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CONVERSATIONS
WITH DR. GOLD
by Michael A. Nystrom
BullNotBull.com
February 6, 2007
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 grandfatehr 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:
Prechter says:
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 |
1929
Dow
Allied Chemical
American Can
American Smelting
American Sugar
American Tobacco B
Atlantic Refining
Bethlehem Steel
Chrysler
General Electric Company
General Motors Corporation
General Railway Signal
Goodrich
International Harvester
International Nickel
Mack Truck
Nash Motors
North American
Paramount Publix
Postum Incorporated
Radio Corporation
Sears Roebuck & Company
Standard Oil (N.J.)
Texas Company
Texas Gulf Sulphur
Union Carbide
U.S. Steel
National Cash Register
Westinghouse Electric
Woolworth
Wright Aeronautical
|
2007
Dow
3M Company
Alcoa
Altria Group
American Express
American International Group
AT&T
Boeing
Caterpillar
Citigroup
Coca-Cola
DuPont
Exxon Mobil
General Electric
General Motors
Hewlett-Packard
Home Depot
Honeywell International Inc.
Intel
International Business Machines
Johnson & Johnson
J.P. Morgan Chase & Company
McDonald's
Merck
Microsoft
Pfizer
Procter & Gamble
United Technologies
Verizon
Wal-Mart Stores
Walt Disney
|
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.
As always, comments on
this story are welcome here.
© 2007
Michael A. Nystrom
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Michael A. Nystrom
Cambridge, MA
www.bullnotbull.com
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