Thursday, July 4, 2013

How Gold Lost Its Luster, How the All-Weather Fund Got Wet, and Other Just-So Stories

by John Mauldin

We have not revisited the topic of gold in Outside the Box recently, mostly due to the fact that nearly everything I read on the subject is derivative of what I have been reading for years. There hasn't been much that would cause me to think about gold in a different way, and that is the purpose of Outside the Box: to present new perspectives and make us think.

I have recently started to read the work of Ben Hunt at Epsilon Theory. His ideas are interesting in that he examines markets from a behavioral economics perspective, with ample doses of game theory and history, a combination that few people can bring to the table. (In a random but pleasant development, I will get to have lunch with him next week in Dallas when he visits my town. I look forward to it.)

I have read this piece twice and expect to look at it a few more times. He leads off with some interesting thoughts on the role and significance of sweeping social narratives, and in particular the "Narrative of Gold," but there is more than thinking on gold in today’s Outside the Box. Pure gold bugs will be annoyed, but since I am neither gold bug nor pure, I find this a very useful essay. A small taste –

The source of gold’s meaning, whether you are a market participant in 1895 or 2013, comes from the Common Knowledge regarding gold. J.P. Morgan said that gold is money, and he was right, but only because at the time he said it everyone believed that everyone believed that gold is money. Today that same statement is wrong, but only because no one believes that everyone believes that gold is money….

To market participants in 2013 gold means lack of confidence in money, and their behavior in buying and selling gold similarly reflects this meaning. Buying gold today is a statement that you believe that global economic events may spiral out of the control of Central Bankers. It is insurance against some sort of massive monetary policy mistake that cannot be fixed without re-conceptualizing the global economic regime – hyperinflation in a developed nation, the collapse of the Euro, something like that – not an expression of a commonly shared belief in some inherent value of gold.

Thus the Narrative of Gold is still significant, but mostly in contrast to the narrative that has assumed primacy today: the Narrative of Central Banker Omnipotence. Like all effective narratives, says Ben, this one is simple: central bank policy will determine market outcomes.

Then Ben makes a crucial point:

You may privately believe that J.P. Morgan is still right, that gold has meaning as a store of value. But if you participate in the market on the basis of that belief, then you will buy and sell gold in an incredibly inefficient manner. You would be a smart gold investor in 1895, but a poor gold investor today.

This is some of the best, most fundamental thinking about gold that I have seen. But Ben's thesis is larger than that. He wants to understand the manner in which historical correlations and correlation-based investment strategies come under tremendous stress in markets undergoing structural change. "I get VERY nervous," he says,

when I am told that … a socially constructed behavior such as the assignment of value to highly symbolic securities is "timeless and universal", particularly when the composition and preference functions of major market participants are clearly shifting, particularly when monetary policy is both massively sized and highly experimental, particularly when political fragmentation is rampant within and between every nation on earth.

I am back in Dallas after a long and very tiring trip. I think I overreached in terms of what I tried to do on the trip, and on my return I find myself as exhausted as I have ever been, on top of which I seem to have picked up a nasty virus somewhere along the way. Not that I did not enjoy every moment. Cyprus , Croatia, Switzerland, even France were all fascinating, with so many good times and meetings. I think I need to try and cram less into the schedule. That might mean a personality change is in order, as trying to do too much is one of my real weaknesses. So much opportunity, so little time. A little zen focus might be in order.

And now, I suggest you read Ben Hunt’s essay and appreciate his take on narrative. Have a great week, and for my US readers, enjoy the Fourth of July. I am off to the optometrist now to find out why I'm having such trouble focusing my eyes. I had laser surgery some 15 years ago, and they said it would last about 10 years, so my “sell-by” date is long past. The problem has slowly been getting worse and now demands to be dealt with.

Your thinking about multiple points of focus analyst,

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