Gold or stocks: what to hold during the Great Correction

Goldman Sachs says investors will make money investing in either gold or stocks. Are they right?

By , Guest blogger

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    This graphic shows the price of gold over the past 12 months. Gold prices have risen all year, and the stock market is rallying. So where should the far-sighted investor put their money?
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Gold or stocks?

Gold will go up another $300 next year, says Goldman Sachs. Bloomberg reports:

Gold rose 27 percent this year, heading for a 10th consecutive annual advance. Investors are seeking hard assets as governments and central banks led by the Federal Reserve pump more than $2 trillion into the world financial system.

Gold will reach $1,690 an ounce in 12 months, from $1,390 now, and probably peak the following year, Goldman estimates. Gold in exchange-traded products backed by the metal reached a record 2,105 metric tons on Oct. 14 and holdings were last at 2,093 tons, according to data compiled by Bloomberg. That’s equal to about nine years of US mine output.

Hey, making money is easy. Gold goes up every year. If you believe Goldman it will go up another 20% next year.

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But if you believe Goldman, you’ll make money in stocks too. Here’s another Bloomberg report:

The benchmark gauge for American equities will rise 11 percent to 1,379 in 2011, bringing the increase since 2008 to 53 percent, the best return since 1997 to 2000, according to the average of 11 strategists in a Bloomberg News survey. Goldman Sachs Group Inc.’s David Kostin, the most accurate US strategist this year, said sales growth will spur a 17 percent rally in the S&P 500 through the end of 2011.

Market analysts say earnings will hit record highs, keeping valuations below historical averages at the same time government spending aids the economy. Reaching their average forecast for 2011 would give the index annualized gains of 15 percent over three years, twice the rate anticipated by Pacific Investment Management Co.’s new normal theory that anticipates deficits and increased regulation will limit returns.

Kostin, Goldman Sachs’ New York-based strategist who said last year the S&P 500 would end 2010 at 1,250, wrote in a note Dec. 6 that below-average bond yields help create a “superb backdrop” for equities. He expects the S&P 500 to finish 2011 at 1,450, the second most-bullish call among 11 firms surveyed.

So, Dear Reader, you have a choice. Gold or stocks? Goldman says you’ll make money no matter which one you choose.

We’re not so sure. The way we look at it, we’re still in a Great Correction. Trouble is, if you read the newspapers you’d barely realize it. The financial press says the economy is “recovering.” The analysts are calling for higher asset prices. Advisors are overwhelmingly bullish. And shoppers are said to be going back to the malls that once knew them.

And what’s this? Outstanding consumer credit – the key measure of leverage in a society – went up in September and October. The economy isn’t de-leveraging. It’s adding debt, not subtracting it!

But hold on. If you look at the composition of the “consumer” credit figures, you discover that:

1) The total credit numbers are actually going down; it’s the adjustments that make them appear higher

2) The positive (increasing credit) numbers come from government-supported credit (such as student loans)

3) Take out the government-backed debt and you will see an impressive collapse of credit

The Great Correction is real. It’s a fact of life. And it won’t go away anytime soon.

So, what will it be? Gold or stocks?

We’ll take gold.

Stocks are a bet on an improving economy – on growth…on profits…on prosperity.

If we’re really in a Great Correction, it could be many years before the economy begins to grow again.

But isn’t the economy recovering? What, are you kidding? There are 15 million people without jobs. If the economy continues to “grow” at these rates, they’ll never find work again. Every month, the workforce grows with the population. The number of new jobs barely keeps up.

In order to get a real recovery, the economy will have to grow much more strongly. And that isn’t very likely, not as long as so many people are reducing their debt levels and saving for their retirements.

Sooner or later, investors are probably going to realize that the economy isn’t really recovering. They’ve gone for a dozen years with no net gains from stocks. They’re bound to give up, sooner or later. Once they see that this economy will not make their stocks more valuable they’ll begin to shift their focus from capital gains to income. They’ll look for dividends.

But at current stock prices, investors are lucky to get a dividend yield of 2%. Not enough to compensate them for giving up their money. They’ll want 3% to 5%. And in order to get that level of dividends stock prices will have to go much lower – down by as much as 60% or so.

Could gold go down too? Yes. And it probably would – if the feds would permit the economy to de-leverage in an orderly way. Instead, they’re fighting it…digging in their heels…and holding onto the furniture to try to avoid getting dragged along.

They’ve tried monetary policy. They’ve tried traditional fiscal policy. Nothing worked. So, now they’re trying QE2.

Will that do the trick? No. If you could really make people more prosperous by printing money, quantitative easing would be a lot more popular than it is now.

Of course, it won’t “work.” But the feds have already shown that they have no intention of giving up. Obama appointed a bi-partisan panel to figure out how to reduce the deficit. The panel made some modest proposals. And both Congress and Obama himself rejected them. If there is to be de-leveraging of the public sector, it will be over their dead bodies.

Which is the way we’d like to have it.

But it won’t happen soon. Instead, they’ll continue on this route until they can’t go any further. The Fed has already printed up $1.3 trillion trying to avoid the correction. And they’re now working on another $600 billion.

And when that doesn’t work, they’ll probably print up some more…

…and they’ll keep printing (why would they stop?)…

…until the whole system blows up.

THAT’S when you’ll be glad you bought gold rather than stocks.

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