Two years ago, common wisdom declared you an idiot if you didn’t own gold. Today you’re seen as an idiot if you do. In late 2011, when we first bought small positions in gold following an almost 20% price pullback, we made it very clear that our action was not because we believed prices were destined immediately to follow their decade-long march to higher levels. When prices resumed their rise into late 2012, we were chided for having established such a small position.
When we first acquired the metal, we did so to hedge against the depreciation of the dollar by a Federal Reserve seemingly intent on inflating away debts that could never otherwise be repaid. We said that the gold holding might or might not be rewarded in the near term. We argued that there is no legitimate measure of the “appropriate” price for gold. It moves higher or lower on waves of investor emotion, characterized at extremes by fear and greed. At the time of our initial purchases, we indicated that if prices rose from there, we would end up with nice profits on a small portion of the portfolio. On the other hand, we would continue to build the gold position only if prices declined–perhaps even precipitously.
When the price rise in 2012 stalled short of the 2011 high, we took profits on a portion of the initial position. We rebuilt our position to the 3% level at successively lower prices in early 2013. We increased the position to 4% when prices plummeted last week, bringing the average purchase price down significantly.
I am not a believer that one should average down on price unless the reason for holding an asset remains strong. That reason certainly remains true for gold. Over many millennia, gold has been universally recognized as a valuable commodity. It will still be so thousands of years from now, unlike many corporations or currencies that live and die over time. While the specific price level of gold will inevitably fluctuate, the lesson of history is clear. If countries devalue their currencies by printing more of them, the price of gold rises in terms of those currencies.
Notwithstanding talk of tapering or the eventual end of quantitative easing, US budget deficits will remain huge for years to come, providing compelling incentive for the Fed to continue its efforts to inflate that debt away. The story is similar throughout virtually the entire developed world.
We suggested when we began the gold purchase program that portfolios would ultimately benefit most if prices declined over time and allowed us to build a bigger position at successively lower prices. That still remains true. We simultaneously warned that, should that happen, clients would be uncomfortable in the short run, but would almost certainly reap greater rewards in the long run. Wherever gold’s ultimate low price proves to be, whether this year or in the years ahead, it will take only a relatively small rally to render the full position profitable if the average purchase price is carefully crafted. The potential upside is unlimited and largely dependent on the extent of central bank money creation.