Gold is Safer than Treasuries as Hedge Against Inflation

“Truth, like gold, is to be obtained not by its growth, but by washing away from it all that is not gold.”

-- Leo Nikolaevich Tolstoy

Any time an asset increases in dollar terms, you have to ask yourself two questions:

1. Is the asset rising alone, relative to the rest of the economy? 

2. Or is the asset rising in value along with everything else in the economy?

If, for instance, you had bought 1000 shares of Microsoft in 1988, you would have seen their values rise dramatically over the next decade, while most other asset values stayed relatively low across the economy as a whole. If, however, you had bought, say, shares of Coca-Cola in 1995, you would have seen the value of those shares rise only slightly over the next decade, relative to everything else.

On to my favorite subject. If you buy gold, and it gains value in dollar terms, what does that mean? If you buy an ounce of gold at $100, and it goes to $1000, what what are the implications? Has everything else in the economy risen by 900% as well? In an environment where the money supply is expanding, and prices are rising, you need to make sure the assets you buy can outpace the currency collapse caused by inflation. I'm short treasuries right now, and my rate of return over the last year has been strong. But clearly prices in the economy haven't risen at the same rate.

My prediction regarding Treasuries -- and the reason I shorted them -- resulted not from my belief that Treasuries are no longer perceived to be the safe store of value they once were. The U.S. has printed an unprecedented amount of currency, and as these dollars hit the economy, prices and interest rates are going to skyrocket. I believe that, while investors mistakenly believed Treasuries were a safe store of value -- driving yields to historical lows -- they have now realized the folly of that assessment, and they are beginning to run from Treasuries as fast as their little legs can carry them.

The last year has borne some of this out, but it hasn't yet happened anywhere near the magnitude it eventually will. As I said, Treasuries are falling because of the return of risk-appetite -- not because of a perceived loss-of-quality. And that's why I believe shorting Treasuries was -- and still is -- a no-lose proposition: whether people eschew faith in them or not, yields are going higher, and if my prediction is correct, they're going much higher -- rather than returning to, say, the historical average.

So let's say my prediction is correct. Let's say the massive inflation the government is creating right now is going to drive prices and interest rates higher. Obviously, my Treasury short would benefit greatly, but what will gold do? And this is really what it all boils down to: for several years, gold and Treasuries moved nearly in tandem. They were both perceived to be of high quality. But despite the Fed's best efforts, yields on Treasuries have climbed over the last year -- even as they continued to be perceived as safe.

If I'm right -- if the world is losing faith in Treasuries and the dollar -- the first sign of it has been the decoupling of the price movements in gold and Treasuries. In other words, Treasuries continue to lose value as gold compounds its upward march, and that's why I continue to think I'm right -- that we've entered into a new economy. The world is beginning to shun the dollar and Treasuries as viable vehicles for the storage of value.

And would wouldn't investors lose faith in Treasuries and the dollar? Why on earth would investors be fleeing to Treasuries and selling gold? That makes absolutely no sense, and in the long-term, I'm certain we're going to see an absolute reversal of this trend.

Nothing, in my opinion, is more important or germane to the future direction of the global economy than the relative price movements of Treasuries and gold right now. This is the place where I'm focusing all my attention, and it will be very interesting to see how it all plays out, because I think we're on the threshold of a historic event -- or, more appropriately, a series of events.

For the time being, bear in mind that falling prices right now are not a product of deflation -- they are a product of deleveraging. Deflation, by definition, is a decrease in the amount of currency available, and the Fed is increasing, not decreasing the amount of available currency.

You folks have a great day. I'm going to go get a grill. Putting my money where my mouth is.


As it were.