Regardless of whether you consider yourself a gold bug or would just as soon see the yellow metal disappear from investors' collective radar screen, you should admit one thing: Gold is a constant. That and its pretty yellow shine have made it valuable since the dawn of time. You can print more paper and lower its purchasing power at will, but gold will remain.
This makes gold's performance in 2008 puzzling. Yes, it is up 11%, but that is dwarfed by the returns on other commodities. If we are in an inflationary environment, and this hardly seems controversial anymore, and if we are in a weak-dollar and a politically risky environment, and if bullion buyers in India and the Persian Gulf have greater wealth than they did a year ago, then why hasn't gold put $1,000 in the rearview mirror?
After all -- and this will drive my gold-bug friends nuts to hear this -- who cares where the price of gold is? If the prices of energy, food or industrial materials increase, behavior must change. If the price of gold rises, it just means we can store more pieces of increasingly worthless paper per ounce.
Many people assume that gold simultaneously hedges both inflation and currency risks. They assume this so strongly that they feel actual analysis of the data is superfluous. Let's revisit an indicator I introduced in May 2003, dubbed the annualized inflation gauge, or AIG, not to be confused with the woebegone insurer of the same name. This is the expected inflation, as measured in the Treasury inflation-protected securities, or TIPS, market, converted to an annualized number.
If we annualize repo rates and subtract them from the AIG, we get a net expected inflation number, which is the bedrock of my "handful of dirt" model. That states that even a handful of dirt will rise in nominal price if expected inflation exceeds the interest rate cost of holding it.
Howard L. Simons is president of Simons Research, a strategist for Bianco Research, a trading consultant and the author of The Dynamic Option Selection System. Under no circumstances does the information in this column represent a recommendation to buy or sell securities. While Simons cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.
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