All that Glitters is Not Gold: Sometimes it's Oil, too

Occasionally a light bulb flashes on and for a split second I see the miles of landscape in all its tortuous detail. Everyone gets this from time to time, it's called insight or inspiration or intuition.

Gold hit a 27 year high this week before pulling back today to about $730 per ounce. Oil likewise has been on a tear, now at $80 per barrel, due to geopolitical tension and increasing demand from developing economies. Also, agricultural grains and livestock have seen higher demand worldwide as more people move into the middle class. So while the prices of many essential items have been increasing, the official US inflation rate is reported as low, mainly because the government chooses to exclude food and energy from their statistics.

Here's the deal, and feel free to correct me if I'm wrong.. The Consumer Price Index, as a measure of inflation, is a balance between various commodities, assets and products that the government sets in order to measure the stresses and strains on the economy. At any given time, some assets are deflating while others are inflating in value, and monetary policy is supposedly set to keep these in line.

The problem is that the assets most of us working folks are not increasing in value, while the costs of those commodities on which we rely are increasing in cost. We get paid in US dollars, and the US dollar has decreased in value against every major currency and is now at an all time low in the dollar index. Our houses have likewise decreased in value, or at least have not increased in value commensurate with inflation. US stocks, while they may have increased in dollar terms, the gains have been mitigated by the continued decrease in the dollar index, so in real terms the gains versus commodities and foreign currencies have been negligible or negative.

This devaluation of our homes and our paychecks has occurred at the same time our real world cost of living has increased. The government tells us that the CPI is 2.3%. Bullshit. Gas has increased 45% in two years and food has increased at least 20% depending on what your family eats. Food and energy are a proportionally larger part of the living costs for a middle class family. When the government uses a decrease in home prices to offset the increase in gas and food, then the numbers are skewed and they are not reflecting the true cost of living for the average American. Barry Ritholtz at The Big Picture has been a stalwart voice expounding on the inflation numbers coming out of the federal government.

Recently we have seen a ripple go through the credit markets due to a large increase in the numbers of subprime mortgages that have been made. With interest rates at historic lows, the housing market has been booming, but apparently that growth was not enough for the mortgage lenders who took liberties to loan money to people who had no assets or job, and what ho!, they can't pay their mortgages. Imagine that.

The federal reserve chairman, Ben Bernanke, has acted to bail out the economy by adding liquidity, i.e. lowering short term interest rates that the fed charges banks. The immediate effect of this move is to assuage the fear that homeowners will default on their mortgages by keeping interest rates low enough for many marginal mortgage holders to hang on for a while longer. The other immediate effect is to remove the moral hazard that would normally have been felt by lenders who made such ill-advised loans. It's a bail out. The ultimate effect for the rest of us, however, is a further devaluation of the dollar, i.e. our paychecks are worth less.

Which brings us back to gold and its 27 year high. I'm not some wingnut goldbug who has stashes of Krugerrands in my mattress. Most of my retirement funds are in diversified stock mutual funds and I do very little trading of these retirement funds other than an occasional re-balance.* Lately, however, I've been a little leery. The rise in gold and other commodities has me spooked. How long can we devalue the US dollar and not feel some pinch in the overall US economy? When will foreign investors lose confidence in holding US dollars? The current rise in gold, silver, platinum and copper prices is evidence that the US dollar may be losing its cache as the haven of safety in a tempestuous world. As geopolitical tension rises, US treasuries and dollars should become more sought after, and that's not happening.

Historically, the last time such dollar devaluation had occurred was the early 1970's. Nixon took the US dollar off the gold standard, we had huge war debt from an unwinnable and unpopular war and inflation tore up the value of the greenback. Sound familiar? As we rattle sabres against Iran, where do you think the price of oil and gold will go, or is it all baked in already? If you think the price of gold will stop short of an all time high now after rising this far, please let me know your rationale. If you think that some technological breakthrough will make the fossil fuel internal combustion engine obsolete before the Chinese hit he highways, please let me know.

Sure, economic slowdowns will occur and financial cataclysms will happen from time to time, but the macroeconomic tendencies all point to a continued increase in the use of commodities and the continued decrease in the value of the US dollar versus gold and other hard assets.

These are not merely rhetorical observations. If you had $100,000 to invest, where would you put it? Would you buy US real estate? Ha! Would you buy US dollar denominated stocks like Starbucks and General Electric? Perhaps the latter. Or would you play into the global growth story and invest in areas that are a lock to grow over the next 10 or 20 years? The two dominant themes, as I see it (and have seen it for a while now), are 1) Asia, and 2) commodities. And get rid of your dollars.

No?

* My retirement funds are sacrosanct and are invested in staid Fidelity funds of various stripe. However, I do have a stash in a discount brokerage account that is traded actively, and fortuitously has been a source of fun, adventure, intellectual challenge and significant wealth generation lo these many years. I make a point not to comment on individual trades, but perhaps I'll alter this policy in the future.