A gold enthusiast? Listen to the head — and history.
Barry Ritholtz
Washington Post, January 11 2014




How much money did you make from gold’s spectacular run from under $500 a decade ago to more than $1,900 two years ago? How much did you lose from the 38 percent collapse since its September 2011 peak?

Last year was the first time this century that gold ended the year down from when it began. But gold investors have been making investing and trading errors for what seems like forever.

The mania for gold, like all manias preceding this one, is ending badly. And while gold may yet establish a comeback, much of the damage has already been wrought.

More importantly, did you learn anything from that epic boom and horrific bust? If the savvy observer approaches gold’s rise and fall as an objective history lesson, there are broad principles to be derived and behaviors to be avoided. That is, if humans can ever begin to learn from experience.

Consider the following lessons as applicable to not just gold, but any investment:

1 . Beware the Narrative:

As we noted in July, everybody loves a good story. The narrative form has been around for thousands of years longer than the written word. It is how humans transfer information. We love a tale of heroes and villains and conflicts requiring a neat resolution.

In finance, storytelling is a major part of any sales pitch, and gold is no different. The credit crisis and Great Recession created the perfect environment for the gold narrative to prosper. Bailouts and rescues and global coordinated central bank actions played right into the hands of the gold bug story. Both quantitative easement and zero-interest-rate policies were the perfect foils for what was described as inevitable: The collapse of the dollar (and all “fiat currency”) and imminent hyperinflation.

Instead, the dollar hit three-year highs; inflation was nowhere to be found. Even as the Federal Reserve kept up its policy of “QE infinity,” gold kept heading lower. The problem with all of this was that even as the narrative was failing, the storytellers never changed their tale.

When it comes to investing, there are two problems with that kind of storytelling: It ignores actual data. And it makes investors feel good, regardless of what is actually happening.

2. Carefully Examine New Investment Products:

The creation of the SPDR Gold Trust exchange-traded fund (NYSE: GLD) was a major shift in how investors could buy gold. More commonly called the Gold ETF, GLD was described as “the innovation that opened gold investing to the masses.”

The back story is fascinating. GLD was a creation of the World Gold Council — an organization created by global gold-mining companies for the sole purpose of developing markets — after “two decades of depressed prices and a growing glut of the yellow metal,” as the Wall Street Journal put it.

It was enormously successful: Lipper called GLD the “fastest-growing major investment fund ever.” During its bull run, the fund was buying $30 million of gold daily. By 2012, the SPDR Gold Trust was the second-biggest equity holding after Apple in self-directed 401(k) plans

Salesmen always need something to sell. In GLD, they found a perfect vehicle to pull in the masses.

3. Ignore History at Your Own Peril:

(or, Everything eventually becomes a trade): You cannot be in the market very long and grow attached to anything, as everything eventually disappoints you. I call this my universal entropy theorem of investing, and it is why everything from Microsoft to the 10-year bond, from Apple to gold, eventually goes to hell. (Just look at how often stocks get tossed from the Dow Industrials.)

Gold has frequently had these run-ups only to get trounced eventually. See 1974-76, 1981, 1983-85, 1987-2000, 2008 and now 2011-14.

4. Leverage is Always Dangerous:

Physical gold (like all commodities) is purchased via futures contracts. The leverage involved is typically 15 or so to 1 — meaning, for every $1000 of gold futures you buy, you have to put up only about $67. To buy the same amount of stocks would require $500.

Any investment bought via credit always runs the risk of margin calls and, eventually, liquidation. It was true for the dot-com stocks, for no-money-down houses and for subprime collateralized debt obligations. It is just as true for precious metals.

When you buy anything with lots of leverage, it does not require a whole lot to go wrong to lose it all. At 15-to-1, a mere 7 percent price drop can generate a margin call, meaning you gave have to put up more capital or you lose all of your prior investment. With all of those newbie gold enthusiasts who were inexperienced in the futures markets, it is no surprise that there were plenty of wipeouts.

The CME Group, the world’s largest commodities exchange, was concerned about all this leverage. It acts as both a clearing house for trades and as the guarantor of all contracts. It could get stuck holding the bag in the event of big price swings and bigger losses. As gold rallied past $1,000, the CME Group did the prudent thing — raising margin requirements. Even some pros were caught unaware by the increases.

In September 2011, with volatility increasing, the CME Group raised gold margin requirements by 21 percent — leading to more margin calls, forced selling and liquidation. That marked the high point of the gold run.

5. Understand the Circumstances of the Moment:

In military aviation, the concept is called situational awareness. In a dogfight, pilots have to be aware of everything in all four dimensions — 3-D space, plus how things change over time.

The idea is important for investors, as well. Although gold does well when the news flow is bad, eventually, the cycle will turn. Bad news gets better as the economy recovers, people get hired, sentiment perks up, retail sales improve.

Quite a few gold investors came to believe that the bad economic news had become a permanent condition. They forgot that the Great Depression eventually ended, and so, too, did the Great Recession. They got lost in the moment — an expensive mistake.

6. Don’t Be Unwilling to Walk:

Try this simple thought experiment before making any investment: Ask yourself “What would make me reverse this position — what would make me sell?” Most professionals have a long list of factors. Often, a simple price decrease will get traders to cut their losses.

Not so with gold bugs. Whenever I asked that question — what would make you sell — the most common answer I heard was “I’ll stick with gold.”

This is a dangerous mind-set. It is especially important to have an exit strategy with a “loved” holding — specifically because of that big emotional attachment.

If nothing will make you reverse your biggest present holding, you have a huge, devastating flaw in your approach to investing.

7. Ask What is Already Reflected in the Price:

This is one of the biggest differences between professional and amateur traders.

Pros in the gold market understood what was already reflected in the price — whether it was the Indian wedding season or moves by China’s central bank that had an impact on demand. Genuine surprises that are unknown to the market can move prices. Most of the narratives (See this or this) do not.

8. Don’t Guess:

For people familiar with equity investing, where the focus is on earnings and cash flow, gold can be perplexing. Relative to equities, it has no fundamentals. It also has no cash flow, or earnings, or dividends.

Instead, some people tried to guess the direction of macro issues, such as interest rates, GDP, corporate earnings, debt, unemployment, inflation, and the U.S. dollar, to surmise where gold prices were going.

This is a near-impossible task. It is certainly not a reasonable basis for deploying your capital.

9. Ignore End-of-World Tales, Conspiracy Theories and Other Nonsense:

As we noted in 2011, after a recession, the least rational rise (temporarily) to prominence. My advice then was to ignore them. Why? Because salesmen never let the facts get in the way of a good narrative.

Too many discussions about gold contain ominous forecasts about what the end of civilization is going to be like. Spurious correlations, ominous fear mongering seemed to be a key part of the narrative. Mix in one part dollar collapse and two parts hyperinflation, and the conclusion is you MUST own gold.

The problem is that fear mongering is about what has already happened — and not about the future. The dollar? It already collapsed 41 percent from 2001 to 2008. Inflation? We already had very strong inflation in the 2000s.

Gold is marketed through a combination of fear and dishonesty. At least various equity products are marketed through a combination of hope and dishonesty. It’s a far less depressing sales spiel.

10. Pay Attention to the Skeptics:

Someone challenges the belief in gold, and instead of responding with empirical, data-driven counter-arguments, the true believers revert to personal attacks. Scroll through the comment section of the blog ZeroHedge.com to see the sort of nonsense that passes for debate. A lack of reasoned discourse is overcompensation for a weak investment thesis.


The ups and downs of gold over the past 10 years are not unique. Like any other investment, people became emotionally involved with the trade. Mistake were made, money was lost.

Astute investors will learn something from watching and thinking about other people’s mistakes. Hopefully, you can avoid repeating these errors when the next mania rolls around.


A longer version of this was published at Bloomberg View.

Ritholtz is chief investment officer of Ritholtz Wealth Management. He is the author of “Bailout Nation” and runs a finance blog, the Big Picture. Twitter: @Ritholtz.

Category: Markets

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

18 Responses to “What Can You Learn from the Rise & Fall of Gold?”

  1. eroldictat says:

    God help me, I saw this and I thought you devoted another weekend WaPo piece to gold. I have no special axe either way, but it’s just getting…OLD. I’m very happy for your success, BR, I truly am. But if you will accept a touch of criticism I think you’re getting spread too thin. TBP followers loss, to be sure. I miss your eclectic stuff.

    • I always take last week’s WaPo column and republish it on the blog the following Saturday.

      Also, it was unusual for me, but: I took the monster 2500 word Bloomberg piece and cut it in half, and simplified it for WaPo

  2. brokrbob1 says:

    Excellent article with universal lessons for all investors and all investment vehicles. I don’t know if you listed the lessons in order of importance but if you did, “Beware the Narrative” is rightly numero uno. Nothing screws people up more than a compelling narrative that is correct for a time but comes to an inevitable end.

    I started on Wall Street in 1979, with inflation raging and the Hunt brothers trying to corner the silver market. Gold peaked at 850 (quite a run from 35 in 1971) and spent the next 20 years declining to the secular lows around 250 in 2000. Inflation was a reality throughout those decades but gold declined nontheless. New production techniques (heap-leach mining was the fracking of the early ’80s) had much to do with new supply, but the investment thesis that inflation means higher gold prices was shown to be wrong. Gold is no different than corn or oil or internet startups. Push the price high enough and new supplies appear. The timing may differ but the results never do.

    • constantnormal says:

      “Excellent article with universal lessons for all investors and all investment vehicles. ”

      Absolutely !!! I signed in to add a similar reply of my own, and found you had beaten me to it.

      In my eyes, the things to watch out for are compelling (to the point that fundamentals and the rest of the market are ignored) stories, and the dangers of leverage. Also, the risks inherent in trying to not leave a dime on the table, forgetting that many (most?) bubble collapses occur over a weekend, when the typical investor can only watch their money burn brightly, on its way to becoming ashes …

      I recall a former manager at a company we both had taken early retirement from, who was telling me about how she had the bulk of her retirement savings in the DGP ETN, and was doing spectacularly, back around the time that gold was in its ascendency (~$1600 as I recall) … I wonder (but not a lot) whether she took profits and got out prior to the end …

      Sans leverage, one can make grave mistakes, and occasionally recover from them, bruised and battered, but not destroyed. Crank up the leverage (via options, futures, or even simply 50% margin), and complete destruction is the likely outcome.

      I eagerly await the comeuppance of the banksters, who have a serious addiction to leverage. One can dance in and out of shark-infested waters for a long time (if one is careful), but when one goes for lengthy swims daily, only one outcome is possible … only a matter of time …

  3. MinskyMinded says:

    When an asset class falls 38% it’s probably a reasonable risk/reward to buy.

    Zulauf likes gold.


  4. nick.lamps says:

    My favorite: 3. Ignore History at Your Own Peril

    Nothing lasts forever. Every company is one or two bad moves away from failure.

  5. Ny Stock Guy says:

    Gold was one of those investments that worked out for me pretty well, but mostly because of dumb luck. Back in the 90′s (I think!) I bought a bunch of gold coins at $50 each. They sat in my bottom drawer for 20 years. Two years ago I sold most of them at $1500 each.

    • Yofish says:

      Given that the price of gold averaged around $350/oz in the 90′s that’s the best-deal gold story I’ve ever heard concerning price basis/return. I derive that they were ounces given the price received. I have goldminer friends that dream of that ratio. One has to go back to 1972 to find gold @ that level.

  6. Yofish says:

    The best sentence in this piece: “Consider the following lessons as applicable to not just gold, but any investment”. Everyday, people make bad choices out of hope and fear and this is not just exclusive or peculiar to investing. That some of the Saturday morning TV gold selling extravaganza’s are funny at the same time they are exploitative, doesn’t mean they aren’t any more so than my banker, years ago, trying to get me to take out a HELOC because it ‘was a smart thing to do’. Here in AK, in the 80′s, after the pipeline was built, it was wipe-out city, literally. It’s what all the ‘smart money’ was doing: borrowing money to build yet another stripmall or buy a pleasure boat. I have friends that will never recover from those investing mistakes.

    I get that this is a ‘rub the nose’ in it piece. However, for some of us, PM’s have been a good investment.

  7. odnalro zeraus says:

    We also learned that expected and fought wars cause the price of gold to go up in anticipation of the government deficits increases caused by war expenditures and the expectation of debasement of the currency and high inflation.
    One could have bought gold at around $300 in the years 2001 to 2003, when Afghanistan was attacked in 2001 and Iraq in 2003 and the debt ceiling began to escalate, after five years at rest.
    Lesson # 1 : Buy gold in war time.
    Lesson # 2 : Not everything that shines is gold, but when the US abandoned the gold standard, the US dollar became the world’s reserve currency. It benefited us the most.
    Q3 also became an increment to the deficit.
    Lesson #3 : As wars and Q3 are on the way down and out so is gold.

  8. odnalro zeraus says:

    Lesson #1 : Wars will cause the price of gold to rise, as they are expected to increase government deficits and debase the currency and crate inflation. So when war coming buy gold and get rich, as in 2001 (Afghanistan} and 2003 (Iraq) at which time gold around $300.
    Lesson # 2 : Government deficits, without wars, ( Q3) also bring gold prices up.
    Lesson # 3 : When wars and Q3 are on way out the price of gold goes down.
    Universal rule : Anticipated increases in government deficits will cause gold prices to go up.
    Not everything that shines is gold, but when the US abandoned the gold standards, the US dollars has become the world reserve currency; which has benefited us more.

  9. sdpost5 says:

    Well, Barry is perhaps my favorite analyst of many things financial and many things not financial. I’ve spent some time trying to value gold, and it’s not easy. It got ahead of itself. But at these prices it’s not in bubble territory. At least, it’s not overpriced by a factor of several times. It rose faster than other markets. And there are corrections, in this case so far a more minor correction than we’ve seen with various stock indexes multiple times over the last 15 years. Gold is boring in that it’s static. But it’s funny how gold bugs take so much flak when gold goes down, while stock investors evoke more sympathy when stocks go down.

    There is a lot I could say about this. But central bankers around the world have been manipulating currencies in ways that are unprecedented. I don’t think some exposure to a currency that has lasted for thousands of years while mostly holding its value is irrational at all. Gold has always seen new highs eventually — ask the Germans or Argentinians how gold compares to some of their attempts at fiat. Also, it’s not entirely fair to point out that gold investors use futures while stock investors must put up 50%. In fact, with portfolio leverage, you put up less than 50%. Stock futures are also wildly popular, and were part of the reason for the flash crash. Weird leverage was part of the reason for the crash of 1987. Both of these are as bad or worse than anything the gold market has experienced.

    The gold market is like any other modern market. If you buy and hold forever you should expect a correction. A 38% percent decline however can occur within a bull market runup. So pointing out that gold falls should not spark great epiphany for anyone who pays attention to finance.

    I agree that one needs to be careful. And Barry’s insight is valued and thought-provoking as it almost always is.

    I would be interested to see more about the best ways to value gold. Indeed, a dip in gold is not strictly “bad” for investors who would like to buy into a commodity that has on average held its value for thousands of years. I didn’t want to buy at $2000. But if the price is right, gold could be very attractive.

  10. ch says:

    Apply the same framework to US Treasuries and they start looking very much like gold at $1900 in 2011.

  11. darkstar says:

    Gold has tracked the money supply pretty closely – they’ve both gone up at about the same rate since 2000 – until a couple of years ago, when they decoupled. Why that happened, I don’t know – deflation? Fed conspiracy? Gold got ahead of itself? – I don’t know and I don’t know that anybody else knows for sure either.

    But one thing I do know – I’ve never seen hatred for an asset class this intense since, I don’t know – equities in the spring of 2009? And gold mining stocks are hated even more than the metal. So maybe now’s a great time to buy – with a stop loss if gold closes for the week below 1180. Not buying at 1200 might prove to be as big a mistake as buying at 1800. We’ll see.

    • 3 responses:

      1) There are no such thing as toxic assets, only toxic prices. The issue may not be that Gold is hated per se, but when it was up 500% over 5 years, that might have been a factor.

      2) As John Updike said, “Gold loves bad news” — you can see that in the narrative the gold fans tell, and, when Gold is doing well, everything else is usually in the crapper. Hence, it often is a harbinger of bad mojo. Its not so much disliked as the environment it thrives in.

      3) Bonds today are about as hated as any asset class ever was; Equities were hated for the first 150% of this rally, but people have started to come around to the idea of them.

      4) Don’t underestimate the jackass factor when it comes to gold. Quick, name the 5 biggest goldbugs you can think of — how many of them are not D-Bags?

  12. ch says:

    Not 1 in 100 American financial types or analysts understand what has occurred in gold since the peak in September 2011 & continues apace to date.

    To paraphrase Barry, “there isn’t good news or bad news, there’s just change.”

    The world has decided it doesn’t want to use UST’s as the global reserve asset anymore, & they understand that a gold futures contract underwritten by the US/UK authorities is no different than a Treasury bond. That’s why foreign nations & investors (and Goldman Sachs) are buying so much physical gold & why the futures price of gold has collapsed in the face of record physical demand.

    There is a growing mound of evidence that the world is departing the UST as reserve asset. Simply because most US commentators choose to ignore that growing pile of evidence does not mean it ceases to exist.