January 20, 2010

Money Magazine Still Hates Gold, So, Buy It!

Over the last decade, it would have been possible for investors to make lots of money doing exactly the opposite of what Money Magazine has been telling their readers to do and one of the best examples of this can be found in their very consistent advice about gold.

Put simply, the yellow metal has no place in a Money Magazine reader's investment portfolio, that is, if they want to RETIRE RICH like the happy couple in the magazine cover to the right.

Don't you just love this type of imagery? They're so happy.

These trends look like they'll be carrying well into the new decade since, by the time it's over, we will likely have seen one of the most exciting final stages to a long-term bull market ever and Money Magazine will no doubt be advising their two million readers to stay away from precious metals all the way up until the end, at which time, their advice will finally be good advice.

But, that process will take years, and there's no telling how high the gold price may go between now and then.

What brings me to this discussion of Money Magazine and gold is that, recently, I've been on the receiving end of a steady flow of correspondence from the nation's most popular personal finance magazine regarding the upcoming expiration of my latest one-year subscription and the pressing need for me to send another $15 or $20 their way to keep it coming.

Well, they won't be getting any checks from me in the new decade since, around here, for most of the last decade, their publication was used as a contrary indicator of sorts and something to poke fun at. Now, both of these routines are getting a little old.

For a brief history as it relates to housing, see the following items:

May 23, 2005 - Shame On You CNN/Money!
Jun 02, 2005 - Money Magazine Does Real Estate
Sep 30, 2005 - Money Magazine Does a One-Eighty
Feb 09, 2006 - Leave Your Equity Alone!

They were wrong about the housing market up until it was obvious that the crash had already begun and they've been wrong about the stock market for a full decade, as many investors now know all too well. Yet, the encouragement continued to come even during the worst of it as seen in The market crash in Money Magazine covers from last March.

While their home remodeling tips and ways to save money on all kinds of expenditures have been helpful, their investment advice has been absolutely terrible as noted here about a year ago in Let Money Magazine fix your portfolio? where the graphic below first appeared.

Note that, in addition to the new black line representing an investment in gold, full-year data for 2009 has been added to the chart that includes all the mutual funds from Vanguard that the magazine's editors feel should be part of your investment portfolio.

This was part of a rather detailed comparison a year ago and its reappearance today along with that added black line was prompted by this article from the most recent issue, the issue that will likely be my last.

Though I haven't interspersed comments in a lengthy quoted article in some time, these latest Money Magazine thoughts about gold as an investment were just crying out for attention and, for old time's sake at least, it seemed like a good idea to have a look at the whole thing.

Off we go...

Coming down with gold fever
By Stephen Gandel

At Harrod's department store in London, you can pick up a South African Krugerrand or a 27-pound gold bar along with a sweater and bed linens. Gold is sold like candy out of train station vending machines in Germany. Indian households are borrowing against jewelry the way Americans did not so long ago against their homes. And U.S. investors poured $15 billion into gold funds in 2009, as they were pulling money out of stock portfolios.

Once of interest mainly to central bankers, Swiss jewelers, and folks who are convinced the Trilateral Commission runs the planet, gold is now the world's "it" investment. The question for you: If you buy now, are you getting in on the precious-metal equivalent of Microsoft and Intel circa 1986, or a Miami condo circa 2007?

Investors have turned to gold for centuries in times of trouble, and as panic over the global financial crisis took hold in late 2008, gold prices started heading up from around $700 an ounce. While panic has abated, fear remains -- of inflation building in the global economy, of an armageddon for the U.S. dollar, of Armageddon, period.

But at some point late last year, as gold touched $1,200 an ounce, greed seemed to take over from fear as the main motivation to buy.

Mark Hulbert, who tracks investment newsletters, notes gold scribes have become so enamored of their subject that they're telling subscribers to devote more than two-thirds of their portfolios to it. SPDR Gold Trust (GLD), an exchange-traded fund that invests in the metal, is now the second-largest ETF in the country, after one that tracks the S&P 500.

That's not so surprising. "When something goes up as quickly as gold has, the main thought is, Why am I not in it? And how can I get in it quickly?" says behavioral economist Dan Ariely, author of Predictably Irrational. "That's the same thing that happened with housing."

Can fear and greed keep gold prices climbing? In the short run, perhaps. But the case for gold as an investment? That's built largely on straw, as you'll see from the discussion that follows.

And it's only in fairy tales that one can spin straw into gold.

Tale No. 1: Inflation is a looming threat, and gold offers you better protection than stocks or bonds.

The reality: The price of gold is the only thing that seems to be rising.

Inflation is the most common reason gold bugs give for why you need this metal in your portfolio. After all, gold is a hard asset, and real things are expected to hold up better to inflation than paper assets like stocks.

The fear of rising prices is why Peter Schiff, chief global strategist for Euro Pacific Capital, thinks gold could eventually climb to as high as $5,000 an ounce.

But consumer prices aren't actually rising. At least not yet.

Gas, for instance, costs less than it did a year ago.

So does a gallon of milk -- down about 20%. A Big Mac costs a bit more, but not by much. You get the point. Prices on a number of consumer goods peaked in the summer of 2008 and have been falling or stabilizing ever since.

5 centuries of bubbles and bursts

To be sure, ramped-up government spending could lead to higher inflation. But that's not a sure thing in recessionary times -- especially in downturns as bad as this one, when consumer demand for goods and services is so depressed.

"For inflation to happen, the government would have to spend more than the trillions of dollars that were lost in home values and bad loans in the credit crunch," says Frank Holmes, CEO of U.S. Global Investors. "We are not near that." And this comes from a guy who manages his firm's gold fund.

Even if Schiff is right and inflation is about to flare up, that's still no reason to be hoarding gold. The investment management firm Research Affiliates studied the last period of sharply rising prices -- the late 1970s -- to find out what was the best investment to own back then. The answer: not gold.

In fact, the study found gold prices and inflation had very little correlation. Between January 1977 and April 1980, small-company stocks were actually the best-performing asset, outpacing gold and other commodities by 4 percentage points a year during that stretch.

And over a much longer period -- since the end of 1974, when the federal government permitted U.S. households to own gold as an investment for the first time since the Great Depression -- even the S&P 500 index has whipped inflation by a wider margin than the metal has.

The reason gold may have been such a popular inflation hedge in the '70s was that there were few alternatives for small investors back then. Not only was that before the rise of low-cost stock index funds, it was decades before Uncle Sam came out with a class of bonds -- Treasury Inflation-Protected Securities, or TIPS -- that are guaranteed to keep pace with rising prices.

And let's face it: It's a lot easier to keep an electronic record of your TIPS bonds on your firewall-protected hard drive than to store gold bricks in your living room.

Tale No. 2: Unlike stocks, gold is real and tangible. So it will hold its value.

The reality: Gold prices fell for a quarter-century before the recent rally.

Gold bugs will argue that you can put more faith in a 27-pound block of metal that you can see and touch than in bits of data sitting on a Treasury Department server.

But remember that the whole "real equals safer" argument was cited as the reason housing values would never sink precipitously -- and you know how that played out.

At least stocks give you a share of a firm's earnings, and many pay dividends to boost your overall return. Gold is merely a commodity, and a volatile one at that. Gold prices fell in 14 out of 20 years between 1981 and 2000, and finished that two-decade run having dropped by more than half -- and that's before the effects of inflation are considered.

But isn't there a limited supply of gold around the world? And doesn't that mean prices will have to go up?

Not exactly. The truth is, no one really needs gold. Besides its use in jewelry, gold serves very few functions. In fact, industrial demand for the metal has been falling for years.

Tale No. 3: Despite its spectacular run, gold is still cheap by historical standards.

The reality: Gold isn't that inexpensive. And who says it's guaranteed to return to old highs?

Gold hit a record $850 an ounce back in 1980. In today's dollars, that comes out to about $2,200 -- or about twice the current price.

But just because gold is cheaper than it once was doesn't mean that it's a screaming bargain. If deflated price is the sole reason something is worth buying, then you should be rushing out to pick up Nasdaq stocks or houses in Las Vegas instead. On an inflation-adjusted basis, both are down off their all-time highs more than gold is.

Okay, but is gold at least attractively valued? A common tool used to determine if an asset is cheap is its price/earnings ratio, which takes what an asset is trading for and divides that by the profits it produces. But because gold doesn't generate earnings, that's impossible to ascertain.

Gold-mining stocks, however, do have P/E ratios, because they're shares of companies that mine and process the metal. And since these stocks are influenced by movements in gold prices, they can be a decent proxy for whether the metal itself is over- or under-valued.

Two of the largest publicly traded gold companies, Newmont Mining (NEM, Fortune 500) and Barrack Gold (ABX), sport P/E ratios of around 17, based on 2010 estimated earnings. Thanks to surging earnings, the P/Es for both stocks are actually lower than they've been in years. Yet the shares are still more expensive than the S&P, with a P/E of 15. This doesn't mean gold can't go higher. But you can't call it cheap.

Tale No. 4: As the world sours on the U.S. dollar, the demand for gold will take off.

The reality: Even China is wary of gold prices rising too much.

Some think recent shifts in the global economy's balance of power are what's causing gold prices to spike.

Foreign governments have long stockpiled U.S. dollars to shore up their own currencies. And as the buck has sunk with our weakened economy, nations like China have been selling dollars to boost their gold holdings. Global central banks are expected to have bought more gold in 2009 than they sold -- the first time that's happened in 20 years.

But the fear that gold is going to replace the dollar as the world's store of value is largely unfounded. The fact is, governments don't act like pure currency speculators. They hold dollars for economic and political reasons that go beyond the day-today value of the buck. Even with its recent purchases of gold, China still holds 20 times more of its reserves in the greenback than in gold.

And as this metal gets more expensive, central banks are becoming price-sensitive. A deputy governor of the Bank of China in early December said higher prices might slow that country's gold purchases.

If you fear the dollar's slide, there are far easier (and cheaper) ways to wager against it. "The U.S. economy is in some serious trouble down the road, but I'm not going to pay this much for insurance," says Steve Leuthold, chief investment officer for the Leuthold Group.

Instead, Leuthold says he is buying stocks in Latin America and Asia, which are a natural hedge against the dollar's demise. After all, if you buy assets denominated in foreign currencies, and those currencies rise in value while you hold them, you can make money simply on the exchange rates -- even if the underlying assets don't appreciate.

Tale No. 5: The "smart money" is buying gold. So you should too.

The reality: Only a small number of sophisticated investors are getting in on the action.

Gold has always been a favorite of doomsayers and conspiracy theorists. But last year it started to go more mainstream. Some of Wall Street's most successful investors are now into gold, including star hedge fund managers such as John Paulson and David Einhorn.

But before you join this movement, consider who these converts are. Paulson made money betting correctly that tens of thousands of mortgage loans would go bust in 2007 and 2008. As for Einhorn, he's best known as a short-seller -- someone who wagers that stocks are going to go down. In other words, it's really Wall Street's version of the same doomsday crowd that's caught the gold bug. It would be different if, say, Warren Buffett was buying up this stuff. He isn't.

So you'd do well to heed the warning of economist Nouriel Roubini, who was ahead of the pack in predicting the credit crisis. People who argue that there's economic justification for gold prices continuing their rise, he wrote recently, "are just talking nonsense."