This blog is written weekly by Dock David Treece, a registered investment advisor with Treece Investment Advisory Corp. It is meant to share insight of investment professionals, including Dock David and his father, Dock, and brother, Ben, with the public at large. The hope is that the knowledge shared will help individuals to better navigate the investment world.

Wednesday, May 12, 2010

Buying the Bull

This week we’d like to educate investors on a frequently overlooked and little-understood topic in finance: The life cycle of an investment. The example we’d like to use, because of its current place in its own life cycle, is Gold.

Tracing Gold from 1998 to present provides a fantastic illustration for investors of how an investment progresses through stages over time, rising out of relative obscurity to become the focus on national headlines.

In 1998 and 1999, Gold, as an investment class, was absolutely dead. Prices for the metal had gone nowhere but down for an entire generation, and Gold was hovering around 20-year lows. In short, Gold was cheap, very cheap. This relative “cheapness” led some investors – not many, but some – to begin accumulating holdings in both the metal and companies that mine it.

Through the year 2000, gold remained relatively unattractive (and still extremely cheap) as the tech bubble, then peaking, dominated headlines and commanded the attention of investors around the world.

After the tech bubble burst in late 2000, the government began cutting interest rates in order to stimulate the floundering economy. Thus, in 2002-03 Gold became a buying opportunity as a hedge for investors against the impacts of inflation.

After interest rates set by the Fed bottomed Gold ceased to be an inflation hedge and became an anti-dollar investment from a foreign exchange standpoint between 2003 and 2007. At that time, as the offshore bandwagon picked up steam and significant business moved out of the US – or sprang up elsewhere – the dollar began to suffer. Since Gold maintained its inherent value, the price in dollars increased.

The dollar, relative to other currencies, bottomed in late 2007, yet Gold remained a great investment option. From 2007 through 2009 Gold maintained its popularity, not as an inflation hedge or an anti-dollar play, but as a source of a relative safety in the market, a store of value.

Since 1999, as you can see, the reasons for owning Gold have changed, but the result has been the same: the price of Gold has increased. Now, after progressing through each of these stages, we continue to find ads for Gold on TV, radio, and in print. As I write this the commentators on CNBC are singing Gold’s praises.

Unfortunately, none of the reasons for owning Gold exist any longer. Gold is not cheap; in fact, quite the contrary, it just set its all-time highs. It is not, in our view, a good currency play, since the dollar is likely to increase over the next several years, as we have discussed in previous articles regarding the coming wave of on-shoring.

Finally, Gold is not necessary at present as an inflation hedge. The reason is simple: Currently inflation is not a concern. Prices have not been increasing, and real money supply growth as measured by M3 is actually negative, and by no small figure.

Instead, the only remaining reason to buy Gold is as a momentum play; in other words, to buy it because it has been going up. Unfortunately, that is the birth of a bubble, by definition. That doesn’t mean that the price of Gold can’t continue to rise, it will likely continue to do so until something bursts the bubble.

However, at this point any further gain in Gold’s price is totally unsupported by fundamentals. For investors, when the price of an investment ceases to be tethered to value, that investment becomes nothing more than a bet.

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