At the height of the bubble in Internet stocks in late 1999, exuberant investors were buying shares of companies as if the stock certificates themselves were precious commodities, like gold.
Many of the dot-com companies had issued the shares with no prospects of generating revenue or earnings in the foreseeable future, a giant red flag to a rational equity investor.
But shares were being bid up simply on scarcity value. Contrarian traders complained that they could not borrow Internet stocks to sell short because investors were hoarding shares.
Considering the late 1990s, it’s fair to say that today’s scarcity-driven mania is at least in the right church: the tabernacle of gold. But there’s a good chance you could be in the wrong pew.
The recent run-up in gold prices, to more than $1,000 an ounce, coincided with unhappy times in the stock market. StreetTracks Gold Trust, an exchange-traded fund that tracks the price of gold, is up 42 percent in the last 12 months. The Standard & Poor’s 500 index is down 6 percent.
Newly minted gold investors might think, therefore, that gold’s price runs opposite to stocks and provides valuable diversification. In fact, gold’s performance during so-called bear markets in stocks, periods of at least a 20 percent decline in the S&P 500, is mixed.
Gold rallied during the 2002 stock market slump, posted little change during the 2000-01 bear market, and dropped sharply in the long bear market of 1980-82.
In turn, rallies in stocks don’t necessarily spell trouble for gold.
Gold essentially kept pace with stocks in the long bull market period in stocks from October 2002 through July 2007.
Analysts attribute three factors to the dynamics of gold’s price: the value of the dollar (a weak dollar typically contributes to higher gold prices), speculative manias about inflation and geopolitical stress (more stress and inflation fears often mean higher gold prices), and actual demand for gold by prosperous consumers (especially consumers in India and the Far East, where gold is used to display and hoard wealth).
In recent years, the weaker dollar and stronger economies in Asia offset fairly benign U.S. inflation indicators to keep gold’s price on an upward path. Wealthy oil producers in the Mideast are buying gold as a hedge against the falling dollar.
In recent weeks, the Federal Reserve’s interest rate cuts and multibillion-dollar succor to Wall Street have rekindled inflation fears and helped form a perfect storm of bullishness toward gold. Unlike oil, which is trading at record highs on an inflation-adjusted basis, gold stands at half its inflation-adjusted record of more than $2,000 an ounce.
But before you join the church of gold, you need to remember the initial point here: Stocks aren’t gold, and gold is not a stock.
You can passively own a low-cost basket of stocks and, in effect, participate in the constantly expanding capability of your fellow human beings to generate economic value through business enterprises. No safer road to wealth has ever been found.
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Although many jewelry purchasers might disagree, gold is the anti-matter of economic value creation. Gold creates no value. Despite the gold frenzy, gold mining companies have been mediocre stock performers this year. The principal market for trading gold, the futures market, is a zero-sum game: For every winner there is a loser.
If you join the church of gold, don’t plant yourself in one pew reserved for gold believers. You need to actively play both sides of the aisle. Exchange-traded funds and exchange-traded notes offer long (buy) and short (sell) positions. Your evolving judgments about the outlook for the dollar, inflation and global prosperity should form your portfolio balance.
Like all commodity futures markets, trading is ruled by a hard-bitten elite of producers, fabricators and professional speculators.
If you think you can sing in this chorus, good luck and amen.
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