Oh, the lonesome goldbug. Always on the fringes of the financial community but finally vindicated after a 12-year bull run in precious metal prices.
However, today goldbugs are under fire. Gold and silver prices, as measured by the SPDR Gold Trust (ETF) (NYSEARCA:GLD) and the iShares Silver Trust (ETF) (NYSEARCA:SLV), are down 25% and 30% year-to-date, respectively.
So what went wrong? Two holes are emerging in the bull thesis.
Goldbugs have made one promise: hyperinflation is just around the corner.
With the Federal Reserve’s massive quantitative easing program, printing billions of dollars every month, the U.S. dollar is bound to collapse and prices will skyrocket!
Yet despite all of the Fed’s efforts, there’s still no inflation in sight. This month, the U.S. Labor Department reported consumer prices rose only 1.5% year-over-year. Well below historical averages.
Of course, many goldbugs don’t trust the government’s statistics.
Okay, let’s take a look at liquid, commodity markets that the government can’t manipulate. Surely, if inflation exists it will show up there. The Powershares DB Commodity Index is a useful proxy for the commodity market. This ETF contains a diversified basket of the 13 largest commodity futures markets including gasoline, Brent crude, heating oil, gold, soybeans, etc.
So any inflation there? Nope. The index is down 10% over the past two years. Commodity prices have been weak due to falling industrial demand from China and new supply discoveries. Many markets like copper and coffee are hitting fresh 52-week lows.
Maybe inflation is right around the corner. No, that’s not likely either. According to the Cleveland Fed, U.S. Treasury Inflation Protected Securities (TIPS) are only pricing in a 1.4% inflation rate over the next 10 years.
So why have the inflation zealots been so wrong? A fundamental misunderstanding of the banking system.
Goldbugs often point to the hyperinflation of Zimbabwe or the Weimar Republic as a warning of what’s to come. But these episodes in history aren’t suitable comparisons.
The vast majority of the money in circulation today is electronic credit, which can be destroyed. Despite the massive inflationary measures by the Fed, these efforts have only compensated for the deflationary forces in the economy following the collapse of the credit bubble in 2007.
All of the new money is just sitting on bank balance sheets to replace losses on soured loans and bad derivative bets.
In reality the Federal Reserve isn’t as powerful as we might think. It’s not really in control of the entire money supply but, depending on how you count it, less than 10% of the total ‘money’ in circulation.
The second problem for gold bulls is that there aren’t any near-term catalysts that could drive precious metal prices higher.
The Fed is likely to taper its bond buying program, possibly by the end of the year, after a rash of positive economic reports. Gross domestic product grew 2.5% during the first quarter and consumer spending posted a nice 3.2% gain. The economy also generated 165,000 jobs in April bringing the unemployment rate down to 7.5%.
These numbers suggest the end of pedal-to-the-metal monetary policy. At the moment no one is looking for the Fed to increase its stimulus measures.
This creates a pretty dismal picture for the bulls. No new stimulus means no catalyst to justify higher metal prices.
Foolish bottom line
But perhaps the biggest problem with goldbugs is that their investment decisions are driven by ideology rather than facts. To question their thesis is to question their entire worldview. This is not a appropriate mindset for investing.
Robert Baillieul has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.
The article 2 Holes in the Goldbug Thesis originally appeared on Fool.com.
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