The Midas Touch

What a difference a few days make. I planned on making this post last Thursday after a client meeting where the discussion included the pros and cons of an investment allocation to gold. My basic premise is no truer today than it was before gold's plunge in price Monday, but it would have given me a few bonus points to state my thesis on gold before the dramatic sell off.

The case for gold in a portfolio like the case for any precious metal is difficult to make. The theoretical support would be that it is a good inflation hedge, an historical store of value across societies and time, and uncorrelated with most other investments. But that is where the difficulty begins because those beliefs are not as ironclad as goldbugs would have you believe. In fact the most important theoretical support for gold, inflation hedging, seems to be the weakest case of the three. We'll get to that in a second, but first let's consider what gold lacks.

Gold lacks industrial use. It is not a capital good. It is a consumer good. So is bread, Travertine tile, and 55"-LED LCD TVs. Unlike bread, it won't go bad, but also unlike bread, it won't do you a bit of good if you eat it. It is durable like Travertine tile, but a lot more expensive--so much so that someone might try to steal it, which makes it expensive just to protect. One ounce of gold will buy you a pretty good TV. At the margin, I'd rather have the TV. Already there is something funny about using this soft, yellow metal as an investment asset.

Here are two of the top seven Warren Buffett quotes on gold as told by Minyanville:

3. "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."

4. "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 – that’s probably about a third of the value of all the stocks in the United States…For $7 trillion…you could have all the farmland in the United States, you could have about seven Exxon Mobils (NYSE:XOM) 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 Exxon Mobils." [Note: The price of gold has changed since this quote was made. The gold would buy much less today.]

The first quote alludes to a chief problem many including myself have with gold as an investment--it has no cash flow. Aside from a potential positive roll yield when the futures market is in backwardation, a gold allocation generates no gains but does have substantial costs to maintain (transactions, storage, and carrying).  And realize that not having a cash flow of any kind (direct to the investor like a dividend or interest payment or indirect to the firm like a profit stream) means we can only value it based on the amorphous idea that someone does and will want it at a future date at a price attractive for us to sell.

Let's now turn to the historical record. To be a good inflation hedge, an asset should have a high correlation to inflation along with relative outperformance of inflation--when inflation is high, the asset is high or higher and when inflation is low, the asset is low or not as low. The first part is crucial. We want our inflation hedge to come through in the clutch. The U.S. left the gold standard in April of 1968 allowing gold to freely float when priced in dollars. It is at this point that it became investable as a theoretical hedge against dollar inflation.

Well, for the period April 1968 through April 2013 gold has only about a 13% correlation to CPI, which is to say they have basically been uncorrelated over this time span. The correlation doesn't improve much in the high inflation days of the late 70s and early 80s. The S&P 500 was even more uncorrelated with CPI at about -10%. But for what it gave up in correlation, it more than overcame in return. [UPDATE: the correlation between gold and CPI for the 1973 - 1985 period is only about 14%.]

Looking at the total return from owning gold to owning the S&P 500 with dividends reinvested over this time span, the comparison is not close. The S&P 500 returned over 6,850% while gold returned over 3,560% (see chart below). [Note: The source for these calculations is the St. Louis Fed's FRED. When using Bloomberg, I get somewhat different results for gold, about 4,400%. I will try to get clarification on this calculation to verify why there is a discrepancy. UPDATE: Looking further into the Bloomberg data it seems that the historical gold price is a composite and that the TR calculation is much closer to the FRED data, about 3,843%.]

This return difference is impressive. While gold was in the lead for two decades, the S&P 500 made a strong comeback to take over. Only the recent run up in gold has helped the yellow metal gain some but not all ground. And notice the long lulls for gold. This is another knock against it. For someone retiring in 1984, it would not have been a very good store of retirement value.

Over the full span the S&P 500 is over 50% higher in value. To understand how big that is think about everything you own and then imagine not having half of it.

Gold beckons you to enter, but there is no disguising what I fear.
To love the gold investment, the golden words poured into my ear,
there must be another whose heart is cold
He loves only gold.

Thinking like an economist at the Sooner Club Tailgate

As part of the benefit package associated with being a large enough donor to The University of Oklahoma Athletic Department, our group gets two complimentary passes to the Sooner Club Tailgate before each home football game. The event is described as:

Before each home football game, more than 5,000 Sooner Club members are treated to a variety of complimentary food and beverages provided by more than 40 local restaurants and vendors. Special entertainment is provided by the Sooner spirit squads, the Pride of Oklahoma marching band, and our own emcee and DJ.

It is held inside the Mosier indoor practice facility originally used by the football team (before the Sooners discovered the forward pass circa the 1990s—the roof is too low) and currently used by track & field teams. It is almost as large as a football field inside. The overwhelming majority of the floor space from the middle out is occupied by tables and chairs while the surrounding sidelines on both sides host the various vendors of food and beverage.

While I don't actually over analyze this opportunity as described below, I thought it would be a good thought experiment to explore.

Here are some relevant facts to consider as I try to think like an economist:

• The event opens 2.5 hours before kickoff; I like to be in my seat at least 45 minutes before kickoff.
• I generally will be on campus 2.5 hours prior to kickoff--I am already in the area naturally but on the other side of campus. I enjoy eating something before the game and I always have done so.
• The line to get into the tailgate begins forming outside the doors about 30 minutes before it opens. Getting to the front of the line would mean leaving 30 minutes earlier from my house.
• The event is very crowded for the space and lines are present at nearly every vendor booth constantly.
• Vendors often run out of some items. Occasionally, one will run out of all items.
• The event is about a half-mile walk out of my way, which would mean, of course, a half-mile extra in return.
• There is a good variety of food offered considering only tailgate-likely foods. The food is very similar to what is offered elsewhere inside and outside the stadium. More on this in the strategy below.
• Generally, I attend the tailgate with my 8-year-old daughter.
• Just to be clear this is an all-you-can-eat event including all-you-can-drink with soft drinks, bottled water, and beer offered. The beer offered includes real beer like Shiner Bock and that from the local microbrewery Coach’s Brewhouse along with nonsense like Budweiser, Bud Light, and other forms of badly flavored water.
• The two complimentary Sooner Club Tailgate tickets are part of the package for the stadium tickets my group purchases including the season donation. Receiving the tickets cannot be avoided and does not factor into our decision to purchase our stadium tickets. Regardless, once I’m at the game, it would be a sunk cost even if we had explicitly purchased the tickets for the purpose of attending the tailgate in the future. More on this in the strategy.
• You basically can’t take food or drink out of the event, but only beer is really monitored. A bottled water or some of the packaged goods like Hostess donuts pass inspection. The layout of the facility and its surroundings preclude the risk that someone would make a repeated run in and out distributing food to outsiders.
• A normal plate at one of the vendors inside the tailgate would probably be priced outside the tailgate on game day at between $8 and $12.

Here are some irrelevant facts to disregard:

• The Sooner Club sells tickets at the door priced at $30 for adults and $15 for children 12 and under. Since it is just me and my daughter and we have tailgate tickets already, these price points are not important. This is the first lesson. To determine the value of the event to me, I must consider my opportunity cost in obtaining it--the value of the next best alternative foregone. The price of the tickets at the door is not relevant.
• A normal plate at one of the vendors would probably be sold at the vendor's primary place of business on a normal day at between $5 and $8. Also not relevant and in this same vein, a hot dog in 1940 cost $.30.

Here is my thinking and strategy:

Do I attend?

• If the weather is bad (rain or snow or high, very cold winds), the decision not to attend the tailgate is easy. The walk over is unprotected from the elements. I’d rather stay warm and dry in the Student Union and pay for the same meal. The price of my food thus at most equals the amount at which my daughter and I value being warm and dry. Remember, the tickets, even if explicitly purchased before the season, would be a sunk cost at this point.
• Otherwise, I will generally attend unless there are some special circumstances like meeting friends from out of town before the game. Again, the price of food purchased as an alternative would be equal to or less than the value I place on meeting the friends. So far this year I am 3 for 3 in attendance. I must need better friends :).

Do I get there early to get to the head of the queue before it opens?

• No. The food is good, but that isn't really important. It must already be good enough because I am attending. What matters is the range of opportunities within the tailgate (the best food relative to the worst food), and all this leads us to the expected food. Remember that I said vendors do run out. Presumably the highest demanded food has the greatest chance of running out. Also, there are varying lines of people within the tailgate waiting to get each vendor’s food. The best food will have the longest and quickest forming lines. So, I was wrong before? Here is where thinking like an economist helps and leads me to the answer not to get there early.
• It is unlikely that there is much difference between the vendors for the typical consumer. If you have very atypical tastes, this might be a reason to get there early. More likely it would be a reason not to attend as the cost would be too high. Snobby foodies can’t afford to attend “free” tailgates.
• If there were much of a difference, the line to get in would form that much earlier and the fight inside would be that much more intense. It is hard to beat the crowd when price is not a rationing tool.
• I like to watch as much football as possible on Saturdays. My daughter can't walk as fast as me. Leaving early or rushing across campus to get to the front of the line is costly. And we can safely assume it isn't worth it. The food isn't likely to be that much better than the competition outside, isn't likely to be greatly different once inside, and isn't likely to all run out—not if the Sooner Club really intends this as an enticement to be a big donor. 

Am I picky about what I get to eat?

• No. While not snobby, I do consider myself a foodie. The food here is good, and some is better than others. Do I scout out my options on the website before the game knowing some vendors drop in and out? Do I do an initial recon mission once first in the facility to plan my attack? No and no. Remember, there is a limit to how good and how bad the food can be, and the internal lines will smooth out the differences for the typical consumer. I do consider myself fairly typical in this case.
• An example: Bubba’s BBQ is very good. Burger King is an average burger. Bubba’s BBQ is at the back, and the line moves slowly. Burger King is at the front and is quick. There are a lot of trade offs here, but they most are negligible except for my time. The marginal benefit of the BBQ over the burger is greatly outweighed by the marginal cost of 10 minutes longer spent waiting. My goal is to get in, get something decent to eat, get over to the game.
• You just can’t go that wrong or that right in this situation. There is no grand arbitrage to be played here. Grab some food. Attempting to find the optimal solution is costly to the point of ridiculous. The margin of error on food choice is much, much lower than the risk of wasting your time. In short, you're fearing regretting the wrong thing (food choice instead of time spent).
• The one area where I will exert a little choosiness is beverage. My preference is beer, but my first choice, Coach's Brewhouse, is usually out of reach because the line is too long. Moving down the preference chain until time spent is worth the taste usually lands me at Blue Moon or Shiner Bock. Again, the best choice is made at the marginal trade off.

How much do I eat?

• It is not that good; hence, it is not worth getting stuffed. In fact, I think the risk of overeating is high; so I am careful to be moderate--unlike I was in expounding upon this post.