Once Again, the Gold Narrative Fails

The Gold Fairy Tale Fails Again
The stories devised to explain why gold will rise, even though it has fallen for four years, are exercises in valuing narrative over analysis.
Bloomberg, December 2, 2014

Will they never learn?

Yesterday, oil rallied 4.3 percent and gold gained 3.6 percent as commodities had an up day after a long and painful fall. The fascinating aspect of the trading wasn’t the $45 pop in gold, nor the even greater percentage rally in oil, but the accompanying narrative. (As of this writing, each has giving up about half of those gains).

When it comes to speculating, especially in precious metals, it is all about storytelling. Over the years, I have tried to remind investors of the dangers of the narrative form (See this, this and this). Following a storyline is a recipe for losing money.

Why? The spoken word emerged eons ago and narration was a convenient way to pass along information from person to person, generation to generation. Your DNA is coded to love a good yarn of heroes and villains and conflicts to resolve, preferably in a way that is both exciting and memorable.

However, your genetic makeup wasn’t created with the risks and rewards of capital markets in mind. When it comes to being suckers for storytelling, I have been especially critical of the gold bugs. Since 2011, the gold narrative has been a money loser, the secular bull market for the metal clearly over.

However, gold often provides a plethora of teachable moments. I want to point out several recent gold narratives that have been dangerous to investors.

One of my favorite narratives involves the SPDR Gold Shares, an exchange-traded fund. The history of this ETF — often referred by its ticker symbol, GLD — is a fascinating tale, well told by Liam Pleven and Carolyn Cui of the Wall Street Journal. Since its peak in September 2011, GLD has declined 37 percent.

As we discussed almost a year ago, the most popular gold narrative was that the Federal Reserve’s program of quantitative easing would lead to the collapse of the dollar and hyperinflation. “The problem with all of this was that even as the narrative was failing, the storytellers never changed their tale. The dollar hit three-year highs, despite QE. Inflation was nowhere to be found,” I wrote at the time.

More recently, the narrative has shifted. Switzerland was going to save gold based on a ballot proposal stipulating that the Swiss National Bank hold at least 20 percent of its 520-billion-franc ($538 billion) balance sheet in gold, repatriate overseas gold holdings and never sell bullion in the future. This was going to be the driver of the next leg up in gold. Except for the small fact that the “Save Our Swiss Gold” proposal was voted down, 77 percent to 23 percent, by the electorate.

Why anyone believed this fairy tale in the first place is beyond me. Surveys of voters suggested that the ballot proposal was likely to fail. And yet there’s muddled thinking about gold among the bears too. Short sellers loaded up on bets that gold would plummet, a mistake in its own right since the outcome was all but foretold. When the collapse failed to materialize as the ballot initiative lost, the shorts had to cover their errant bets, sending spot prices higher (temporarily it seems).

Why do these narratives all tend to fail? For the most part, they reflect information that is already in prices. Markets are far from perfectly efficient (they are kinda- sorta-eventually-almost efficient). But they are more efficient than many seem to assume. What’s that you say? Consumers in China and India are big buyers of gold? You mean, the way they always have been?

Indeed, most of the recent narratives contain information that is already reflected in prices. Yesterday, I read a breaking news article that said India’s decision to lift gold import restrictions would have a big, positive impact on prices. The problem with that narrative is that India eased import limits in May — and it moved gold prices higher by all of 0.5 percent.

Perhaps you prefer the narrative about the “Worst Gold Shortage In Over A Decade.” That’s only if you define shortage as an excess of supply versus demand for the overpriced metal, which has since fallen about 40 percent from its 2011 peak.

As noted above, the narrative fails in both directions. The debate in my mind is how to value gold beyond what the next buyer is willing to pay for it. One of the more eccentric valuation arguments comes from Citigroup Chief Economist Willem Buiter, who claimed gold is worthless, trapped in a 6,000-year-old bubble:

Gold is unlike any other commodity. Gold is costly to extract from the earth and to refine to a reasonable degree of purity. It is costly to store. It has no significant remaining uses as a producer good – equivalent or superior alternatives exist for all its industrial uses.

Yes, any traded good can see prices occasionally run amok. But as a trader, if you think you are smarter than 6,000 years of market pricing, then you are begging for the financial gods to beat you senseless. Yesterday’s market pop gave Buiter’s analysis a thrashing.

Perhaps the most egregious narrative failure came from Grant Williams of Mauldin Economics. He imagined a conversation 30 years from now about China’s secret three-decade-long, gold-buying spree, dating to November 2014. Well, we only need to wait 30 years to see if this prediction is correct. In the intervening years, don’t worry if this combination of wishful thinking and cognitive dissonance leads to market losses: Chinese gold buyers will save you, if only you are patient enough.

As John Kenneth Galbraith famously said, “Faced with the choice between changing one’s mind and proving that there is no need to do so, almost everyone gets busy on the proof.” Rather than accepting certain unpleasant realities, gold bugs have contorted themselves into a painful waiting game.

This seems to be the preferred approach of too many investors. They engage in emotionally satisfying story lines that are either already reflected in prices, or just wrong. It tends to cost them dearly.

Once again, the narrative fails.

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This column was originally published at Bloomberg View on December 2, 2014.