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Putting the Gold Price in Perspective
by James Turk
A note from James Turk
– I wrote the following article for “Information
Line”, published by Michael Checkan and Glen
Kirsch, the proprietors of Asset Strategies
International, Inc. in Rockville, Maryland,
http://www.assetstrategies.com/index.php
The first thing people usually consider when
buying gold is its price, but unfortunately,
they are grabbing the wrong end of the stick.
Price is of secondary importance. To explain
why, one has to examine the reasons for buying
and holding gold.
The motivation to buy gold is usually driven by
the pursuit of some defensive financial
strategy. For example, gold is a proven and
time-tested inflation hedge, so people acquire
gold if they believe inflation is likely to
worsen. This defensive strategy aims to protect
your purchasing power because with gold you hold
sound money instead of some inflating national
currency.
Another defensive motivation to acquire gold is
its unique attribute of being money with no
counterparty risk. This significance of this
risk was highlighted by the bank-run at Northern
Rock in the UK last year and more recently, Bear
Stearns in the US. People withdrew their money
from those banks because they recognized that
their ‘money’ was only as good as the financial
capability of those banks to make good on their
promise. In contrast, gold is not dependent upon
a promise because it is the only money that is a
tangible asset, and not an I.O.U. of some
financial institution.
Another reason people focus on the price of gold
is because they consider it to be an investment,
but it’s not. Investments generate rates of
return because you put money at risk, for
example, by lending it or buying equity in a
company. If the investment is successful, you
will generate a return, increasing your wealth.
But gold doesn’t do this. Gold preserves wealth;
it doesn’t increase it.
For example, one ounce of gold purchases
approximately the same amount of crude oil today
as it has at anytime over the past 60 years. Who
would want an investment like that? Gold hasn’t
generated any rate of return. It hasn’t given
its holders the opportunity to buy more crude
oil. But because you can still buy essentially
the same amount of crude oil, an ounce of gold
has done exceptionally well at protecting wealth
by preserving purchasing power, which is what
money is supposed to do.
Money is a temporary store of value where we
place a portion of our wealth while we decide
whether to spend, invest or save (hoard) it. So
when we hoard gold, we are in fact saving money
until that moment in time when we decide to
spend or invest it, which brings me back to my
basic point.
Does one question the price (i.e., purchasing
power) of dollars before choosing to open a
savings account? No, of course not. Savings
represent the portion of one’s accumulated
wealth held as liquidity (i.e., money) either
for a rainy day, to accumulate before spending
or investing it, or just to safeguard this
portion of your wealth safely and securely. But
an inflating dollar doesn’t achieve these aims.
The dollar – and indeed every other national
currency – has severe problems that undermine
their usefulness. In contrast, protecting wealth
is what gold does exceptionally well by
preserving the purchasing power of one’s
liquidity, not necessarily from day-to-day or
week-to-week, but consistently and reliably over
longer periods of time.
So instead of focusing on gold’s price when
buying it, focus on what gold is, what it
offers, and what it accomplishes for you. Gold
is a form of savings that securely preserves
that portion of your wealth that you choose to
hold as sound money.
I recognize that it is difficult to view gold in
this way and to give little regard to its price,
particularly because we are so used to looking
at prices of goods and services in terms of
dollars and not gold. Also, we have been trained
to think of gold as an investment instead of
what it really is – money. But we can overcome
these biases and incorrect conventional wisdoms.
One way to do that is to consider accumulating
gold on a regularly monthly basis. In other
words, save some money every month, but don’t
save dollars, the purchasing power of which is
being inflated away. Save sound money instead.
Save gold.
When gold is viewed in this way, it is clear
that even with the four-fold increase in the
gold price since 2001, no one has ‘missed the
boat’. Building savings by accumulating gold is
always a good thing.
Putting the Gold Price in Perspective –
follow-up
The above article generated some interesting
questions from readers of “Information Line”.
Here is one of those questions and my response.
Q. – "I read this with interest, but if I buy
gold in 2008 at $1000 per ounce and now it’s
2010 and gold is $500 per ounce, why do I not
feel good??? Of course, if you buy gold in 2000
at $280 per ounce and sell in 2008 at $1000 I
know you feel good, but life does not always
work that way!"
A. – You are looking at gold from the
perspective of a trader. In other words, you
assume that the only advantage to owning gold is
to profit from its price swings. Gold is money,
and there are also other important benefits that
come from owning physical gold. These include:
No counterparty risk – When you own physical
bullion, you own a tangible asset. Physical gold
is money not dependent upon anyone’s promise,
which is an attribute becoming increasingly
important as the present financial crisis
deepens. Ask anyone who had money in Northern
Rock in the UK or Bear Stearns about their
experience when those banks failed. Better yet,
ask anyone who lived through the Great
Depression to learn about the fear that arises
when your wealth is reliant upon counterparty
risk in a financial crisis.
Consistency in commodity purchasing power – If
gold were to drop to $500 in 2010, the price of
crude oil, wheat and other commodities will have
also dropped. You would be able to buy gasoline
at $2 per gallon again, and a loaf of bread at
much less than today’s price. There is a close
correlation between the price of basic
commodities and gold. So the loss of purchasing
power from a drop in gold’s price may be less
than it seems at first glance.
Not reliant upon government decisions – The
value of the dollar is dependent upon government
politicians and bureaucrats. Therefore, the
dollar has become a political tool, rather than
what money is supposed to be, namely, a neutral
tool useful in commerce available to one and all
and unfettered by government interference.
Government actions can undermine the usefulness
of currency. Moreover, when you own dollars you
are speculating that the government will not
take any actions harmful to the currency. That’s
not a good bet because experience has shown that
governments eventually and inevitably totally
destroy the currency under their management.
Assets outside the banking system – Gold
provides diversification by enabling you to
place a portion of your money outside of banks,
and indeed, the entire monetary system of fiat
currencies. Therefore, this portion of your
wealth is removed from the threat of capital
controls and other government imposed
restrictions. This safety you receive from gold
can be enhanced further when you store gold in
countries outside of where you live and where
there is no history of asset confiscation by
government.
The above points explain why gold has value.
Namely, it is useful in many different ways. But
there is one last point worth mentioning.
While the future is unknowable and
unpredictable, the probability of gold falling
to $500 in 2010 is “slim to none”. The only way
for gold to fall to that level would be for the
purchasing power of the dollar to be
significantly enhanced. In other words, instead
of inflating the dollar, the US government would
need to embark on a new monetary policy aimed at
deflating the dollar, the result of which would
be to enhance the dollar’s purchasing power,
repeating the experience of the Great
Depression. Monetary policy is aimed
specifically at avoiding another deflationary
Great Depression, so it is reasonable to expect
that the dollar will continue to be inflated,
meaning the price of gold will continue to rise. |