Gold in National Geographic

National Geographic Magazine's January 2009 issue has an article about gold:

http://ngm.nationalgeographic.com/2009/01/gold/larmer-text

While investors flock to new gold-backed funds, jewelry still accounts for two-thirds of the demand, generating a record $53.5 billion in worldwide sales in 2007. For all of its allure, gold's human and environmental toll has never been so steep. Part of the challenge, as well as the fascination, is that there is so little of it. In all of history, only 161,000 tons of gold have been mined, barely enough to fill two Olympic-size swimming pools. More than half of that has been extracted in the past 50 years. Now the world's richest deposits are fast being depleted, and new discoveries are rare.

I cannot understand why people and central banks are willing to pay so much for gold. It has less utility than platinum and silver. Most items that rely primarily on scarcity to attract consumers eventually lose demand and their high value. With gold, however, consumers can't seem to get enough. At least gold's value is not artificially inflated, as with diamonds (See DeBeers litigation). Still, I cannot think of another product whose attraction has such little correlation with its utility.

With platinum and gold selling at similar prices, I would probably go for the platinum. For now, my only precious metal is silver, which I own through a silver trust ETF (SLV).

Update: the print edition of the National Geographic has two charts on page 42 and 43 that are worth a look. One is called, "What it's worth," and the other is called "How it's used." If readers find a link to the charts, please let me know or please post a comment.

Bonus Round: Steve Forbes on gold.

Bonus Round 2: from the Italian Job, about gold: it "is our only refuge."

Update on 12/23/08: here is a comment I posted on seekingalpha.com, in response to other comments:

I appreciate all of your comments, but the only one that makes sense to me is Albert Ling's. He says that expensive products are expensive precisely because of their lack of utility. Although he doesn't expand on his hypothesis, he makes sense. The low utility of certain products, including gold, reveals an important trait--namely, that their buyer can afford useless objects, confirming the buyer's high disposable income, and therefore status.

I don't disagree with the ultimate end of the gold bugs, which is to establish a hard currency. Once most central banks moved away from gold and into fiat currency, gold no longer qualified as an agreed-upon unit of currency. Only if we return to the days of hard currency will gold have value because of its utility in determining currency. Until that day, its value seems to be linked to consumer demand and perception rather than utility.

Other people argued that almost no other products have prices relating to their inherent value, citing beachfront property; Mona Lisa; and Apple stock. Those examples are somewhat inapt.

1. Beachfront property has value because it is something that is necessary--shelter. It can also be used every day. Gold is not necessary, while shelter is required for most people.

2. The Mona Lisa has value because it is a unique historical artifact. Unique historical items tend to be valuable, despite their lack of utility, because history has value to most human beings. Therefore, I have no logical hangup with a historical painting connected to Leonardo da Vinci and the Renaissance having value. The Mona Lisa's value is inherent in its existence, which links it to a specific time period that will be studied as long as human beings exist.

Other paintings, however, especially so-called modern art, may have no value in the future. I would never buy a MoMa painting.

3. Apple stock is a harder one to analyze. It has no utility at first glance, because it does not pay dividends. (Many value investors avoid non-dividend paying stocks, because they don't see any definite return.) Yet, Apple stock has utility because it is easily traded, like currency, for other things, which do have utility. Gold is not easily traded for cash all over the United States. Apple stock, on the other hand, once liquidated, will buy a farmer in a rural area as well as a NY banker in a big city immediate utility. Therefore, its utility lies in its quick, convenient conversion into a unit that confers utility.

Conquest of Happiness

I was going through some old books and found The Conquest of Happiness, by Bertrand Russell. Bantam Books priced it at 95 cents on my edition, but the wisdom inside is priceless. Here are some passages I highlighted when I first read the book:

The secret of happiness is this: let your interests be as wide as possible, and let your reactions to the things and persons that interest you be as far as possible friendly rather than hostile.

Where outward circumstances are not definitely unfortunate, a man should be able to achieve happiness, provided that his passions and interests are directed outward, not inward. It should be our endeavor, therefore, both in education and in attempts to adjust ourselves to the world, to aim at avoiding self-centered passions and at acquiring those affections and those interests which will prevent our thoughts from dwelling perpetually upon ourselves. It is not the nature of most men to be happy in a prison, and the passions which shut us up in ourselves constitute one of the worst kinds of prisons. Among such passions some of the commonest are fear, envy, the sense of sin, self-pity and self-admiration...the happy man is the man who lives objectively, who has free affections and wide interests, who secures his happiness through these interests and affections and through the fact that they, in turn, make him an object of interest and affection to many others. To be the recipient of affection is a potent cause of happiness, but the man who demands affection is not the man upon whom it is bestowed. The man who receives affection is, speaking broadly, the man who gives it.

The best part, however, is the very last page of the book. Here is a link to the book, so you can discover it for yourself.

Roy Haynes

Neal Templin, move over--there's a new cheapskate in town, and his name is Roy Haynes:

http://abcnews.go.com/Business/Economy/story?id=6002830

70 bucks for a wedding? I bow down to this financial wizard. Anyone who calls me cheap is going to hear about the great Roy Haynes.

Madoff and SIPC

When you click on the SIPC website, you will see a pop-up screen for "Madoff claims." I've been reading stories about the hard-luck investors and charities that invested with Madoff everywhere. In fact, Saturday's WSJ could almost be called propaganda designed to convince readers to feel sympathy for Madoff investors (thank God for the James Grant article, which salvaged the issue). Don't fall for it. Most of these investors knew what they were getting themselves into when they invested with a hedge fund. As for the people who invested through a "feeder fund," they should blame their well-connected managers and leave Main Street taxpayers alone.

First, only sophisticated individual investors can invest with hedge funds. A hedge fund is a private investment fund open to a limited range of investors. Such a fund is less regulated and allowed to undertake a wider range of activities than other investment funds. Basically, the rich have created a separate avenue of investment designed to make them even more rich--or, in some cases, less rich. Hedge funds come with unique risks--and individual investors knew that going in. That's partly why few of Madoff's investors asked questions--a hedge fund is designed to be less regulated, so there's more allowances made for secrecy. Madoff operated as a hedge fund until 2006, when the SEC finally forced him to operate solely as a broker-dealer.

Second, you should always be wary when the government or the media says Wall Street should have more protection or attention than Main Street. Investors like you and me are limited to KKR Financial (KFN) or Blackstone (BX) if we want a piece of the hedge fund mystique. How are those stocks doing? Well, KFN is around 57 cents per share. BX is about $6/share, with a 52 week high of $23.87/share. In short, Main Street investors didn't do much better than Madoff's investors--and the SIPC isn't going to help us. Why should Madoff's investors--who already had access to a special fund--get special help or special sympathy? I don't see sob stories featuring Blackstone or KKR investors.

I am deeply concerned that taxpayer monies may be used to reimburse Bernie's rich investors more than the usual $500,000 SIPC coverage. Bernie's investors should receive half a million dollars each. I fear that Congress will increase or finance SIPC insurance, purportedly as a populist move (I can already hear the words, "For our protection")--and then make the increased limits retroactive. If that happens, taxpayers will be paying more bailout money, this time to sophisticated, rich investors.

Don't be scammed. Most Madoff investors were doing fine before Madoff, and they are still better off than 99% of the American population today. If they convince you otherwise, perhaps they really do deserve to be called sophisticated investors--after all, if Madoff's rich investors are smart enough to get reimbursed for 100% of their losses when they knowingly invested in a less regulated fund, the American taxpayer is indeed unsophisticated.

Update: Kathleen Pender of the SF Chronicle had a very comprehensive article about Madoff in the Chronicle's December 21, 2008 issue (page C1).

Update: Madoff's investors are already asking for a taxpayer bailout:

"There's no doubt that hearings will be held on this, and some government aid is a very logical request," said Robert Schachter, an attorney with New York-based Zwerling, Schachter & Zwerling, which is representing several Madoff victims. "If we're bailing out Wall Street and the auto industry, maybe these individuals should be bailed out too."

[Additional cite, Joe Bel Bruno, AP Business Writer]

More on Madoff here:

1. "Capitalism without Failure is like Religion without Sin"

2. Clark Winter on hedge funds, in The Either/Or Investor, page 88: (although the book was pre-Madoff scandal, it still has relevance to Madoff):

Hedge funds are basically nondirectional investments designed to take advantage of the indecision of markets. Once upon a time, you needed to be a millionaire in order to be qualified to invest in hedge funds--they are loosely regulated, and it is possible for investors to lose all of their money quickly if a manager's strategy goes awry...so only wealthy investors are allowed to use hedge funds as investment vehicles. But increasingly, institutional investors such as universities and mutual funds have placed a portion of their money with hedge fund managers, to their customers' benefit.

[on page 105] Wall Street's performance demands had gotten so out of line that some corporate chieftains could only make their numbers by faking them.
Update: It was only a matter of time--Madoff's investors have asked the 111th Congress for a bailout. The House of Representatives has obliged, and the House Committee on Financial Services is currently reviewing H.R. 2798. As of July 10, 2009, H.R. 2798 has not been submitted for a vote. You may write to the House Financial Committee using the following link: http://financialservices.house.gov/contact.html

Here is my letter, which you are welcome to copy:

Dear House members:

I am asking that you vote against H.R. 2798 or decline to submit the bill for a full House vote. The proposed bill seeks to bail out Madoff's investors under the guise of shoring up the SIPC. For example, SIPC members will only be expected to pay $1000 annually (up from $150 annually) into the SIPC fund. This amount is stunningly low, given that credit unions have had to pay millions of dollars to shore up their own version of SIPC, called the National Credit Union Share Insurance Fund (NCUSIF). Star One Credit Union, for example, will be assessed a $44.2 million charge to maintain adequate member protection. Thus, a revised annual SIPC fee of $1000 is laughable if consumer protection is the goal.

H.R. 2798 would be even more comedic if the money to expand SIPC protection wasn't coming from taxpayers. Unfortunately, because the SIPC has been woefully underfunded, if Congress passes H.R. 2798, the U.S. Treasury must issue loans to raise the SIPC fund's available credit from one billion dollars to $2.5 billion. As you know, the U.S. Treasury is basically the American taxpayer, so ordinary Americans and their children will be on the hook for this proposed bailout.

Most tragically, H.R. 2798's proposed penalties for white collar crime are too low at five years' jail time and a $250K fine. Such minimal deterrence will not protect the public against a future Madoff. Approving such low penalties post-Madoff may cause voters to wonder if white collar criminals have lobbyists. I would not want my name associated with H.R. 2798 in its current form.

Sincerely,
Name

Update: Click here for more on Madoff's investors.  It's titled, "To Madoff's Investors: Welcome to Main Street."

Dividends and Historic Stock Returns

John Bogle was recently on Nightly Business Report. He indicated that about half of the historic 10% return from the stock market was from dividend income:

So I think we can move toward more normal returns in the stock market now for some very fundamental reasons. First the dividend yield, an important part of long- term stock market returns. In fact, in the long-term the stock market return of 9.5 percent is a 4.5 percent dividend yield and 5 percent earnings growth.

How do tech stocks--most of which don't pay dividends--fit into this rate of historic return? I am not sure, but the year 2000 tech bubble and collapse has probably wrecked many stock market stat sheets, or at least made them more difficult to create. One thing's for sure, though--it's hard for large cap, established companies to argue against dividends. Companies like Oracle and Google are going to have a difficult time encouraging buy-and-hold investors if they refuse to pay shareholders a dividend.

Generous Benefits Will Bankrupt California

From the WSJ, 12/18/08, A4:

Calpers, which stands for California Public Employees' Retirement System, is California's pension fund for government workers. It provides retirement and health benefits to more than 1.6 million state and local public employees. From June 2007 to June 2008, the fund declined from $239 billion to $182 billion. Basically, Calpers lost $57 billion of taxpayer monies. Even with this loss, Calpers has almost $113,000 for each California employee's retirement and health benefits. This amount sounds generous, and it's certainly better than what most Americans have, but the pension is still underfunded. As a result, taxpayers will be forced to pay higher taxes to make up the shortfall, or will suffer inflation and a weaker American dollar as the government prints money to give to itself. In this way, public pensions are ticking time bombs, ready to release dangerous inflation unless something is done.

Congress and state legislatures talk about regulation, but they don't pass laws forcing cities and states to fully fund their pensions and/or to prevent borrowing money from pension funds. I remember Al Gore talking about putting Social Security funds into a "lock box," i.e. a box that is untouchable. Too often, when cities, counties, and states need money to finance a project or to cover a revenue shortfall, they dip into the retirement funds of police officers, firefighters, and other government employees. Eventually, the monies will have to be paid because a) the government employees have paid into the system; and b) the political will to reduce or deny retirement funds is non-existent. Just witness the auto bailout--if we cannot avoid printing money to give to GM and Chrysler, which lost billions of dollars annually, we surely cannot avoid printing money to give to retirees).

In addition to creating a lock box, the government needs to pare down benefits. Every dollar paid to a government employee means another dollar coming out of non-government employee pockets. Here is a quote from the WSJ story:

Like many residents who work for private employers, Ms. Nolan-Stewart, an AT&T manager, says she is astounded at the generosity of public-employee pensions. "If I were to retire, my retirement would be one-quarter of what I make today for the rest of my life," she says. By contrast, city firefighters and police who retire at age 50 with 30 years of service may retire with 90% or more of their final salary.

The WSJ (12/17/08, A1) also reported that Calpers used leverage (borrowed money) to boost returns; however, using leverage also means that losses are magnified, which may explain the fund's recent poor performance.

So Calpers engaged in a risky investment strategy with taxpayer money, and few Californians seem to care. Americans seem to have been so distracted with Iraq, they forgot about domestic surveillance and protecting our finances from government ineptitude. That's too bad, because history shows that every major empire has collapsed from within, not from an outside threat.

Government Gets Bigger

Greg Mankiw reminds us all why he's a Harvard professor and we're not. When government expands, it almost never contracts again. As a result, most new government programs lead to current and future taxpayers contributing more of their money to the government's coffers every year--and it doesn't stop. Thus, taxpayers should be ever-vigilant when it comes to any government expansion, even those purportedly for our benefit.