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May 29, 2013

DOUG #KASS: The Case to Buy #Gold

   • There is a time, place and price for every asset class.



   • Gold gets dug out    of the ground in Africa, or someplace. Then we melt it down, dig another hole,    bury it again and pay people to stand around guarding it. It has no utility.    Anyone watching from Mars would be scratching their head.

   • The problem with    commodities is that you are betting on what someone else would pay for them in    six months. The commodity itself isn't going to do anything for you.... [I]t    is an entirely different game to buy a lump of something and hope that    somebody else pays you more for that lump two years from now than it is to buy    something that you expect to produce income for you over    time.

   • Gold is a way of    going long on fear, and it has been a pretty good way of going long on fear    from time to time. But you really have to hope people become more afraid in a    year or two years than they are now. And if they become more afraid, you make    money; if they become less afraid, you lose money -- but the gold itself    doesn't produce anything.

   • I will say this    about gold. If you took all the gold in the world, it would roughly make a    cube 67 feet on a side.... Now for that same cube of gold, it would be worth    at today's market prices about $7 trillion dollars -- that's probably about a    third of the value of all the stocks in the United States.... For $7 trillion    dollars ... you could have all the farmland in the United States, you could    have about seven ExxonMobils, and you could have a trillion dollars of    walking-around money.... And if you offered me the choice of looking at some    67-foot cube of gold and looking at it all day, and, you know me, touching it    and fondling it occasionally.... Call me crazy, but I'll take the farmland and    the ExxonMobils.

   • The major asset in    this category is gold, currently a huge favorite of investors who fear almost    all other assets, especially paper money (of whose value, as noted, they are    right to be fearful). Gold, however, has two significant shortcomings, being    neither of much use nor procreative. True, gold has some industrial and    decorative utility, but the demand for these purposes is both limited and    incapable of soaking up new production. Meanwhile, if you own one ounce of    gold for an eternity, you will still own one ounce at its    end.

   • What motivates most    gold purchasers is their belief that the ranks of the fearful will grow.    During the past decade, that belief has proved correct. Beyond that, the    rising price has on its own generated additional buying enthusiasm, attracting    purchasers who see the rise as validating an investment thesis. As "bandwagon"    investors join any party, they create their own truth -- for a    while.

   • I have no views as    to where it will be, but the one thing I can tell you is it won't do anything    between now and then except look at you. Whereas, you know, Coca-Cola will be    making money, and I think Wells Fargo will be making a lot of money and there    will be a lot -- and it's a lot -- it's a lot better to have a goose that    keeps laying eggs than a goose that just sits there and eats insurance and    storage and a few things like that.

 

-- All  of the above quotes are from Warren Buffett

In many  ways, I have shared Warren Buffett's skepticism on gold, as expressed in his  seven quotes above.

Also,  in support of Warren's ursine view of the precious metal, is Oaktree Capital  Management's Howard Marks, who has written that gold is a lot  like religion. In religion, you either believe in God or you don't. In the gold  market, you either believe in gold or you don't. 

In the  past, I have agreedon the subject of gold with both The Oracle of Omaha  and The Oracle of Oaktree. In fact, I recently debatedwith Peter Schiff about gold, providing the bear case  for the asset class (albeit, at much higher prices).

In  essence, the gold market is a state of mind -- the subject of gold is an  emotional one. It neither represents a corporate franchise that increases over  time as profits are earned and retained such as, say, Procter & Gamble ( PG), with a protected  moat -- nor is it a productive asset. As such it is hard to ascertain what the  intrinsic value of the commodity is.

On the  latter point, gold doesn't produce profits or cash flow and, as such, fails to  provide a stream of income. Its future price is simply dependent upon someone  willing to pay more for the asset class compared to its  price today.

While  it might take time for the price of gold to build a real bottom, there is a  time, place and price for every asset class.

Why  Now?

This  morning, I paid $133.30 for SPDR Gold Trust ( GLD) in premarket  trading.

Below I  will discuss my reasons for building a position in gold over the next few weeks  and months.

Expectations  for the price of gold are now low and diminished . Gold  experienced a speculative blow-off top 18 months ago as the European debt crisis  peaked, the threat of a U.S. default ceiling rose and coincident with the debt  rating of U.S. being lowered.

A most  unpopular asset class provides a contrarian's appeal . Weak  price action since September 2011 has created an improved reward vs. risk. Hereis  the price of gold since 1833. And below is a chart that follows the price of  gold since 1970.

As you  can see, the price of gold is more than $500 an ounce below the fall 2011  peak.

Last  month's gold selloff looks like a selling price and volume  climax . That  first day of the mid-April collapse was a near 5 standard deviation move lower  (or every 4,700 years) on huge notional volume of $20 billion. On the following  Monday, gold took an even greater beating. Over the two-day period, there was a  8 standard deviation event, which occurs statistically about every billion  years.

Negative  sentiment extreme . The  sharp price drop in gold has brought on a growing short  position.

With it  lies the seeds for a potential short squeeze or perhaps some latent demand from  short sellers.

The  growing consensus view of an acceleration in the rate of global economic growth  may be too optimistic . As  such, not only might the recent rise in real interest rates be nearly over (as  it holds the seeds for detracting from growth) but it raises the prospects for  more QE, lasting much longer than many market participants  expect.

The  U.S. dollar's recent strength might peter out . A higher U.S. dollar  is typically seen as a gold negative. But the recent strength, reflecting a  growing consensus of Fed tapering, might be  short circuited if global growth moderates.

More  currency debasing lies ahead . The  currencies of all the major countries, including ours, are under severe pressure  because of massive government deficits. The more money that is pumped into these  economies (the printing of money, basically), the less valuable the  currencies become and more valuable gold is.

Inflation  is gold's friend . The  world's debt load cannot be paid back in constant dollars. Reflating (and  inflation) seem inevitable (though inflation may lie out into the distant  future) and is the natural outgrowth of monetary policy.

Tail  risks remain . I  don't subscribe to the notion that all economic tail risks have been eliminated  nor that the shoulders of growth will be borne by monetary policy. Rather I view  an upcoming "aha moment," in which it becomes recognized that easing is losing  its impact as the Fed is pushing on a string. Again, QE might be with us for a  lot longer than many anticipate.

Demand  for physical gold is rising . It is  interesting to note that when the price of gold had its two-day crash in  mid-April, the price for physical delivery (gold coins, etc.) held better (the  premium increased) than future prices. (View about 33 minutes, 50 seconds into this  presentationby Grant Williams.)

Previously  bullish brokerages have given up on gold . Credit Suisse , JPMorgan and Goldman  Sachs have recently slashed their gold price projections. I view  this surrender as consistent with a possible contrarian  signal.

Summary

Recognizing  that the intrinsic value of gold is difficult to evaluate, now seems a  propitious time to consider diversifying some portion of one's portfolio into  gold.

There  is probably no better time to consider diversifying one's portfolio into a  depressed asset class (e.g., gold) than when the crowd is optimistic about a  vigorous and self-sustaining global economic recovery and when the world's stock  markets are at record high prices.

Gold,  which had a speculative blow-off to the upside back in 2011 (18 months ago), now  appears to have had a selling climax last month.

Investor  sentiment toward gold probably can't get much worse, and the growing optimism  regarding the trajectory of global economic recovery may not get much better in  the weeks and months ahead.

Position: Long  GLD

 

Douglas  A. Kass

Seabreeze Partners Management Inc.

 

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