Warren Buffet on gold and cash

I've been enjoying a new (to me) blog - Kid Dynamite's World.  KD has a really great analysis of Warren Buffet's most recent prognostications on gold and government bonds.

Suffice to say, Warren doesn't think much of gold as an investment class.  

The key point - highlighted by KD is:

He (Buffet) can’t fathom how an investor could chose the cube over the other portfolio of productive assets.  Then he points out this reality:
“Beyond the staggering valuation given the existing stock of gold, current prices make today’s annual production of gold command about $160 billion. Buyers — whether jewelry and industrial users, frightened individuals, or speculators — must continually absorb this additional supply to merely maintain an equilibrium at present prices.”

I'm inclined to agree with Buffet.  Gold is not an investment, it is merely a directional bet on a useless asset.   You could make the same bet on, say, nice wine.   At least if that bet goes bad you could still drink the stuff.

Gold rally overdone?

Apparently some say so.  Presumably they are the ones who just sold.

SPY and GLD correlations and volatility.

Apparently the value of the GLD ETF (an Exchange Traded Fund that holds gold) has exceeded the value of the SPY ETF (which holds stocks from the S&P 500).  All this gold is held in bank vaults in London (which in light of recent riots may not be that sensible).  The total amount of gold held by the fund in these vaults is about 41. 5 million ounces, which is about 1300 tons.  That seems like a lot of gold.

In the article, a hedge fund manager was quoted as saying that
“Gold has become something of a near-perfect hedge for financial assets such as stocks,”
This got me thinking - I wonder what the correlation between GLD and SPY is?

Here are the daily correlations.  Note that GLD has been trading since 2004.
2004-2011: 0.0506
2008-2011: 0.0108
2010: 0.1961
2011: -0.2655

First of all we can see that over the long run, there has only been a weak correlation between GLD and SPY.  In 2010 however this correlation became positive and quite strongly so.   But for the first half of 2011 we can see a strong negative correlation.  While not a "near perfect" hedge, it certainly looks like GLD is moving against stocks.  The problem of course is predicting how long this movement will continue and at what point in time (if ever) the old pattern of a small positive correlation will reassert itself.

Looking at daily annualized standard deviations, (assuming 250 trading days) we see that GLD is a little less volatile that SPY.

2004-2011
SPY Std Dev:  22.6%
GLD Std Dev: 21.0%

2011
SPY Std Dev. 20.00%
GLD Std Dev. 15.24%

Surprisingly SPY is not as volatile as you might think - perhaps a classic case of investors anchoring their beliefs too much on recent market gyrations.

While I don't make prognostications, it does seem likely that a large amount of the demand for GLD may be coming from people moving money out of stocks.  If this is the case, then if and when the stock market starts to rebound, we should see a pretty rapid fall in the price of gold.

Is gold at a record high? Actually, no.

A nice take down in the NYT about the current gold frenzy.   Gold isn't at a record high after you adjust for inflation.   And as the author of the article says "you should always adjust for inflation".

Personally, I think there is a gold bubble forming.  I predict prices below $1000 in a year.

Investing in Gold

From time to time I get asked by students whether people should invest in gold.   The obvious attraction is that it has seen huge price appreciation.  The huge negative is that it is very risky.   Here's a nice article the briefly summarizes some of the arguments for and against gold.

Link via Greg Mankiw's blog.