By Jeremy Adams – August 5, 2010
During the past month the price of gold has been on quite a roller-coaster, at one point dropping some 50 points in only a couple of days. Media outlets, financial bloggers, and market bulls alike began screaming from the rooftops that the gold bubble had finally burst. And then there were the laymen investors who scurried about calling their precious metal brokers and flooding the Internet seeking solace.
This worrisome attitude is something of a mystery to me. I don’t understand how or why anyone who owns gold could be so emotionally affected by daily moves in its price. Imagine for a moment if other assets, like your home, were constantly assessed and subsequently revalued. How might that affect homeowners on a daily basis? I question if so called “investors” even understand their gold positions in the first place. Why is it that anyone would want to own this yellow metal anyway?
It certainly shouldn’t be as a traditional investment – that much I am sure. There are several reasons precious metals should not be viewed in the same light as stocks, bonds, and mutual funds. First, physical ownership offers no financing options. There are no income or dividend-yielding potentials, and absolutely no tax benefits. The gold and precious metals markets can also be very volatile when viewed in the short term. Prices are highly susceptible to manipulation through various Exchange Traded Funds and the commodity markets. They are also very sensitive to daily fluctuations in the currency markets.
Second, there is a fundamental difference between purchasing a stock and acquiring physical gold. This difficult, yet important concept to understand is that gold has absolutely no earning potential. Unlike a stock that represents some underlying value in a company, or a bond that equates to a subjective evaluation of a company or country’s credit worthiness, gold is simply an asset that only allows you to preserve the purchasing power of your wealth at any given time. It provides you with the ability to protect your earnings through uncertain financial times. This is because the true monetary value of gold rarely changes.
A quick example is as follows:
In 1920, an ounce of gold equaled $20. Luxury homes during the same time period were worth around $8,000. Therefore, one could purchase such a home for 400 ounces of gold. Fast forward to today where an ounce of gold equates to roughly $1200. For that exact same 400 ounces, you could purchase a comparable home for $480,000. However, the initial $8,000 in paper currency from 1920 wouldn’t even cover your property taxes!
The only thing that gold allows you to invest in is your future. When fiat currency like US dollars are exchanged for gold, paper money with nominal value is being traded in for real money with monetary value. Gold provides the long-term hedge against the destructive political forces of government. It is how we guard ourselves from the inflationary policies coming out of Washington; and ultimately, how we protect ourselves against negative real interest rates (the difference between the rate of inflation, or consumer price index, and the Federal Reserve controlled interest rates that affect our bank accounts).
Currently, the government understates inflation using the consumer price index (CPI) at 2%. Some of the most generous savings and money market bank accounts are barely paying out 1% in interest. Therefore, US dollars sitting in a bank account are losing 1% annually. When you consider the real rate of inflation to be around 5-6% (utilizing CPI measurements from before the Clinton administration), your savings are actually depreciating at upwards of 5%.
As the overall value of the dollar continues to decline, the nominal price of gold will also continue to rise. In contrast, for the price of gold to fall, the dollar would have to gain strength accordingly; a difficult scenario to imagine in today’s political and economic climate. But no matter the outcome, the monetary value of gold will always remain the same.
It is important to recognize the difference between investing for a return and investing for your future. Gold offers nothing more than a way to preserve your wealth against the falling value of the dollar. At best, you can look forward to outpacing the negative real interest that even the most generous money market accounts may offer – And at worst, do nothing more than maintain the purchasing power of your savings.
All Things Considered – John’s Commentary
Jeremy Adams has one of the finest commands of the Austrian school of economics of anyone I personally know. While everyone seems to be worried about how the price of gold is going to perform or under-perform, Jeremy makes an excellent case as to why that should be the least of our worries.
Take the time to re-read his article above – slowly. Look for more in the future from Jeremy. We are privileged to have him as a guest author.
Action to Take: As aptly pointed out it Jeremy’s article, continue to purchase modest amounts in regular intervals and don’t try to time the market. You are preserving wealth first… and investing second.
What to Buy: Today I helped a gentleman purchase ½ ounce gold Eagles for the same per ounce price as 1 ounce Eagles or Buffalo’s. In addition, I showed him a host of coins of a half ounce or less that sell for premiums of 6 percent or less. There are great buys available if you dig a little bit.
Quote of the Day: “The gold standard makes the money’s purchasing power independent of the changing ambitions and doctrines of political parties and pressure groups. This is not a defect of the gold standard; it is its main excellence.” – Ludwig von Mises
