ERICOPOLY

Exactly. Volatile. People say it is the ultimate tool of maintaining your purchasing power... but tell it to the person who bought in 1980. People come up with these examples that say things like "the cost of a fine tailored suit today is about what it was 100 years ago priced in gold". Well sure, but 8 years ago that wasn't the case, it could only buy you a third or a half of that same suit. So the volatility is really crazy, such that whether you maintain 100% or 50% of your purchasing power is highly dependent on what decade you unload at, or what year within that decade -- almost like a broken clock that is exactly right a couple of hours out of 24, and off by several hours most of the rest of the time. Sure, that clock will reliably give you the accurate time again, but how long do you have to wait?

In 1970, gold was $35 an ounce and US median house price was $17,000. Today that same house costs $485,714 (priced in gold). So either housing is a screaming deal priced in real money (gold), or gold is expensive. Yes, if there is hyperinflation gold will rise in dollar terms, but so will a lot of other things (like agricultural commodities for example).

Fortunately for him: 1) he started investing that money when everyone had given up on stocks 2) his wife's family was loaded (and in government bonds) so he wasn't sweating bullets when the portfolio was down Then of course good for him for pulling it off.

Oldye has been consistently suggesting that gold is overpriced, so I think he really did mean the puts. I have been giving a lot of thought to all of this. Gold might do best in a panic, but just like Yahoo stock was once best in a panic to own tech stocks. At the end of the day, in a global inflation scenario, worldwide buying power will be limited to actual currencies (including CDN, AUD, etc...) and what people in those countries can actually afford to purchase with their currencies. So it would like agricultural commodities would be a good idea -- and in fact, the #1 idea of Jim Rogers who states that while he does own some gold, he thinks agricultural commodities will do far better. I'm in the camp that USD is going to be worth a lot less in 10 years. I just want to be smart about this and not just buy gold because it's the first thing we think of -- I want some kind of value based approach so that we preserve our buying power to the maximum. So agricultural commodities sound brilliant to me because after all, people need to eat and food prices are not already soaring as is the case with gold.

So I think Hoisington's main point (in layman's terms) is that doubling the money supply doesn't push prices up unless private credit is extended. After all, money in my pocket didn't double as a result of the Fed actions. My sister doesn't have twice the money. The people unemployed in California don't have twice the money. Unless people expand lending to these consumer folks, how is the Fed action going to push up prices? My thinking is that the Fed action is propping up financial entities so that they will be in the position to extend lending as some point in the future, and to keep them from dramatically scaling back on their existing level of lending (which would push prices down). I agree with you though that if the USD depreciates against other world currencies, then the price of basic commodities will rise in USD terms and thus not all price inflation can be averted. No free lunch, but not necessarily an immediate doubling of the price level simply because the money supply doubled.

Galbraith points out in Money: Whence It Came, Where it Went that inflation is actually good, in very small controlled doses. But you ask about Hoisington. Well, in Hoisington's essay he points out that prices are set by supply and demand, and that without private credit expansion the money simply isn't getting into the hands of people who buy things, so prices won't rise. Personally I think the currency will be devalued until this country actually produces something more than it consumes, and as I wondered out loud years ago I think the bubble in this country is incomes... people just have high incomes relative to the rest of the world and I couldn't figure it out... but you can see, that's why the jobs go overseas. So I too think incomes will need to come down to global standards, whereever that may be. The only other option I can think of is tariffs on manufactured imports, but then (in addition to a trade war) it would mean that we can't afford cheap imported goods anymore so again, falling standard of living. I like the thinking of the Austrians because if you run the country that way we'd not have gotten into this mess in the first place. But I would like to ask von Mises about the velocity of money.

The current exchange rate movements and gold vs the USD in 2009 alone do support that narrative, but it's up in the air as to whether or not it "confirms this dilution". Gold for example is also blowing away the AUD -- does this mean it is confirming a dilution of the AUD? Gold might just be going off on an overvaluation of it's own -- it would more closely support your thesis if strong currencies like the AUD were keeping pace with gold, but that clearly isn't so. The AUD has lost 1/3 of it's purchasing power against gold in the past 12 months. The other monetary currency, silver, is also getting left behind by gold this year... and we know for sure that it's no clear sign of dilution of silver 8) The USD has actually only lost a couple of percent against the AUD in the past 12 months, and if you go back 15 months the USD has actually strengthened... despite all of the bailouts and money printing. Confirmation of what then? Dilution?

Lack of credit is the reason why Hoisington doesn't believe the problem will be inflation. You also mention that the gold standard held back credit, and thus held back inflation. And so you are on the same page as him, sort of. Only you don't seem to agree that holding back credit will hold back inflation, this time. http://www.hoisingtonmgt.com/pdf/HIM2009Q2NP.pdf One of the more common beliefs about the operation of the U.S. economy is that a massive increase in the Fed’s balance sheet will automatically lead to a quick and substantial rise in inflation. An inflationary surge of this type must work either through the banking system or through non-bank institutions that act like banks which are often called “shadow banks”. The process toward inflation in both cases is a necessary increasing cycle of borrowing and lending. As of today, that private market mechanism has been acting as a brake on the normal functioning of the monetary engine.

Ultimately, all currency's REAL depreciation will be measured vs. gold. If the inflation of any sovereign currency outpaces its real ability to pay (Real economic growth), then it will devalue vs. gold. Like all calculations of net worth, the target constantly moves, sometimes in large jumps... these produce blips on the overall trend line, but at the end of the day the value of the AUD (or any currency) will reflect the amount of real inflation (real growth vs monetary inflation) of the particular currency. Historically silver has been a monetary metal as well. Shouldn't silver and gold maintain a relatively constant exchange rate over time (ignoring for a moment the fact that silver is actually getting scarcer)? Do you buy the argument that silver is money? It has been treated as such throughout history. I am trying to determine how much gold has overshot (high price for a cheery consensus), and am scratching my head as to why the same arguments that are supporting gold don't also apply to silver.

OK I'll bite... Let's pretend for argument's sake that gold is money... the ultimate store of value on the planet, the go to guy when fiat currencies fail and economic empires decline. This has been the case through recorded history, when international monetary arrangements become volatile through currency manipulation and devaluation, the flight to safety is a flight to gold. As late as 1971, all participating sovereign currencies were linked to gold at a fixed rate. This fix had many advantages.. international trade boomed in a world where money was sound. The big disadvantage (in the view of governments) was that it capped individual governments spending and set a limit on issuing credit which tended to crimp economic expansion in booming economies and penalized emerging economies for the same reason.. lack of credit. The world's dominant currency (USD) was forced to break its peg to gold in order to pay off its spending on the ruinous Vietnam War and fund its budgetary deficit. Credit was thus expanded and the USD, no longer backed by gold, but backed by its dominant economic growth engine, maintained its supremacy. At this point the USD became a promise to pay and was backed by the largest and strongest economy on the planet. Even though monetary inflation of the USD was now a given, as long the growth of national GDP, kept pace, the dollar would inflate at a low and manageable rate and was universally accepted in lieu of gold and gold backed currencies (although the Swiss Franc, which until recently was convertible to gold, remained the ultimate sound currency). Over time the price of gold reflects the accumulated inflation of the national currency, it spikes when the ability to repay is brought into question.. in highly inflationary times like the late 70s. When the US economy expanded and the money supply was constrained to funding real economic growth, the price of gold languished, but over time still reflects the decline in real purchasing power of the USD. To get a real feel for actual purchasing power, calculate prices in terms of gold ounces (or goldgrams, which are now a popular way of owning gold in Asia). The value of an ounce of gold over time has been constant, the purchasing power of fiat currencies such as the USD over time erodes. Let's look at the famous 5 cent cigar which JP Morgan (the guy, not the bank) could no longer find in 1910... today it would probably cost about 10 bucks USD or .01 ozs of gold. In 1910, .01 ozs of gold was about 21 cents, roughly the same price for a commodity whose real cost remains unchanged over the century. http://www.wisegeek.com/what-is-the-historical-price-of-gold.htm To the question at hand... the recent moves of the AUD and the price of gold. US economic growth is severely compromised through years of credit expansion which funded malinvestment... producing no real economic growth and thus diluting the value of the world default currency.. the USD. Moreover the intention of governments is to continue the dilution of the currency through record deficit spending and credit creation, which to date have only settled past bad investments without any net real wealth creation. At the same time the economy is experiencing a sever cyclical downturn which will further the erosion of GDP in REAL terms (vs. gold and sounder currencies like the AUD). If GDP as measured in USD increases, but declines in terms of the USD indexed to a basket of alternate currencies, or the USD indexed to the price of gold, we can say that US GDP has declined in REAL terms. The same argument can be made for the major stock indexes. If the S&P 500 is at the same level as it was a year ago does this mean that stocks have retained their value? Of course not, if the USD has declined against the aforementioned indexes. So the AUD and other currencies where GDP is expanding ahead of the creation of fiat currency will continue to appear to appreciate against the greenback, when in fact it is the greenback depreciating against the AUD. The real measure of the purchasing power of the AUD (or CDN or others) will always be vs. the price of gold. Since the future purchasing power of the buck is in doubt and its movements volatile, other nations are making alternate arrangements to facilitate international trade and looking elsewhere for customers and flows of capital. Barring some miraculous economic turnaround, the USD has lost its role as the world default currency, and an investor wishing to preserve his purchasing power would be well advised to own some physical gold. This offers an explanation of why USD is depreciating against AUD. It also offers an explanation of why USD is depreciating against gold. However, it does not explain the rapid depreciation of the AUD against gold.

There was also talk that gold is not inflated vs the cost of "a fine tailored suit". So I looked for the cost of what that would be -- now, where do we find data on the cost of a "fine tailored suit" 50 years ago vs 10 years ago vs today? It turns out that well, one needs to define "fine". The quality of fabric makes all the difference. So who is publishing numbers that accurately compare the same quality grade of fabric in say, 1910 vs today? As one can see, the difference can be a matter of 4x in price. http://www.askmen.com/fashion/fashiontip/34_fashion_advice.html The suit's fabric will make the difference between a $1500 suit and a $6000 one. That's why many popular designers use fabrics with a grade of 100s or 110s [quality of fabric] to cut costs and increase markups. Because you're not paying for the brand name, you can opt for higher quality grades and still pay the same price or cheaper. Anything above a grade of 110s is guaranteed to make a respectable looking and durable suit. As you may have guessed, higher grade equals better quality and an elevated price. Grades range from low 80s to high-end super 180s.

I should really be asking Broxburnboy who knows a lot about gold. I had a long discussion with him a year ago. He suggested that gold is rising vs the USD due to monetary policy. I suggested that everything still has a fair price, but that essentially led to a statement that well, gold is money. So recently I've been rethinking the topic with the recent drum pounding about gold and inflation. Cardboard for example recently suggested that gold is a good buy. So tying some other statements together, like "gold is money", well silver is also money and silver is not being debased. So why is gold crushing silver? And why is gold crushing the AUD when the argument is that gold is merely rising vs the USD monetary inflation?

If you look at it over a 6 month period (when the Fed's debasement of the USD has been most concerted) the question then becomes; Why is the Australian dollar rising so rapidly against gold? http://i163.photobucket.com/albums/t314/ripleyx/Finance/gldvsaud.jpg It's true, the closer you look the forest is invisible. I mean, if you walk within 2 inches of a single old growth douglas fir you are not going to see anything but. I went to 5 years hoping this is a bit more like viewing the forest from 1,000 feet -- it irons out the panic to the USD that took place last year. The 5 year period shows that AUD/GOLD got out of whack long before the financial crisis (the gold bugs like to say that the drop in the GOLD/USD ratio had nothing to do with fundamentals, but rather panic).

I actually thought you were drawing a distinction between fair price and intrinsic value, and that was the twist (you used those two terms which have different meanings).

Thought of something... Then there is gold vs silver (money vs money standoff): http://finance.yahoo.com/q/bc?s=GLD&t=5y&l=on&z=m&q=l&c=slv Why is gold (real money) appreciating vs silver (real money)? And silver is tracking the AUD closer, at least over the past few years: http://finance.yahoo.com/q/bc?t=5y&s=AUDUSD%3DX&l=on&z=m&q=l&c=slv

I have a desire to preserve my spending power from a devaluation of the USD. Regarding gold, as I've mentioned before I think it already prices in a lot of inflation that hasn't yet happened. Some people don't agree with that, however... But let us take a currency like the Australian dollar where the government isn't going fiscally crazy and isn't monetizing and doesn't have huge unfunded liabilities... all the things that people claim are causing the gold to climb in USD terms. Why is gold rising so rapidly against the Australian dollar? http://finance.yahoo.com/q/bc?t=5y&s=AUDUSD%3DX&l=on&z=m&q=l&c=gld I'm not trying to stir up a debate on whether or not gold is going to crash to 10 bucks or anything, but can't it at least crash back to the AUD/USD line on that chart in the link above? Or is gold priced accurately and does the Australian dollar need to inflate to catch gold? Or do the goldbugs think that the Australian dollar is really depreciating in real terms against gold at this pace?

Buffett talks about it a lot but from what I can tell it works for him only because he avoids the more speculative range of outcomes (sticks to companies with lasting qualities).

I am personally worried because I am up 85% pre-tax this year and it came very, very quickly -- after being down beginning in early February and still down by 3% in early July. It's easy to feel manic. It seems others are feeling better about it too. Now... if they all feel better about it and spend, then it becomes better. But if they all change their minds again and feel scared, then they'll drive the bid down on stocks and we're all poor and terrified again. Trouble is, when we were all poor and terrified the forward potential gains looked extremely enticing in the stock market. But now that we all feel fantastic, the forward gains look much worse. •Men are spending more on drinks and lap dances at strip clubs. Many people simply feel a little richer after a 50% rebound in the stock market and with all the talk about a possible recovery. Citigroup strategist Tobias M. Levkovich estimates households have regained $5.4 trillion in wealth because of the market rebound. http://articles.moneycentral.msn.com/Investing/CompanyFocus/Good-news-the-splurge-is-back.aspx

I started the year fully invested and remained so all the way through the bottom of the market. I thought your strategy of being all cash was too conservative to start the year but you were right in the end. You played it perfectly. I sold WFC puts a few weeks ago as a means of making another 40% by Jan 2011, yet while maintaining my potential entry price at just $21.12 (And the meek shall inherit the Earth...), which is barely above the cost that HWIC paid. The strike is $30 so I really am not counting on any further market advance to make my money. Should the market correct again, you will do better. I'm happy though with my potential return being capped at 40%.

Australia -- few talk about it here. I would not mind being stuck with Australian currency denominated assets given that I'm a dual citizen US/Australia and the place is very nice. I nearly bought WBK (listed on NYSE) but don't understand banking well enough to analyze it.

Depends when you ask him. He said 1080 last October. Why did he then drop it a few months later?

The strange thing about inflation, in the 1970s/1980s anyway, is that it seems to have driven down the market P/E, giving cash buyers a chance to get back a fair chunk of their real earnings power after the fact. Grantham talked a little bit about this earlier this year -- people wanted higher earnings yields to compete with the high short term cash yields. So I know some are thinking about buying stock in great businesses as real assets as an inflation hedge, but the last time around that was not the best play -- it was best to wait for them to crash first. Then their P/E's reflected high earnings yields that outperformed inflation as inflation eventually subsided. Same with long term bonds as well.

It is possible that extra factories (and other PP&E items) were built to meet credit driven consumer demand. In that case, it would suggest we face a lower P/B multiple as many of those assets will sit unproductive until demand swells back to prior levels (which normally happens in a V shaped recovery, but not for a very long time in an L shaped recovery). So if it's L shaped, then lower P/B would make sense.

Hey I'm up for lunch anytime. Belatedly (never got a chance to implement it) I had an idea of going 2x long ORH in my IRA accounts and then to short FFH in my brokerage account (in an amount exactly 1/2 of the ORH position). I figured I would be building up a loss on the FFH position that would be useful for tax purposes, yet on a total net worth basis would not be suffering real losses. But I never did attempt to follow the strategy (only thought of it a month or so ago). Like the cycling through ORH, NB, FFH, this idea is now meaningless too.

I think they get most of their returns from investments, not from insurance. The 80% in equities certainly delivered the bulk of their gains this year for example, with book value up nearly 30% YTD. Let's suppose in a parallel world there is another Fairfax run by the same investors but that isn't involved with insurance underwriting, so the only way to deliver gains would be from their investments. Then you are comparing them to somebody like Leucadia. How much premium then are they worth? Remember, Leucadia's record is inferior.