Rich Dad, Poor Economist
July 24th, 2006I want to preface this post by saying that I have read just about every book ever published by Robert Kiyosaki and his team of Rich Dad's Advisors. There have been lots of useful nuggets of financial wisdom and some not so useful. I suppose that is to be expected in a field as broad as personal finance. The passage I want to talk about today is something he just published in his Yahoo Finance article Bet on Gold, Not on Funny Money (click to page 2).
First off, I would like to say that whether or not you believe gold prices will go higher from here is irrelevant. What I want to point out is some very weak economic logic and draw a parallel to some other misinformed thoughts that frequently prevail in markets. In his article he says the following:
Historically, one barrel of oil has been worth about 2.2 grams of gold. Even when the dollar dropped in value, the ratio between gold and a barrel of oil remained pretty fixed. But recently, it has taken 3.4 grams of gold to buy a barrel of oil, which means either oil is expensive or gold is cheap.
I'm betting that gold is cheap, and that it'll correct as oil goes higher and countries such as Russia, Venezuela, the Arab states, and Africa become more reluctant to accept the U.S. dollar. For a while now, we've been allowed to pay for the goods and services from other countries with funny money, but the world appears to be less and less willing to take it as payment.
The key phrase here is historically. Many people, including those who build portfolios using CAPM and Beta use historical correlation as a means of diversifying and/or projecting risk. Rather than assume that the current price pair will revert back to its historical pattern I think it is wiser to ask why it is now different and could that difference go forward into the future. There is absolutely nothing in the field of economics that says past correlations have to hold true into the future. Why does the fact that it now takes 3.4 grams of gold to buy a barrel of oil mean one or the other is mis-priced? It doesn't.
The first sentence of the 2nd paragraph is a little confusing to me. The fact those countries will be more reluctant to accept dollars (weakening the dollar and strengthening gold) has very little to do with the oil/gold pricing relationship. The whole sentence is a non sequitur. In the world of statistics we like to say that correlation does not mean causation. Trying to say gold prices will rise because of their historical correlation to barrels of oil is not the same as saying that gold will rise because of a weakening dollar. I am not quite sure why he jumped from one right into the other. Did he know that the assumption "which means either oil is expensive or gold is cheap" was tenuous at best? Possibly.
I realize that oil is traded on world markets using dollars but that does not mean that the price of oil must maintain correlations with gold. Anyways, can you think of a few reasons why it now takes more gold to buy oil than it has historically? Here are a couple I can think of.
- Oil is now in much higher demand than gold (even as gold reaches multi-decade highs). Therefore, the amount of gold required to buy oil must rise to meet that demand.
- Oil is a consumable. Gold is not. Just about all the gold ever mined is still above ground in some form or another. Oil is consumed and disappears and the ever present search for it continues as its supply diminishes. A change in the quantity supplied can move the price upwards in terms of gold.
I am sure there are many others. In conclusion, don't fall prey to believing that past relationships always have to carry forward into the future. Certainly don't make investing decisions based on that type of thought. Things change for a reason and that reason may very well cause historical price patterns to veer off course for long durations of time.
"Begin challenging your own assumptions. Your assumptions are your windows on the world. Scrub them off every once in awhile, or the light won't come in."
-Alan Alda
Disclaimer: this post is for informational purposes ONLY. Please read the disclaimer before even thinking about relying on me to make a financial decision!
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