That’s why boneheaded gold schemes turn up like Simon Cowell at a Botox clinic.

But just as better living through chemistry can make you smile for a while, so “enhancing” the gold market looks doomed to leave your face sagging in the end. GoldLink IncomePlus, a Sydney-based fund manager that floated on the ASX in July 2005, raised some Aus.$150 million (US$129 million) from investors since opening in 1998.

Now it’s got barely one dollar in seven to give back.

The 86% loss came after “seven really good years and one bad year,” as the founder, Richard Kovacs, told The Australian in early December. “That big loss has destroyed my business and my credibility.”

It has also left with A$20 million earned in nine years, apparently, and the multilevel marketing-type name (GoldLink IncomePlus) should have given it away. But you might struggle to see quite how “gold” and “income” can ever sit together in the same product. Not one that actually keeps working, that is.

“The age-old problem with bullion,” as the Sydney Morning Herald announced to its readers in February 2006, “is that while gold might be pretty to look at, it hasn’t paid interest or dividends.

“No more. GoldLink’s IncomePlus Fund trades like a share and pays a fully franked dividend four times a year — totaling 10 cents — by borrowing gold cheap from central banks and selling it in the futures market and investing the proceeds.”

Or rather, according to The Australian in its report at the start of this month, “The company operated a trading strategy betting that volatility, or fluctuations, in gold prices would remain constant or increase.”

Whichever route GoldLink actually followed into gold options, as the gold market has soared since mid-2005, it also took a series of breathers, knocking volatility lower and destroying anyone betting that volatility would keep rising.

“The scheme wasn’t model driven [and] it wasn’t human error,” pleaded Richard Kovacs in late November, just before the rest of the board joined him and quit on the eve of an angry shareholders’ meeting.

“The fact is,” Kovacs went on, “the global options market fell and fell from late 2006 into 2007, and that adversely affected the value of our portfolio.” And he was so close to getting it right!

Price volatility in the gold market has since shot higher. “One-month volatility rose from a low of 10.8% in July, to 17.4% in November,” notes Jessica Cross in the latest Yellow Book from Virtual Metals. “Day for day,” agrees Wolfgang Wrzesniok-Rossbach at Heraeus — the German refinery group — “the interday movements in gold prices have been larger than what used to be the complete trading range for a whole quarter.”

“And within this highly volatile market,” he adds, “gold continues to hold onto its generally upward trend.”

Indeed, holding physical bullion — and leaving it well alone — would have matched the 15% yield squeezed out by GoldLink IncomePlus pretty well over the last half decade, for U.S. investors at least.

Gold hit new record highs for Australian owners in November this year, just as it did for British gold buyers. Anyone trading in U.S. dollars, meanwhile, could have enjoyed an annual “income” from gold — selling their gains each New Year’s Eve, and then using that yield to live off for the coming 12 months — of 17.6% gross on average since the start of 2003:

In a bull market this strong, why meddle with options at all? Why not just buy gold and hold it?

Well, first, of course, only an idiot would put all of his money into a “nonyielding asset” — or so your financial adviser would say. (Just ask him yourself; he could probably do with a laugh)

Second, there was no guarantee the price of gold would keep rising, but with GoldLink’s system, it “[was] not essential for the gold price to rise,” as the Sydney Morning Herald noted at the start of 2006. For the first couple of years, GoldLink managed to make bankable cash out of flat, and even falling, gold prices.

Last, but not least, running a complex gold trading program pays management so much more when you’re doing something clever that your investors don’t quite understand.

“Since it started six years ago,” the SMH added in 2006, GoldLink, “has posted an annual pretax return of about 15% after taking out the 1.75% management fee and a quarterly 15% performance fee.”

“It simply beggars belief that Mr. Kovacs has continued to claim these huge fees as manager despite the huge losses,” said David Woodiwiss — one of 3,000 investors now expecting the return of just 20 cents on the dollar, rather than a return of 15% per year — to The Australian in early December.

Richard Kovacs is reckoned to have paid himself more than $17 million for running these funds into the ground. But to be fair, he was worth every penny — as along as it lasted — for squaring the circle of gold versus income.

You see, financial service firms the world over hit a big problem when they give in to demand and sell gold to private investors. For the damned stuff flatly refutes everything else your financial adviser will tell you.

First, gold doesn’t pay you an income. Indeed, it costs you to own it unless you buy “unallocated” gold, swapping your storage fees for risking your gold on somebody else’s balance sheet.

The charges for owning gold outright, on the other hand, can soon add up to 2% or more of your bullion’s value each year. That eats into your wealth faster than most actively traded mutual fund fees.

So capital appreciation — in terms of your domestic currency — remains the gold buyer’s one hope. And this lack of income sets gold, like all base commodities, far apart from the paper bonds and equity shares that pay brokers their fees and set up commission trails for advisers.

Even if a stockholder doesn’t receive a dividend this year, at least he or she can expect stock price appreciation as the rest of the market bets on future returns showing up soon after the board chooses to split profits with the company’s owners.

At least that’s what Google stockholders must be telling themselves…up there at a price of 54 times earnings right now.

The net result of dividends or capital growth, however, can sometimes prove hard to distinguish. It’s a cash gain either way, whether realized or not. And your financial adviser will always advise that real long-term wealth comes from rolling this year’s earned income back into your holdings.

Reinvesting your dividends like this will then sprinkle the magic of compound interest onto your wealth — “the eighth wonder of the world,” as Albert Einstein once said. And who’d want to turn away Tinker Bell?

But once you’ve built up your wealth, you can’t eat reinvested income. Which is why retirees and pension fund managers know only too well the financial industry’s other great standby: Stocks are for growing your money; bonds then pay out in retirement.

Like most received wisdom, however, this is simply “a bad idea whose time has gone,” as Linda Stern writes. The theory that retirees should keep a lot of their money safe in bonds just doesn’t stack up, she explains, pointing to a study by Tom McGuigan at the Burns Advisory Group in Connecticut. He tested different portfolio mixes against typical retirement withdrawals, testing them over a range of three-decade periods and starting with a 5% drawdown in the first year.

These imagined withdrawals then grew by the rate of inflation each year…and McGuigan’s got bad news for anyone hoping to eat or keep warm at, say, 90 years of age after retiring at 60: Bonds just don’t pay.

“The all-bond portfolio was the big loser,” says Stern. “It only lasted 30 full years in three of the 26 periods tested. But the 60/40 mix…wasn’t that much better. It succeeded less than half of the time, lasting 30 years in just 11 of the 26 periods tested.”

Putting all of your money into the S&P, even during the greatest bull market on record, would have fed and clothed you with only a 69% success rate. “The only portfolio that had a 100% success rate,” the study found, “was a completely diversified portfolio of stocks that included shares of large and small companies and growth and value companies.”

Looking ahead today, however, pensioners and near-retirees — as well as pretty much everyone else trying to grow their money in 2008 — have got to wonder: What happens to that 100% strike rate for broadly invested stockholders if growth now gives out?

Nearly one-third of retirees holding just S&P 500 stocks would have come up short since the end of the 1960s. The only sure route to surviving the full 30 years of McGuigan’s study was to allot a portion of money to small cap and growth shares, as well.

But cut out the ‘80s and ‘90s boom in growth shares and how many “completely diversified” stockholders would have spent the last few years of their life eating from trash cans, instead of feasting at Tootsies?

Throw in the gnawing inflation — and falling stock earnings — of ‘70s-style stagflation and you might come to ask whether stocks now offer anything near a livable income for retirees today.

Trying to live off an “income” paid by gold bullion, in contrast, is a crazy idea no financial adviser would dream of. But at least the dead metal preserved wealth throughout the ‘70s. If inflation keeps rising on the fresh tide of fed rate cuts, gold might just beat stocks and bonds yet again in 2008.

Regards,
Adrian Ash
January 3, 2008

How to Make an Income From Gold was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

THE GOLD PRICE JUST CLOSED OUT NOVEMBER 2007 at an average of $806.25 per ounce, a new record high — and the third record month on the run.

Not that you’d know that from reading the newswires, however. And fair’s fair.

The bull market has just collapsed after all…

“I think you’ve got liquidation,” one trader said to Dow Jones as the gold market sank on Friday, Nov. 30. “The gold bulls [are] throwing in the towel here.”

“When you see so much volatility at the top of the range, that tends to signal the end of the move,” said Richard England, a trader at Standard Bank. “I’d say the risk to the gold price is to the downside.”

Indeed, “Gold’s raving rally is over,” as another metals-head said.

Put another way, selling gold will give investors “an avenue to benefit from the prospect of a stabilization in the dollar,” just as Jim O’Neill of Goldman Sachs advised on Nov. 29.

“We would now use a short exposure in gold, expressed in U.S. dollars, to capitalize on a gradual relaxation of credit concerns in the financial sector over the coming months.”

And just how far does Goldman Sachs think the price of gold will tumble as the credit markets spark up a joint and breathe deep ahead of Christmas? The only U.S. investment bank to actually make money during the credit crunch so far (albeit on paper and marked to model) reckons you can look for a 15-20% setback, driven by a bounce in the U.S. dollar.

Something doesn’t fit, though. “Did you see that the metals desk at Goldman Sachs just recommended gold again?” noted a leading and very experienced gold market analyst to me by e-mail. It begs the question, we agreed.

Is this a political ploy?

After all, the U.S. dollar has never been worth less on the international currency markets. Treasury Secretary Henry Paulson says he believes in a “strong dollar”…yet he’s done zip to beef it up, either with higher interest rates at the Fed or a slowdown in U.S. government debt growth.

And he did use to run Goldman Sachs as its CEO, you know.

“We see scope for acceleration through $770 to retest the $600-650 levels prevailing ahead of the summer,” O’Neill went on, while on Tuesday this week, his colleague at Goldman Sachs in New York, Oscar Cabrera, forecast average gold prices in 2008 of $800 an ounce, up from $687 in 2007.

“We see upside risks to our forecast,” Cabrera added — meaning that the gold market looks likely to rise above even his revised targets.

Better get your story straight, Goldman! Is it time to buy, sell or move onto shorting subprime mortgage bonds that you issued last year?

Conspiracy theories aside, it remains a fact that trying to ride this bull market in gold often feels like trying to get your heaviest friend home after way too much beer. At first glance, the big fella seems an immovable object. Once he’s slumped on the pavement, he stays slumped — or so it looks.

But you know for a fact that he really is making progress. So if you just stick with him, you really will both get home, maybe sometime before dawn. The trouble is, making progress means getting your over-sauced friend up on his feet.

And that’s when the trouble begins.

Soon as he’s up, he starts lurching from streetlamp to streetlamp, shouting at strangers and waving his fist at the cops. The big guy gets mighty quick too, sprinting first into traffic and then straight back onto the sidewalk.

Anyone who gets in his way risks getting squashed under the weight of hops, malt and yeast in his belly. Crashing about, he keeps taking eight giant strides back for every 19 steps forward. And he keeps on repeating — in a slurred, but ever-angrier growl — that he ain’t going nowhere until he’s got a kebab or a pizza to help soak up the booze.

Slow progress still comes, however, as you steer out of the traffic and back onto the sidewalk. Given a chance, you might even get him onto the night bus in one piece.

Sobered up and back at our desks, it’s not just in dollars that gold’s long-term bull market rolls on.

Versus the euro, gold averaged more than €549 per ounce in November, a new 24-year record. Measured in British pounds sterling — against which gold hit five new all-time highs this month — gold in November averaged £389 per ounce, another record high.

Does that mean the gold versus sterling is only sure to keep climbing? No, not at all. But standing 145% above its bear market low of August 1999, gold priced in pounds gives the lie to sterling’s strength.

Yes, the former world No.1 hit a quarter-century high to the dollar this month, up there above $2.12. But it’s been losing against the rest of the world’s money at the very same time, dropping more than 3% for 2007 to date.

And priced against gold, the pounds in my pocket (what few there are) have never been more worthless.

Regards,
Adrian Ash

December 10, 2007

Gold’s Big Drunken Night Out was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

“If you think the U.S. dollar’s losing ground against gold, just take a look at what’s happening to sterling.”

WHAT WILL IT TAKE FOR THE mass of investors to wake up and buy gold?

Are they still waiting for a new all-time high, perhaps, even after watching the metal beat stocks and bonds for more than six years?

Well, a new all-time high in the gold price just came for British investors. You might not think that’s possible, what with the pound sterling now breaking new quarter-century highs against the dollar above $2.06.

You might think it laughable for me to say the pound is weak, given the absurd cost of living here in London. At current exchange rates, a pack of cigarettes cost me nearly $12 this weekend.

Sure, maybe I should quit…but do I also need to stop taking the tube (now more than $8 for a single journey), eating lunch (up to $6 for a factory-made ham and cheese sandwich), or going to the cinema (at least $20 before you buy popcorn)?

The financial media, meanwhile — even when they deigns to comment on gold, formerly the axiom of Britain’s dominant position in world trade and finance at the height of its empire — remain fixated on the dollar price of gold.

Why? Because dear old Blighty is free and clear of the problems causing the U.S. dollar to sink against gold, right?

But not according to gold, we ain’t…

“Debt-ridden Britons owe £216 billion [$445 billion] on credit cards and unsecured loans, but are refusing to rein in their spending,” reports the Metro newspaper given away free on the tube today.

“Consumer debt rose by £1.35 billion [$2.78 billion] last month and total debts, including mortgages, went up by £11.2 billion, to £1.38 trillion [$2.84 trillion].

“It means the country is slipping £15 million further into the red every hour, or £373 million a day.”

Put another way, the British nation is growing its household debts by more than $6 per day for every man, woman and child. That’s excluding the government’s outstanding debt, valued above $1.18 trillion by the end of the 2006-2007 tax year.

In short, personal debt in the United Kingdom — home to the “strong pound” — is now rising by $1 million every four minutes. Total household debt stands above 160% of personal income, and it’s just overtaken an entire year of economic output.

Outstanding government debt, meanwhile, is equal to another 42.6% of GDP, the highest proportion in nearly a decade. It also happens to be 10 years since the British nation last managed to break even on its international trade in goods and services.

Our balance of payments deficit reached more than £48 billion in 2006 (nearly $98 billion), more than 10 times the worst gap of the mid-1970s, back when the trade gap threatened “a violent withdrawal” of foreign investment, according to internal government memos.

Energy Minister Lord Balogh, an economist by trade, privately warned the prime minister of a “possible wholesale domestic liquidation starting with a notable bankruptcy…The magnitude of this threat is quite incalculable.”

The risk of a run on the pound in the mid-’70s became so great — provoked in no small part by government debt hitting 53.8% of annual GDP — that Britain, led by a Labor government just like today, begged the International Monetary Fund (IMF) for a bailout to help it cope as unemployment and inflation reached “exceptional levels.”

The pound began its long descent from $2.42 to barely $1.08 over the following decade, while unemployment rose to 10% of the working population as inflation surged above double digits annually between 1973-1982.

Still, it couldn’t happen today!

“Expect a sustained knock-on impact of the recent credit crunch on the wider [U.K.] economy,” warns David Miles, chief U.K. economist for Morgan Stanley in London. He’s not being alarmist; he’s simply summarizing the Bank of England’s own view, as stated in its recent Financial Stability Report.

In particular, the Bank of England fears the rise in the price of credit will push far beyond the spike in short-term London money market rates. “Partly that is because risk premiums and profit margins for lenders had been squeezed to unsustainable levels,” explains David Miles. “Indeed, in the U.K. mortgage market, spreads had fallen to levels that made it hard to make money.”

Now lenders are looking to make money by lending wisely — and at a profit — once again. Hence the collapse in new mortgage lending seen in September. Down by one-fifth from the same month last year, said the Bank of England this week, new mortgage lending in fact sank by 27% from September 2006, according to the British Bankers’ Association’s latest data.

First-time buyers are “potentially vulnerable” to the threat of falling house prices sparked by this collapse in new lending. Added to higher interest rates — now at 5.75%, from 4.50% two years ago — the “sharp increase in the proportion of new mortgages with high loan to income multiples since 2004 has resulted in interest payments reaching 20% of first-time buyers’ average incomes,” says the Bank of England, “the highest share since 1991″ — the banner year for the last crash in U.K. house prices.

Private investors playing the property market may be even worse off, however. “Net rental yields remain negative,” the Old Lady warns in her ironically titled Stability Report. “Bank staff estimate that after deducting costs, the rental yield was about 2.3 percentage points lower than the mortgage rate in third-quarter 2007.

“Recent investors are relying on continued house price appreciation to earn positive returns, [but] buy-to-let investors have often invested in new-build flats in the United Kingdom, which have experienced much lower rates of price appreciation than houses.”

What about the “smart money” of professional investment funds buying commercial and retail property in the U.K. — the next big thing, according to press pundits and seasoned real estate experts alike? Oops! No, again.

“Recent falls in U.K. commercial property prices and the more persistent falls in yields, along with the potential for overcapacity given a large pipeline of construction, make this sector particularly prone to further shocks and to rises in the cost of finance,” says the Bank of England.

But surely the City of London — the powerhouse of the U.K. economy, now vying with New York as finance capital of the world — will forge ahead, no matter what? The financial services sector has been growing at a greater than 10% annual clip, but the widely respected Ernst & Young ITEM consultancy just halved that outlook in response to the credit crunch now forcing job cuts across the Square Mile. Researchers at CEBR, another London consultancy, believe 6,500 finance jobs will go as a direct result of this summer’s credit crunch.

And gold, meanwhile…dumb, yellow, shiny gold…says the British pound has never been worth less than it is today. In this race to the bottom, all prices are relative, of course.

But the pound sterling could soon become the dollar’s poor cousin once again, just as it was during the global stagflation of the early 1980s.

So while gold priced in British pounds may have lagged the dollar price for the last half decade, it’s just broken a new all-time record — and it looks to be pointing higher again.

Regards,
Adrian Ash

November 6, 2007

Poor Cousins was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.