May 8, 2013

Volatility, gold on Wall Street

Posted in Finance, Uncategorized, Wall Street tagged , at 10:05 PM by Robert Barone

There are two truths all investors need to remember about Wall Street.

No. 1: Whenever Wall Street is involved, markets become volatile, even unstable. Many examples exist including the meltdowns of 2001 and ’09. Last year, we had the “flash crash” and the issues surrounding Facebook’s IPO. The week of April 15 produced both the three-minute AP/Twitter meltdown (the “Tweet Retreat”), and the dramatic fall in the price of gold.

No. 2: The reason for such volatility is “greed” and “fear” on the part of the large Wall Street players. Greed can be seen in the widespread use of leverage, margin, derivatives, futures and options, all of which multiply the returns on committed capital. Once greed drives prices to heights that can’t be justified, the slightest jolt causes fear and a cascade of sell orders as all the major players, seeing leverage work against them, rush for the exits at the same time.

The recent gold meltdown, underlying fundamentals

Clearly, fear gripped Wall Street’s holders of gold on April 12 and 15. The closing price on April 11 was $1,550 per ounce. On April 15, it was $1,352 per ounce, a 12.8 percent decline. At this writing (April 27), it has recovered about half of the loss, closing at $1,462 per ounce on April 26.

Because we are talking about something that trades on Wall Street, no one can say for sure that the selling pressure is over. But there are some fundamental issues that investors need to understand regarding the yellow metal:

• Gold was not in a speculative bubble. Its rise in price since the turn of the century has been based on the fundamentals of fiscal and monetary malfeasance on the part of many western industrial nations including the U.S., the U.K., the European Union and Japan.

• The 12.8 percent rapid fall in gold’s price was not based on a shift in those fundamentals but was just a bout of Wall Street “fear.” In fact, since April 15, reports from all over the world (including India and China) indicate a massive amount of gold buying by main street consumers. The U.S. Mint sold out of its physical coins immediately after April 15. Clearly, main street knows a bargain when they see one.

• Volatility in the price of gold is nothing new. Can’t remember such volatility? Try 2008. From March 17 to 20, 2008, the price of gold fell 5.8 percent (from $1,000 per ounce to $943 per ounce). It then proceeded to fall to $710/oz. in November of that year, a 29.1 percent total drop. That is almost exactly the magnitude of the 28.2 percent fall from gold’s Sept. 2, 2011 peak of $1,884 per ounce to the recent nadir.

Gold’s historic outperformance

Yet, gold has been a spectacular performer since the turn of the century with much higher returns and lower volatility than stocks. Such performance relative to both inflation and equities is shown in the accompanying tables.

Table 1 shows the annualized returns of gold if purchased on Dec. 31, 1999, and held to March 31, April 15 or April 26 of this year. Also shown are the returns of the S&P 500 (including reinvested dividends). For good measure, I threw in the official annualized inflation rate (CPI-Gov’t), and a more realistic inflation rate (CPI — 1980) calculated by John Williams of Shadowstats.com using the 1980 CPI methodology. As you can see, gold was the asset class to hold throughout this period.

Table 1: Annualized Returns of Gold, Stocks & Inflation

From: 12/31/99 To: 3/31/13 To: 4/15/13 To: 4/26/13
Gold

13.8%

12.4%

13.0%

CPI – Gov’t

2.5%

 

 

CPI – 1980

9.6%

 

 

S&P 500

0.5%

0.4%

0.6%

 Table 2 shows the returns of stocks and gold from the stock market lows of March 9, 2009. If you were not gripped with “fear” in March 2009 (the vast majority of Wall Street players were) and you bought at the lows, you did great. However, if you bought gold then, your portfolio also performed, just not quite as well.

Table 2: Annualized Returns Since Stock Market Lows of ‘09

From: 3/9/09 To: 3/31/13 To: 4/15/13 To: 4/26/13
Gold

14.6%

9.9%

11.9%

S&P 500

23.0%

22.4%

22.8%

Table 3: Annualized Returns 12/31/99 to Stock Market Lows of ‘09

From: 12/31/99 To: 3/9/09
Gold

12.4%

S&P 500

-7.5%

 
It isn’t fair to look at Table 2 without a look at Table 3, which shows what the returns on the two asset classes were in the nine-plus years from the turn of the century to the S&P 500 lows. Note that if you held the S&P 500 during that entire period, your annual return was a large negative (-7.5 percent), while gold produced a large positive annual result (+12.4 percent).
 
 
Conclusion

The price of gold is volatile because Wall Street is involved. Nevertheless, its volatility hasn’t been as great as that of stocks in this century. The returns produced by gold have beaten inflation by anyone’s measure and have whipped the returns produced by stocks, unless you invested heavily on March 9, 2009.

Despite Wall Street’s recent tantrum, the underlying fundamentals for owning gold haven’t changed, as can be seen from the overwhelming demand for the yellow metal coming from main street consumers since that tantrum ended.

The mention of securities/commodities, such as gold, should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals.

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp, Matt Marcewicz and Marvin Grulli) are available to discuss client investment needs. Call them at 775-284-7778.

Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

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