate bond funds, and carefully selecting individual stocks.
As a bonus for those who have made it this far, I’d like to mention three books I highly recommend, probably not on most readers’ shelves, that offer great perspective on Treasuries, sovereign debt, and capital markets: The 7 Deadly Innocent Frauds of Economic Policy, by Warren Mosler, whose arguments and ideas for revitalization make excellent sense – nevertheless it’s clearly been profitable to doubt/fear the printing press by investing in precious metals; Trade Myths: Globalization has left trade balances behind, by Enzio von Pfeil, whose arguments are just as straightforward as Mr. Mosler’s but deal with highly controversial trade imbalances and foreign holders of Treasuries; and The Volatility Machine: Emerging Economies and the Threat of Financial Collapse, by Michael Pettis, who could probably publish a revised edition easily by substituting the U.S. for an emerging economy. His discussions of pro- and counter-cyclicality are invaluable. I would liken Mr. Pettis’ insight on the importance of balance sheets to Martin Whitman’s approach as a value investor.
Disclosure: I am long SLV.
