Thursday, March 15, 2007

Hedging Against Dollar Weakness

iio comments to "Gold Mining for Fun and Profit" -
... I know you are more a trader, but, do you have an opinion on gold as a long-term "investment". I have been heavily invested in gold through an IRA since Nov 2004. I had viewed it as less of an inflation hedge and more of a dollar hedge.


I have watched gold for over 30 years and find that the more I watch the more I'm convinced that if the "gold bugs" knew what they were talking about gold would already be over $2000 an ounce. But that's not to say that their theory of a weakening dollar is not correct. The problem is - in the new economy which is truly global and is only going to get more so - all money is weighted equally. If you put any three instruments on the table and divide the first by the second you will come up with the ratio for the second to the third. When one moves the others move in tandem either up or down as their relationship requires.

What does that mean? Simple - if I have a dollar and it is worth at this moment in time x euros it will be worth 1/x GBP. The Euro will be worth x/1 GBP. And so on. Every movement in every currency is followed by a like movement in every other currency. And what does that mean?

Simple - the dollar can't fail. It can only become weaker against Euro's or stronger against Yen's but it can't fail because it is in a single cauldron of currency.

Currently the dollar is the international currency but slowly but surely in order to reduce the influence of the U.S. in these matters the oil producers are moving to Euro-based pricing - which, because of the instantaneous nature of the spot market doesn't mean jack.

We already have (national pride aside) a universal international currency that is used by every country and it isn't gold. It's this debit card I have in my pocket and have been carrying and using for over 25 years and it doesn't matter where I am in the world I can get cash with it. And I can get cash in the currency of the local economy even though my bank is dollar based.

So, no - I don't think gold is a good investment against a dollar collapse because I don't think the dollar can collapse - it doesn't exist any more - what exists are digits.

So if you want to hedge against inflation or a dollar weakening or even a dollar strengthening my suggestion is this - oil and real estate. And by real estate I don't mean houses or buildings I mean land where houses or buildings might be constructed some day. Find a builder that has a lot of undeveloped land and buy in. And if you can't own a well - own a company that owns wells - or, by using one of the many ETFs buy a lot of companies that own wells.

Otherwise play gold as you would any other stock - when the set-up calls take the trade.

And that's my humble opinion on the subject.

35 comments:

IIO said...

Thanks for that honest answer! You say the dollar can't fail. In a technical sense I can understand what you mean. But from a practical sense, wouldn't a weakened dollar wreak havoc for our debt-dependent economy as countries stop investing in it? What happens when social security and medicare cannot be financed? That would pulverize the dollar, wouldn't it?

Thanks again.

MachineGhost said...

I really liked Marlyn's answer. Here's my own two cents.

Owning gold is like playing musical chairs. It's only useful once every, single last chair in the room is gone. In the modern world where there is no longer a gold or silver standard, credit creation is both public and private, when and where would there ever not be a proverbial chair anymore? If you're insisting on Armegeddeon, exactly how useful is gold in the post-apocalyptic world of the TV show Jericho, or the nuclear holocaust movie The Day After?

I view the Dollar as a archaic relic like the British Pound which was the world's reserve currency until it quite suddenly lost that status in the 1950's. As a citizen of the British Empire back then, would it have been worth it to have been hoarding gold as a hedge against the Pound? Inquiring minds want to know.

Ultimately, it's all about confidence and let's remember Marlyn's Rule #1. As long as U.S. monetary and fiscal policy inspires international confidence, there will be demand for dollars.

Maybe that's a wee bit too unscientific you say? Fine, subtract the CPI from the GDP and there's an answer. Gold does not start to go up unless real short term interest rates are negative (e.g. deflation). That's the monetary cause. The fiscal cause is war (destroying hard assets that need to be replaced is very inflationary, not to mention creating more debt out of thin air above revnues to juice up the military-industrial complex to wage the destruction). Yes, gold is a dual-hedge, but I could argue holding both long-term U.S. Treasuries and TIPS/I-Bonds fulfills the same role (most interestingly, I-Bonds are also paid-in principal protected in a deflation).

MachineGhost

Marlyn Trades said...

Thank you, both, for the discussion. I lean more towards MachineGhost in my views but I once embraced those of iio. I'm not sure if that's a maturity or capitulation but them's just the facts.

But this discussion is taking us away from where I want to be so I'm going to ask that we end it now. Unfortunately we could spend years discussing it with no real end and no advantage to anyone. Again thank you.

Anonymous said...

I do not understand the argument that a currency cannot fail. I think it depends on what one calls a failure. To me, it is a failure of a currency when the citizens and holders of debt of the issuing country,and who by fiat or contract must accept the currency, can buy increasingly less with it. To me, it seems that holding a currency which gains strength against the failing currency is a good hedge.

I am interested in why you would prefer raw land or land with site improvements only as a hedge against a weakening currency. Why not an income producing property? What about commodities in general as opposed to just oil or securities related to it. I am not being argumentative here. I am trying to understand how others are coming to grips with these finance issues.

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