Gold bugs get sort of squashed in the long run

May 05, 2002|By Jay Hancock

LIFE SEEMS uncertain and scary to almost everybody these days except the people who own the metal that ruined Midas, shod Montezuma and shielded Neil Armstrong from moon radiation.

The price of gold, the eternal refuge in political turbulence, is up 12 percent since December. The top 25 mutual funds this year are gold funds, according to Morningstar. Gold mine stocks, enjoying the perception that gold will keep going, have risen 40 percent since the New Year.

Gold buffs do not overtly take pleasure in the economic collapse of Argentina and Japan, the Israeli-Arab crisis or the prospect of war with Iraq. But they know in their bones that the world is a shifty place, held together by abstract rules enforced by complex institutions run by errant humans.

So they are not surprised when trouble calls, and when it does, they are happy to have bet on a financial instrument that depends on no army, no central banker and no law except one named after Murphy.

Gold will always be an interesting short-term, casino-type investment because its price oscillates like an oil derrick. But it has been a terrible long-term investment since 1980, when then-Fed Chairman Paul A. Volcker attacked and later crippled inflation with high interest rates.

Inflation was the reason to buy gold three decades ago. When President Richard M. Nixon stopped redeeming dollars for gold in 1971, critics predicted that an unmoored greenback would dry up and blow away, and that's what seemed to happen. As U.S. consumer prices rose by 6 percent, 9 percent, 11 percent a year, the dollar shrank by the same proportion.

By 1980, the dollar was worth half what it was worth in 1971, and the lesson, to many, looked painfully clear: Create your own, private monetary system with a safe full of shiny, yellow metal with an atomic weight of 196.97. Gold rose from $40 an ounce in 1971 to $850 an ounce in early 1980.

That the problem was the Federal Reserve's bad management of the money supply and not the ditching of the gold standard didn't seem to occur to anyone. But the diagnosis was, indeed, an incompetent Fed. Under Volcker and then Alan Greenspan, the central bank learned to control a dollar unanchored by gold by raising interest rates and shrinking the money inventory when inflation barked.

As a result, gold has peeked over $500 an ounce only a couple of times since 1981, got stuck below $400 after 1996 and nearly touched $250 in 1999 and last year. Communism fell, capitalism triumphed, the stock market soared, and Greenspan mastered market and universe.

But gold bugs, confident in the forces of error, entropy and chaos, bided their time.

James Grant, a gold bull and editor of Grant's Interest Rate Observer, likes to say the value of gold moves in the opposite direction of Greenspan's reputation. With the economic recovery uncertain, the U.S. trade deficit straining the system, the dollar losing value against world currencies, the stock market wheezing and one gauge of the money supply growing like it hasn't since the 1970s, gold fans like their chances.

Gold owners are also happy that supplies have tightened, as central banks have stopped selling bullion in big volume and mines are poorly equipped to rapidly crank up production to meet new demand. And, as always, they emphasize their asset's aesthetic, symbolic allure.

The metal popped from $279 an ounce at the beginning of the year to $312 Friday.

I agree that gold looks better than a Treasury bond on a wrist or a bosom, but as a long-term investment it doesn't seem more attractive than it did a decade ago.

Gold fanatics bring to mind Europe's 19th-century aristocracy, which, to its misfortune, largely shunned the new joint-stock corporations because it believed wealth grew only from the land.

Gold bullion pays no dividends or interest. The world's central banks hold more reserves in U.S. Treasury securities than gold these days.

For all its beauty, gold is a commodity like rubber or oil, one whose scarcity is automatically undercut by new sources of production when prices rise.

To bet on gold is to bet against human ingenuity, which has a pretty decent record. The cost of finding and processing a barrel of oil plunged by more than half in the 1990s; there is no reason to think Earth's gold reserves are not similarly vulnerable to technology.

The valuable capital of the 21st century is intellectual, not mineral.

That's why stock in Eli Lily & Co. sells for 10 times the assets on its balance sheet. The drugmaker's worth is in its patents and scientists' brains, not in its buildings and beakers.

My wager is on the system, Greenspan and an eventual waning of present troubles. For the long haul, I'll take a few shares of Lily or any attractive U.S. company over a high-class rock.

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