Saturday, June 12, 2010

Gold - Part 1

Gold.

What do you think of, immediately, when you read that word and think of gold? What image is conjured in your mind?

Is it of an overflowing treasure chest, perhaps recently dug up by a very happy pirate? Or perhaps of Fort Knox, with stacks ceiling high of shiny gold bars? Or maybe of the wealth of royalty and the church - crowns, chalices and crosses?

If you thought of any of these things, or something like it, then you would probably be normal! The interesting thing about all of these images or perceptions of gold are that it's a) Very valuable and b) practically unobtainable by normal people.

Here is the thing though, at this point in time gold is not particularly valuable and is obtainable by anyone. You may think that US$1200/AUD$1400 or so (as of when I write this) is a lot of money. However, it isn't when you think of the wealth of kings or the church, or to look at it in another way, compared to the $ value of debt in the world. If you think of the cost of the average house, you could buy many kilos of gold for this. So, the perception that gold is unobtainable is currently false. I say currently, because it is quite possible that this perception may become reality in the future.

The other interesting thing about how most people view gold is that they do NOT view it as money. Some gold coins are stamped with a dollar value, but that is so low compared to the cost of the metal content nobody in their right mind would trade a coin for paper currency. No, gold is not considered currency. You can not pay your electricity bill with it.

It is worth pointing out that in Zimbabwe, where hyperinflation has destroyed the local currency, gold is a currency. Grains of gold can be used to by groceries. When things go very, very badly wrong with the paper currency, gold can be used. Why would people trust it more than paper? Well, in Zimbabwe's case they simply added more zeros to the paper until it was worthless. Gold can not be wished into existence, it must be mined and this takes effort. It's rarity and lack of manipulated supply is part of it's allure.

While I'm on that line of thought, what makes gold special? Why do people like it, or value it? This is worth trying to understand, as it will have an impact on the value of gold in the future as events play out. As just mentioned, limited supply is one factor. What else? Well, as a member of the Periodic Table of Elements, gold is a fundamental particle, and can not be manufactured. People have tried, for years, and you just can't do it (unless you have something like the LHC, which is not exactly a practical solution).

Gold has some rare physical properties too, that I think are important factors. It does not oxidise, which in practical terms means that it stays shiny forever. This everlasting quality is why it is seen as a store of wealth. Unlike other investments, time does not affect it. A lump of gold given to you when you were born will be the same lump when you are 100 years old. Humans like shiny things, it makes them visually interesting. Don't underestimate this as a factor.

Gold is also a pleasant colour - light yellow. It can be white (more silver content) or pink/red (more copper), but the purer it is, the yellower it gets. Most metals are grey/silvery in colour - so this yellow is a rare thing. Again, this adds to the visual interest, especially in jewellery. This colour looks good against many peoples skin. Without getting into the psychology too much, I think it's easy to see that gold could be used to make oneself more attractive. Again, don't underestimate this as a factor.

Rounding out the interesting properties of gold is it's immense density. What this means is that a small amount is valuable, and transportable. In an emergency, it's about the most valuable thing you can carry with you. Diamonds are, these days, partly ruled out because they are now able to be manufactured so that they are practically indistinguishable from natural flawless diamonds.

So, gold has a lot of things going for it. It this all of the reasons that make it valuable? No, there is one more - rarity. This isn't just limited supply (that governments can't come up with 10x, 100x, 1000x the volume each year), but that it is only found in small volumes in certain places around the world. If every rock in your garden (and everyone elses) was made of gold, it would be worthless. On the contrary, most of us are likely to live out our entire lives and never see a piece of natural gold in nature. You just don't stumble on it on your average walk.

Another plus is that gold has no counter party risk. What this means is that it's not a debt, you do not rely on someone else to "come good on a promise". This is not so of money in a bank (who can close and ... it's gone), or a stock in a company who can go bust. You get the idea. Even cash is a promise by the government to hold it's value and not overspend. The counter party risk example here is again, Zimbabwe.

Because gold has universal and fundamental appeal, it is globally recognised as having value. Paper notes may not be convertible if you flee a country, but gold will be.

In summary then, the positives of gold is eternally shiny, pleasantly yellow, very dense, very rare and has no counter party risk.

What about the negatives?

Well, is it "useful"? While it does have some uses, but it's not overly so. Many of it's uses are simply celebrating it as precious - as in jewellery. I shake my head when I see gold plated TV cables. Compared to other precious metals, I think gold isn't brilliant in this area. Silver has more industrial uses - which is good for it as this means it is "consumed", and it becomes rarer still. Some people have argued that gold is valueable because it does not have any other use. I find this a somewhat weak argument myself, but it does have some merit. The basic idea is that gold has a single purpose - to store wealth - and nothing else.

I am amused when discussing gold, someone invariably says something along the lines of "it's useless - you can't eat gold!". Well, for a start, most people don't eat paper money either. In Australia, it's not even paper - our money is actually plastic (it's more durable than cotton, I believe, and harder to forge). Besides, you can eat gold - it'll pass right through you with no effect whatsoever - and gold flakes are often put on very fancy desserts and foods. So, forget that line of thinking, a wealth store is not meant to be eaten. On saying that, if you are starving, a loaf of bread is vastly more valuable to you than a kilo of gold. In a crisis, if you can't eat, gold will not be what's on your mind.

Some people, mostly of the doomer survivalist type, also come out with arguments that guns and ammo (lead) are more valuable than gold. The line of reasoning is "I will shoot you and take all of your gold!". This brings into question the issue of personal security, and perhaps how to keep your gold safe (ie hide it). If you have wealth, you can buy security, assuming things have not devolved to cave-man like chaos. I think some form of security is a good idea, I'm not opposed to this at all. I also think there is "security in obscurity", stay low under the radar and you will not be a target.

Note too that when I am talking about gold, I am talking about the physical metal in your hand. Not an ETF, or some paper promise of gold which may or may not be there -- that's counter party risk again. I would avoid "paper gold" unless you have a very specific short term investment strategy and understand the risks involved. Paper gold and physical gold are NOT the same thing, despite currently trading at the same price. One day this will change, radically.

Other detractors of gold point to the historical precedent of the US making owning gold illegal, and it being effectively confiscated. I think this is a fair enough concern, on the basis that those in power will change the rules to suit them, no matter how unreasonable. What will happen if this was to transpire is that gold would go underground - to the black market. The price would up a great deal too I suspect, and the governments would have no slice of the action, which is not a desirable outcome for them. I don't see this as likely, but possible. I am generally a law abiding citizen, but I wonder if I felt a law passed such as making gold ownership illegal whether I would abide by it. If the law itself is theft, should you? The other issue with this is that laws change in a country only - and gold ownership is worldwide.

If, say, the US tried to ban gold ownership for it's citizens, the outcome would be a massive revaluation everywhere else. Central banks do not want gold re-valued, I don't think, at least, not yet. Paper money is so much easier to manipulate to their whims, to devalue, to create and distribute as they see fit. Paper money is power if the populace has faith in it. I don't think that they want to give up this power, and are trying to keep a paper based system going for as long as possible. I find it revealing to know that central banks keep tonnes of gold. Why do they do that, do you think? Why too are they net buyers of gold now?

So, sorry if this post is meandering but gold has many facets to consider and ponder over. It touches at the heart of what we consider wealth and money, and these are deep topics once you get going.

Now, in my opinion gold serves one other important function. It is an insurance policy, a hedge (in it's correct usage of the term), against currency collapse. If a percentage of your wealth (how much? good question) is in gold, it can't really be easily destroyed. That sense of protection, particularly in times of financial chaos, are what makes gold valuable. Again, in my opinion, we are headed for a great deal more chaos that we have even seen in the last few years. There are too many charts that have gone parabolic, and compound interest on unpayable and unfathomable amounts are crushing the whole viability of the system itself. History is full of failed currencies, but not full of failed globalized financial systems. Perhaps the closest example is the fall of the Roman Empire, but even this doesn't quite capture where we are today.

The value of gold then, as measured in today's (inflation adjusted) dollars, is highly likely to keep on rising. If even a small proportion of the population loses faith in paper currency and invests in gold then the price will rocket up. It is likely that gold will rightly be seen as only being affordable by kings again, and this makes silver the gentleman's choice. When gold reaches the stratosphere, then silver will start it's major rise as a viable alternative to day to day currency. You might buy a house or land with gold, but your weekly groceries with silver.

While I am on this thought, I think it's funny that in Australia at least, people still call our coins "gold" and "silver" coins. None of our coins contain gold or silver, but they are made to roughly look like they do. This is a psychological trick, a slight of hand. Really, it's all a fake. The US had the real deal with the "silver dollar" but that got killed because again it was too hard to keep up the ruse and it was holding back the currency manipulators. What is a silver dollar worth today?

So, should you own some gold? If so, how much? And how should you buy it, and if it's physical, where should you keep it? Should you pay off debts first? Should you stock up on food, buy land first? What happens if you are effectively broke?

Look, everyone is at a different stage of life and has a different story in terms of wealth. If you have no wealth at all, then any discussion of gold is perhaps moot. It doesn't apply to you. You have no wealth to preserve. If you are currently living hand-to-mouth, that is, pay check to pay check, then you are probably in the same boat. You might be able to save a bit each paycheck and store this in gold or silver, but maybe not. It would be good if you could, really. If you have lot's and lot's of money, or are in a later stage of life and are living off investments, you perhaps have a lot of wealth to be concerned about. The common advice given is to invest in the stock market and interest bearing government bonds. I think this is all well and good, but a percentage of your wealth should be in precious metals, just in case. How much? Well, perhaps as much as it takes for you to feel comfortable that this makes you safe. 10%. 20%. Who knows, something like that. You have to work that out yourself.

As for me, I have some gold, but not a lot. I'd really like to have more. Honestly. A real gift would be a collapse in the gold price right now. I'd double my holdings if it went under $1000 again, or perhaps more. I don't know if it will, but it might. I suspect we are in for wildly volatile times ahead, and these may briefly present great opportunities for those willing to act quickly. What is likely though is that price may fall suddenly but it might be impossible to find supply. Once the gold rush starts in earnest, the currently open door to the man on the street may be slammed shut. I think this is likely, but I don't know when things will unfold. It could happen this year, next year, or 2012. I think it'll happen by then at least, and probably with escalated world tensions if not outright world war. Times they are a-changing.

This was but a scratch of the topic on gold. I'll come back to this subject another time and look at other elements of it. In the mean time, if you are interested in gold as a subject, I recommend reading current and past posts on FOFOA (Friend of Friend of Another, yes, very x-files). Until then, good luck with any gold (and silver) holdings you may have!

2 comments:

Robert said...

Good job laying out your thoughts. came over from ZH. Keep up good work. Will check back often. Yip

Saul said...

Cheers!