Monday, July 19, 2010

How Far Can Gold Go...

Dominic McCormick has written a thoughtful piece looking at gold's future, which attempts to clear up some misunderstanding about the metal as a portfolio holding. He pulls away from the gold-as-money issue, arguing that gold is a counter-cyclical asset relative to confidence in the financial system. As such, it can balance off financial assets whose value is tied to such confidence. He notes that gold is becoming more popular as an alternative investment, albeit in the teeth of a number of vocal gold skeptics. That rise in popularity leads him to conclude gold is closer to the end of its bull market than the beginning, although he does say the current bull market could go on for several years. [The metal's been been rising for more than nine years.] Given this increase in popularity, there is a chance of gold forming a blow-off top should it become a must-have asset.

One point he made caught my eye:
Critics, meanwhile, get obsessed with arguments that gold doesn’t have an income stream, cannot be valued easily and relies heavily on speculative buyers/investors. It is therefore crucially reliant on “confidence” – something they argue is very fickle. This is true, but confidence affects the return on all investments. Even a stock or a market with a known dividend can fall 50 per cent if sentiment sours and its price/ earnings ratio falls from 20 to 10 without any change in the underlying fundamentals.
The part about confidence being fickle made me wonder if those skeptics are confusing gold with the fractional-reserve system. A loss in confidence could collapse the fractional-reserve banking system far more quickly, and more completely, than a loss of confidence in gold. To the extent to which gold skeptics are fiat-money fractional-reserve system boosters, the shoe is on the other foot.

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