# “Answers” to Hedge Fund Analyst Quiz on Gold

We pick up from we were last: http://csinvesting.org/2016/02/11/analyst-quiz-part-ii/

Analytical point #1: CPI is a meaningless measure to determine the future dollar price of gold.  CPI is an arbitrary government statistic. You are comparing gold in US Dollars (apples) with an index of oranges, grapes, raisins, etc.)

You must have mentioned this to stay employed at Ackman’s hedge fund.

#### The Futility of Price-Inflation Measurements

The practical problems with price indexes such as the CPI are the issues of which prices are to be measured and what “weights” will be assigned to what goods. Another problem is deciding what to do about changes in quality. For example, what do you do when Apple introduces a new and improved iPhone at the same price as the previous version?

To deal with this, government statisticians systematically increase the weights for goods that are going down in price and reduce the weights of things are going up in price. If the quality of a good goes up, the statisticians “hedonically” reduce the price of the good.

Those sorts of adjustments do not seem fair to most normal people. If you are eating more ramen noodles and fewer lamb chops you can take little comfort in the fact that that the CPI is staying inside the Fed’s target range. Moreover, under the system of hedonic adjustments, every time entrepreneurs and engineers come up with better products for consumers at lower prices, the Fed takes credit for keeping inflation under control.

https://mises.org/library/many-failures-cpi

Why hasn’t the CPI picked up since 2008? https://mises.org/library/problems-cpi

The first thing to keep in mind is that the CPI is not an economic variable. It is a statistic that at best gives an inaccurate picture of an economic phenomenon: inflation. To calculate the monthly CPI, the US Department of Labor takes a weighted average of prices of various things that consumers purchase, and then its statisticians try to figure out the various proportions of different items in a “mythical” household budget. For example, the statisticians may hold that housing costs are 30 percent of household expenditures, food costs 20 percent, gasoline another 15 percent, and so on.

https://mises.org/library/whats-wrong-cpi

Analytical point #2: Gold maintains its purchasing power over

L O N G periods of time. Gold is the “golden constant” (Jastram).  Look at research over the past 600 years: : RoyJastram-TheGoldenConstant

Jastram arrived at four conclusions:

• Gold is a poor hedge against major inflation. (Jastram finished his book in 1977, only 6 years after the link between gold and the dollar was broken. For the period prior to 1971, gold was fixed in price to the US dollar or British Sterling.
• Gold appreciates in operational wealth in major deflations. Of course if gold is money (it is!) then it should appreciate relative to the goods it can be exchanged for.
• Gold is an abysmal/ineffective hedge against yearly commodity price increases.
• Nevertheless gold maintains its purchasing power over long periods of time. This is not because gold eventually moves towards commodity prices but because commodity prices return to gold.

In contrast in the late twentieth and early twenty-first century it was the market price of old which adjusted so that the purchasing power of gold relative to general prices returned to a constant.

Other main points to glean are:

• Gold is money – J.P. Morgan
• Gold maintains its purchasing power over decades but not necessarily year-to- year.
• Gold at the “Attila effect.” Jastram points out that throughout history men and women have turned to gold in times of distress, whether political, economic or personal.  Gold is sought for two basic needs: the imperative to survive and to be secure; and the desire to possess and enjoy beauty.
• Gold, unlike all paper-based assets, is no one’s liability. It therefore has a near-unique “safe-haven” quality since its value cannot be eroded by any declining of the creditworthiness of its issuer unlike fiat currencies.

In choosing the title The Golden Constant, Jastram did not imply that there was an absolute mathematical rule to which the purchasing power of gold adhered, but rather that gold exhibited the qualities of constancy in a wider sense. The fact that gold is almost immune to corrosion, rust or decay is one element of this. The metal has an enduring attraction for humankind. Also, the purchasing power of gold, while in fluctuation, returns over the centuries and in different countries to a broadly stable level is testament to all these elements of its constancy.  How many grams of gold to purchase cattle in Rome vs. today in Cedar City, Utah?  Not much difference despite the thousands of years of time and the different local.

You then advise Ackman that if investors lose faith in Central Banks’ ability to manipulate both credit and investors, then gold might be a safer place to hold wealth than dollars.  You then instruct Mr. Ackman to carefully view this video.

In all seriousness, you should have learned two concepts:

Be careful in comparing data sets.  CPI is useless.

If you choose to research an asset or money, then study ALL its history. Don’t look at just the most recent past.