European central banks are selling less gold. They used to keep the price down – perhaps not intentionally – by selling tons of the stuff every year. It was mad, of course. The British government – under then- chancellor of the exchequer, now Prime Minister Gordon Brown – actually sold a huge quantity of gold in 1998/99 at the lowest price in two decades. This was the famous “Brown Bottom” to the gold market. Soon after, we came out with our Trade of the Decade – selling stocks on rallies, buy gold on dips.
Since then, the price of gold has risen from $260 to over $1,000…and recently pulled back to the low 900s. Stocks, at least in nominal terms, fell heavily in ’01-’02…then rallied back to about where they had been at the end of the ’90s.
Our guess was that the stock market peaked out in January 2000. Since then, we’ve taken the to-and-fro of stock prices as market noise…misleading investors into thinking there is another great bull trend underway…and making it hard to hear what the market is really saying. In real terms…that is, adjusted for inflation…there is no doubt about it. The Dow is down about 30% in terms of consumer prices…and down 75% in terms of gold and oil.
Now, after all this time…the nominal trend of stock prices seems to be going down too.
It’s easier to follow the real trend in stocks by looking at price-to- earnings ratios than actual prices. You will see that the stock market follows long, broad trends – roughly coinciding with movements in the credit cycle. When people are feeling confident…they lend at lower rates…and they buy stocks at higher prices. More or less. At the top of the cycle, they’ll pay 20…30…50 times annual earnings for a stock. At the bottom, they want a more immediate and more sure pay off; stocks typically sell for only 5 times earnings.
Where are we now?
We are between 15 and 20. Not terribly high…but a long way to go before the market bottoms out.
As to the other side of the trade, European central banks have finally realized that selling their most important asset into a rising market was not such a good idea after all. They’re now curtailing gold sales.
And from the United States, we hear that dealers are running out of bullion coins. No wonder; these coins are the cheapest and easiest way to protect yourself from the risks of inflation (and, under certain conditions, deflation too).
One of the nice things about bullion coins is that once you buy them and put them away, they tend to stay put. You see the gold price going down and you may be tempted to call your broker and say: ‘let’s sell out that gold ETF.’ But you are less likely to get out your coins and lug them to the dealer. Not only is it more trouble, but coins are regarded as a kind of insurance…a kind of patrimony…that you sell only as a last resort. In a long bull market, coins are the perfect way to hold gold; you’re less tempted to get rid of them when the price dips. So, you end up riding the long wave all the way to its end.
Then, of course, you’re also likely to forget to sell. But that’s a story for another day.
And, judging by the current market climate, it’s likely that more and more investors will be turning to gold as a safe haven for their portfolio. Yesterday, the price hit above $900…and if things keep going the way they have been, $900 an ounce for gold will seem like a bargain.
*** How about that Warren Buffett! He bought $5 billion worth of Goldman preferred. The stock gives him a 10% annual dividend. Plus, he got warrants good for another 5 big bills worth. These come with a strike price of $115 a share – a discount of more than 15% from Friday’s closing price. That alone has a value – probably about $2 billion…which puts Buffett’s effective yield at 17% (according to a calculation in Barron’s). The Oracle of Omaha is showing those New York slicks a trick or two.
Markets and Money