When to sell your gold?

November 5th, 2009

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Our long time readers know that we are very much in favour of gold. All our articles about gold are in the context of an entrance strategy into gold (e.g. our book How to buy and invest in physical gold and silver bullion).

But what about the exit strategy from gold? When is it time to sell gold?

Even though the season to disinvest in gold is still quite a long time away, investors have to be very clear in their minds when the right time for an exit is. Otherwise, they will end up like the fictional Mr Goldbug mentioned in our book.

To understand the answer to this question, we must first understand clearly the reasons for getting into gold in the first place. Our book has a very clear exposition on that. Also, when we use the word “gold,” we mean physical gold, not financial asset disguised as ‘gold’ (see Is long gold mainstream? if you do not know what we mean).

As we wrote in our book,

Remember, gold will only do well in times of economic disaster?in every other time, the investment performance of gold is mediocre.

Thus, we will repeat this point again: gold is not a hedge against common types of? price inflation. Instead, it is a hedge against the loss of confidence in fiat money (extreme price inflation is a symptom and warning of such) and the financial system (price deflation is one of the possible symptoms of such).

Each step of the path towards economic disaster will see the rising price of gold. Initially, the bull market in gold is still confined to ‘gold’ (i.e. financial assets disguised as gold). As long as the masses have yet to switch from investing in ‘gold’ to gold (i.e. physical gold bullion), it means that there’s still confidence in fiat currencies and the financial system. This is because ‘gold’ is still denominated in terms of fiat currencies, which means the yardstick to measure the value of ‘gold’ is still in fiat currencies. So, while a bull market in ‘gold’ is still in progress, the complete breakdown in fiat currencies has yet to occur.

Of course, should sound monetary policies emerge at that time, it is time to sell your gold. You can learn from what happened in the 1980s. As we wrote in Peering into the soul of Ben Bernanke,

Paul Volcker, the chairman of the Fed in the 1980s, is the anti-thesis of Ben Bernanke. He was credited with ending the US?s stagflation crisis in the 1970s by crushing the economy into the worst recession since the Great Depression. To do this, he had to raise interest rates to unbelievably high levels, to the point that in 1981, interest rates charged by banks exceeded 20 percent (Note to Australian readers: the Labor was often blamed for the super high interest rates of the 1980s. Now you know where such high interest rates come from- such high interest rates was a global phenomenon). Paul Volcker crushed severe inflation by crushing the growth of money supply.

So, should someone like Paul Volcker take the reins of the Federal Reserve and dishes out really tough medicine, you know it is time to sell your gold. Those gold bugs who fail to see this and hung on to their gold obstinately suffered serious losses.

As the economic and monetary system deteriorates further, it is only a matter of time when confidence in fiat currencies will be completely eroded. By that time, the bull market in ‘gold’ will become a bull market in gold (the real, physical ones), which will eventually become a mania at the peak of the hyperinflation. The extreme pain of hyperinflation will eventually trigger monetary reforms. Assuming that the successor of the completely broken fiat currency is based on a much sounder monetary system, then as we wrote in Is deflation inevitable?,

When that happens, confidence is finally restored to the newly introduced money, which will have the immediate effect of price deflation. Deflation will happen because people no longer fear that their money will lose value and no longer need to spend it immediately (i.e. demand for money increases), which decreases the velocity of money.

This will also be the time to sell your gold for whatever the successor money is (unless gold itself becomes money).

If the successor is another fiat currency system, then the cycle will repeat once again. Hopefully, the next breakdown will happen outside your lifetime.

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