Gold: Inflation and Market Indicator
For years, I had a fight with The Wall Street Journal editorial
board over its front-page summary of market indexes, which
highlights a dozen daily indicators, including stocks, bonds,
oil, the dollar, etc. Yet it deliberately omitted the
single-most significant asset that each day measures the level
of geo-political and monetary stability around the world: Gold!
Dan Henninger, deputy managing editor of The Journal, wrote me,
"We do not believe gold is the best indicator of inflation."
Since the Keynesian revolution of the 1930s, gold has been
relegated to a "barbarous relic." The establishment prefers flat
money to the gold standard. It wants government rather than the
market to maintain authority over money. It doesn't want to
legitimatize a "non-performing" asset that might be warning of
trouble down the road. As they say in the commodity trading
pits, "Gold is just another commodity." Wrong! Gold is not just
another commodity. Today, let's look at gold as an inflation and
market indicator... and what we should be investing in right
now.
First, how many other commodities have served for centuries as
money? Not oil, soybeans, or pork bellies. Moreover, unlike
other commodities, gold is never used up in the production
process. Annual production increases at a steady 1-2% a year and
is added to the total stock of gold, creating a monetary Rock of
Gibraltar in a sea of instability. As a result, gold has always
preserved its purchasing power over the long run.
Gold always returns to its full purchasing power, although
sometimes it may take several decades to do so. Granted, the
price of gold became more volatile as the world moved off the
gold standard since the 1930s. But as Steve Forbes told me in a
recent interview, "Gold is volatile because monetary policy is
volatile. Gold is a constant, like the North Star." In my
economics classes at Columbia University, I demonstrate the
long-term value of gold by holding up a $20 Saint-Gaudens Double
Eagle gold coin. Prior to 1933, our grandparents carried this
coin in their pockets as money. Back then, they could buy a
tailor-made suit for one double eagle, or $20. Today, the Saint
Gaudens coin, which is worth between $600 and $1,000, depending
on its rarity and condition, can buy the same tailor-made suit.
Gold also has the amazing ability to accurately forecast the
direction of the general price level and interest rates.
Recently, I ran an econometric model with the assistance of John
List, a top economist now at the University of Chicago. We
tested three commodity indexes (Dow Jones Commodity Spot Index,
crude oil, and gold) to determine which one best anticipated
changes in the Consumer Price Index (CPI) since 1970. It turns
out that gold proved to be the best indicator of future
inflation, as measured by the CPI - even better than oil. The
lag period is about one year. Most of the media and the general
public think oil is the premier indicator of economic
performance. An energy crisis means a recession, right? Not
always! Germany and Japan, for example, import most of their
oil, but they avoided the 1979-82 recession. Today, energy
prices have doubled, but there's no sign of recession. One
reason is that the world economy has become more
energy-efficient, and thus less dependent on oil and gas as the
major source of energy. Douglas Bohi, director of the energy and
natural resource division of Resources for the Future in
Washington, D.C., claims that energy accounts for only 3-4% of
the total cost of producing goods and services in the U.S. Our
econometric model also suggested that higher gold prices spell
higher long-term interest rates. They tend to move together.
Will the price of gold stay above $500? Ultimately, gold is an
inflation hedge. When gold declines, it means less inflation
down the road. When gold goes up, it means more inflation ahead.
What is gold predicting now? Gold has been in a major bull
market since 2001, when the terrorist attacks took place in New
York and Washington.
What Does This Mean for the Future? Four things Regarding
Inflation and the Markets: 1. War is inflationary. Since 2001,
the Bush administration has dramatically increased government
spending to fight terrorism and the war in Iraq. The Fed has
been accommodating this increased spending with more money. 2.
Expect more inflation ahead, as measured by the CPI and other
price indexes. 3. Expect higher interest rates as inflation
heats. 4. Higher inflation is bullish for hard assets in 2006.
So, as far as the markets are concerned, I recommend buying gold
and silver coins, mining stocks, oil and gas and real estate.
Suggested fund: RS Global Natural Resources Fund (RSNRX), which
has a five-star rating from Morningstar.