Over the past month, I’ve read a lot of articles about the virtues of investing in gold. Especially in Facebook forums, there’s a lot of talk about how gold makes a great long-term investment. (Fortunately, I haven’t seen any comments like this in the GRS community on Facebook.)
Whenever the economy gets turbulent, the goldbugs come out in force. They shout from the hilltops that the world is doomed and that the only safe haven is gold. And I’ll admit, their arguments can sound pretty convincing.
When I started this site in 2006, I felt unqualified to comment on gold. I hadn’t read much about it, and I didn’t feel educated enough to offer an opinion. That’s changed.
Now, after fifteen years of reading and writing about money, I know enough about economic history and I know enough about gold as an investment to have what I believe is a (somewhat) educated response to this subject. And that response is this: Gold makes a lousy long-term investment.
Today, let’s have a discussion about the pros and cons of investing in gold while using my own opinion as a starting point. (And note that this article contains my opinion. It’s backed up by some facts, but it’s still my opinion. Don’t take everything that follows as gospel.)
Put simply: I’m not a fan of precious metals. I have 0% of my investment dollars in gold and silver, and I expect that to hold true for the foreseeable future. It’s my opinion that gold is a bad investment right now. Let me explain my reasoning.
Before we dive into the meat of this article, it’s important to understand that I’m not an economist, and I’m not a gold expert. But for the past fifteen years, I’ve made a career out of personal finance, and gold is one tiny part of that subject. The core of this article was originally published here on 10 May 2011, the last time the goldbugs were out in force. This update contains substantial revisions. Also, please note that many of the comments on this article are from its original publication in 2011.
The Gold Standard
Many folks dislike our current monetary system because it’s based on fiat currency. That is, a dollar is worth an arbitrary amount because the government says so. It’s not based on anything concrete. Plus, the government can add and remove cash from the money supply at will, which affects the dollar’s value.
U.S. dollars — and other world currencies — were once backed by gold. Under the Gold Standard, you could ask a bank to convert your paper money to gold at the legal rate (whatever that might be). In order for the government to print more money, they had to have the gold to back it.
Proponents of the “Gold Standard” argue that since the U.S. abandoned it in 1933, the dollar is more susceptible to inflation. That’s true. But the Gold Standard didn’t eliminate inflation, and it created other problems besides.
I am not an economist, and I struggle when it comes to economic theory, but my understanding is that much of the run-up to and aftermath of the Great Depression was thought to have been caused by the Gold Standard. Under the Gold Standard, currencies were much more susceptible to speculation and devaluation, which could lead to runs on the banks. That’s why the U.S. abandoned it. And it wasn’t only the United States that did so. Not a single country in the world uses the Gold Standard anymore. Until recently, most economists and politicians considered it a deserved relic.
Note: Though it’s long, this 2004 speech from Ben Bernanke about money, gold, and the Great Depression is interesting, and explains why we’re not likely to ever return to a Gold Standard in the U.S.
The Intrinsic Value of Gold
Some proponents of gold like it because they say it has intrinsic value. That is, they say that gold has value in and of itself. (Kevin McElroy does a good job explaining this concept at The Street.)
Goldbugs would have you believe that when diaster strikes — we enter a post-oil economy, we’re nuked by terrorists, dinosaurs escape from Isla Nublar, or a new virus wipes out half the world population — that paper money will be worthless and we’ll all be trading in gold. Because of its intrinsic value, it’ll become a form of currency. I’m not convinced.
Let’s say I’m a shopkeeper. I have a minimart and I have a shotgun to defend my stock from looters. If we’re in some sort of post-crisis world where dinosaurs roam the earth, I doubt I’ll want your gold. It’ll be just as worthless (or as valuable) as paper money. Why? Because in reality, gold too is fundamentally a fiat currency. That is, people have assigned it an arbitrary value. That value vanishes in a crisis, just as the value of paper money does.
If I’m a shop owner in this situation — or I’m your neighbor with a vegetable garden — I’m going to be want to be paid with something real, something like a carton of eggs or some shells for my shotgun.
In other words, I don’t think much of gold’s intrinsic value. To me, assigning value to gold is just as arbitrary as assigning value to anything else. If we’re in a real crisis, I’m not convinced that gold’s going to save the day. This is just one more reason I’m not investing in gold. (Again, this is my opinion. You may disagree.)
My first two objections to owning gold are based purely on theory. Nobody knows for sure what would happen if we returned to the Gold Standard. If dinosaurs roamed the earth, we’d have more important things to worry about than the form of our currency. But I have other, more concrete objections to investing in gold right now.
Investing in Gold During a Bubble
As I write this, gold is hovering at about $1700 per ounce, which is just off its recent peak of $1756.70 two weeks ago. But that’s not only its recent high; that’s also nearing all-time highs for the stuff. (As near as I can calculate, gold’s inflation-adjusted high was about $2250 per ounce back in January 1980.)
Here’s a chart (generated at Macrotrends) that shows historical gold prices:
And here’s the same info, but with inflation-adjusted prices:
Modern gold prices bottomed out in 1999. Prices stood at $262 per ounce in April 2001 (an inflation-adjusted $380). Between then and May 2011 — when I first wrote this article — gold enjoyed impressive returns of over 20% nearly every year. At that time, the goldbugs were loudly shouting, “Now is the time to buy.” Peter Schiff, perhaps the loudest goldbug of them all, was predicting prices of $5000 per ounce in the near future.
“I’m skeptical,” I wrote at the time. “I think gold is more likely to see $500 an ounce in the next decade than $5000 an ounce.”
Who was closer to correct? Peter Schiff, a self-proclaimed expert on the subject? Or me, a guy with no special knowledge about gold, but a healthy skepticism of shysters and charlatans?
For a couple of years, gold hovered between $1600 and $1700 per ounce. But then it crashed. By December 2015, gold prices had dropped to $1070 per ounce. Gold bounced between $1200 and $1300 an ounce until about a year ago, at which time it began its climb back to $1700, which is where it sits today.
In hindsight, I think it’s clear that we were in a gold bubble in 2011. And I think we’re entering one (or already in it) today. We’ve seen several price bubbles in the U.S. over the past twenty years.
First, the boom in tech stocks in the late 1990s.
Then, the run-up of housing prices in the mid 2000s.
Next, the second stock bubble at the end of the last decade.
Finally, the gold bubble that I just described.
Plus, you could argue that during recent years we’ve been in another stock-market bubble, and I wouldn’t necessarily disagree.
During these bubbles, the proponents of each investment made compelling cases for why “this time is different!” More people bought gold and stocks and homes, which drove prices up, which made the investments look more appealing, which meant more people bought, which drove prices up until…
The bubble burst.
The bubble always bursts.
During the bubble, there are plenty of snake-oil salesmen with silvery tongues who will try to convince you that this isn’t actually a bubble, that this is where prices are meant to be. Many of these people actually believe what they say. (Though, to be clear, some don’t. Some know exactly what they’re doing.)
After the bubble, there are a lot of people wondering what happened to their wealth.
Right now, in April 2020, the price of gold is high because the demand for gold is high. Over the past year — and especially, during this coronavirus pandemic — our country’s economic policies have created a fear of the future, which means many people are clinging to gold as a sort of insurance. Gold prices are rising. How high will they go?
Peter Schiff is once again enjoying some time in the spotlight, proclaiming that gold will hit $5000 an ounce. He’s been singing this tune for almost fifteen years now. I’m not sure why people continue to listen. Long term, I think gold prices are more likely to drop than they are to rise. (But I do think gold will climb — or, at least, stay steady — for a year or two.)
But, hey — I could be wrong. Maybe the gold bubble isn’t a bubble. Maybe prices won’t come crashing down again. You need to decide that for yourself. Right now, I’m willing to bet on the side of history.
Bonus!
You have no idea how much work goes into a post like this. I do hours of research and write thousands of words before cutting back to the essentials. And with topics involving lots of data, I go down all sorts of rabbit holes while playing with numbers.
For instance, on a whim, I decided to check the effect of the last few Presidential administrations on the price of gold. This is mostly meaningless, but it’s still interesting to see.
The Carter numbers are odd. Nearly all of that 322% increase came during the last few months of his administration. Again, I’m not saying this data has any meaning. I just find it fascinating. If you want to fritter away time by playing with numbers, you may find this page of historical gold prices handy.
(And that’s an hour of my time wasted that could have been used to write another article about clipping coupons or budgeting.)
Gold as a Long-Term Investment
For me, the most compelling case against investing in gold can be found in the historical record. Goldbugs like to praise the stuff because it’s a “hedge against inflation”. Gold tends to retain its value as prices rise. That’s true — but long term, that’s all that it does.
There are other things that tend to keep their value during inflation, if that’s what you want. Real estate, for one. And TIPS (Treasury inflation-protected securities, a type of bond). And maybe even savings accounts.
If you want to fight inflation, there are better options. In his book Stocks for the Long Run, Jeremy Siegel crunched the numbers to find the historical performance of several common investments. The results? Between 1926 and 2012:
Gold had a real return (meaning: “after-inflation return”) of about 2.1%.
Bonds returned about 5.7%, or about 2.6% after inflation.
Stocks returned an average of about 9.6% per year, and a real return of about 6.4%.
And, according to this academic paper, home prices have appreciated at about 0.9% per year over the past 150 years.
Of course, past returns are no guarantee of future results. Perhaps Schiff is right. Perhaps over the next thirty years, gold will average an annual return of 6.4% and stocks an average return of 2.1%. Nobody knows for sure. But my bet is on the side of history.
Ironically, despite the inflationary basis of a paper money system, well-preserved paper money from the early nineteenth century is worth many times its face value on the collectors’ market, far surpassing gold bullion as a long-term investment. An old mattress found containing nineteenth-century paper money is a better find for an antiquarian than an equivalent sum hoarded in gold bars!
There’s no real take-away from that, I suppose. It’s just funny.
My Father Invested in Gold
You might think that the current gold fever is the first of its kind. Actually, it’s not. Gold fever seems to strike every decade or so, whenever there’s a run-up in prices. (That’s the irony. Nobody’s excited about investing in gold when prices are low. They’re only excited when prices are high. Need I mention how foolish this is as an investment strategy?)
The first time I remember being exposed to gold fever was when I was a boy.
My father became a goldbug during the economic crisis of the late seventies and early eighties. He was convinced prices were going to soar permanently, so he started investing in gold. The things he said then are just like the things I hear the goldbugs saying today. It’s like history repeating itself.
Though he could barely afford to put food on the table, during 1980 Dad found a way to buy ten gold coins at roughly $500 each. (Plus whatever commission he paid.) He loved to show them to us kids: “Look at my pretty pieces of metal.” Dad had no savings or investments, so these coins were his nest egg.
The eggs turned out to be rotten.
As I recall, Dad sold a few of the coins almost immediately because we needed the money to buy food and clothing. No worries. The price of gold had risen, so he made a little profit. But he held the rest of his “pretty pieces of metal” until the mid 1980s, when he decided to start the custom box company. Then he sold the coins for just over $300 an ounce. He lost about a thousand dollars on what he thought was a sure thing. The sure thing turned out to be a bubble.
Further reading
Fore more interesting stories about investing in gold, check out:
If you know of good articles about investing in gold, please share them in the comments.
Should YOU Invest in Gold?
For all of these reasons, I’m not investing in gold. Not right now. Not at these prices. Does that mean you should avoid investing in gold? Not at all. It means you should do your own reading and research and find out what the best decision is for you. Don’t just take my word for it, but don’t be persuaded by a bunch of ads on radio or TV, either.
Whether you’re for or against gold as an investment option, I encourage you to read rational, well-written articles from the other side. Try to figure out where they’re coming from. Does the opposition make some good points? After reading another opinion, do you think there might be times that you could see their point of view?
In my case, I’m not completely against investing in gold. In fact, I’m persuaded that it generally makes sense to have some in your investment portfolio as part of a strategy of diversification. In time, I plan to add a little. Eventually. (But not now, not when prices are at record highs.) However, with one exception — see the sidebar below — I can’t imagine ever devoting more than five percent of my portfolio to the stuff. (And even that seems high.)
My opinion is that we really are entering another gold bubble, and that the bubble will eventually burst. When it does, I may buy a bit of gold. Until then, I’m happy to watch the roller coaster ride from the outside.
The Permanent Portfolio
One investment strategy that I find appealing uses a lot of gold. This is the permanent portfolio, as developed by Harry Browne. The permanent portfolio calls for a fixed asset allocation:
25% in U.S. stocks, to provide a strong return during times of prosperity
25% in long-term U.S. Treasury bonds, which do well during prosperity and deflation
25% in cash (a money-market fund) to hedge against recession
25% in gold to provide protection during periods of inflation
If I were to choose any other investment plan than the one I have, it’d be this one. I find the arguments compelling, and wouldn’t be surprised if five years from now, I’ve adopted this strategy.
Reminder: This is another one of those topics that tends to inspire passionate debate. It’s fine to disagree with each other (and with me), but please keep it civil. Sound fair?
In 2006, J.D. founded Get Rich Slowly to document his quest to get out of debt. Over time, he learned how to save and how to invest. Today, he's managed to reach early retirement! He wants to help you master your money — and your life. No scams. No gimmicks. Just smart money advice to help you reach your goals.
If you’re that sure of that L&MF, why not invest in a reverse gold stock? I’m down about 30% on the one that I put money into last year. Teaches me to stick to industries that I know. If the analysts that do this stuff for a living 12 hours a day get stuff wrong based on what they “know”, the small individual investor has to leverage whatever they can – and stay out of what they can’t know.
I would not invest in reverse gold either. It’s too uncertain – it’s almost like the dot com era. There is enough hype to drive the prices up, but one of these days, the gold craze is going to pop, and leave a lot of people with nothing to show for it.
Right at the top for gold and right at the bottom for the stock market.
JT McGee says10 May 2011 at 09:08
Couldn’t agree more!
The reality is that leverage should afford many people the opportunity to get excessively wealthy in commodities. Look at the Forbes 400–most didn’t make it in this highly levered casino.
“Why would anyone invest in something that’s at it’s value is at an all-time high?”
The price of gold went from ~$1000 to ~$1550 in about a year and a half, making new all time highs all along the way. Would your thought process be the same when it was making new highs at $1000? You’d have missed out on a 50% gain.
Because gold is at an all-time high doesn’t mean it will not go higher. It will go do high, you will be shocked. As for silver, After this pandemic hoax is past us, watch what happens to the economy when hidden technologies are released to be contructed by industry. They will rerquire huge amonts of silver and the price will go sky high from shoratages
I also read Siegel’s Stocks for the Long Run and decided against investing directly in gold after reading what he had to say.
I am, however, invested in gold and silver (and other metals) indirectly through my investments. I know a few of the ETFs that I have hold shares in mining companies.
The US government does not dictate the value of the dollar, it is set by exchange rates, interest rates, economy, and a bunch of other factors. The US dollar floats. The Chinese Yuan is set pegged to the dollar, as are a few other currencies. But ultimately any currency is worth what it will buy, not what the government says. Just ask the people of Zimbabwe.
That is where you are wrong. The government has complete control on the value of the dollar. The have the FED which can print as many dollars as they want which will in itself decrease the value of the dollar.
What a fantastic and well-research article! One of the best I’ve read.
With any bubble, there’s opportunities for profit-taking but it is risky. Gold is definitely a short-term speculative investment right now, not long-term.
Another point to make about gold… NPR morning edition recently had a story about how the gold bubble is making mines that are not usually profitable worth mining… if that keeps up, the supply of new gold is going to bring prices down.
I also wonder what Glenn Beck going off the tv is going to do to the price of gold. Might be a good time to short it. 🙂
A sane conversation on gold, and why it’s not the panacea.
Does it make sense if I say I always had misgivings about the gold rush, but could never really put my finger on it? The proponents just make it sound too good to be true… and we know how that works.
Your history recap here is very interesting.
Also, you said that people don’t realize how much work goes into a post like this… it’s just a demonstration of the value you provide, amigo!
I totally agree with Aaron. Gold didn’t pass my sniff test, and now I’m relieved to see that others feel the same way.
Also, JD, none of your time tunneling through rabbit holes is wasted. You now have expansive knowledge which will undoubtedly come in handy soon. Probably as soon as your next article or even interview.
In 1940’s when the nazis burned all the farms and crop in my country, and steal all the food, and gold from the peoples hands, and dowries from families daughters, and emptied the Banks from tons of Gold, my Mother told me:
Nothing is shining best then a gold loaf of bread when it comes to dark times like war, or bad economy.
When it comes to survival, nothing is best then growing your own food. Unless savages come along and take it.
Keep old clothes saved, you may need them when it comes to bad times.
God did not plant gold for us to survive, he plant seeds of food. He gave us cotton, and animal hair, and other fibers for us to cloth. We need to respect and save our planet to have and pass all this treasures for our children and generation to come. Why impose them to gold and silver, when, many children never seen the billions of stars at night, never visited a farm, and never experienced true life? The purpose of life.
We have some money in gold coins and perhaps every other week I contemplate selling them. The problem with gold is that there is a pretty high “illiquidity discount” for most people. It just isn’t easy to convert it to cash. In Atlanta, I don’t know of a single locaiton that will buy it back with out taking a pretty significant cut. Additionally I store ours in a lock box, so if the dinosaurs do return, I have to hope that the bank is open!
Hi Scott! I’m in Atlanta and sold some gold to a goldsmith. I figure, since they are an end user I will get a good price. It’s worth it to at least call and ask, they will want to know the total weight and karat you want to sell. This place is very straightforward, read their paragraph about the percent value they will pay for various types of gold: http://www.bthjewelers.com/services/
They’ll pay 93% of the value for pure bullion gold (not sure if that is what gold coins are), or 80% of the value based on karat.
I think people are attracted to gold because it’s a concrete investment. Most people get excited when gold prices go up and think about hocking that jewelry their grandmother left them and their wedding ring from a defunct marriage.
It’s not too great a leap from that emotional excitement to justifying it as an investment. After all, most human decisions are not rational, they’re emotional.
Good for you, J.D., for not buying into the hype, thinking for yourself, and encouraging everyone else to do the same. Finally, a reasonable contribution to the conversation about gold.
I have gold and silver ETF funds and have had the wisdom to but low and sell high. While they make up only 2% of my total investment strategy, it was a way to diversify years ago when stocks were going no where.
I agree with your view and the current gold bubble. Fortunately I was able to get in on gold a few years ago and have watched my investment soar sky high However, I currently have been looking at it with my finger on the sell button due to the feeling that the bubble is about to be popped. Once it does however I will probably buy it back up again and continue to hold for the long term.
Thanks for a really interesting piece. I’ve never understood the complaint against ‘fiat money’. All money is arbitrary, something we just agree has value because that makes it useful to society. NPR had a fascinating story on giant stone money on the Planet Money program; it’s still in use among a small group. Those folks use regular money too, but because the giant stone money still has agreed value, it’s still a useful currency. Looks like this will be one of thoose posts where I check out every one of the links. Good stuff.
The easiest way to understand the objection to fiat money is by being familiar with how most economists define money: http://en.wikipedia.org/wiki/Money
One of the properties of money is that it’s a “store of value”
The ability of governments to print fiat money makes it less able to store value.
Gold, on the other hand, cannot be devalued the same way (I believe the supply increases by 1-2% per year), so it fits the definition of money much better than paper money.
Something’s worth only how much you’re willing to pay for it. There’s no use for gold in a zombiepocalypse. Shotguns shells and samurai swords would be the new gold. I agree with you –gold is no safer than paper money.
Gold jewelry and coins make a *tinkle tinkle* sound when they hit the ground, and can therefore be tossed on the ground in order to distract zombies from your location. Shiny gold can be used like a mirror as either a communication device or a zombie distracting device. And if you happen to have gold bricks, or a bunch of gold melted together by global warming, you can use it as a projectile weapon.
I don’t have any money in precious metals and was actually planning to short silver, but it looks like I missed out on that opportunity after last week.
I can’t understand how people want to keep plowing money into gold and silver when they are reaching all-time highs…
I have several hundred dollars in silver coins -no value beyond their silver(et- one friend suggested that as more people melt down the coins – mine may have value as they become more rare). I do not need to sell them so I just keep them. I inherited them -I suppose at some point I will have to decide what to do with thme
Go online, do some research. Ideally, you’ll find someone close to where you live who is also a member of the ANA (American Numismatic Association).
Take your time, don’t take the first offer and do as much homework as possible on the coins you have. Don’t be afraid to get a second opinion.
Remember, too, that coins, like everything else can decrease in value.
Not a good idea to sell your inherited silver coins when silver prices are so low and so manipulated. This guy really doesn’t know much about silver and where it’s headed. Even today, at $15, it’s no where near it’s high of $50 per ounce back in 1980. It has ways to go. Think why the nations are buying up gold by the tonnage? The banks also. Why the US just create new law that puts gold and silver as tier one assets. They’re positioning precious metals as currency options once again.
JD, one of the best pieces you have ever put together. Well researched, balanced, and a reasoned conclusion based on your work. Good work!
On the article itself, I thought Jim Cramer’s views on it from a while ago were interesting (please don’t throw me off the boards! :)). Basically, he said gold is going up simply because that is what is done in times like these. Sadly, the market does a lot more of this programmatic trading than following real logic. However, this IS a bubble (and not just gold but all commodities) and it will die horribly.
*sigh* Didn’t we just go through this same thing earlier?
Anybody that chooses an equal amount of stocks to their precious metal investments had better plan on living a LONG time. You talk about bubbles and breaking – the stock market has burst many more times than gold or silver.
I’m into silver. It has tripled in the last 2 years and I’m offloading it as we speak, waiting for the settling that will inevitably come.
But I’m done with stocks and bonds, period. My retirement plan? 12 jumbo CDs, 1 maturing every month. Yeah, I can live poor interest better than I can with the Ponzi scheme called the stock market.
Here’s my take on the stock market:
Say you walk a specific route to work every day and pass under a tree. In the tree are monkeys, lots of them and all different sizes. They are tossing wads of cash about and saying “C’mon up!” … And eventually, you do. And you start slinging your wad of cash with the other monkeys.
But one day, things are different. All the big monkeys look at each other, nod, and shake the branches – and all the small monkeys (you and me) fall out and hit the concrete sidewalk. OUCH! You look up and ask them why they did that —
And they say ‘Sorry, nobody could foresee the (insert creative excuse here, planes flying into the twin towers, etc).’
So you pick yourself up and go back to your normal routine. But still, everyday you walk under the monkey tree and there are still plenty of monkeys tossing $ around. And they say “C’mon up!” … But you say no thanks, last time was too painful.
Every day … every day you walk under that tree.
And you know what? Sooner or later, it gets to you – and you are STUPID enough to climb back up in that tree.
Color me as an educated monkey – and I’ll NEVER climb back up in that tree again.
No thanks. I’ll sit on my jumbos and keep saving until I buy another … and another … and another. Yes, I know inflation will eat into their value. Yes, I know stocks HISTORICALLY outperform bank interest.
But I’m one dumb monkey, so I’ll take the guarantee rather than try to beat (remember the golden rule – those with the gold make the rules) the big monkeys at their own game.
Silver. And Gold. Right now, don’t buy – prices are too close to the bubble breaking.
But in the future, after the settlements: You should be at least 10% into metals.
Over the very long run, the stock market averages between 7-8% after inflation. This number varies depending on the source. How is this a Ponzi scheme, a trick, or a tree full of Monkeys?
Besides, with the proper allocation among stocks, bonds, reits, commodiies, etc. This will smooth out the large dips and gains that are inevitable.
How is this a Ponzi scheme? And you don’t think the monkey comparison is valid?
First, to run a Ponzi scheme, you have to create something people think is valuable so you can sell it to them, regardless if it is worth something or not. This is known as “stock.”
What creates value in stock? Nothing. A bunch of people come together and print ink on paper and tell you it has value.
And you believe it. Maybe it does, maybe it doesn’t. How do you know? You don’t.
So you throw your money into the gambling pit. But you don’t make the rules and you are probably a rank amateur, so it is easy to lose money. (I did, btw. On “safe” stocks, too.)
Meanwhile, somebody has your money (a rich person getting richer) and YOU are sweating it out. You make a dollar one day and lose two the next, hoping you will make 3 tomorrow.
Meanwhile, somebody is “creating” more value by printing more ink on paper and selling it to you (or others).
And you don’t think this is another version of the same old game?
About the monkeys: The big ones have shaken the little ones out of the tree many, many times. Stick your head in the sand all you want, but it WILL happen again … and again … and again. If you are stupid enough to climb back up in the monkey tree, I have no sympathy for you.
Or perhaps, you make your living by selling these valuable instruments to people and somehow feel uncomfortable when somebody describes your business in less than glowing terms?
I’m ultra-conservative, if you can’t tell. No more monkey trees. And I’ll retire just fine without consulting the DOW or NASDAQ indexes, thank you.
Here’s the real golden rule: Live WELL below your means and SAVE, SAVE, SAVE.
Actually, that isn’t true. When you buy a stock you become part owner in a company. The price rises and falls with the success of the company.
You can argue that stocks are based on what people think a company is worth (a valid argument). But you must also consider that in the information age, everyone knows everything at the exact same time. The amount of people who buy a stock and sell a stock are equivalent. There are a fixed number of shares until the company decides to issue more of them, so this boils down to a barter type system.
Investing in the stock market is meant to be a long term approach. Ups and downs dont matter in the long run because they true-up to actual value. Read something by John Bogle.
The first rule of investing is buy 4 index funds (ideally 1 large cap, one small cap, one bond, and one intl ex-us) in whatever ratio you are comfortable with.
The second rule is to make your investments deposits automatically into your appropriate index funds.
The third rule is to lose the password to your account.
“What creates value in stock? Nothing. A bunch of people come together and print ink on paper and tell you it has value.”
Actually the profit/earnings (P/E) ratio determines the value of a stock. A companies’ stock can go up if it becomes more profitable. Or to keep it in simple “monkey” terms: stock is valuable because it represents people working in a factory, producing something. Creating value.
Gold on the other hand (much like real estate) just “sits” there. There might be a bubble or a crash, but in itself it “creates” zero value.
The fact that it represents an ownership share in a company, and entitles you to a share of the profits (in good times), a share of the assets (in bad times), and a say in how the company is run.
You seem to be saying that stocks only have value because everyone agrees they do, similar to the fiat currency argument. That’s absurd, and overlooks that companies generate real value, in the form of actual cash profits you can take to the bank.
I like the way you think. I don’t think it’s a matter of disagree or agree, it’s a matter of how much risk you are comfortable with. You and I are very uncomfortable with ANY risk of our hard-earned dollars. Others are willing to risk it for what is on average a better return on investment. On average being the key words as you point out. I love your “shakedown” analogy.
Here is another article on moneylife.in that sheds some light on the prices of gold for Indians. I think it also applies to other countries besides India.
Thanks Rohit for the link to the article on gold prices in India. I was wondering why , in India we’ve never seen a slump in gold prices although JD says it fell in the US.
As an Indian woman, the gold my parents gave me does make me feel more secure and the value has gone up more than 15 times in these 25 years. I believe in buying gold, the real kind, not ETFs.
JD, great article and so well researched. Thank you
I get tired of how much you think you must clarify that this is only your opinion, and that things could be different in the future, and blah blah blah. It seems like half of this article is that type of padding. Say it once at the beginning or end if you really feel the need, and leave it be so that the real content of the article isn’t continually tripped up.
I understand this sentiment. There is no reason to repeat so many times that you are not 100% sure. I know why you would do it, but once really is enough. 🙂
And even though once is enough for many, this is a blog and unless you repeat yourself many times over, the comments will come back accusing you of being a pseudo-expert, or argue your conclusions criticizing your dogmatism, etc. So, I guess I understand where JD is coming from.
Yes yes. I agree. And normally I would only mention this once in an article. But I know from experience that topics like this set people on edge, and if I don’t qualify myself again and again, people will accuse me of trying to be an expert, or of making stuff up, or whatever. So, this time (and you’ll note I don’t always do this), I was careful to add the disclaimer several times. Even I found it tiresome. But I also thought it was necessary.
For a non-economist, I think you sum it up quite nicely.
I never understood Gold Standard proponents, although I believe I understand the flaw in their thinking. They dislike non-value currency because the value is arbitrary. Yes, it is true that the international markets determine the value of currencies like the U.S. dollar (Just like gold), but the government has the power to issue more currency whenever they wish (just about), effectively decreasing this value.
On the other hand, the govt. can never just “issue more gold.” Therefore, to goldists (may I call you this?), gold’s value is completely determined by market value and not subject to govt. whims.
Flaw #1: While you can’t print more gold, gold production / mining is regulated and controlled by many governments, and worse, by certain companies in the style of diamonds (limiting harvests, etc.). So don’t fool yourself that gold is not an artificially controlled substances. Which brings me to…
Flaw #2: Gold has intrinsic value. The flaw here is that the only intrinsic value it has is what we assign to it. You touched on this in your article. Gold is a relatively rare element, so it must be valuable, right? Well, picture of penguins hand-drawn by me are rare too*, so they must be insanely valuable, right? No, because nobody is willing to pay for my pictures, unfortunately.
Currency is created for trading value. The currency I have came at the expense of the value I provide through my job, intellect, etc. So when I purchase something, I am trading value. Goldists agree here, and get caught up with this. They think because we are trading value, then the intermediate step, currency, should have intrinsic value as well, otherwise you are left holding something worthless until you make a purchase.
The problem is that any value is subjective, including the very things currency is meant to trade for, so the value of the currency itself is subjective, and therefore, arbitrary (with respect to social forces).
Gold has been determined by people for thousands of years as a valid form of money. Fiat money has shown throughout history to destroy the country that went to it. Look at the history of the US since we left the gold standard in 1970’s. Oil has gone up dramatically, prices for almost all goods has increased and the value of the dollar has lost almost 90% of its value. The value of a currency needs to based on something and gold over the years has been the thing people value.
That’s why I’m accumulating 55 gal drums of crude and burying them in my back yard. I try to diversify with some vegetable oil and wd-40 with no more than 5% of my oil portfolio in Olive Oil (virgin, of course!) When everyone’s throwing their gold and silver in the streets, I’ll be the only one driving by just smiling and waving, boys…just smiling and waving.
You seem to misunderstand “intrinsic value” concept.
Paper doesn’t have value because you sat at a desk for 3 hours in order to get it. Nobody cares how you earned money (well, the police or your spouse might). Where it took you one hour of consulting work to earn $50, it might take the WalMart greeter five hours to earn that much money.
Does that make your $50 more valuable than the greeters? No, it does not.
The $50 doesn’t have value because of how you worked for it, it has value because it has “Fifty Dollars” printed on it, and someone else will give you fifty dollars worth of something else for it.
It has pseudo-intrinsic value.
So in a roundabout way, you’re agreeing with the goldists.
Meanwhile, gold has intrinsic value because it has multiple uses, just like butter, copper, diamonds, water, etc.
I mean intrinsic in the precise sense, as you would use it in mathematics, meaning “an inherent property”. I am arguing that nothing has intrinsic value (although philosophers argue this point about life), not gold and especially not printed money.
In such a world, there’s no perfect currency. Gold is better than paper money, but it is hardly the solution to all our economic problems as some make it out to be.
You argue my point exactly. People don’t care how I “made my money”. With each transaction, I am trading some amount of my (perceived) value for the (perceived) value of others. The currency is just an intermediary, and as I said, there doesn’t seem to be a perfect one.
You can call it pseudo-intrinsic, but that’s a wishy-washy term.
I dunno about gold having “multiple uses”. We assign it value cause animals like shiny objects.
JD – you da man and that was awesome. Thanks for scouting out the rabbit holes for us.
So now you’ve got me curious – there are so many scams out there when it comes to selling gold. Any thoughts on the best way to “cash in?” I’m wondering if eBay might the fairest way to go…
Katy, I sold mine to a goldsmith. I don’t know if this is the best option, but I assumed that an end-user is going to give me a better price than some “WE BUY GOLD” operation.
Katy,
I am an auctioneer and have coin only auctions 6-7 times a year. I have helped many people sell both gold and silver at prices well above what you get at the “WE BUY GOLD” places and since most auctioneers work on commission the more you make the more we make is always a good bet I will get as much for you as I can. Call an auctioneer that specializes in coins. One estate was offered 16000 for their silver from a dealer and we got 28000 on the auction.
The fact that silver plummeted from $50+/oz to $38/oz in the last few weeks makes me think that there are a lot of large scale investors with vested interests taking profits from bets with precious metals (particularly silver) that will leave naive amateur investors nursing their wounds.
No crazy conspiracy theories here, but the meteoric rise in silver prices stinks of manipulation (not by secret cartels, but by greedy investors!)
Prior to the recent bull run, changes in value of more than 1-2%/day were the norm. I have no interest in buying until this settles down again!
Professional investors make a lot of their money off of the foolishness of amateurs. Not off of manipulation, but good business principals.
If you are willing to buy something for more than its worth, it is your folly not the guy who sold it to you. He’s selling based on the understanding that people WANT his product. Its not his fault you overvalued it.
Buy the market. Look up JD’s index fund articles. While an index fund never beats the average for funds, it doesn’t lose by much either (if at all). It merely performs average. 6-8% return before inflation is fine by me. Its better than anything else out there. And I’m not gambling my success on a single company, but the economy at large.
While amateurs are definitely foolish (and greedy) on occasions, it tends to be because they’re following momentum in markets inflated by investors looking to take the money and run at the first sign of a real dip.
The Great Depression was CAUSED by the abandonment of the gold standard. Major countries abandoned the standard during WWI which lead to huge imbalances. How else were they going to fund war? They had to keep the printing presses going to keep the tanks rolling out.
Do yourself a favor and read “America’s Great Depression” by Murray Rothbard. He clearly shows that the Fed’s increase of the money supply in the “roaring 20’s” put the economy on a seemingly endless path to prosperity – that subsequently collapsed and put us in the Great Depression.
I’m always surprised to see people who think that they know it better than every single government in the world.
This is a great series on the pros and cons of the Gold Standard. I won’t give away the conclusion, but here is a hint: we shouldn’t go back 100 years. 🙂
You should really think why governments would want to remove the gold standard. As soon as the get rid of this barrier they can print money to their hearts desires to pay for things that wouldn’t be possible on a gold standard. Hence the huge debt crisis almost all countries are facing right now. On the gold standard, governments where restrained on what the could spend but as soon as the restriction was gone they started printing money like it was their job. Notice how the dollar has lost 95% of its values since we left the gold standard. This also allows countries to go to war easier because they can jsut print the money to finance the wars. And to anyone who belives the gold standard caused the great depression they should really look at the facts or read a book or too. I would start with Rothbards book first.
The facts I’ve read suggest the opposite of what you are saying. It seems like most economists agree that the gold standard is rightfully abandoned. I guess we can go back and forth on this, but tell me this: if the Gold Standard is such a great idea, why isn’t there a single democracy in the world on it?
That is easy to answer. Its because leaving the gold standard allows government to spend on things that they wouldn’t otherwise be able to afford. They wouldn’t be able to start wars all the time or afford all the welfare programs that all the countries have. I’ll ask you a thing, what has happened to all the nations/countries that had a fiat system in history? Rome, Greek, Egyptians to just name a few.
Your time and diligence are never wasted, JD. That’s what makes GRS better than the rest. Although this article debuts today, it lasts forever, so every time you have occasion to refer someone to it later, that’s a return on the investment of time you put in. And every time one of us refers to it, all the better. Keep up the good work.
Very interesting. I tend to feel that when you’re investing in gold you’re investing in the market’s perception of gold as a safe hedge against inflation since gold has minimal inherent value as an investment. There are industrial and jewelery applications for it but why aren’t you investing in companies around those industries or mining if you want to capture their gains or losses? Gold is too volatile and doesn’t produce income or products to be a good investment for my taste.
William Bernstein (the excellent author of The Intelligent Asset Allocator, The Four Pillars of Investing, etc.) had a good post on the Permanent Portfolio. I suggest you check it out: http://www.efficientfrontier.com/ef/0adhoc/harry.htm
Great article! Thanks for explaining it all so clearly — around here there are constant radio commercials for gold-selling services, and they make me cringe with the extreme scare tactics they use.
As for the “Carter bubble,” given that you say most of the rise came toward the end of his presidency, I wonder how much the Iran hostage crisis played a role.
My husband and I were just talking about this last night.
I’m a coin collector (in a small way) but have never been a gold bug. There are a few gold coins I would like to have, but it’s the coin rather than the gold that I want.
I’ve been predicting a silver bubble which seems to have happened last week; I think silver will stabilize now, but that’s just my opinion.
The best way to buy metals is in mining stock.
We’re kind of accidental coin collectors too. My dad bought my son a 1oz gold coin when he was born. Since that was 3 years ago, it has appreciated considerably and I’m sitting here wondering if I should sell it to get the most return for my kid.
In the end though, I think the coin is neater than the money, and it’ll probably be one of those things he keeps forever. At least until he runs into an emergency and has to sell it at rock bottom prices. :-/
Buying gold is not an investment, it’s insurance. If you think of it as buying insurance, then the argument points you consider change. For one, it might not matter that it doesn’t provide a real (after-inflation) return. In fact insurance costs money.
Now, when you’re buying insurance you have to ask yourself if you are getting good insurance for your money. Everything you wrote in this post suggests that gold is too expensive for the level of insurance you’re getting. TIPs would seem to provide more cost-effective insurance, even better because they simultaneously insure against inflation and deflation.
The one scenario that gold insures most effectively for is the collapse of a currency and rampant government corruption, like happened in Argentina and described in this post: http://ferfal.blogspot.com/2008/10/thoughts-on-urban-survival-2005.html In that scenario, I’d guess that only physical metal is any good. If you want this kind of insurance, I’d say it is pretty clear that you’re going to have to buy actual metal, not “shares”.
Nonsense. Gold isnt insurance at all. In fact its nothing like insurance. If you are truly worried about your own currency collapsing you could just as easily use the forex or even just invest in a foreign stock exchange.
Gold is a commodity, thus its real value will never go up. Basically, a basket of food will cost roughly the same amount of gold no matter what happens to your currency(assuming there isnt a catastrophic food shortage or something).
Is that really true? From JD’s chart in the article, gold is up 76% since Obama took office. I know there has been inflation but I don’t think McDonald’s prices are up 76% in that time… seems to me you could buy more food with an ounce of gold now that you could have in 2009. Maybe there is a long-term correlation but gold is clearly subject to bubbles just like everything else.
Well, there is obviously going to be short-term spikes, but its still a commodity. People became deathly afraid of inflation, and had a surplus of investment money to use(since they unwisely sold their stocks low). So they bought gold. A barrage of infomercials probably helped as well. However, if you think that gold will increase in value above and beyond inflation for a long term, like 25 years, then you’re nuts. What are you basing that off of? Is gold going to become more rare? Will it be used more in manufacturing? What information leads you to believe gold will increase in value, other than doomsayers and whack jobs?
Put it this way, if you had invested in Ford stock instead of gold, you would have gotten a 1000% return instead of the 76% you got with gold. People love to point how well gold has done, yet they omit the obvious fact that everything did well in that same time.
Gold has, and always will underperform other investment instruments.
Gold is insurance only if you can time the market. Unfortunately, that is impractical (if not impossible). Its not insurance when you are betting short term. Its called portfolio tilting.
Insurance is splitting your portfolio 50/50 bonds/stocks. Stocks are good in times of prosperity (i.e. when interest rates are high) and bonds are good when times are tough (when interest rates are low).
When you use it as a hedge, possible. But what if there is a sell off on gold and the economy doesn’t improve. Where is the hedge?
Thank you for the time and effort you devoted to researching and writing this post, J.D. You’ve put forward a strong case against investing in gold, and I also appreciated that you mentioned the Permanent Portfolio as a reasonable strategy for including gold in one’s investments. I also appreciated that you included a mention of Crawling Road, whose piece on gold ownership represents a reasoned, rational approach that is neither hysterically enamored with gold and nor vehemently opposed to it.
I do have one point to add regarding owing gold in a crisis. People on both sides of the issue allude to doomsday scenarios–as you did–when arguing the merits of owning gold. But it doesn’t take a dinosaur escape for gold to be useful in dire straits. Specifically, it’s proven tone useful to own gold during the economic crises in Argentina (around 2001, I think?) and Iceland (2008). I think Crawling Road goes into detail on this.
Excellent article. I also don’t much like gold as an investment, for most of the reasons you cite above.
The gold standard is very workable however. No governments currently are on one now as you mention. But the gold standard is disliked by governments NOT because it can cause depressions or whatever, but because it limits that governments ability to debase it’s own currency.
If a government can’t “print money” to pay off it’s own debts, then its borrowing capacity is
becomes much more limited. Limited borrowing = limited government spending and growth.
I encourage all readers to take a look at what Austrian School of Economics has to say about what causes booms and busts, and how returning to a gold standard in some form would increase wealth and prosperity.
This comment is not endorsed by standard mainstream economists. As JD rightly pointed out in his article, the gold standard would be disastrous in today’s economy, and did indeed make the Great Depression greater than it needed to be. There are a couple of excellent books, one by Eichengreen and one by Temin, that discuss the problems that the Gold Standard caused for the Great Depression.
It is, however, endorsed by many an armchair economist. Who, by the way, cannot backup their claims with effective arguments nor historical facts.
Although I put little faith in professional economists. I read a great comment once on some website, I’ll paraphrase:
“I remember when I was in college. All the smartest students went into the sciences. All the average students became doctors. Everyone else, they went into economics.”
Yet those standard economist never saw the dot.com bubble or the real estate bubble. Funny how the Austrian economist saw both coming and their economic thought actually explains all the booms and bust in the history of the US. But hey, lets not listen to the people who got it right. Keynesian economics has been wrong and will continue to run the US into the ground.
That’s silly. Everybody (all the professors and students in my top PhD program) knew that the dot com bubble was a bubble and that the real estate market was going to collapse (again, its unsustainability was a common point of discussion). (Though I don’t think anybody realized quite how much fraud there was within the real estate market. We knew it was going to be bad, but not quite this bad… we’d envisioned more of a 1980s S&L bad.) Those are both in standard economic theory too. When was the only question, and economic theory can’t predict that, because it is really the realm of complexity and chaos theory.
You may think that standard mainstream economists didn’t predict that because the media didn’t choose to report the majority view. Jon Stewart had a really fantastic piece on media bias towards irrational exuberance around the time he got into that big fight with Jim Cramer.
After gold collapses, you will probably say, “mainstream economists didn’t predict the collapse of gold.” But that doesn’t make it true.
Also, whatever college that was in the previous comment probably didn’t have a business major. Though many folks who get PhDs in economists also have an undergraduate math, physics, or engineering degree. Mine was math. It is far easier to get into and through med school than an econ phd program.
@nicole Did they see it coming in 2002-2006 or did they only see it coming in 2007/08. Are you taught Keynesian or Austrian Economics in your PhD program?
Nobody teaches Austrian economics at a top 10 program. That would be like teaching Marxian theory at a top school. Only as a curiosity. (Well, except that one guy that everybody secretly calls a sociologist behind his back.)
Also, Keynesian economics was out of vogue when I started graduate school… I can’t tell you whether I had it or not because that would tell you which top school I went to for graduate school since only certain top macro-economists teach it in graduate school.
Keynesian economics has made a come-back recently (after the crash) precisely because its predictions and suggestions are so spot-on. The 1980s was really when they stopped doing so much Keynesian economics and started doing lots of abstruse mathematical modeling with predictions that didn’t match the real world in any way shape or form. The history of economic thought is an interesting study and I recommend it for anybody who thinks all there is is Austrian economics and Keynesian economics.
I graduated long before 2008. So yes, predicting dot com crash 2000, real estate crash at least by 2005. The stupid stupid loan terms on our first houses we were being offered as graduates was enough to show the real estate market was unsustainable. Those 20-20-10 loans with the very minimal credit checks? A disaster waiting to happen. The huge run-up in prices in CA? Unsustainable. Everybody knew it, even though they didn’t know the extent of the damage.
“Did they see it coming in 2002-2006 or did they only see it coming in 2007/08”
Paul Krugman saw it coming as early as August 29, 2005, in this article “Greenspan and the Bubble” where he states, “There are signs that the housing market either has peaked already or soon will.”
Also bring Krugman into the mix is funny considering it was his ideas (stimulus and lowering interest rates after the dot.com bubble — Keynesian) that was reason we even had the real estate bubble. Its kinda funny that people still thing even Mr. Keynes himself said that his theory didn’t work unless there was a war. http://www.youtube.com/watch?v=Q1B3CXaudCo http://www.lewrockwell.com/woods/woods116.html
@Nicole — Keynsian theory doesn’t explain the actual cause of any the problems in the last decade. In fact Keynesian theory is the reason we had the real estate bubble in the first place. With the easy money (Keynes theory on softening a recession) the fed was providing the housing bubble wouldn’t have been formed.
Side on heres a funny/ informative video for all those Keynesians
I’m just trying to recommend rational, well written arguments from the “other side”, as JD recommends in the post.
As a follow up poster suggests, I am indeed merely an “armchair economist”! I think I could provide both rational arguments and historical examples to back up my points, but this isn’t likely a great forum to do so in.
Professional, mainstream economists like Bernanke have devalued your US dollar by over 95% in the past century plus. A return to a gold standard would indeed be pretty disastrous for the economy today – the equivalent to a massive hangover following binge drinking. But in the long run the economy, like a person sobering up, ends up better off.
Also on saying the gold standard prolong the depression. Read Murray Rothbards book on the great depression. Its funny how the gold standard before the great depression never caused anything close to what happened during the 1930’s. The only real change between recessions before the great depression is that govt got involved in the market by way of the New Deal Programs. Look at 1921 recession had an even greater decline than 1939 but yet rebounded in one year. How did this happen, the govt stayed out of the way and let the market readjust itself.
I am assuming your PhD economic class only taught you Keynesian economics.
Read Murray Rothbard book on the Great Depression. The gold standard didn’t cause or prolong the depression. If the gold standard was the cause of it then why didn’t we have a great depression in the previous hundred years? Inflating the money supply is the cause for all booms and bust. And govt spending(stimulus) like the new deal only prolongs the problem. If you let the market adjust itself unimpeded then you will get a quicker recovery like in 1921 which had an even greater drop but recovered in about a year.
Another important point about ‘investing’ in gold is that gold does not produce money! If you own a stock, there are two ways to earn money: it can provide dividends, or the stock price can increase and you can sell it. With gold, you only make money if the price goes up.
The reason some (very smart) people do invest in gold is because it can be a healthy addition to your *Asset Allocation*. The idea behind asset allocation is that you want different classes of assets that are not correlated to each other. The most basic classic idea of this is Stocks and Bonds. When stocks go down, often bonds go up and vice-versa. Investing this way is a proven method of increasing investment returns (and is the largest factor in determining your return).
Now, sometimes in crazy markets you see stocks and bonds both go down! So people start looking at other asset classes that are not similar/correlated to stocks and bonds. The big favorites are REITs (real estate investment trusts), Cash, U.S. Bonds, TIPS (Treasury Inflation Protected Securities), and gold.
I’ll skip over real estate for brevity’s sake. But other investment vehicles are all kind of similar to cash. Cash is an asset class/vehicle. You can get a return from your savings account… but the interest rate is low (and variable), it’s subject to inflation, and you get taxed on it. U.S. Bonds are the next step up, you get a fixed interest rate and you can be pretty sure that as long as the U.S. government doesn’t tank, you’ll get your return… but they’re still subject to inflation, also the interest rate is really low right now. Then you have TIPS which have an interest rate equal to the inflation rate plus a little extra, these are usually a really nice hedge against inflation and preserves your cash amount better than normal cash or u.s. bonds! (but they’re still taxable).
So why gold? because many people are concerned about the government’s ability to repay. So they look for a ‘safe’ investment to avoid risk, gold is perceived as such an instrument. And it’s price is due to both people looking for ‘safe’ investments AS WELL AS people just buying it because the price is going up.
The next topic to learn about is revision to the mean! and why when you have an asset allocaiton you should rebalance your accounts! Then you’ll see why having gold in your portfolio isn’t such a terrible idea… but you’ll also see why it should be more in the 1-5% range of your total portfolio size…
I would mention though that many websites and investment books will refer to this 1-5% as “tilting” a portfolio. This is the “fun money” of your account to keep you excited in investing, not the bread and butter of your retirement.
I’ve always thought of gold as something that will always have value, especially when dinosaurs roam the streets. Mainly because that’s what everyone else always says. I absolutely agree that gold is fiat money just as much as any other currency and, but has never thought of it before. Your article fits perfectly with an article I read last week. I may have found the link here at GRS, I don’t remember.
It shows how the first silvercoins where chosen BECAUSE they had no intrinsic value (you couldn’t eat them).
When it comes to using gold as a hedge against economic collapse, maybe you could invest in a basket of gold AND lots of other currencies. If the collapse only affects spesific regions of the world some of your assets could be saved.
Buy low, sell high is an investing rule. As a result, I’ve been selling my gold (not investment gold, but scrap gold) for big bucks the last year or so.
Ha! When they’re gone, we can all swoop in and take their stuff. I know my in-laws, who believe in the rapture, are big on buying gold (because their church told them to), so I’m gonna have me some pretty things on May 23rd!
Thanks for doing all the hard work and research for me! I’ve had very similar feelings about gold for a while now (it’s a bubble, and bubbles always burst), but didn’t have very firm facts or information to back up my gut feeling. Now I feel more informed, so I can go with my gut with a little more confidence 🙂
Matt (with The Online Budget) says10 May 2011 at 07:47
A great, informative article, injected with a nice touch of humor! Thanks. I’ve been kicking around “shorting” gold ETFs for a few months now, but I really don’t have the resources (yet) for doing so. So, for any goldbugs out there: Please buy my newsletter – which has loads of information on investing in Pez dispensers, Beanie Babies, Pets.com stock, and yes – Dutch tulips!
“If I’m a shop owner in this situation – or I’m your neighbor with a vegetable garden – I’m going to be want to be paid with something real, something like a carton of eggs or some shells for my shotgun.”
The movie The Book of Eli with Denzel Washington presents a post-apocalyptic dystopian society where people barter and trade valuable goods as money (clothing, lighters, guns, ammo, food, etc.). I agree that this is a more likely scenario than trading gold.
that is true for awhile but the barter system is very inefficient. Eventually as the society develops again some sort of money will developed because it makes making trading easier. That money may be based in gold, silver, or anything that people find valuable
My dad was a child in Greece during and after WWII, where there was a civil war, unstability and food shortages. He lived on a farm and was poor but they had the farm and they traded with the people around them to get other things they needed. On the other hand people from the city came into the country, begging and offering money, watches, family heirlooms for a loaf of bread and were turned away. Yes it may be “short term”, but short term still may be years and you can’t eat a gold watch when you are starving.
I take exception to this part of your blog post
“I am not an economist, and I struggle when it comes to economic theory, but my understanding is that much of the run-up to and aftermath of the Great Depression was thought to have been caused by the Gold Standard. Under the Gold Standard, currencies were much more susceptible to speculation and devaluation, which could lead to runs on the banks. That’s why the U.S. abandoned it. And it wasn’t only the United States that did so. Not a single country in the world uses the Gold Standard anymore. Until recently, most economists and politicians considered it a deserved relic.”
This is a common mistake made by people today. I would suggest you read Murray Rothbards book on The great depression for understand it more. Another resource on why we went off the gold standard is Tom Woods book “Meltdown”.
I invest in precious metals because i believe the govt will continue to debase the dollar and make it less valuable which makes gold more valuable. Inflation is on its way whether we like it or not and it is just a matter of time till the debt crisis rears its ugly head on the econonmy.
Like J.D. said, gold has no real value. If the world as we know it ended today, gold would mean nothing. If you have all this gold, and I have food, what makes you think I’m going to trade food for gold?
As an investment, I’m not opposed to gold, but I have not invested in any of it. Maybe if the value drops again I would purchase some, but not right now.
Gold is money; i.e. it has all the properties of money: http://en.wikipedia.org/wiki/Money, but most important to your point is that it’s a medium of exchange and a store of value. Unless we’re really talking about an apocalyptic scenario where very few people are left and it becomes very hard to grow food, your stock pile of food will either perish, or be harder to trade for other stuff than my stock pile of gold.
That’s exactly the point: it has all the properties of money. Which makes it (like money) useless in a “end of the world situation” where we will all start bartering for things that feed and protect our families.
I realize talking about an ‘end of the world situation’ is out there, but when you talk about the value of gold you have to. Gold is simply a rock that we have assigned value to. Sure it’s a good conductor of electricity, and can be used for repairing teeth, but beyond that what use does gold have? If the world ended today and I wanted to trade you a petosky stone for food would you? No you wouldn’t. The same is true for gold. It’s simply a rock that we have assigned value to. Just like the dollar is paper that we have assigned value to. Both are good for exchange now, but to pretend that one is more valuable than the other is illogical.
Don’s comment (#28) is spot on! Gold is not a hedge against a catastrophe or even inflation but against the collapse of a currency. It is NOT an investment in order to make x % in y years. It is seen as an insurance in order to preserve at least a part of your wealth should the Dollar or your national currency collapse. And it almost certainly will do that job better than stocks or real estate. JD somehow missed to even mention that motivation.
Btw, just one word about that “you can’t eat gold” notion. Sure, but the same is true for your house, stocks or cash. After a catrastophic event as described in the article your best bet is to have a land miles from anywhere and enough knowledge to grow your own food.
I don’t understand why gold preserves your wealth in the event of currency fluctuations/collapse/hyperinflation better than stocks or real estate? Wouldn’t those things just go up in price along with everything else? If not, would they not be a bargain to buy?! How is gold different than those things?
Buying gold because you expect armageddon akin to 28 Days Later where you need shotguns and huge stockpiles of food seems ridiculous to me. If the world comes to this, the gold you own in ETFs or whatever will be worthless to you and if you’ve stockpiled gold bars in your house, good luck finding people who want them if you’re not dead yourself.
I agree with you that in that situation (which I don’t think anyone should be planning for and is beyond the scope of a personal finance blog) the best bet would be to live in a remote area with your own farm and plenty of ammunition. But aliens could also kill us all tomorrow, or a meteor, or the rapture could take us away too. None of these things is worth discussing anywhere but a conspiracy theory blog.
gold in terms of dollars will increase but gold against any other commodity will stay the same or gold will be able to buy more than was previously possible. Take this for example, in terms of dollars, oil has increase dramtically in the last year but oil in terms of gold has actually gone down in value in the last year.
I agree, let’s not discuss end of the world theories. I only wrote about them because JD suggested they’d be important for gold bugs.
When thinking about a currency collapse we must keep mind that it doesn’t come out of nowhere. In all likelihood we would experience a massive economic slump before and the currency reform would only be the mean to end it. This is where the problem with stocks lies. There will be a lot of bankruptcies. If you happen to own shares in bankrupt companies, you’ve got a problem. Preparing for such a crisis would thus mean careful stockpicking. Which companies are going to survive such a crisis? Since I don’t have a crystal ball, I can only guess that those companies that provide basic goods everyone needs and have little debt stand a higher chance to survive. Bank share holder on the other hand will lose everything. New economy companies could be hit badly, too. How about index funds? Well, they’ll be under pressure, too, as they own shares of “good” and “bad” companies. And then, we should keep in mind that many index funds use swaps to replicate a given index. These products are as dangerous as those debt instruments that caused the near breakdown of our financial system. These funds are likely to vanish entirely as they require the current financial system with its highely vulnerable financial institutions to survive.
To conclude, yes, you should have stocks in times of currency reform but you better make sure you’ve got quality stocks. How about gold? Well, you can at least be sure that it will have a price after the crisis.
How about real estate? I’m certainly not arguing against owning your house. Owning your house has many upsides, most importantly non-financial ones. But let’s say you decide to invest in the housing market and buy additional houses. You either speculate on rising prices so that you call sell higher or on the rent payments. These should cover all your costs including interest on debt. What’s more, common knowledge says inflation helps to reduce the debt burden. Great, isn’t it? Yes, but in times of hyperinflation that will ultimately result in a currency reform, things look a little different. The problem is that expenses may rise a lot faster than income. Why? Because you cannot increase the rent or your wage as fast as prices for food etc. surge. Now, if you have debts, although they’re worth less now than before, you may still not be able to cover the interest. You risk losing your real estate. If you are debt free, the scenario looks a lot better though. You may only become a victim of some sort of equalization of burdens policy policy right after a currency reform but that would a smaller problem. It could be avoided with gold though as the government doesn’t necessarily need to know that you own gold.
All that said, I’m not arguing you should put all your money into gold. Buying gold is an option for everyone who thinks it’s possible that a currrency crash happens. A currency crash is always the result of a overindebted government and (!) private economy. In my opinion, we’re nearing that point in the US, in Europe, in Japan and the rest of the Western world. What’s more, if either the US or Europe collapses, the other one will follow suit. Diversifying out of the US or out of Europe will thus be extremely difficult. So, I’m afraid traditional strategies such as buy and hold and buying index funds will not work quite as good as they used to. Preparing for a huge debt/currency crisis demands a different portfolio: quality stocks, some debt-free real estate, and yes, some physical gold (though I do agree that it would have been better to buy a few years ago). Avoid bonds at all cost and all tricky financial instruments, including swap based index funds (that’s a good idea in normal times, too), gold ETFs etc.
Disclaimer: If you think no huge crisis will occur, ignore everything and go on as usual. I’ve got no crystal ball myself either but I sure think it’s not unlikely anymore that a huge financial crash occurs.
I’ve never understood the reasoning behind hoarding gold in case of a depression or even more serious financial calamity than what we’ve experienced recently. Like you said, I’m pretty sure any type of food, shelter or clothing would be more valuable than a shiny piece of metal if the SHTF.
I’m no economist either, so why do people automatically assume since the dollar is being “devalued” that means gold should increase in value?
Gold (other than it’s true uses as jewelry, in electronics, etc) seems like a giant pump and dump scheme to me – if enough people fall for it being a good “investment” the price goes up.
Don’t imagine total world devastation where everyone is looting for food in a radioactive wasteland. Instead imagine an economic disaster localized in one country or in one region of the world.
Imagine you are a citizen of a small up and coming country. You are a prominent business person and have the equivalent of $10 million USD in stocks/bonds/cash in your country’s currency, and the equivalent of $1 Million USD in gold. Now imagine tragedy strikes your country, and there’s total economic collapse, and your nation experiences hyper inflation, or extreme devaluation of the currency. Your stocks/bonds cash formerly worth $10 million USD are now worth $10 USD and you can barely afford a couple loafs of bread with that.
But your gold is still worth the same that it was worth to other countries as long as they haven’t collapsed as well.
If the whole world collapses, you don’t even physically have the gold anyway.
(relatively) small net worth investors *probably* don’t **need** to invest in gold. But if you have many millions, and you’re worried about the risk of a whole country collapsing and it’s impact on you… well it is a risk (no matter how remote), and it is a valid way to help hedge against it.
If I’m a citizen of “Unstable Country X”, I’m pretty sure I wouldn’t hold all my wealth in local currency. Diversification would take care of 95% of the problem I’m guessing. Until the dollar stops being the default world currency, I’m not going to get too worried.
You are exactly right! The problem is that if you’re in the US (I am). Many people’s portfolios are all in US funds. International Diversification is pretty important and highly recommended.
However it’s important to remember that is only a diversifying of total markets, and markets may or may not be correlated (depending on the hypothetical disaster). So instead of just hedging against market risk through geographical diversification, you can use gold as a different asset class to help achieve diversification.
You are not in any way wrong! i’m just pointing out where gold can be usefull. (but usually only if you’re very rich, see my future post that J.D. asked me to make in the comments).
Don’t neglect the commissions paid on the purchase of solid gold. If you read the fine print on the brochures the various companies will send you, in the “fees” section you will see where they may charge you up to 30% on *each side* of the transaction!
There’s a reason you continue to hear commercials for gold – it’s very profitable!
If you’re referring to GoldLine (there are plenty of others, I’m sure), the markups they charge border on fraud. They give legitimate dealers like Europac Metals (Schiff’s company), GoldMoney, and e-gold a bad name. You shouldn’t have to pay more than a ~5% markup.
Thanks for including the permanent portfolio at the bottom. This has been my choice for several years now because like you I found the arguments and data compelling. It is a good reminder that this approach to gold is different than the bubble approach the rest of the article (and it sounds like your Dad) talks about. Thanks for the time and effort it took to put this together.
I couldn’t quite articulate to people why I was so skeptical about investing in gold and this sums it up beautifully. I can’t think of any value gold would give me personally, or value it would give anyone other than being a commodity with fluctuating demand and price. I don’t see the price of gold plated cables spiking so I can’t see the value in gold.
First of all, silver, gold, platinum, and palladium (the four precious metals that are primarily traded) ALL HAVE VALUE! Ever heard of the catalytic converter? How about the printed circuit board? Solar Panels? Fuel Cells? There are hundreds of other widely used commercial applications for these metals. Yes, we are mining more precious metals everyday. But we are also using more precious metals in everyday manufacturing than ever before.
Just because you invest in precious metals does not mean you are advocating for a “gold standard”. In fact, JD I’m surprised you made that connection at all. Gold/Silver is a commodity just like any other. Buying gas, for instance, does not mean that I am pushing for an “oil standard”.
The quickly rising prices of precious metals is an indicator of how much inflation we have recently experienced.
JD, I think your comment about valuing shot gun shells above precious metals in a time of crisis, may be a bit shortsighted. I think we are much more likely to experience an “energy crisis” than an all out apocalypse, in which case owning a solar panel or fuel cell will be immensely useful. I believe, more so than shot gun shells 🙂
A side note, you might find interesting. The latest drop in silver prices coincided perfectly with the announcement of the assassination of Osama Bin Laden. The prices are only now starting to stabilize, now that some time has passed since the event.
Gold doesn’t have many industrial uses though. I believe that less than 20% of gold mined is used for industry. The rest is jewelry, coins, etc. The other metals you mention have much more use in industry. For example, it is platinum that is used in catalytic converters due to its ability to withstand high temperatures.
I don’t have any investment in gold either. I think it’s bad timing right now. I will probably buy some gold when the price get a much cheaper. I knew some people who were in Vietnam when the communist took over. The gold were the only thing they could take with them. It’s a hedge against all out disaster. I think you can always move to a better situation so gold could be exchange for currency at other places.
Warren Buffett had this thoughtful thing to say about gold:
“You could take all the gold that’s ever been mined, and it would fill a cube 67 feet in each direction. For what that’s worth at current gold prices, you could buy all – not some – all of the farmland in the United States. Plus, you could buy 10 Exxon Mobils, plus have $1 trillion of walking-around money. Or you could have a big cube of metal. Which would you take? Which is going to produce more value?”
I’m not going to argue whether gold is a good investment or not at this current time, the fact is: I don’t know. It is certainly less good of an investment today at $1500 than it was some years ago at $400.
..but, many of your arguments are deeply flawed:
That equities have made good returns since 1926 is pointless for a number of reasons:
Firstly, most people do not have 85 years or an arbitrarily long period of time to save up for retirement. They have about 30-35 years. If you pick a few time intervals for equities that are 30 odd years long, I’m sure you’ll find times when equities have been a lousy investment, as surely as you can find the same for ANY asset class.
Timing and time of holding matter as much as anything in a historical perspective, and if you happen to become an adult at the beginning of a bad run, you may grow old before your investments recover (in real terms, the S&P had negative returns between 1997-2009).
Secondly, as always, past performance is no indicator of future performance.
When it comes to the “intrinsic value” of gold or currency, it has none. Things are only as valuable as the buyer sees them, and as valuable as what you can get in exchange for it. If a replacement for oil was invented tomorrow, oil would soon have less “intrinsic value” than water.
BUT, at this current time I personally have a certain suspiciousness towards the US Dollar: the US monetary base, ie the base amount of currency in circulation has more than tripled in a few short years. Gold above ground on the other hand only increases by about 3-4% per year (I think) – In a race to the bottom, Bernanke’s ability to conjure up money at will and track record of doing puts the dollar at a disadvantage.
Even IF gold is in a bubble, my view is that the dollar is in an even bigger bubble: money printing on such a scale will only mean that prices for just about everything, from commodities to equities will get bid up, as more dollars chase fewer assets. Which asset will get bid up the most is anyones guess, and in real terms, gold may lag behind inflation (hence: “bad investment”), but the dollar is more likely to suffer.
I have no idea which way the economy is headed, but a re-run of 70’ies style stagflation is not a bad bet.
Finally, in the case of the “apocalypse” that some people seem to want to portray:
You’re right. Gold won’t do you much good, nor will dollars. If someone believes in such a scenario, I’d suggest stocking up on bullets and whisky. In post-Soviet collapse Russia, vodka was as good as money.
I like the anecdote about the value of antique paper money due to its collect-ability vs. the equivalent amount of gold. One of life’s little ironies I suppose.
You got one thing right in this article: You don’t understand economics. Thus all of your other conclusions make sense, for someone who doesn’t understand economics.
By the way, one of the ways I will know when the gold bubble has started is when we stop getting articles like this, and we’re seeing articles (from people who don’t understand economics) advocating gold using faulty reasoning.
For instance, the inflation rate is closer to %20 than %2. TIPS does not protect you against inflation. You’d understand this if you understood that inflation is an increase in the money supply, not a growth in prices. (It is trivial for the government to manage “growth” in prices by changing the basket of goods, and simply excluding the areas where prices rise first due to increases in the money supply– energy, which they exclude completely from their claims about “inflation”)
Unfortunately, this ignorance of economics is widespread and results in people thinking their wealth has gone up when they invest in stocks whose price has gone up. The error is assuming the dollars they put in were worth the same as the dollars when they liquidate.
Right now we’re seeing the US Economy shrink, but inflation is so high the stock market and GDP figures are still going up.
It will be extremely painful when people realize the truth of the situation.
After that happens, they will rush to gold and silver and the gold bubble will begin.
Ah yes… A wise man indeed. At the mere mention of http://www.mises.org, I can exhale with confidence that you know what you’re talking about. The author of this article would do good to spend some time on the web site.
Keep up the study of true Austrian Economic principle and you will continue to advance yourself in your community as you explain (correctly) why the dollar is crashing and gold is 5,000 dollars an ounce. Long live Mises/Rothbard/Dr. Paul!!!!
It’s nice to see someone NOT pushing gold/silver/copper etc. I couldnt agree more that if the world was ending, I doubt someone would care about a bar of gold over a piece of food or clothing. We have too many doomsday speculators out there pushing inaccurate knowledge and advice.
“Right now, I’m willing to bet on the side of history”
Not, unless you are shorting it. Otherwise your are just sitting on the sidelines. If you know gold is in a bubble then short it. Otherwise, you just don’t know whether it is or isn’t or are not willing to walk the talk.
Suspecting or even believing that a bubble exists doesn’t give you the ability to predict when said bubble will burst. There is inherent risk on either side of the board in that scenario – either you buy long, and risk that there really is a bubble and it bursts, or you go short, and risk that there isn’t a bubble, or it doesn’t burst when you think it will. Sometimes, the only winning move is not to play.
If the bubble bursts and you short..you will eventually win unless of course the price you buy in at is not in the bubble stage after all. So the point remains, if you have no skin in the game then you’re not willing to back your opinion up. Now, if you say I don’t know whether gold is in a bubble or not so I am staying out. That’s a perfectly acceptable position. But you never “win” with that position you neither win nor lose
Not knowing when the other shoe is going to fall doesn’t mean you have to stop believing in gravity. 😉
“Eventually” is the key word. There’s no such thing as a “buy and hold” short position – eventually, there’s going to be a margin call, and you either have to buy the (stock/commodity/widget), or pony up the cash difference. Even if the value stays the same, you wind up losing money on transaction costs, interest on the margin account, or even the opportunity cost of having your capital tied up. The only way to win is for the price to decline in the time frame during the period you’re invested, and decline enough to cover the costs mentioned previously. Shorts are an okay hedging position, but I’m not terribly enthused about an investment vehicle with limited potential for gains and unlimited potential for losses. You need luck or some very concrete information to consistently profit on shorts.
Though investing in gold may not be such a great idea, certainly selling it to a reputable dealer works well right now with the price high. I just sold a few pieces of 14k gold (scrappy jewelry I inherited) and made an easy $375. I would caution anyone from mailing their gold to distant gold buying companies many of these are shams and you’ll never get the value you should, but in person you can shop around to get the best price and I was actually able to negotiate the price a bit.
There’s a great, old Twilight Zone episode that’s really relevant to this topic, “The Rip Van Winkle Caper” in which gold bar thieves go through suspended animation and wake up in the future to find that their gold stash is worthless and irrelevant. If the link works, you can read the synopsis on Wikipedia. http://en.wikipedia.org/wiki/The_Rip_Van_Winkle_Caper
Another consideration is that gold mining is some of the most harmful mining both to the environment and to people. Mercury is used to separate gold out from other material when it’s being mined. I can show you a picture of miners in the Congo holding mercury in their bare hands. Since there are practically no real gold veins left anymore, gold miners will mine tons and tons of rock volume, producing tons and tons of waste (not to mention completely destroying the area being mined), to extract very small amounts of gold. Cyanide can also be used to leach gold from ore, and this releases naturally occurring arsenic in the rock, which can and does enter the environment at levels toxic to humans and other animals. This occurs in the US, where the mining corp is monitored and has to clean up – imagine what they in places where there aren’t strict environmental regulations. In Africa, thousands of children work in gold mines.
For something with so little intrinsic value (the only practical use I can think of is for dental crown material), its popularity and the lengths we go to in order to get it, just boggles the mind. It reminds me of the diamond engagement ring tradition started by the De Beers. In a way, I have to admire them for finding a way to invest in human gullibility.
U.S. dollars – and other world currencies – were once backed by gold. Under the Gold Standard, you could ask a bank to convert your paper money to gold at the legal rate (whatever that might be). In order for the government to print more money, they had to have the gold to back it.
The government had to actually have gold and silver in order to do any business. Politicians hated this, because they had to take your gold in order to spend it, and people hated having their hard-earned gold taken.
This is why they and the bankers push for “gold-backed paper,” which they could re-value at will; see below for this in action during the depression.
Proponents of the “Gold Standard” argue that since the U.S. abandoned it in 1933, the dollar is more susceptible to inflation. That’s true. But the Gold Standard didn’t eliminate inflation, and it created other problems besides.
Inflation is an increase in the money supply. The only way to inflate gold is to dig more out of the earth. Gold is rare, so this doesn’t happen very quickly, and the supply is finite, so there is a physical limit to how much can be in circulation.
Paper money can be printed as quick as the presses can be run, but modern day fiat money doesn’t even have to be printed – the Federal Reserve simply declares $1.2 trillion new dollars now exist, and electronically transfers them to payees around the globe. They can create inflation on a scale previously unimaginable since they are not limited even by time constraints to run a printing press.
I am not an economist, and I struggle when it comes to economic theory, but my understanding is that much of the run-up to and aftermath of the Great Depression was thought to have been caused by the Gold Standard. Under the Gold Standard, currencies were much more susceptible to speculation and devaluation, which could lead to runs on the banks. That’s why the U.S. abandoned it. And it wasn’t only the United States that did so. Not a single country in the world uses the Gold Standard anymore. Until recently, most economists and politicians considered it a deserved relic.
You need a basic understanding of the two major schools of thought regarding economic theory: Keynsian and Austrian. Have a look at http://www.youtube.com/watch?v=GTQnarzmTOc
Bank runs are not caused by the gold standard – they are caused by fractional reserve banking, where banks figure what percentage of deposits they need to keep on hand for customer withdrawls, and loan out the rest.
In effect, they cook the books so that while claiming your $100 is in the safe, they loan out $90 of your money and hope you don’t try to get all $100 back. There is now $190 in circulation – your $100, and the $90 loaned out. If that $90 is deposited at your bank, it now has $190 in deposits on the books, and only $100 in physical money.
If you both go back to the bank on the same day and try to withdraw all your money, whoever gets there first, wins, and the other goes home hoping the FDIC will pay up.
During the Great Depression, Roosevelt would literally wake up each day and devalue the dollar in respect to gold. Read Garet Garrett’s The People’s Pottage. Tuesday, gold would be $25 and oz.; Wednesday, they’d declare gold is now $35 an oz. This allowed the government and Federal Reserve banks to print an additional $10 for every oz of gold they had without having to get more gold.
This is why central bankers and politicians around the world have pushed every nation off the gold standard — so they can print as much money as they need to fund whatever activities they want to do. Nearly all politicians, and all central bankers are Keynsians. They want central control over the economy, with them at the center.
Every article you linked to about the gold standard and the depression was Keynsian. They all assume that when something “goes wrong” with the economy, “someone” needs to be able to create money out of thin air and “fix it.”
The problem is, Keynsians often have no idea how to fix anything — illustrated by how every single one of Bernanke’s predictions about where the economy, housing market, stock market, etc, would go since he became Fed chairman has been wrong.
And the booms and busts “complained” about by the Keynsians which they claim shows the need for central control and elimination of the gold standard, are created by central banks inflating the money supply through fractional reserve banking and artificially fueling demand, speculation, and price increases.
Goldbugs would have you believe that when diaster strikes – we enter a post-oil economy, we’re nuked by terrorists, dinosaurs escape from Isla Nublar – that paper money will be worthless and we’ll all be trading in gold. Because of its intrinsic value, it’ll become a form of currency. I’m not convinced.
Study history – gold has been the preferred medium of exchange for thousands of years in thousands of civilizations. It has been the preferred medium in this country every time the fiat currency in use had been inflated to worthlessness.
Let’s say I’m a shopkeeper. I have a minimart and I have a shotgun to defend my stock from looters. If we’re in some sort of post-crisis world where dinosaurs roam the earth, I doubt I’ll want your gold. It’ll be just as worthless (or as valuable) as paper money. Why? Because in reality, gold too is fundamentally a fiat currency. That is, people have assigned it an arbitrary value. That value vanishes in a crisis, just as the value of paper money does.
The value of gold does not vanish. It will always be a rare earth metal with multiple uses and always in demand. Even in a barter economy, you may accept payment in, for instance, pre-crisis bicycles, even though you don’t need one, because you know someone else will, and all the bicycle manufacturers got blown up, so noone is making bicycles anymore and you can trade it later for something you do need.
So it is with gold. It is durable, has multiple uses, is easily portable, can be fashioned into handy shapes, and is hard to come by.
Let’s think for a moment. Have we seen any price bubbles before? Maybe even in recent history? Over the past fifteen years, we’ve seen three bubble economies:
And those bubbles are all caused by the Fed printing money and loaning it out at extremely low interest rates. Nearly-free money encourages borrowing and spending at in ways unthinkable at true market rates. You would not borrow $400,000 for a 2-room condo at 20%, but you wouldn’t think twice at 6.5% when you know some sucker will buy it from you a few months down the road for $450,000 at 5.5%.
With a gold standard and without fractional reserve or central banking, bubbles are small and localized. When they burst, a small region is affected, and everyone quickly recovers. It is documented in our nation’s history.
But finally, gold isn’t an investment. It is a store of value. An ounce of gold will almost always be the amount required to purchase a nice tailored suit. Wherever the economy goes, that will hold true, and gold’s “real” value will remain.
We are not seeing a bubble in gold, we are seeing massive inflation from the Fed’s loose money policies. The Fed and our government show every intention of further debasing the dollar, which will make the “dollar value” of gold shoot higher, but will not increase it’s “real” value. If or when the dollar collapses, gold will still have the same value.
J.D.’s note: Mark’s comment is a great example of how you can disagree with someone and still carry on an intelligent conversation. Actually, most of the comments on this post are pretty good. I just wanted to highlight this one because he’s given me some food for thought, and I plan to spend some time reading the links he provided.
I really appreciate this thoughtful argument. I would like to point out that it is a false equivalence to compare the barter of gold to the barter of a bicycle in a barter-system economy. Bicycles have a practical use, they need no fuel and they can maneuver narrow pathways and go off-road. I know I could trade someone a bicycle, or even the parts if the market is saturated. What practical use would gold be to my customers, unless they have agreed upon an arbitrary value for it?
The only difference I can see between what you call currency with stored value, and currency with value by fiat such as the dollar, is that the stored value currency can be divided into smaller pieces of proportionally smaller value amounts.
Also, if the extreme run on the price of gold is NOT a bubble but rather an accurate reflection of inflation, then why haven’t prices for goods and services gone up proportional to the rise in gold prices? To look at things in this way, I can say that the value of a dollar has increased relative to the real estate market.
Think about it this way. Gold and paper became currency because a barter system is inconvenient.
Say Mary has a set of dental tools but wants a bicycle, John has a bicycle but wants apples, Sam has a bushel of apples but wants a cow, and April has a cow but wants dental tools, and they are each worth approximately the same amount. If they try to do a four way trade, they have to somehow a) know about each of the four people and find a way to meet up, or b) happen to come across each other.
Also, transportation of the items becomes an issue. A small pouch of dental tools is a lot easier to transport than a bushel of apples or, say, a herd of cows, so the more complicated or distant the meet-up, the harder it is.
Plus, the more complicated the trade, or the more rare the demand for the item, the harder it gets. For example, the dental tools. While Sam’s bushel of apples is something many people might want, only dentists need dental tools. That doesn’t make them not intrinsically valuable, but in a barter system it does because of the difficulty of finding a buyer who conveniently also has something that you need.
Additionally, imagine how much MORE difficult the trade gets if the items are all worth different amounts. You might be able to trade a fraction of a barrel of apples, but you can’t trade a fraction of a cow if you intend to use the cow for milking or breeding.
Gold evolved as currency because it was a convenient middle man. Now all four people can sell their items to the local grocer, who gives them gold for their items, and they can spend that gold on whatever it is they need. No coordination necessary, since with currency there is no need for the grocer to have the item they need as long as they have enough currency, and it’s easy to create fractions with gold since it’s so easily shaped, and it is light and easy to carry.
This isn’t an argument for a gold standard or investing in gold, mind you, but I think it’s easy to see how an apocalyptic world COULD end up back on the gold standard or some other common currency.
I disagree strongly that there are two schools of thought. There are hundreds of schools of thought. The Austrian school is not a major school by academic standards, though it has many proponents on the internet. Like wikipedia says, “it is outside the mainstream.”
The two mainstream competing schools of macroeconomics are Keynesian and the Chicago School, though neoclassical has been mainstream in the past and may surge up again.
This quote is telling, “Austrian economists reject empirical statistical methods, natural experiments and constructed experiments as tools applicable to economics, saying that while it is appropriate in the natural sciences where factors can be isolated in laboratory conditions, the actions of human beings are too complex for this “numerical” treatment as passive non-adaptive subjects. ”
If you don’t believe in empirics, then nothing you do can ever be disproven.
“If you don’t believe in empirics, nothing you do can ever be disproven.”
True. But conversely, if you put faith in empirics in a situation like economics where it is virtually impossible to separate all the variables, is that any better?
This (long) comment is just sad. The Austrian School is the economic equivalent of Intelligent Design, and taken just as seriously by anyone who knows what they’re talking about.
Actually, taken a bit literally, the Austrian school would argue that economics is organic (spontaneous order) and the Keynesian school would argue for design.
THANK YOU for this post! I’ve been a reader for about 6 months and haven’t commented, but felt compelled on this one. I appreciate the time and effort put into this post. Last year I took a economic class where I learned about gold investments, and all this gold talk has driven me crazy since then! My professor liked to say that by the time everyone is talking about buying gold, it is a bad investment. I 100% agree with you on everything and I am going to forward this article onto several family members who I’ve been arguing with about gold for a while. 🙂
I’ve always been a little leery of the “gold has intrinsic value, so it will always be worth something, even after the end of civilization” argument. Ultimately, gold does have some use in industrial and electronic applications, but if you’re sitting in the post-apocalyptic wasteland, how much use will you get out of the ability to make integrated circuits (without the machinery to fabricate them), thermal protection for satellites, or the like? You can’t eat it, it’s too soft to fashion into a useful tool, it’s too heavy to lug a lot of it around even if you do find a good use for it.
In the event of total societal collapse, food, ammunition, and toilet paper are going to be much better storehouses of value than a relatively useless metal that people value because it’s shiny.
To me at least, it seems like gold is really only of value if there were a PARTIAL collapse of the global economy – if, say, only your country’s economy collapsed. In that case, you could get the same result by allocating some portion of your investments to a basket of foreign currencies – if you are in a scenario where ALL currencies are losing value relative to some arbitrary benchmark, you’re back at the total global collapse, stock up on toilet paper and shotgun shells scenario.
Personally, I say if we’re going to declare an arbitrary “storehouse of value”, I say we go with tulips. It worked for the Dutch back in the 1600s…
Thank you for this well written, level-headed approach to the silver/gold boom. I admit, I recently caught “the silver bug” and overbought silver in relation to my personal net worth.
This article made me seriously reconsider proper diversification, and as a result I am redistributing my investments. The Permanent Portfolio approach is exactly what I have been looking for, and nearly matches my current strategy, while articulating it a lot better.
I’m a long time lurker, but felt the need to praise you for this great, well written article!
Thanks, everyone, for a thoughtful discussion. I especially appreciate Mike S (#82) for his thoughtful rebuttal to my article. Mike, I’ll spend some time this weekend looking through the links you supplied.
I especially like the “gold is a store of value, not a hedge against inflation” responses. That’s an interesting way to look at it.
Finally, to the point that gold prices are rising because of inflation — I’m not sure I buy that. Why then did gold prices decline for twenty years after the inflation in the late seventies and early eighties? We sure weren’t experiencing de-flation then. If gold rises due to inflation, I’d expect it to do so in some sort of systematic fashion. Instead, the current prices are all out of whack with anything. (And are you arguing that we’ve had rampant inflation since 1999, which was when this surge in gold prices began?) No, to me this still looks like a bubble. I can’t see any way around that. Sure, there may be some legitimate gains in the price of gold over the past decade, but much of it is pure speculation.
RE: gold as an investment… I think the problem is that while it is true that the “inherent” value of gold as a value store remains relatively steady, the stock price isn’t just a reflection of that value against the dollar… it also has the human speculation built in, which is subject to a lot more whim than we’d like to think. Just my two cents.
I’m personally not convinced either way on the benefits of investing in gold (stock or bars), but I do agree with Mike that there is in no way a consensus in economics on some of the things you referenced in your article, like the gold standard being the cause of the Great Depression.
After reading this article, I put a stop to my hoarding of gold because this article allows you to think rather than just push an idea at you. I do think we have gone to the next stage of a bubble but not the stage where it will burst and there will be more upside. However, I am satisfied with the amount of metals I have and have bought at the 2009 prices and have since tripled to quintupled my nominal value.
As an economist though, I don’t agree with the history of the Great Depression and the Keynesian economics. It is the Keynesian fiat currency reserve system that puts us into bubbles because of the oversupply of money. The Roaring 20s was the artificial “propserity” that came from devaluing the dollar by printing more notes than we had gold to repay for World War I. World War II created another smoke and mirror “propserity” by FDR confiscating gold and then devaluing the dollar in terms of gold for the first time in history by half. The dollar was $20 an ounce down to $33 an ounce in 1933 to repay the high cost of World War I. FDR set the stage for more borrowing to finance the second World War. World Wars are like alcohol in that you think you need more but it is really doing your body more harm. By creating the need to finance another war, bad money chased out good money and we were no longer able to afford a gold standard. We became more and more in debt from the following Korean and Vietnam Wars so in 1971, we no longer were able to even honor the exchange of notes for even silver so Nixon closed the gold and silver window and Keynesian economics took it’s full effect on the US debt ceiling. The debt ceiling along the years went from millions to billions to trillions.
I don’t see gold as an investment or an insurance but as a barometer of the US economy. And $1500 says that we have printed too much money. During the times when gold was at $250 or lower, we had a surplus and less money in the economy chasing and bidding up goods.
The notion that Gold is not a good buy due to its being at an all time high price is fundamentally flawed. Yes, Gold is at an all time high… and it has steadily been at an all time high for the last 10 years. Todays all time high has consistently been lower than tomorrows price.
I’m no Goldbug I’ve only RECENTLY started SCALING into physical precious metals (I’ve found that the best place to buy and sell is apmex.com, FWIY)
The VALUE of Gold is the same as it has ever been, the reason it is going up in PRICE is that dollars are becoming worth less and less. They are printing money, so it takes more money to buy the same thing, that’s why the PRICE of gold is going up.
Ask yourself this, is the value of a dollar going up or down? If you think it’s going up, Gold will go down in PRICE. If you think the dollar is going to continue to go down in value, Gold will continue to go up in PRICE.
It’s quite simple. My 2 cents, as long as Presidents continue to deficit spend, Gold will continue to go up. As long as QE continues, Gold will continue to go up too.
Gold hasn’t been at an all time high for the last ten years. Gold was trading at less than $300 an ounce until about 2002, as low as it was pre-1980. It didn’t reach an all-time high until about 2007. Here is a graph (please ignore the weak attempt to link gold dips with recessions):
I agree with JD. I believe gold is in a bubble and will crash sooner or later.
However, if you do like gold as an investment I think that its smart to limit your exposure to gold. Don’t put more than 10-20% of your assets in gold. Diversifying your assets is always smart and this is no different.
I had sent this to J.D. in an email, he asked me to paste it here for the discussion. (I love these discussions!)
MBA grad here, so hopefully that gives me enough credibility to keep you from just deleting my email!
First of all, great article, you hit most of the major points, and most of your reasoning was very sound. I did have one thing to add though.
For most people, gold usually isn’t a very good investment. It doesn’t offer dividends, and there are better ways of protecting against inflation, so as an investment the only way to make money off of gold is to sell it for more than you paid for it.
However, for some people it might make sense to have it as part of your asset allocation. The underlying idea of a well planned out asset allocation (used in conjunction with rebalancing) is to (a.) get better returns (b.) reduce risk.
Gold’s best function is to reduce risk, NOT get better returns (although if you had bought a lot in 1999 at $252.80, and are just now rebalancing you would have gotten a large return..).
In your example you pointed out in a world disaster and how gold wouldn’t be a good hedge against disaster because you’d rather have food, clothes, or shotgun shells if the world was in chaos. And in that example you’re exactly right! However, imagine a smaller scale disaster. Where it’s only one country, or one region that experiences economic collapse.
Just hypothetically, let’s say you lived in Mexico and to keep the math easy, 1 peso is worth $1 USD. You’re a wealthy business owner. You’ve got $10 Million peso’s in stocks/bonds/and MIPS (Mexican Inflation Protected Securities), and you have 60% in stocks and 40% in bonds, and are doing all the smart investment things watching out for fees, minding inflation, and generally just using index funds to get the average return… (note assumptions here are all localized to the Mexican total stock market, etc, not the US total stock market).
But then disaster strikes, and Mexico’s economy collapses, the government starts printing money, just like during WWI and WWII where people are pushing wheelbarrows full of money around to buy bread. Your $10M pesos are now worth $10,000 USD, a 99.9% loss and it gets worse day by day!
Now imagine that you had $10million pesos of stocks/bonds/MIPS/and some gold as a hedge against disaster, in fact you had 5% of your assets in gold, the equivalent of $500,000 USD. The economy collapses the same, and your Mexican investments and currency lose 99.9% of their value… but gold doesn’t drop in its value! It’s still worth $500,000USD, because ***other countries and people*** will still trade in gold even though they don’t value the Mexican peso as much. Sure it’s not as good as $10 million USD, but half a million USD is nothing to sneeze at.
This hedge makes more and more sense the richer you are. If you’re a $100M net worth individual in my example, then 5% of gold is still worth $5,000,000 even though your country collapsed. That’s right, total economic devastation of your nation, and you’re still a millionaire. That’s the real risk you’re hedging against in my opinion.
So this example also showcases why it’s not as great of an asset allocation choice for many smaller net worth individuals. Yes, the percentages still apply, but if you only have a $100,000 net worth, and have $5,000 in gold, when the economy completely tanks it’s better than nothing… but $5000 is not going to sustain you and a family for the rest of your life, it will go quick!
So this leads us to where we are now, everyone worldwide tends to invest in the U.S. stock market, and everyone likes TIPS and U.S. bonds because they have a lot of faith that the U.S. government won’t default on its debt and that the u.s. economy as a whole won’t completely collapse… but if you are worried that it might, and you wanted to protect against that possibility, what would you invest in instead?
Most countries are fairly instable (Greece), or at the least not as stable as the U.S. (Japan), and other stable countries are closely tied to the U.S., it’s very possible that any economic disaster that hits the U.S. could conceivable also take out the U.K…, so that’s why many people flock to gold, it’s very tradable on a world wide scale, and you don’t have to figure out “who’s the 2nd most stable country after the U.S.”.
Some people are getting on the gold bandwagon because ‘look at the price go up!’, this is dangerous. However some people are just putting it into their asset allocations as an alternative asset class to hedge against risk. When a lot of people do this it’s called a ‘flight to safety’ in economic terms.
That makes so much sense, thank you for posting this comment! I would only like to ask, if you are an investor in the US and the US economy collapses, is it realistic to expect other nations’ economies to remain stable? Haven’t we seen that the US subprime lending meltdown/the bursting of the US housing bubble caused the 2008/2009 worldwide economic crisis? Or was this not actually caused by the US economic crisis? It seems to that the US economy has much potential to drag the rest of the world down with it because the NYSE is used globally.
I mean, I know that you touch on this, but it doesn’t seem like there would be any nation in line behind the US, as you say, if the worldwide economy collapsed. I’m just arguing for the sake of argument here. Your point is very well taken.
Most gold bought and sold today is of course not used as a raw material. It is stockpiled in a belief that it will retain some value no matter what happens in the world. You may have noticed i said ‘some’ value.
At this moment the people thinking it is a good idea to buy gold outnumber those who think it is a bad one. This is my amateur, simple view on economics. It gets more complicated when you think where the money comes from.
An investor has options. Where are the money not going? What are people not investing in. What investments are people selling, to put the money in gold? Maybe it is something boring like farmland? I sure hope not.
Whoever has gold right now, and is interested in selling it may have gotten lucky, or more likely they knew what they were doing when they bought it. Why are they now selling at all? If gold is such a great investment, and since people have been buying it for a good while now you would expect the supply to run low, there is a limit to how much gold can be dug up from the ground, so i doubt new supply explains it.
What i really would like to know is, what the people who have been selling gold for the past year or two have been investing the money in?
JD opened this article by saying he would like to discuss the pros and cons of investing in gold. The article presented half of the story, and it would have been nice to see his pro-gold investment opinion. Here are a few points he might have used:
-Gold, silver, etc are commodities and are used in a variety of objects: electronics, jewelry, photo voltaic cells, among others. My point is commodities DO have intrinsic value.
-Pretending that gold has never reached these levels is ridiculous. In 1980, it hit $850 -which is $2,400 in today’s dollars when adjusted for inflation.
-Central banks around the world as well as investors are worried about paper currency, especially with the EU and the US. Gold has been something to revert back to should governments default on their debts or the people’s faith in currency fails.
This last point is the reason I choose to invest in gold. The economy is straggling under the weight of an unbalanced budget, real estate is floundering as more homes foreclose, and the dollar is losing strength. All of these (maybe in a week, maybe in 5 years) point to a decline of the US dollar and an increased value in gold.
So hop aboard, because if you’re like me, you’d rather have a little fun watching the commodities market than having my money in equities right now!
Thanks for the thoughtful post. I’ve started reading you recently, and find your writings invaluable.
I mostly agree with your viewpoint on gold, and the theory of ‘fiat currency’. One reason I don’t wear any ‘bling’; what’s the point of (possibly) getting mugged for wearing a useless hunk of rock?
More to the point, I just wanted to say that gold IS used in electronics these days. I believe it’s used in circuitry because it conducts better then other things. Of course, if the Dinosaurs do rise again, we won’t need our iPhones and laptops anyways.
This is one of the reasons there is some payoff for the recyclers of the electronics.
1. Even if it becomes a trusted commodity in an apocolypse, how the heck am I supposed to buy food with it, if its worth thousands of dollars an ounce. I’m going to have to have some super accurate scales.
2. Every time hyper-inflation has happened, (East Germany, Recently in Africa, several years ago in Turkey).. Nobody turned to precious medals. They would barter. I will sell you this chicken for that sweater.. etc..
@Brian:
Actually, recently in Africa (Zimbabwe), US Dollars AND gold became the preferred means of payment.
As for thousand dollars an ounce: one of the commonly used criteria for money is that it should be divisible, which gold more than fully satisfies, it is divisible and of a predictable standard (gold is quite a soft metal, and very easy to divide).
It’s divisible to a point…at $1000 an ounce, you’d need to be able to accurately and quickly come up with a cube of gold 2mm x 2mm x 2.625mm to pay for a $5 footlong. Unless the exchange rate fluctuated that day, and the .005 ounce footlong became a .0046 ounce footlong…
@Eric:
“Unless the exchange rate fluctuated that day, and the .005 ounce footlong became a .0046 ounce footlong…”
Yes, and?
What’s the difference between that and if you have an account in USD and happen to buy a footlong in Paris? The price may fluctuate with the USD/EUR exchange rate during the day.
You’re kind of arguing a futile point.
_EVERYTHING_ fluctuates. All the time. If you think the USD holds some sort of magical constant value, you’re dangerously deluded (in fact, the purchasing power of a USD has lost some 98% since the introduction of the Federal Reserve).
Would you argue that a weak dollar is better because it is easier to more accurately divide $10000 at a 100th of the value of what it was in 1917? Because that is effectively what you are saying.
I hear Zimbabwe dollars are great. You can divide them down to a billionth without even having to resort to cents…
I believe you may have missed my point – the exchange rate is relatively meaningless, but how easy would you find it to accurately shave off 4% of the mass of a piece of gold the size of a kernel of corn? I don’t know about you, but I’m not in the habit of carrying a triple beam scale with me.
I would argue that a weak dollar does have value, by making it relatively cheaper to export US goods, thus reducing trade deficits, but my post was referring to the relative difficulty of paying for purchases with a currency an order of magnitude more valuable than a typical purchase, especially one denominated by weight.
Again, the “you can’t eat gold” point is not a very valid one. The same is true for your house, your stocks or your (then worthless) cash. Gold is more a store of value and not necessarily something that allows you to buy food in the middle of a crisis.
First, commentators, please stop with the “end of the world” analogy. A far more likely event will be “end of civilization as we know it,” which is a far cry from end of the world. When Rome fell, when the German Empire fell, when countless other civilizations fell, gold never lost its value because there was always someone somewhere (usually nearby) who wanted it. Stories abound about people using gold to buy their way to freedom from Viet Nam, Korea, etc. during those upheavals in their civilization.
That said, gold experts and those who sell gold will be the first to tell you that it’s only for a part of your portfolio. It’s complementary to your stocks, bonds, cash, annuities, and other investments, not a replacement. Central banks around the world are stocking up on gold. They realize that the dollar (world’s reserve currency) is being abused by our government’s profligate ways, and that it’s BUYING POWER, is diminishing year after year and that one way to protect the buying power is through the possession of gold.
And as far as using it to buy things, you will have to convert it to a legal tender. Just the way you sell stocks or bonds to be able to utilize the value, so too will you have to sell the gold. That’s just the way it is. You can buy gold in fractions of an ounce, so you do not have to do the equivalent of breaking a $100.00 bill for a $0.05 piece of candy. You just sell that 1/10 ounce coin or bar, or that 1 gram bar if the value goes to $5000 an ounce.
Since so much is opinion, in my opinion, having exposure to gold in your portfolio is no different from having an emergency fund for your other financial plans. How much or how little is ultimately up to you, but just be mindful that since Biblical times, gold has had value and has never gone to zero worth, unlike stocks (Lehman Bros, etc), fiat currency (Confederate dollars). Outside of an end of the world scenario, in which only food, water, shelter (and an AR-15 w/ ammo), will be worth anything, gold will always have worth — and will again not long after the world is reborn from the ashes of the old.
I’m glad Siegel came up in this post since I would have referenced it anyway. Stocks way outperform any other asset class in history and gold has done practically nothing in terms of appreciation in the long term. And the short term is way too volatile for me to look into investing. I also take a similar stance with Buffet in putting my money into companies who can create real value instead of into a shiny rock that has little worth outside of what people perceive. That’s not to say you can’t make money off it, but I believe there are better places for your assets.
I’m glad you brought up Siegel and his book, because I would have referenced it anyways. Stocks are much better to invest in for the long run and gold has barely had any appreciation through extended periods of time after adjusting for inflation. The short term volatility isn’t something I would personally want to get into, but I do believe that some people can make money off of it. I take Buffet’s advice by sticking to companies creating real value instead of a shiny rock, the perception of which depends on the whims of people.
I think it does an excellent job of explaining what our current money is, and how gold became money in centuries past, and why gold can provide us with more benefits. It is a touchy topic, but I think this 1996 42 minute “movie” is coherent and thought provoking. Enjoy.
I think investing in a house and a good garden is better insurance against disaster than gold any day, and you point out that the returns are the same. Thanks! You can’t eat gold or sleep inside of gold.
Nice job JD on this article. Entertaining read. I think you should keep this one in the back of your head for 2012 or 2013 when the bubble bursts as a referral.
That is not a character of a solid investment. What you should look for in an investment is a steady return on your investment. And gold gives you no return at all. (Except of course for the occasional bubble if you get out on time.)
You misunderstand the problem with the Gold Standard. The Gold Standard required a government to have the exact amount of gold to back up any notes that it issued. That is why gold was such a valuable commodity. Unless more gold was acquired, under the Gold Standard, more notes weren’t supposed to be issued. The problem with the Gold Standard is people became accustomed to using a note that represented Gold instead of the actual Gold.
Since, it was uncommon for people to actually cash the Note in for Gold, Governments committed fraud by printing more money then there was Gold. If governments didn’t have enough gold, they’d print more notes and pay for debt knowing there wasn’t actual gold to back up the notes. Since people rarely asked for the notes to be redeemed, people were not the wiser that there wasn’t enough gold to cover the notes.
So, in the Great Depression people rushed to the banks to cash their notes in for Gold. The banks, however, didn’t have enough gold to honor the notes because more notes existed then their was gold.
The governments didn’t want to get caught cheating so they’d locked the banks down, took the gold, and changed the system.
Governments prefer the new system because it provides them more means to cheat the little people. The money has no intrinsic value so it can be manipulated more easily.
A friend sent me this article and this is my response to him.
Thank you for sharing this article. Â I enjoyed reading it… of course I do not consider myself an expert, however I can refute all his arguments very very specifically (and point out many of the facts he is dead wrong about). Â We went off the gold standard in the 1970’s not the 1930’s. Â There were different levels of us detaching our currency from gold. FOREIGN governments could still exchange their dollars for gold until the 1970’s (the end of the true gold standard). Â I’ll give you one specific argument against this article and I’ll keep it at that for now because it would take too long to hit all of his points.
With response to the “intrinsic value of gold/silver” fiat currency and a precious metals standard…Â
After 1965, the government stopped using real silver to create the coins we use in circulation. Â They did this because they knew their inflationary policy of devaluing the currency would make the intrinsic value of say “dimes” more valuable than the face value of the coin (or the actual purchasing power of a dime). Â Basically, one could melt down the pre 1965 dime, extract the silver and hold about 5 dollars in todays money worth of silver with the metal. Â
The great Peter Schiff articulates this well as he explains that gasoline is actually cheaper now than it’s been for many decades, when you compare it to the Constitutional money we originally minted. Â Here’s his quote:
“In 1931, gasoline got to 17 cents per gallon during the great depression. But for most of the 50 years 1920-1970, gasoline was between 20-30 cents per gallon. It wasn’t until the 1970’s that we left the gold standard that gas prices really started to rise. But today, right now you can buy a gallon of gas for less than one dime, less than ten cents. So in terms of real constiutional money, silver that was coined by the US Mint, gasoline has never been this cheap. It’s only when you have fiat money, the paper money the FED is running off the printing presses… that’s the only reason prices are rising.”
“If you can find a dime coined in 1964, you can take that dime and purchase a gallon of gas. That proves that gasoline is not getting more expensive, our money is losing its value.” Â
(I know I said I would keep this to one specific point but I gotta keep going) Â Wars have been waged over gold and silver. Â Entire indian tribes in America were displaced because gold was believed to be found in the land held by the natives. Â As far as recorded history tells us, gold and silver are real money because of the restraint and honesty it forces between those who chose to use it as a means of exchange.
Gold/silver are elements found on the periodic table.  They do not burn, tear, or degrade. Because gold and silver dug up off the ocean floor from a 1400’s ship wreck is exactly the same stuff we mine today, humans associate value to it. Heck, oil was worthless to a pre-industrialized existence.  Water is precious depending on geographical location, but what makes gold and silver unique is that they are impossible to “create.” Â
To poses these metals, you must exchange true goods and services that others want. Â Eggs, shotgun shells and paper money will never be a sound currency. I can make a chicken farm and harvest eggs to become a rich man (if eggs were currency). Â I could assemble gun powder and shells to create an endless supply of ammo, and if I’m the federal reserve, I can supply the world with endless amounts of paper money.
Gold and silver always have and always will be immune to such creation. Â This is essential in understanding the role of the word “money.” Â Money is a medium of exchange. Â It stores value in terms of labor and ingenuity… of production and savings. Â Technically, anything can be deemed “money” as long as two parties agree to exchange it for goods and services. Â But what makes gold and silver REAL money in terms of our existence here on earth is its enduring qualities and its inability to be “created” by humans.
To the extent that the author speaks of a crisis in which shit completely hits the fan in an “every man for himself” type scenario, of course people aren’t going to trade their basic survival tools for gold/silver or “money” because “money” is simply a representation of labor or production and used for exchange. Â Â
You know about our hierarchy of needs.  NOTHING comes before our basic necessity to survive and I have never claimed that money would take precedence over those needs in dyer situations. That’s an unfair argument against any “store of value” or “medium of exchange” but the author tries to use it in his attack of gold/silver.  What the hell would I want to exchange for the basic food and water needed to survive the current day? Nothing, so the authors argument against gold/silver in the most dyer crisis is bogus. Â
I would like to ask him this, “What fiat currency would he choose to hold in a true crisis OVER gold/silver?”  If he had to pick one over the other when shit hit the fan and could hold any currency on earth, would he pick silver/gold over Dollars/Pesos/Yen? Of course he would… Â
I know you’re probably tired of reading this, but let me hammer home one last scenario I just thought of…. Lets say it’s 1800’s America and I have nothing. Â I walk into a town where a farmer owns a restaurant and a pub. Â I could conveniently offer to work all day on his farm in exchange for a big meal and some beer at his pub. Do I need money? Absolutely not. As long as the Farmer tells his bar and restaurant manager to let me eat because I’ve worked for him all day… So in that instance, the word of the farmer is the medium of exchange between my labor and the beer and food I receive for such labor. Â
In such a situation, I would never need money until I decided I wanted to cut back on my beer intake, save some of my labor for other resources for other endeavors. Â Over the period of a month, I could work hard, eat and drink less and eventually the farmer would be in debt to me! Â Or, he could simply give me something that represents the labor I haven’t spent at his restaurant and pub. Â But if I can only spend it there and nowhere else I am kinda screwed. Â If he uses tobacco leaves to represent that labor, I could just skim some off the harvest and screw him, if he uses paper money and it rains one night and the money is ruined, I get screwed. Â In this instance and every other in recorded history, gold/silver would be the best medium of exchange because for the farmer to poses it, he would have had to exchange true goods/labor to receive the gold/silver. Â For the farmer to give it to me, then I had to give him useful labor. Â ANYTHING ELSE representing such an exchange can be compromised.
The gold standard was abandoned because the government couldn’t pay its bills, paving the way for our current predicament of a $14 trillion national debt. Waging wars and bailing out banks is much easier when the cost can be borrowed and inflated away with fiat money.
Gold cannot possibly be considered an investment. Why? Because it has proven, over the longest track record of nearly any commodity in history, to have an internal rate of return of… 0.00%. It is a fantabulous *store* of money, and thus a great commodity to act as a cornerstone for a currency (in some form or another, perhaps with accompaniment). But investments have internal rates of return. Everything else is speculation. You can make a lot of money speculating, but the fact remains that you are only market timing and that is a zero-sum game.
To make matters worse, gold is highly volatile for personal usage purposes. Over centuries its volatility is impressively low. Over decades it is disturbingly high. This is why currency-backing is one of the few things gold is great at, because currencies, if set up in certain ways, can ignore quite a bit of volatility in their backing and can ensure that only the medium- to long-term averages matter.
As a great store of money, gold is also a good place to go to avoid the effects of a currency’s utter and permanent collapse, though if you know so much about the future you could also just go to a currency that isn’t going to collapse.
J.D.,
Although My Comment Is Quite Tardy,
I Personally Want To Thank You For Your Recent Displays Of Journalistic Online Courage To Put Forth Your Opinion On Known Controversial Topics — Such As The Lottery And Gold — Because Although You Are An Experienced And Highly-Talented Writer, It Can Be Quite Disparaging If Your Opinion Peice Recieves Many Negative Remarks.
In Addition, I Also Want To Thank ALL Of YOU, The Faithful GRS Readers, For Keeping The Tone Of These Discussions Quite Civil. This Context Of ‘Respectful-Debate’ Allows Us To Further Our Knowledge & Expand Our Understanding Of Opinions & Facts Foreign To Us; This Often Insights The Essential Sentiment Necessary To Benefit A Contemporary Developing World: Change.
What I see here are people discussing gold from an investment point of view, but there is another form of hedging against the future and that is survival if the whole system collapses or breaks down. Having land and being as self sufficient as possible is my goal. Barter and trade will be the mainstay. If society is broken down and you are using gold to buy with, rest assured that someone will attempt to relieve you of your stash and it may prove harmful to your well being.
Great article, now if you would only write one on selling gold jewelry and things right now that would be helpful. After attempting to sell old jewelry to raise money to pay for 3 kid’s braces I have decided it is a ripoff. But would love another opinion.
Interesting reservations, and a lot of them make sense. But “not owning gold for the last few years” means you have been wrong. Gold has been the best-peformaing asset of the last ten yeras, a trend that’s likely to continue.
FYI, I am the author of “All the Glitters: The Ultimate Gold Report” and would like to share some of my analysis:
1) Your gold stats are misleading. You go back to 1926, yet most of the years you include are when there was a gold standard and the price of gold was fixed. Of course, there can be no market appreciation when the government sets the price. Isn’t it interesting though that as soon as the government junked the gold standard the price shot up 10X in a number of years?
2) Gold has gone up nearly 2,000% since the U.S. went off the gold standard in 1972. This appreciation beats the annual appreciation in the stock market.
3) Hmmm. is it coincidence that gold took off after the government felt that it should go off the gold standar? I think not. The market is telling you something. Seems like cause and effect to me. Democracies with politicians love to print money.
4) I analyzed 5 historical quantitative metrics, including global debt, money supply, commodity price increase, negative real interest rates, and I could find no evidence that gold is “overvalued.” Gold price gains have been driven by all of these factors, which are positively correlated to gold. For gold to stop going up, at least half of these trends would have to change. And debt would need to be reduced.
5) Using historical metrics valuing gold against numbers such as global debt and money supply, it is still not overvalued, according to my studies. In fact if you take the 300-year mean of the gold price against money supply that number is $2,200. /oz
6) Everybody talks about a “gold bubble” but to have a bubble everybody has to own it and it needs to be overvalued on fundamentals. Emprical evidence points to neither situation (despite all the chatter, I actually know very few people have have any sizeable amount of their portfolio dedicated to gold).
7) China will buy more gold. Definitely.
8) Do you really think you are right and that billionaires John Paulson, Carlos Slim, Marc Faber, Jim Rogers, and Paul Tudor Jones are wrong?
5) Really? a 300 year mean? You want to include three centuries in a calculation? Except for how incomparable economies from that time are to today’s economy, did you consider how a lot of the world’s Gold supply might not have been found yet?
I think the Warren Buffet argument is silly becusae he has underperformed the market for the last ten years and gold has outperformed the market. So are you saying he didn’t wich he had bought something that has averaged 15% a year for the last decade.
The point of my analysis is that gold is currently in a primary bull market (unlike stocks), and that is likely to continue until at least 3 of the 4 driving factors are eliminated. It will continue to rally until there are signs of this happening. Right now there are no signs of this happening.
China: The central bank is buying a ton of gold. They are a buyer in scale. They are accumulating reserves at a rate of almost $1T USD ever two years! They obviously will want to diversify out of hits growing pile of dollars and gold will be one of the key assets that they will buy (among other things).
In the late seventies, I was living at home, putting myself through college and working two part-time jobs. When gold fever bit, I proudly bought my first Kuggerand with my hard-earned savings. I think I paid about $375 for it, back when I was earning $2 per hour. For safekeeping, it went into my mom’s jewelry drawer. A couple of months later, we had a big family party. The next day, something made me want to see my lovely gold coin. Of course, it was gone. It was an expensive lesson at the time, but I figure it has saved me a bundle in the long run. My first Kugger was my last and I’ve never been tempted by “precious metals” again.
So let me get this straight: Because you did not secure a valuable gold coin that you bought for $375 which would now be worth $1500, that was a bad investment?
I don’t quite follow the logic. That would be like saying if you crashed your car in a careless accident, cars must be totally worthless.
I didn’t read all of the comments, so hopefully this wasn’t covered yet. But I wanted to throw in my $0.02.
I remember reading an article online (which I can’t find now) that historically looked at situations where “the dinosaurs escaped”. The only example I remember specifically was the Warsaw Ghetto siege during WWII. The summary of the article was that in situations like that, life skills were far more valuable than any gold or currency. Barter of skills such as hair cutting, preserving food, sewing clothes, raising and slaughtering animals, etc. became the norm for their society.
So level up those life skills and invest your money elsewhere.
The Fed and the US government have painted themselves into a corner. They can either raise interest rates, destroying the bond market and putting a temporary strangle hold on the economy…or they can continue to deflate the currency. They will choose to deflate the currency. We’ll have QE3 as soon as QE2 wraps up.
Inflation is here. Its not just gold, pick any commodity.
The more dollars they print…the more purchasing power your gold investments can protect.
Hmm great effort put into this article but there’s a lot here I don’t buy into. I’ve been reading a lot of arguments against gold online and a lot don’t make sense to me.
Here are the common trends in anti-gold buying reasons and why I don’t agree with them:
1) Zombie Apocalypse scenario – This is worst of the worst case scenario… in a movie! With billions of people on earth the chances of most people being in a situation where the options are food or gold…weapons or gold… are pretty damn low. In the real world, people have more options than that.
2) No intrinsic value – I’d say the fact that it’s rare and can’t be created by humans is already an intrinsic value in itself added to the fact that gold is beautiful. There is a high price in beauty. People die over beauty and go crazy over it. I’m surprised I don’t read about gold’s beauty and an innate love of gold held by many many people.
Demand = Value
3) Comparing a gold bubble against tech stocks of the late 90s – If the stocks plummet you have nothing but paper and excuses from the people who failed. With gold you have gold. And the other 2 reasons I mentioned above why it has value.
Just like beachfront properties are higher in value than most other kinds of residential properties, emotions play a huge role in demand (therefore value) of gold. We’re humans not robots. Until the day comes where people won’t find beauty and appeal in gold, gold will always have high value against fiat currencies and even raw commodities. Anyone can grow more corn and raise more hogs but never gold.
There’s a huge difference between price and value. Precious metals are finite resources where as paper currency can be printed into infinity. Paper fiat currencies don’t grow on trees, but they are printed out of thin air. If central banks (another scam) can print them at will, what value do they hold? All fiat currencies have a shelf life. Keep holding onto that shit and all your asses will be broke. Apparently ancient wisdoms have been lost on modern societies. Y’all bagged on gold and silver out of fear and ignorance but y’all failed to see their real values. Go open up your fucking computers, tablets, smart phones and other electronic devices and see what they’re made of, then go consider PM’s contributions to modern societies. There are many reasons why they fucking call it precious metals. It’s god’s money. Fiat currencies come and go, but gold and silver are forever. PMs are universal money. You go back 5000 years or forward 5000 years, they’ll still be recognizable. But no one will recognize your fiat currencies. My guess is that when our current fiat currency system fails, all your asses are gonna sink along with it. Good luck! And Bob’s your uncle!
For current readers (in 2020), this is the dividing line between comments on the old version of this article and comments on the new version. I’ve removed a dozen spammy comments from the past decade, but now I have to go work in the yard. Later today, I’ll read through ALL of the comments to make sure the conversation is coherent and relevant.
So, J.D. did you end up adding gold to your portfolio as you suggested at the end of the post? Up to 25% as suggested by the Permanent Portfolio is quite a lot.
I’m also curious as to what people consider as “buying gold”. Some people mean actually buying the metal, while others buy stocks in mining companies or some other type of gold back investment vehicle. There’s a pretty big difference between the two, I think.
I did not add gold to my Portfolio over the past decade, and was never tempted. That said, the primary reason I didn’t was because I haven’t really had an income for the past ten years. I’ve been in semi-retirement mode, and any money I make is used for living expenses. That said, if I had been investing, I might have considered moving toward the Permanent Portfolio after gold dropped following the last bubble.
To bring this discussion current and on to the really important stuff a) I like your new thumbnail sketch and b) you hit it squarely on the head about the dinosaurs escaping from Isla Nubar.
Did you see the last Jurassic Park? They are now loose on our mainland, specifically California. How the heck are we supposed to outrun dinosaurs while wearing masks? I can hardly wear them and walk.
Your approach on inflation seems very incomplete. What caused the steep rise in gold prices after the monetary crisis was related to the money creation and the value of the dollar. The reason why gold is rising today and probably only at the beginning of a next wave up similar to 2010 is de unstoppable money creation of the central banks. The money printing at the scale that his happening now is unseen in history since 1930. In that sense, not studying the relation of money creation, volatility of money and the dollar/gold price, is in my view pretty superficial. I lack the real analysis and the debate on money creation and asset prices in general, gold in particular. That explains what is happening and going to happen with the gold price for the future. And that is why all experts, including bankers like Bank of America and all other major banks (who usually do not put their money on gold), are now pointing to gold as the best possible investment for the future. Hope that adds to the discussion.
The reason to invest in gold is not for the value that it has but for its volatility and for its negative correlation with the stock market. The stock market goes down the value of gold goes up, you sell your gold and buy stocks. The stocks go up you put a little back into gold. It doesn’t take much to positively affect your portfolio, even 5%. Take a look at portfolio charts and see how 95% SCV and 5% gold tightens the financial independence graph and makes the worst case scenario one year better and the best case scenario 1 year better.
Who cares if there is any rationality behind gold. All that matters is that other people, including governments, value gold as a safe haven. It’s all psychological, even if you think the psychology is stupid, it doesn’t matter, it makes you money. You don’t even need to own the physical stuff, just an ETF. The gold bugs are right, partially, owning gold is a good idea and now is a great time to be selling!
I actually agree with your point, Jon. It’s this negative correlation to the stock market that actually makes me consider something like the Permanent Portfolio, which is so heavily weighted in gold. (The Permanent Portfolio is deliberately constructed from four non-correlated asset classes and is meant to provide a relatively high rate of return without wild gyrations.) And I could absolutely buy the idea of a rational 95% stock/5% gold portfolio to reduce volatility.
Thanks for pointing this out! I’ve only just come to realize that “rebalancing” is a thing, before about a month ago I thought everything was just “buy and hold”. I found a relatively recent GRS article on it, so I’m gonna go read that next and edumacate myself. I do see this article’s point though since it’s focusing on Gold’s suitability as a simplistic long term investment.
I will say this topic was really timely for me as it was actually on my mind a couple days ago.
Any opinion on the Dragon portfolio as explained by Artemis’s research? https://taylorpearson.me/thedragon/
tl;dr: According to Artemis’s research, the optimal portfolio from 1929 to 2019 was:
Domestic Equity (24%)
Fixed Income/Bonds (18%)
Active Long Volatility (21%)
Commodity Trend Following (18%)
Physical Gold (19%)
Never heard of this before, but I’ve opened the page for later reading. My initial inclination is that it’s far too heavily weighted in gold/commodities with not nearly enough in equities. But I’ll read the article to see if I can parse the logic.
With the interest rate at zero, quality companies trading at outrageous price multiples no sane person would ever pay for a business in their neighborhood, and a year or two before we can even dream of something resembling full employment, I feel alternative investments are warranted. The chance of inflation is low in the US at this time, so gold isn’t a great bet. But I’m holding some GLD anyhow, specifically because of the uncertainty. Inflation anywhere in the world could impact the price of gold. What if Brazil prints too much money, wouldn’t that drive up the price of gold as rich Brazilians look for a way to preserve their capital?
I grew up in India where gold was/is considered the pinnacle of investment. People who have trouble keeping a roof over their heads would buy gold coins stitched to a cheap gold chain and keep adding coins to it. I have relatives who say that selling gold is what you do just before you go dumpster-diving. This is the reason that when India had to fly a 747 loaded with gold to London to prevent a default (in 1992) that liberalization of the economy could be started.
Having said that, relatives of mine who have invested in houses, stocks and other such investments have come out way ahead. In US, the comparison is even more stark. Every time I have met someone advocating buying gold, I tell them “I am ready to buy gold coins the moment those coins start producing baby gold coins”
A few thoughts on why gold (bullion) is a good hedge asset against your equity portfolio:
1. correlation of gold to equities are strongly negative during steep equity crashes (and are otherwise uncorrelated). This provides downside protection.
2. the gold price is usually inversely related to real interest rates (which are going to be low to zero for the foreseeable future). When “risk free” sovereign debt has no yield, the opportunity cost while holding gold is lower.
3. gold has little intrinsic value (its an inert material) outside of the commercial jewelry market, which is a good thing… unlike other commodities that have industrial uses, the price volatility is less tied to the economic cycle.
4. gold has been around (in an economic sense) for thousands of years – many times longer than even the most stable countries/governments today… that is to say, regardless of its intrinsic value, people have believed in its value for a very long time. Its a undeniable track record.
5. the rate of gold extraction from the earth is stable and predictable, which helps stabilize the price.
6. Bullion, though harder to access, lacks the counter-party risk ETFs carry. And, as we’ve seen with COVID-19’s impact on gold future prices in recent months (due to issues of guaranteeing physical delivery, with many parts of the global economy on lockdown), holding the physical asset vs. derivatives of it is often a safer bet.
I’m not sure I would personally own gold “instead of” any asset classes, its more about the diversification benefit of gold within a broader portfolio. Because of the characteristics mentioned above, its a good exposure to maintain long-term, to balance equity risks. Buying now versus the depressed prices we’ve seen in recent years might be unfortunate timing, but it doesn’t diminish the hedge case for gold in the long-run.
*I’m not a professional financial advisor. These are my personal opinions.
Exactly this! Gold is the original form of money and not a substitute for stocks. Instead, it is a hedge for a currency/financial crisis (in which almost all assets, including stocks, lose value). So don’t exchange your stocks for gold, but exchange your cash in the bank for gold and digital gold (= bitcoin).
I was in Canada in the late ’70s, when the Vietnamese boat people came. They’d had to escape from Vietnam in small boats, often being attacked by pirates, make it to Thailand, and then to North America (Canada took more boat people than any other nation). Some of them were alive because they’d had some gold to buy their way out of harder spots than most any American alive today has ever been in. And a lot of them bought guns when they got to Canada – which was quite difficult to do compared to the US. Made me think that a little gold and a gun weren’t a bad idea.
My goodness, more than 10 years later, I discovered you answered my question with an entire article! I’m just coming around to the idea of the permanent portfolio, whether exact or slightly tweaked.
I have heard that many gold sellers have run out of gold to sell, it may be difficult to even buy some. Gold ETFs are always available, but that is just not the same as owning physical gold.
This really captured my feelings about gold investments for so many years. I never understood the thought process of buying gold. And typically easy magical solutions don’t work out.
I just try to buy low and sell high. Perhaps I make a mistake and switch it occasionally.
The narrative is working just fine. It’s been three months since I published this article. That’s a blink of an eye in investing time. Come back in three years, and let’s have a chat about where gold and stock prices are then. Better yet, let’s chat in thirty years.
Found this article on gold. The fact is, is that we have over $150 trillion dollars of unfunded liabilities. If you look at the budget projections from the treasury department, in a few decades, our fiscal situation is a disaster. Complete. Disaster. The easiest and only way out for a government is to “print money” and have the FED buy assets. Gold may not perform that well in 5 or 10 years. But if I live to old age (another 50 years), I suspect that Gold will be much more valuable in dollar terms. Also, if I sell it for less than a $10,000 transaction, it doesn’t get reported to the government. If you have stocks, then have inflation, and sell your stocks at a higher price…you are really paying taxes on a nominal gain. It will destroy any true increase in purchasing power increase.
Precious metals are INSURANCE, not an investment. My goal is to have 10-15% of my portfolio in gold and silver by the time I retire (early). We are in unprecedented times and IMHO we need some unprecedented percentages of our wealth in precious metals.
Gold is not neccesarily an investment, it preserves wealth. If you want to make a short-term (quick) buck, gold is not for you, which is 100% perfectly fine. It stood 5000 year for a store of value, and it will keep doing so. It is able to stand the test of time.
Many just want that their value (=hard work) has the same price. Inflation, QE, and other stuff dillutes your value in terms of price. How is that even possible? One hour of your work still is that, one hour.
We have become so accustomed with price instead of value.
Please learn the difference between an asset and an investment. I assume that you have never came across an inflation like the one happened in Weimar republic or most recently Zimbabwe. Rather than seeing an ounce of gold costs 1700$, see it as 1700$ gives you an ounce of gold. Currency values are susceptible to change but not the ‘weight’ of gold. In other words, gold is a security, not a money maker.
The Bible tells us that the day will come when people will throw their gold and silver into the streets. Revelation states no one will be able to buy or sell without the mark of the beast which seems to be digital currency. So gold and silver will be useless.
When you are starving, gold and silver will not feed you. That’s why the best investments are the things you will need that will keep you alive.
There are 234 comments to "Is buying gold a good investment? Why I don’t invest in gold".
I haven’t considered gold for an investment in over a year. Why would anyone invest in something that’s at it’s value is at an all-time high?
Sure, I think it has a potential to increase in value, but since it’s at it’s peak now, it’s just a foolish investment.
If you’re that sure of that L&MF, why not invest in a reverse gold stock? I’m down about 30% on the one that I put money into last year. Teaches me to stick to industries that I know. If the analysts that do this stuff for a living 12 hours a day get stuff wrong based on what they “know”, the small individual investor has to leverage whatever they can – and stay out of what they can’t know.
I would not invest in reverse gold either. It’s too uncertain – it’s almost like the dot com era. There is enough hype to drive the prices up, but one of these days, the gold craze is going to pop, and leave a lot of people with nothing to show for it.
I’m staying out of this craze all together.
This is the time to buy gold. The stock market has not yet finished it’s correction downward.
Right at the top for gold and right at the bottom for the stock market.
Couldn’t agree more!
The reality is that leverage should afford many people the opportunity to get excessively wealthy in commodities. Look at the Forbes 400–most didn’t make it in this highly levered casino.
“Why would anyone invest in something that’s at it’s value is at an all-time high?”
The price of gold went from ~$1000 to ~$1550 in about a year and a half, making new all time highs all along the way. Would your thought process be the same when it was making new highs at $1000? You’d have missed out on a 50% gain.
Looks like timing was just right to short gold in 2011. Now it “might” be bottoming, for awhile, at least.
Because gold is at an all-time high doesn’t mean it will not go higher. It will go do high, you will be shocked. As for silver, After this pandemic hoax is past us, watch what happens to the economy when hidden technologies are released to be contructed by industry. They will rerquire huge amonts of silver and the price will go sky high from shoratages
I also read Siegel’s Stocks for the Long Run and decided against investing directly in gold after reading what he had to say.
I am, however, invested in gold and silver (and other metals) indirectly through my investments. I know a few of the ETFs that I have hold shares in mining companies.
The US government does not dictate the value of the dollar, it is set by exchange rates, interest rates, economy, and a bunch of other factors. The US dollar floats. The Chinese Yuan is set pegged to the dollar, as are a few other currencies. But ultimately any currency is worth what it will buy, not what the government says. Just ask the people of Zimbabwe.
That is where you are wrong. The government has complete control on the value of the dollar. The have the FED which can print as many dollars as they want which will in itself decrease the value of the dollar.
the FED is not a government entity. it is a privately held mega bank.
Actually, it’s both public and private.
Its more public than private
What a fantastic and well-research article! One of the best I’ve read.
With any bubble, there’s opportunities for profit-taking but it is risky. Gold is definitely a short-term speculative investment right now, not long-term.
Another point to make about gold… NPR morning edition recently had a story about how the gold bubble is making mines that are not usually profitable worth mining… if that keeps up, the supply of new gold is going to bring prices down.
I also wonder what Glenn Beck going off the tv is going to do to the price of gold. Might be a good time to short it. 🙂
Thank you, J.D.
A sane conversation on gold, and why it’s not the panacea.
Does it make sense if I say I always had misgivings about the gold rush, but could never really put my finger on it? The proponents just make it sound too good to be true… and we know how that works.
Your history recap here is very interesting.
Also, you said that people don’t realize how much work goes into a post like this… it’s just a demonstration of the value you provide, amigo!
I totally agree with Aaron. Gold didn’t pass my sniff test, and now I’m relieved to see that others feel the same way.
Also, JD, none of your time tunneling through rabbit holes is wasted. You now have expansive knowledge which will undoubtedly come in handy soon. Probably as soon as your next article or even interview.
In 1940’s when the nazis burned all the farms and crop in my country, and steal all the food, and gold from the peoples hands, and dowries from families daughters, and emptied the Banks from tons of Gold, my Mother told me:
Nothing is shining best then a gold loaf of bread when it comes to dark times like war, or bad economy.
When it comes to survival, nothing is best then growing your own food. Unless savages come along and take it.
Keep old clothes saved, you may need them when it comes to bad times.
God did not plant gold for us to survive, he plant seeds of food. He gave us cotton, and animal hair, and other fibers for us to cloth. We need to respect and save our planet to have and pass all this treasures for our children and generation to come. Why impose them to gold and silver, when, many children never seen the billions of stars at night, never visited a farm, and never experienced true life? The purpose of life.
We have some money in gold coins and perhaps every other week I contemplate selling them. The problem with gold is that there is a pretty high “illiquidity discount” for most people. It just isn’t easy to convert it to cash. In Atlanta, I don’t know of a single locaiton that will buy it back with out taking a pretty significant cut. Additionally I store ours in a lock box, so if the dinosaurs do return, I have to hope that the bank is open!
Hi Scott! I’m in Atlanta and sold some gold to a goldsmith. I figure, since they are an end user I will get a good price. It’s worth it to at least call and ask, they will want to know the total weight and karat you want to sell. This place is very straightforward, read their paragraph about the percent value they will pay for various types of gold:
http://www.bthjewelers.com/services/
They’ll pay 93% of the value for pure bullion gold (not sure if that is what gold coins are), or 80% of the value based on karat.
I think people are attracted to gold because it’s a concrete investment. Most people get excited when gold prices go up and think about hocking that jewelry their grandmother left them and their wedding ring from a defunct marriage.
It’s not too great a leap from that emotional excitement to justifying it as an investment. After all, most human decisions are not rational, they’re emotional.
Interesting post!
Good for you, J.D., for not buying into the hype, thinking for yourself, and encouraging everyone else to do the same. Finally, a reasonable contribution to the conversation about gold.
I have gold and silver ETF funds and have had the wisdom to but low and sell high. While they make up only 2% of my total investment strategy, it was a way to diversify years ago when stocks were going no where.
I agree with your view and the current gold bubble. Fortunately I was able to get in on gold a few years ago and have watched my investment soar sky high However, I currently have been looking at it with my finger on the sell button due to the feeling that the bubble is about to be popped. Once it does however I will probably buy it back up again and continue to hold for the long term.
Thanks for a really interesting piece. I’ve never understood the complaint against ‘fiat money’. All money is arbitrary, something we just agree has value because that makes it useful to society. NPR had a fascinating story on giant stone money on the Planet Money program; it’s still in use among a small group. Those folks use regular money too, but because the giant stone money still has agreed value, it’s still a useful currency. Looks like this will be one of thoose posts where I check out every one of the links. Good stuff.
The easiest way to understand the objection to fiat money is by being familiar with how most economists define money: http://en.wikipedia.org/wiki/Money
One of the properties of money is that it’s a “store of value”
The ability of governments to print fiat money makes it less able to store value.
Gold, on the other hand, cannot be devalued the same way (I believe the supply increases by 1-2% per year), so it fits the definition of money much better than paper money.
Something’s worth only how much you’re willing to pay for it. There’s no use for gold in a zombiepocalypse. Shotguns shells and samurai swords would be the new gold. I agree with you –gold is no safer than paper money.
Shane, I disagree.
Gold jewelry and coins make a *tinkle tinkle* sound when they hit the ground, and can therefore be tossed on the ground in order to distract zombies from your location. Shiny gold can be used like a mirror as either a communication device or a zombie distracting device. And if you happen to have gold bricks, or a bunch of gold melted together by global warming, you can use it as a projectile weapon.
Additional: In a pinch, you could make bullets out of gold. Or swords, although it’s inadvisable to make a sword out of a soft metal.
And as an aside – in case of a werewolf apocalypse (or certain types of vampires), won’t you feel stupid that you didn’t invest in silver?
LOL – I like the creativity. You all seem to have good survival instincts!
Thanks Andy! I just watch way too many zombie movies. 😀
I don’t have any money in precious metals and was actually planning to short silver, but it looks like I missed out on that opportunity after last week.
I can’t understand how people want to keep plowing money into gold and silver when they are reaching all-time highs…
I have several hundred dollars in silver coins -no value beyond their silver(et- one friend suggested that as more people melt down the coins – mine may have value as they become more rare). I do not need to sell them so I just keep them. I inherited them -I suppose at some point I will have to decide what to do with thme
I’d be happy to take them off your hands!
Seriously, if you don’t want them, find a dealer and sell them.
How do you find a dealer?
Go online, do some research. Ideally, you’ll find someone close to where you live who is also a member of the ANA (American Numismatic Association).
Take your time, don’t take the first offer and do as much homework as possible on the coins you have. Don’t be afraid to get a second opinion.
Remember, too, that coins, like everything else can decrease in value.
Not a good idea to sell your inherited silver coins when silver prices are so low and so manipulated. This guy really doesn’t know much about silver and where it’s headed. Even today, at $15, it’s no where near it’s high of $50 per ounce back in 1980. It has ways to go. Think why the nations are buying up gold by the tonnage? The banks also. Why the US just create new law that puts gold and silver as tier one assets. They’re positioning precious metals as currency options once again.
JD, one of the best pieces you have ever put together. Well researched, balanced, and a reasoned conclusion based on your work. Good work!
On the article itself, I thought Jim Cramer’s views on it from a while ago were interesting (please don’t throw me off the boards! :)). Basically, he said gold is going up simply because that is what is done in times like these. Sadly, the market does a lot more of this programmatic trading than following real logic. However, this IS a bubble (and not just gold but all commodities) and it will die horribly.
*sigh* Didn’t we just go through this same thing earlier?
Well written, but I respectfully disagree.
Anybody that chooses an equal amount of stocks to their precious metal investments had better plan on living a LONG time. You talk about bubbles and breaking – the stock market has burst many more times than gold or silver.
I’m into silver. It has tripled in the last 2 years and I’m offloading it as we speak, waiting for the settling that will inevitably come.
But I’m done with stocks and bonds, period. My retirement plan? 12 jumbo CDs, 1 maturing every month. Yeah, I can live poor interest better than I can with the Ponzi scheme called the stock market.
Here’s my take on the stock market:
Say you walk a specific route to work every day and pass under a tree. In the tree are monkeys, lots of them and all different sizes. They are tossing wads of cash about and saying “C’mon up!” … And eventually, you do. And you start slinging your wad of cash with the other monkeys.
But one day, things are different. All the big monkeys look at each other, nod, and shake the branches – and all the small monkeys (you and me) fall out and hit the concrete sidewalk. OUCH! You look up and ask them why they did that —
And they say ‘Sorry, nobody could foresee the (insert creative excuse here, planes flying into the twin towers, etc).’
So you pick yourself up and go back to your normal routine. But still, everyday you walk under the monkey tree and there are still plenty of monkeys tossing $ around. And they say “C’mon up!” … But you say no thanks, last time was too painful.
Every day … every day you walk under that tree.
And you know what? Sooner or later, it gets to you – and you are STUPID enough to climb back up in that tree.
Color me as an educated monkey – and I’ll NEVER climb back up in that tree again.
No thanks. I’ll sit on my jumbos and keep saving until I buy another … and another … and another. Yes, I know inflation will eat into their value. Yes, I know stocks HISTORICALLY outperform bank interest.
But I’m one dumb monkey, so I’ll take the guarantee rather than try to beat (remember the golden rule – those with the gold make the rules) the big monkeys at their own game.
Silver. And Gold. Right now, don’t buy – prices are too close to the bubble breaking.
But in the future, after the settlements: You should be at least 10% into metals.
Hey, what do I know? I’m just another monkey.
http://www.youtube.com/watch?v=p7w64fbqYQY
I respectfully disagree.
Over the very long run, the stock market averages between 7-8% after inflation. This number varies depending on the source. How is this a Ponzi scheme, a trick, or a tree full of Monkeys?
Besides, with the proper allocation among stocks, bonds, reits, commodiies, etc. This will smooth out the large dips and gains that are inevitable.
How is this a Ponzi scheme? And you don’t think the monkey comparison is valid?
First, to run a Ponzi scheme, you have to create something people think is valuable so you can sell it to them, regardless if it is worth something or not. This is known as “stock.”
What creates value in stock? Nothing. A bunch of people come together and print ink on paper and tell you it has value.
And you believe it. Maybe it does, maybe it doesn’t. How do you know? You don’t.
So you throw your money into the gambling pit. But you don’t make the rules and you are probably a rank amateur, so it is easy to lose money. (I did, btw. On “safe” stocks, too.)
Meanwhile, somebody has your money (a rich person getting richer) and YOU are sweating it out. You make a dollar one day and lose two the next, hoping you will make 3 tomorrow.
Meanwhile, somebody is “creating” more value by printing more ink on paper and selling it to you (or others).
And you don’t think this is another version of the same old game?
About the monkeys: The big ones have shaken the little ones out of the tree many, many times. Stick your head in the sand all you want, but it WILL happen again … and again … and again. If you are stupid enough to climb back up in the monkey tree, I have no sympathy for you.
Or perhaps, you make your living by selling these valuable instruments to people and somehow feel uncomfortable when somebody describes your business in less than glowing terms?
I’m ultra-conservative, if you can’t tell. No more monkey trees. And I’ll retire just fine without consulting the DOW or NASDAQ indexes, thank you.
Here’s the real golden rule: Live WELL below your means and SAVE, SAVE, SAVE.
Actually, that isn’t true. When you buy a stock you become part owner in a company. The price rises and falls with the success of the company.
You can argue that stocks are based on what people think a company is worth (a valid argument). But you must also consider that in the information age, everyone knows everything at the exact same time. The amount of people who buy a stock and sell a stock are equivalent. There are a fixed number of shares until the company decides to issue more of them, so this boils down to a barter type system.
Investing in the stock market is meant to be a long term approach. Ups and downs dont matter in the long run because they true-up to actual value. Read something by John Bogle.
The first rule of investing is buy 4 index funds (ideally 1 large cap, one small cap, one bond, and one intl ex-us) in whatever ratio you are comfortable with.
The second rule is to make your investments deposits automatically into your appropriate index funds.
The third rule is to lose the password to your account.
“What creates value in stock? Nothing. A bunch of people come together and print ink on paper and tell you it has value.”
Actually the profit/earnings (P/E) ratio determines the value of a stock. A companies’ stock can go up if it becomes more profitable. Or to keep it in simple “monkey” terms: stock is valuable because it represents people working in a factory, producing something. Creating value.
Gold on the other hand (much like real estate) just “sits” there. There might be a bubble or a crash, but in itself it “creates” zero value.
“What creates value in stock?”
The fact that it represents an ownership share in a company, and entitles you to a share of the profits (in good times), a share of the assets (in bad times), and a say in how the company is run.
You seem to be saying that stocks only have value because everyone agrees they do, similar to the fiat currency argument. That’s absurd, and overlooks that companies generate real value, in the form of actual cash profits you can take to the bank.
I like the way you think. I don’t think it’s a matter of disagree or agree, it’s a matter of how much risk you are comfortable with. You and I are very uncomfortable with ANY risk of our hard-earned dollars. Others are willing to risk it for what is on average a better return on investment. On average being the key words as you point out. I love your “shakedown” analogy.
Here is another article on moneylife.in that sheds some light on the prices of gold for Indians. I think it also applies to other countries besides India.
Are gold prices infallible?: http://www.moneylife.in/article/are-gold-prices-infallible/8606.html
Thanks Rohit for the link to the article on gold prices in India. I was wondering why , in India we’ve never seen a slump in gold prices although JD says it fell in the US.
As an Indian woman, the gold my parents gave me does make me feel more secure and the value has gone up more than 15 times in these 25 years. I believe in buying gold, the real kind, not ETFs.
JD, great article and so well researched. Thank you
I get tired of how much you think you must clarify that this is only your opinion, and that things could be different in the future, and blah blah blah. It seems like half of this article is that type of padding. Say it once at the beginning or end if you really feel the need, and leave it be so that the real content of the article isn’t continually tripped up.
I understand this sentiment. There is no reason to repeat so many times that you are not 100% sure. I know why you would do it, but once really is enough. 🙂
I agree. That was tiresome.
And even though once is enough for many, this is a blog and unless you repeat yourself many times over, the comments will come back accusing you of being a pseudo-expert, or argue your conclusions criticizing your dogmatism, etc. So, I guess I understand where JD is coming from.
Yes yes. I agree. And normally I would only mention this once in an article. But I know from experience that topics like this set people on edge, and if I don’t qualify myself again and again, people will accuse me of trying to be an expert, or of making stuff up, or whatever. So, this time (and you’ll note I don’t always do this), I was careful to add the disclaimer several times. Even I found it tiresome. But I also thought it was necessary.
For a non-economist, I think you sum it up quite nicely.
I never understood Gold Standard proponents, although I believe I understand the flaw in their thinking. They dislike non-value currency because the value is arbitrary. Yes, it is true that the international markets determine the value of currencies like the U.S. dollar (Just like gold), but the government has the power to issue more currency whenever they wish (just about), effectively decreasing this value.
On the other hand, the govt. can never just “issue more gold.” Therefore, to goldists (may I call you this?), gold’s value is completely determined by market value and not subject to govt. whims.
Flaw #1: While you can’t print more gold, gold production / mining is regulated and controlled by many governments, and worse, by certain companies in the style of diamonds (limiting harvests, etc.). So don’t fool yourself that gold is not an artificially controlled substances. Which brings me to…
Flaw #2: Gold has intrinsic value. The flaw here is that the only intrinsic value it has is what we assign to it. You touched on this in your article. Gold is a relatively rare element, so it must be valuable, right? Well, picture of penguins hand-drawn by me are rare too*, so they must be insanely valuable, right? No, because nobody is willing to pay for my pictures, unfortunately.
Currency is created for trading value. The currency I have came at the expense of the value I provide through my job, intellect, etc. So when I purchase something, I am trading value. Goldists agree here, and get caught up with this. They think because we are trading value, then the intermediate step, currency, should have intrinsic value as well, otherwise you are left holding something worthless until you make a purchase.
The problem is that any value is subjective, including the very things currency is meant to trade for, so the value of the currency itself is subjective, and therefore, arbitrary (with respect to social forces).
* Ok, you caught me. They’re not that rare.
Gold has been determined by people for thousands of years as a valid form of money. Fiat money has shown throughout history to destroy the country that went to it. Look at the history of the US since we left the gold standard in 1970’s. Oil has gone up dramatically, prices for almost all goods has increased and the value of the dollar has lost almost 90% of its value. The value of a currency needs to based on something and gold over the years has been the thing people value.
.
Exactly!!!!
That’s why I’m accumulating 55 gal drums of crude and burying them in my back yard. I try to diversify with some vegetable oil and wd-40 with no more than 5% of my oil portfolio in Olive Oil (virgin, of course!) When everyone’s throwing their gold and silver in the streets, I’ll be the only one driving by just smiling and waving, boys…just smiling and waving.
😉
You seem to misunderstand “intrinsic value” concept.
Paper doesn’t have value because you sat at a desk for 3 hours in order to get it. Nobody cares how you earned money (well, the police or your spouse might). Where it took you one hour of consulting work to earn $50, it might take the WalMart greeter five hours to earn that much money.
Does that make your $50 more valuable than the greeters? No, it does not.
The $50 doesn’t have value because of how you worked for it, it has value because it has “Fifty Dollars” printed on it, and someone else will give you fifty dollars worth of something else for it.
It has pseudo-intrinsic value.
So in a roundabout way, you’re agreeing with the goldists.
Meanwhile, gold has intrinsic value because it has multiple uses, just like butter, copper, diamonds, water, etc.
I mean intrinsic in the precise sense, as you would use it in mathematics, meaning “an inherent property”. I am arguing that nothing has intrinsic value (although philosophers argue this point about life), not gold and especially not printed money.
In such a world, there’s no perfect currency. Gold is better than paper money, but it is hardly the solution to all our economic problems as some make it out to be.
You argue my point exactly. People don’t care how I “made my money”. With each transaction, I am trading some amount of my (perceived) value for the (perceived) value of others. The currency is just an intermediary, and as I said, there doesn’t seem to be a perfect one.
You can call it pseudo-intrinsic, but that’s a wishy-washy term.
I dunno about gold having “multiple uses”. We assign it value cause animals like shiny objects.
JD – you da man and that was awesome. Thanks for scouting out the rabbit holes for us.
So now you’ve got me curious – there are so many scams out there when it comes to selling gold. Any thoughts on the best way to “cash in?” I’m wondering if eBay might the fairest way to go…
Katy, I sold mine to a goldsmith. I don’t know if this is the best option, but I assumed that an end-user is going to give me a better price than some “WE BUY GOLD” operation.
Katy,
I am an auctioneer and have coin only auctions 6-7 times a year. I have helped many people sell both gold and silver at prices well above what you get at the “WE BUY GOLD” places and since most auctioneers work on commission the more you make the more we make is always a good bet I will get as much for you as I can. Call an auctioneer that specializes in coins. One estate was offered 16000 for their silver from a dealer and we got 28000 on the auction.
A very timely piece J.D.
The fact that silver plummeted from $50+/oz to $38/oz in the last few weeks makes me think that there are a lot of large scale investors with vested interests taking profits from bets with precious metals (particularly silver) that will leave naive amateur investors nursing their wounds.
No crazy conspiracy theories here, but the meteoric rise in silver prices stinks of manipulation (not by secret cartels, but by greedy investors!)
Prior to the recent bull run, changes in value of more than 1-2%/day were the norm. I have no interest in buying until this settles down again!
Professional investors make a lot of their money off of the foolishness of amateurs. Not off of manipulation, but good business principals.
If you are willing to buy something for more than its worth, it is your folly not the guy who sold it to you. He’s selling based on the understanding that people WANT his product. Its not his fault you overvalued it.
Buy the market. Look up JD’s index fund articles. While an index fund never beats the average for funds, it doesn’t lose by much either (if at all). It merely performs average. 6-8% return before inflation is fine by me. Its better than anything else out there. And I’m not gambling my success on a single company, but the economy at large.
Not sure I agree.
While amateurs are definitely foolish (and greedy) on occasions, it tends to be because they’re following momentum in markets inflated by investors looking to take the money and run at the first sign of a real dip.
Hence my comments about manipulation.
The Great Depression was CAUSED by the abandonment of the gold standard. Major countries abandoned the standard during WWI which lead to huge imbalances. How else were they going to fund war? They had to keep the printing presses going to keep the tanks rolling out.
Do yourself a favor and read “America’s Great Depression” by Murray Rothbard. He clearly shows that the Fed’s increase of the money supply in the “roaring 20’s” put the economy on a seemingly endless path to prosperity – that subsequently collapsed and put us in the Great Depression.
finally a sane person in these comments
How funny… I was just thinking that this topic seems to attract a lot of crazies.
I’m always surprised to see people who think that they know it better than every single government in the world.
This is a great series on the pros and cons of the Gold Standard. I won’t give away the conclusion, but here is a hint: we shouldn’t go back 100 years. 🙂
http://www.npr.org/templates/archives/archive.php?thingId=133252308
You should really think why governments would want to remove the gold standard. As soon as the get rid of this barrier they can print money to their hearts desires to pay for things that wouldn’t be possible on a gold standard. Hence the huge debt crisis almost all countries are facing right now. On the gold standard, governments where restrained on what the could spend but as soon as the restriction was gone they started printing money like it was their job. Notice how the dollar has lost 95% of its values since we left the gold standard. This also allows countries to go to war easier because they can jsut print the money to finance the wars. And to anyone who belives the gold standard caused the great depression they should really look at the facts or read a book or too. I would start with Rothbards book first.
The facts I’ve read suggest the opposite of what you are saying. It seems like most economists agree that the gold standard is rightfully abandoned. I guess we can go back and forth on this, but tell me this: if the Gold Standard is such a great idea, why isn’t there a single democracy in the world on it?
That is easy to answer. Its because leaving the gold standard allows government to spend on things that they wouldn’t otherwise be able to afford. They wouldn’t be able to start wars all the time or afford all the welfare programs that all the countries have. I’ll ask you a thing, what has happened to all the nations/countries that had a fiat system in history? Rome, Greek, Egyptians to just name a few.
Your time and diligence are never wasted, JD. That’s what makes GRS better than the rest. Although this article debuts today, it lasts forever, so every time you have occasion to refer someone to it later, that’s a return on the investment of time you put in. And every time one of us refers to it, all the better. Keep up the good work.
Very interesting. I tend to feel that when you’re investing in gold you’re investing in the market’s perception of gold as a safe hedge against inflation since gold has minimal inherent value as an investment. There are industrial and jewelery applications for it but why aren’t you investing in companies around those industries or mining if you want to capture their gains or losses? Gold is too volatile and doesn’t produce income or products to be a good investment for my taste.
William Bernstein (the excellent author of The Intelligent Asset Allocator, The Four Pillars of Investing, etc.) had a good post on the Permanent Portfolio. I suggest you check it out: http://www.efficientfrontier.com/ef/0adhoc/harry.htm
Great article! Thanks for explaining it all so clearly — around here there are constant radio commercials for gold-selling services, and they make me cringe with the extreme scare tactics they use.
As for the “Carter bubble,” given that you say most of the rise came toward the end of his presidency, I wonder how much the Iran hostage crisis played a role.
The cockeyed.com story on “Cash4gold” is a fun read. It’ll reinforce your opinion of those radio commercials.
My husband and I were just talking about this last night.
I’m a coin collector (in a small way) but have never been a gold bug. There are a few gold coins I would like to have, but it’s the coin rather than the gold that I want.
I’ve been predicting a silver bubble which seems to have happened last week; I think silver will stabilize now, but that’s just my opinion.
The best way to buy metals is in mining stock.
We’re kind of accidental coin collectors too. My dad bought my son a 1oz gold coin when he was born. Since that was 3 years ago, it has appreciated considerably and I’m sitting here wondering if I should sell it to get the most return for my kid.
In the end though, I think the coin is neater than the money, and it’ll probably be one of those things he keeps forever. At least until he runs into an emergency and has to sell it at rock bottom prices. :-/
Buying gold is not an investment, it’s insurance. If you think of it as buying insurance, then the argument points you consider change. For one, it might not matter that it doesn’t provide a real (after-inflation) return. In fact insurance costs money.
Now, when you’re buying insurance you have to ask yourself if you are getting good insurance for your money. Everything you wrote in this post suggests that gold is too expensive for the level of insurance you’re getting. TIPs would seem to provide more cost-effective insurance, even better because they simultaneously insure against inflation and deflation.
The one scenario that gold insures most effectively for is the collapse of a currency and rampant government corruption, like happened in Argentina and described in this post: http://ferfal.blogspot.com/2008/10/thoughts-on-urban-survival-2005.html In that scenario, I’d guess that only physical metal is any good. If you want this kind of insurance, I’d say it is pretty clear that you’re going to have to buy actual metal, not “shares”.
Nonsense. Gold isnt insurance at all. In fact its nothing like insurance. If you are truly worried about your own currency collapsing you could just as easily use the forex or even just invest in a foreign stock exchange.
Gold is a commodity, thus its real value will never go up. Basically, a basket of food will cost roughly the same amount of gold no matter what happens to your currency(assuming there isnt a catastrophic food shortage or something).
Is that really true? From JD’s chart in the article, gold is up 76% since Obama took office. I know there has been inflation but I don’t think McDonald’s prices are up 76% in that time… seems to me you could buy more food with an ounce of gold now that you could have in 2009. Maybe there is a long-term correlation but gold is clearly subject to bubbles just like everything else.
Well, there is obviously going to be short-term spikes, but its still a commodity. People became deathly afraid of inflation, and had a surplus of investment money to use(since they unwisely sold their stocks low). So they bought gold. A barrage of infomercials probably helped as well. However, if you think that gold will increase in value above and beyond inflation for a long term, like 25 years, then you’re nuts. What are you basing that off of? Is gold going to become more rare? Will it be used more in manufacturing? What information leads you to believe gold will increase in value, other than doomsayers and whack jobs?
Put it this way, if you had invested in Ford stock instead of gold, you would have gotten a 1000% return instead of the 76% you got with gold. People love to point how well gold has done, yet they omit the obvious fact that everything did well in that same time.
Gold has, and always will underperform other investment instruments.
Gold is insurance only if you can time the market. Unfortunately, that is impractical (if not impossible). Its not insurance when you are betting short term. Its called portfolio tilting.
Insurance is splitting your portfolio 50/50 bonds/stocks. Stocks are good in times of prosperity (i.e. when interest rates are high) and bonds are good when times are tough (when interest rates are low).
When you use it as a hedge, possible. But what if there is a sell off on gold and the economy doesn’t improve. Where is the hedge?
Thank you for the time and effort you devoted to researching and writing this post, J.D. You’ve put forward a strong case against investing in gold, and I also appreciated that you mentioned the Permanent Portfolio as a reasonable strategy for including gold in one’s investments. I also appreciated that you included a mention of Crawling Road, whose piece on gold ownership represents a reasoned, rational approach that is neither hysterically enamored with gold and nor vehemently opposed to it.
I do have one point to add regarding owing gold in a crisis. People on both sides of the issue allude to doomsday scenarios–as you did–when arguing the merits of owning gold. But it doesn’t take a dinosaur escape for gold to be useful in dire straits. Specifically, it’s proven tone useful to own gold during the economic crises in Argentina (around 2001, I think?) and Iceland (2008). I think Crawling Road goes into detail on this.
Excellent article. I also don’t much like gold as an investment, for most of the reasons you cite above.
The gold standard is very workable however. No governments currently are on one now as you mention. But the gold standard is disliked by governments NOT because it can cause depressions or whatever, but because it limits that governments ability to debase it’s own currency.
If a government can’t “print money” to pay off it’s own debts, then its borrowing capacity is
becomes much more limited. Limited borrowing = limited government spending and growth.
I encourage all readers to take a look at what Austrian School of Economics has to say about what causes booms and busts, and how returning to a gold standard in some form would increase wealth and prosperity.
This comment is not endorsed by standard mainstream economists. As JD rightly pointed out in his article, the gold standard would be disastrous in today’s economy, and did indeed make the Great Depression greater than it needed to be. There are a couple of excellent books, one by Eichengreen and one by Temin, that discuss the problems that the Gold Standard caused for the Great Depression.
It is, however, endorsed by many an armchair economist. Who, by the way, cannot backup their claims with effective arguments nor historical facts.
Although I put little faith in professional economists. I read a great comment once on some website, I’ll paraphrase:
“I remember when I was in college. All the smartest students went into the sciences. All the average students became doctors. Everyone else, they went into economics.”
Yet those standard economist never saw the dot.com bubble or the real estate bubble. Funny how the Austrian economist saw both coming and their economic thought actually explains all the booms and bust in the history of the US. But hey, lets not listen to the people who got it right. Keynesian economics has been wrong and will continue to run the US into the ground.
That’s silly. Everybody (all the professors and students in my top PhD program) knew that the dot com bubble was a bubble and that the real estate market was going to collapse (again, its unsustainability was a common point of discussion). (Though I don’t think anybody realized quite how much fraud there was within the real estate market. We knew it was going to be bad, but not quite this bad… we’d envisioned more of a 1980s S&L bad.) Those are both in standard economic theory too. When was the only question, and economic theory can’t predict that, because it is really the realm of complexity and chaos theory.
You may think that standard mainstream economists didn’t predict that because the media didn’t choose to report the majority view. Jon Stewart had a really fantastic piece on media bias towards irrational exuberance around the time he got into that big fight with Jim Cramer.
After gold collapses, you will probably say, “mainstream economists didn’t predict the collapse of gold.” But that doesn’t make it true.
Also, whatever college that was in the previous comment probably didn’t have a business major. Though many folks who get PhDs in economists also have an undergraduate math, physics, or engineering degree. Mine was math. It is far easier to get into and through med school than an econ phd program.
@nicole Did they see it coming in 2002-2006 or did they only see it coming in 2007/08. Are you taught Keynesian or Austrian Economics in your PhD program?
@nicole,
Yeah, I think business and finance would be more appropriate in that quote.
Nobody teaches Austrian economics at a top 10 program. That would be like teaching Marxian theory at a top school. Only as a curiosity. (Well, except that one guy that everybody secretly calls a sociologist behind his back.)
Also, Keynesian economics was out of vogue when I started graduate school… I can’t tell you whether I had it or not because that would tell you which top school I went to for graduate school since only certain top macro-economists teach it in graduate school.
Keynesian economics has made a come-back recently (after the crash) precisely because its predictions and suggestions are so spot-on. The 1980s was really when they stopped doing so much Keynesian economics and started doing lots of abstruse mathematical modeling with predictions that didn’t match the real world in any way shape or form. The history of economic thought is an interesting study and I recommend it for anybody who thinks all there is is Austrian economics and Keynesian economics.
I graduated long before 2008. So yes, predicting dot com crash 2000, real estate crash at least by 2005. The stupid stupid loan terms on our first houses we were being offered as graduates was enough to show the real estate market was unsustainable. Those 20-20-10 loans with the very minimal credit checks? A disaster waiting to happen. The huge run-up in prices in CA? Unsustainable. Everybody knew it, even though they didn’t know the extent of the damage.
@Michael
“Did they see it coming in 2002-2006 or did they only see it coming in 2007/08”
Paul Krugman saw it coming as early as August 29, 2005, in this article “Greenspan and the Bubble” where he states, “There are signs that the housing market either has peaked already or soon will.”
source: http://www.nytimes.com/2005/08/29/opinion/29krugman.html
@Lindsey
haha funny because the person i was talking about talked about it as early as 2002 (Peter Schiff).
http://www.youtube.com/watch?v=A0Uk3hKnQQ8
Also bring Krugman into the mix is funny considering it was his ideas (stimulus and lowering interest rates after the dot.com bubble — Keynesian) that was reason we even had the real estate bubble. Its kinda funny that people still thing even Mr. Keynes himself said that his theory didn’t work unless there was a war. http://www.youtube.com/watch?v=Q1B3CXaudCo
http://www.lewrockwell.com/woods/woods116.html
@Nicole — Keynsian theory doesn’t explain the actual cause of any the problems in the last decade. In fact Keynesian theory is the reason we had the real estate bubble in the first place. With the easy money (Keynes theory on softening a recession) the fed was providing the housing bubble wouldn’t have been formed.
Side on heres a funny/ informative video for all those Keynesians
http://www.youtube.com/watch?v=GTQnarzmTOc
I’m just trying to recommend rational, well written arguments from the “other side”, as JD recommends in the post.
As a follow up poster suggests, I am indeed merely an “armchair economist”! I think I could provide both rational arguments and historical examples to back up my points, but this isn’t likely a great forum to do so in.
Professional, mainstream economists like Bernanke have devalued your US dollar by over 95% in the past century plus. A return to a gold standard would indeed be pretty disastrous for the economy today – the equivalent to a massive hangover following binge drinking. But in the long run the economy, like a person sobering up, ends up better off.
Also on saying the gold standard prolong the depression. Read Murray Rothbards book on the great depression. Its funny how the gold standard before the great depression never caused anything close to what happened during the 1930’s. The only real change between recessions before the great depression is that govt got involved in the market by way of the New Deal Programs. Look at 1921 recession had an even greater decline than 1939 but yet rebounded in one year. How did this happen, the govt stayed out of the way and let the market readjust itself.
I am assuming your PhD economic class only taught you Keynesian economics.
Read Murray Rothbard book on the Great Depression. The gold standard didn’t cause or prolong the depression. If the gold standard was the cause of it then why didn’t we have a great depression in the previous hundred years? Inflating the money supply is the cause for all booms and bust. And govt spending(stimulus) like the new deal only prolongs the problem. If you let the market adjust itself unimpeded then you will get a quicker recovery like in 1921 which had an even greater drop but recovered in about a year.
Another important point about ‘investing’ in gold is that gold does not produce money! If you own a stock, there are two ways to earn money: it can provide dividends, or the stock price can increase and you can sell it. With gold, you only make money if the price goes up.
The reason some (very smart) people do invest in gold is because it can be a healthy addition to your *Asset Allocation*. The idea behind asset allocation is that you want different classes of assets that are not correlated to each other. The most basic classic idea of this is Stocks and Bonds. When stocks go down, often bonds go up and vice-versa. Investing this way is a proven method of increasing investment returns (and is the largest factor in determining your return).
Now, sometimes in crazy markets you see stocks and bonds both go down! So people start looking at other asset classes that are not similar/correlated to stocks and bonds. The big favorites are REITs (real estate investment trusts), Cash, U.S. Bonds, TIPS (Treasury Inflation Protected Securities), and gold.
I’ll skip over real estate for brevity’s sake. But other investment vehicles are all kind of similar to cash. Cash is an asset class/vehicle. You can get a return from your savings account… but the interest rate is low (and variable), it’s subject to inflation, and you get taxed on it. U.S. Bonds are the next step up, you get a fixed interest rate and you can be pretty sure that as long as the U.S. government doesn’t tank, you’ll get your return… but they’re still subject to inflation, also the interest rate is really low right now. Then you have TIPS which have an interest rate equal to the inflation rate plus a little extra, these are usually a really nice hedge against inflation and preserves your cash amount better than normal cash or u.s. bonds! (but they’re still taxable).
So why gold? because many people are concerned about the government’s ability to repay. So they look for a ‘safe’ investment to avoid risk, gold is perceived as such an instrument. And it’s price is due to both people looking for ‘safe’ investments AS WELL AS people just buying it because the price is going up.
The next topic to learn about is revision to the mean! and why when you have an asset allocaiton you should rebalance your accounts! Then you’ll see why having gold in your portfolio isn’t such a terrible idea… but you’ll also see why it should be more in the 1-5% range of your total portfolio size…
Great post. Really well said.
I would mention though that many websites and investment books will refer to this 1-5% as “tilting” a portfolio. This is the “fun money” of your account to keep you excited in investing, not the bread and butter of your retirement.
I’ve always thought of gold as something that will always have value, especially when dinosaurs roam the streets. Mainly because that’s what everyone else always says. I absolutely agree that gold is fiat money just as much as any other currency and, but has never thought of it before. Your article fits perfectly with an article I read last week. I may have found the link here at GRS, I don’t remember.
http://rhetoricaldevice.com/articles/BriefHistoryOfMoney1.html
It shows how the first silvercoins where chosen BECAUSE they had no intrinsic value (you couldn’t eat them).
When it comes to using gold as a hedge against economic collapse, maybe you could invest in a basket of gold AND lots of other currencies. If the collapse only affects spesific regions of the world some of your assets could be saved.
Buy low, sell high is an investing rule. As a result, I’ve been selling my gold (not investment gold, but scrap gold) for big bucks the last year or so.
JD, I enjoyed this post, thanks.
I predict the value of gold is going to drop dramatically on May 22nd, after all the crazy people who advocate for it disappear in the rapture.
ROFL
+1
Ha! When they’re gone, we can all swoop in and take their stuff. I know my in-laws, who believe in the rapture, are big on buying gold (because their church told them to), so I’m gonna have me some pretty things on May 23rd!
Thanks for doing all the hard work and research for me! I’ve had very similar feelings about gold for a while now (it’s a bubble, and bubbles always burst), but didn’t have very firm facts or information to back up my gut feeling. Now I feel more informed, so I can go with my gut with a little more confidence 🙂
A great, informative article, injected with a nice touch of humor! Thanks. I’ve been kicking around “shorting” gold ETFs for a few months now, but I really don’t have the resources (yet) for doing so. So, for any goldbugs out there: Please buy my newsletter – which has loads of information on investing in Pez dispensers, Beanie Babies, Pets.com stock, and yes – Dutch tulips!
“If I’m a shop owner in this situation – or I’m your neighbor with a vegetable garden – I’m going to be want to be paid with something real, something like a carton of eggs or some shells for my shotgun.”
The movie The Book of Eli with Denzel Washington presents a post-apocalyptic dystopian society where people barter and trade valuable goods as money (clothing, lighters, guns, ammo, food, etc.). I agree that this is a more likely scenario than trading gold.
that is true for awhile but the barter system is very inefficient. Eventually as the society develops again some sort of money will developed because it makes making trading easier. That money may be based in gold, silver, or anything that people find valuable
My dad was a child in Greece during and after WWII, where there was a civil war, unstability and food shortages. He lived on a farm and was poor but they had the farm and they traded with the people around them to get other things they needed. On the other hand people from the city came into the country, begging and offering money, watches, family heirlooms for a loaf of bread and were turned away. Yes it may be “short term”, but short term still may be years and you can’t eat a gold watch when you are starving.
I take exception to this part of your blog post
“I am not an economist, and I struggle when it comes to economic theory, but my understanding is that much of the run-up to and aftermath of the Great Depression was thought to have been caused by the Gold Standard. Under the Gold Standard, currencies were much more susceptible to speculation and devaluation, which could lead to runs on the banks. That’s why the U.S. abandoned it. And it wasn’t only the United States that did so. Not a single country in the world uses the Gold Standard anymore. Until recently, most economists and politicians considered it a deserved relic.”
This is a common mistake made by people today. I would suggest you read Murray Rothbards book on The great depression for understand it more. Another resource on why we went off the gold standard is Tom Woods book “Meltdown”.
I invest in precious metals because i believe the govt will continue to debase the dollar and make it less valuable which makes gold more valuable. Inflation is on its way whether we like it or not and it is just a matter of time till the debt crisis rears its ugly head on the econonmy.
Like J.D. said, gold has no real value. If the world as we know it ended today, gold would mean nothing. If you have all this gold, and I have food, what makes you think I’m going to trade food for gold?
As an investment, I’m not opposed to gold, but I have not invested in any of it. Maybe if the value drops again I would purchase some, but not right now.
Gold is money; i.e. it has all the properties of money: http://en.wikipedia.org/wiki/Money, but most important to your point is that it’s a medium of exchange and a store of value. Unless we’re really talking about an apocalyptic scenario where very few people are left and it becomes very hard to grow food, your stock pile of food will either perish, or be harder to trade for other stuff than my stock pile of gold.
That’s exactly the point: it has all the properties of money. Which makes it (like money) useless in a “end of the world situation” where we will all start bartering for things that feed and protect our families.
I realize talking about an ‘end of the world situation’ is out there, but when you talk about the value of gold you have to. Gold is simply a rock that we have assigned value to. Sure it’s a good conductor of electricity, and can be used for repairing teeth, but beyond that what use does gold have? If the world ended today and I wanted to trade you a petosky stone for food would you? No you wouldn’t. The same is true for gold. It’s simply a rock that we have assigned value to. Just like the dollar is paper that we have assigned value to. Both are good for exchange now, but to pretend that one is more valuable than the other is illogical.
Don’s comment (#28) is spot on! Gold is not a hedge against a catastrophe or even inflation but against the collapse of a currency. It is NOT an investment in order to make x % in y years. It is seen as an insurance in order to preserve at least a part of your wealth should the Dollar or your national currency collapse. And it almost certainly will do that job better than stocks or real estate. JD somehow missed to even mention that motivation.
Btw, just one word about that “you can’t eat gold” notion. Sure, but the same is true for your house, stocks or cash. After a catrastophic event as described in the article your best bet is to have a land miles from anywhere and enough knowledge to grow your own food.
I don’t understand why gold preserves your wealth in the event of currency fluctuations/collapse/hyperinflation better than stocks or real estate? Wouldn’t those things just go up in price along with everything else? If not, would they not be a bargain to buy?! How is gold different than those things?
Buying gold because you expect armageddon akin to 28 Days Later where you need shotguns and huge stockpiles of food seems ridiculous to me. If the world comes to this, the gold you own in ETFs or whatever will be worthless to you and if you’ve stockpiled gold bars in your house, good luck finding people who want them if you’re not dead yourself.
I agree with you that in that situation (which I don’t think anyone should be planning for and is beyond the scope of a personal finance blog) the best bet would be to live in a remote area with your own farm and plenty of ammunition. But aliens could also kill us all tomorrow, or a meteor, or the rapture could take us away too. None of these things is worth discussing anywhere but a conspiracy theory blog.
gold in terms of dollars will increase but gold against any other commodity will stay the same or gold will be able to buy more than was previously possible. Take this for example, in terms of dollars, oil has increase dramtically in the last year but oil in terms of gold has actually gone down in value in the last year.
I agree, let’s not discuss end of the world theories. I only wrote about them because JD suggested they’d be important for gold bugs.
When thinking about a currency collapse we must keep mind that it doesn’t come out of nowhere. In all likelihood we would experience a massive economic slump before and the currency reform would only be the mean to end it. This is where the problem with stocks lies. There will be a lot of bankruptcies. If you happen to own shares in bankrupt companies, you’ve got a problem. Preparing for such a crisis would thus mean careful stockpicking. Which companies are going to survive such a crisis? Since I don’t have a crystal ball, I can only guess that those companies that provide basic goods everyone needs and have little debt stand a higher chance to survive. Bank share holder on the other hand will lose everything. New economy companies could be hit badly, too. How about index funds? Well, they’ll be under pressure, too, as they own shares of “good” and “bad” companies. And then, we should keep in mind that many index funds use swaps to replicate a given index. These products are as dangerous as those debt instruments that caused the near breakdown of our financial system. These funds are likely to vanish entirely as they require the current financial system with its highely vulnerable financial institutions to survive.
To conclude, yes, you should have stocks in times of currency reform but you better make sure you’ve got quality stocks. How about gold? Well, you can at least be sure that it will have a price after the crisis.
How about real estate? I’m certainly not arguing against owning your house. Owning your house has many upsides, most importantly non-financial ones. But let’s say you decide to invest in the housing market and buy additional houses. You either speculate on rising prices so that you call sell higher or on the rent payments. These should cover all your costs including interest on debt. What’s more, common knowledge says inflation helps to reduce the debt burden. Great, isn’t it? Yes, but in times of hyperinflation that will ultimately result in a currency reform, things look a little different. The problem is that expenses may rise a lot faster than income. Why? Because you cannot increase the rent or your wage as fast as prices for food etc. surge. Now, if you have debts, although they’re worth less now than before, you may still not be able to cover the interest. You risk losing your real estate. If you are debt free, the scenario looks a lot better though. You may only become a victim of some sort of equalization of burdens policy policy right after a currency reform but that would a smaller problem. It could be avoided with gold though as the government doesn’t necessarily need to know that you own gold.
All that said, I’m not arguing you should put all your money into gold. Buying gold is an option for everyone who thinks it’s possible that a currrency crash happens. A currency crash is always the result of a overindebted government and (!) private economy. In my opinion, we’re nearing that point in the US, in Europe, in Japan and the rest of the Western world. What’s more, if either the US or Europe collapses, the other one will follow suit. Diversifying out of the US or out of Europe will thus be extremely difficult. So, I’m afraid traditional strategies such as buy and hold and buying index funds will not work quite as good as they used to. Preparing for a huge debt/currency crisis demands a different portfolio: quality stocks, some debt-free real estate, and yes, some physical gold (though I do agree that it would have been better to buy a few years ago). Avoid bonds at all cost and all tricky financial instruments, including swap based index funds (that’s a good idea in normal times, too), gold ETFs etc.
Disclaimer: If you think no huge crisis will occur, ignore everything and go on as usual. I’ve got no crystal ball myself either but I sure think it’s not unlikely anymore that a huge financial crash occurs.
Great piece. Re massive price increase under Carter:
http://en.wikipedia.org/wiki/1979_energy_crisis
I’ve never understood the reasoning behind hoarding gold in case of a depression or even more serious financial calamity than what we’ve experienced recently. Like you said, I’m pretty sure any type of food, shelter or clothing would be more valuable than a shiny piece of metal if the SHTF.
I’m no economist either, so why do people automatically assume since the dollar is being “devalued” that means gold should increase in value?
Gold (other than it’s true uses as jewelry, in electronics, etc) seems like a giant pump and dump scheme to me – if enough people fall for it being a good “investment” the price goes up.
Don’t imagine total world devastation where everyone is looting for food in a radioactive wasteland. Instead imagine an economic disaster localized in one country or in one region of the world.
Imagine you are a citizen of a small up and coming country. You are a prominent business person and have the equivalent of $10 million USD in stocks/bonds/cash in your country’s currency, and the equivalent of $1 Million USD in gold. Now imagine tragedy strikes your country, and there’s total economic collapse, and your nation experiences hyper inflation, or extreme devaluation of the currency. Your stocks/bonds cash formerly worth $10 million USD are now worth $10 USD and you can barely afford a couple loafs of bread with that.
But your gold is still worth the same that it was worth to other countries as long as they haven’t collapsed as well.
If the whole world collapses, you don’t even physically have the gold anyway.
(relatively) small net worth investors *probably* don’t **need** to invest in gold. But if you have many millions, and you’re worried about the risk of a whole country collapsing and it’s impact on you… well it is a risk (no matter how remote), and it is a valid way to help hedge against it.
If I’m a citizen of “Unstable Country X”, I’m pretty sure I wouldn’t hold all my wealth in local currency. Diversification would take care of 95% of the problem I’m guessing. Until the dollar stops being the default world currency, I’m not going to get too worried.
You are exactly right! The problem is that if you’re in the US (I am). Many people’s portfolios are all in US funds. International Diversification is pretty important and highly recommended.
However it’s important to remember that is only a diversifying of total markets, and markets may or may not be correlated (depending on the hypothetical disaster). So instead of just hedging against market risk through geographical diversification, you can use gold as a different asset class to help achieve diversification.
You are not in any way wrong! i’m just pointing out where gold can be usefull. (but usually only if you’re very rich, see my future post that J.D. asked me to make in the comments).
Don’t neglect the commissions paid on the purchase of solid gold. If you read the fine print on the brochures the various companies will send you, in the “fees” section you will see where they may charge you up to 30% on *each side* of the transaction!
There’s a reason you continue to hear commercials for gold – it’s very profitable!
If you’re referring to GoldLine (there are plenty of others, I’m sure), the markups they charge border on fraud. They give legitimate dealers like Europac Metals (Schiff’s company), GoldMoney, and e-gold a bad name. You shouldn’t have to pay more than a ~5% markup.
Thanks for including the permanent portfolio at the bottom. This has been my choice for several years now because like you I found the arguments and data compelling. It is a good reminder that this approach to gold is different than the bubble approach the rest of the article (and it sounds like your Dad) talks about. Thanks for the time and effort it took to put this together.
I couldn’t quite articulate to people why I was so skeptical about investing in gold and this sums it up beautifully. I can’t think of any value gold would give me personally, or value it would give anyone other than being a commodity with fluctuating demand and price. I don’t see the price of gold plated cables spiking so I can’t see the value in gold.
A few notes about precious metals:
First of all, silver, gold, platinum, and palladium (the four precious metals that are primarily traded) ALL HAVE VALUE! Ever heard of the catalytic converter? How about the printed circuit board? Solar Panels? Fuel Cells? There are hundreds of other widely used commercial applications for these metals. Yes, we are mining more precious metals everyday. But we are also using more precious metals in everyday manufacturing than ever before.
Just because you invest in precious metals does not mean you are advocating for a “gold standard”. In fact, JD I’m surprised you made that connection at all. Gold/Silver is a commodity just like any other. Buying gas, for instance, does not mean that I am pushing for an “oil standard”.
The quickly rising prices of precious metals is an indicator of how much inflation we have recently experienced.
JD, I think your comment about valuing shot gun shells above precious metals in a time of crisis, may be a bit shortsighted. I think we are much more likely to experience an “energy crisis” than an all out apocalypse, in which case owning a solar panel or fuel cell will be immensely useful. I believe, more so than shot gun shells 🙂
A side note, you might find interesting. The latest drop in silver prices coincided perfectly with the announcement of the assassination of Osama Bin Laden. The prices are only now starting to stabilize, now that some time has passed since the event.
Gold doesn’t have many industrial uses though. I believe that less than 20% of gold mined is used for industry. The rest is jewelry, coins, etc. The other metals you mention have much more use in industry. For example, it is platinum that is used in catalytic converters due to its ability to withstand high temperatures.
I don’t have any investment in gold either. I think it’s bad timing right now. I will probably buy some gold when the price get a much cheaper. I knew some people who were in Vietnam when the communist took over. The gold were the only thing they could take with them. It’s a hedge against all out disaster. I think you can always move to a better situation so gold could be exchange for currency at other places.
Warren Buffett had this thoughtful thing to say about gold:
“You could take all the gold that’s ever been mined, and it would fill a cube 67 feet in each direction. For what that’s worth at current gold prices, you could buy all – not some – all of the farmland in the United States. Plus, you could buy 10 Exxon Mobils, plus have $1 trillion of walking-around money. Or you could have a big cube of metal. Which would you take? Which is going to produce more value?”
I’m not going to argue whether gold is a good investment or not at this current time, the fact is: I don’t know. It is certainly less good of an investment today at $1500 than it was some years ago at $400.
..but, many of your arguments are deeply flawed:
That equities have made good returns since 1926 is pointless for a number of reasons:
Firstly, most people do not have 85 years or an arbitrarily long period of time to save up for retirement. They have about 30-35 years. If you pick a few time intervals for equities that are 30 odd years long, I’m sure you’ll find times when equities have been a lousy investment, as surely as you can find the same for ANY asset class.
Timing and time of holding matter as much as anything in a historical perspective, and if you happen to become an adult at the beginning of a bad run, you may grow old before your investments recover (in real terms, the S&P had negative returns between 1997-2009).
Secondly, as always, past performance is no indicator of future performance.
When it comes to the “intrinsic value” of gold or currency, it has none. Things are only as valuable as the buyer sees them, and as valuable as what you can get in exchange for it. If a replacement for oil was invented tomorrow, oil would soon have less “intrinsic value” than water.
BUT, at this current time I personally have a certain suspiciousness towards the US Dollar: the US monetary base, ie the base amount of currency in circulation has more than tripled in a few short years. Gold above ground on the other hand only increases by about 3-4% per year (I think) – In a race to the bottom, Bernanke’s ability to conjure up money at will and track record of doing puts the dollar at a disadvantage.
Even IF gold is in a bubble, my view is that the dollar is in an even bigger bubble: money printing on such a scale will only mean that prices for just about everything, from commodities to equities will get bid up, as more dollars chase fewer assets. Which asset will get bid up the most is anyones guess, and in real terms, gold may lag behind inflation (hence: “bad investment”), but the dollar is more likely to suffer.
I have no idea which way the economy is headed, but a re-run of 70’ies style stagflation is not a bad bet.
Finally, in the case of the “apocalypse” that some people seem to want to portray:
You’re right. Gold won’t do you much good, nor will dollars. If someone believes in such a scenario, I’d suggest stocking up on bullets and whisky. In post-Soviet collapse Russia, vodka was as good as money.
I like the anecdote about the value of antique paper money due to its collect-ability vs. the equivalent amount of gold. One of life’s little ironies I suppose.
You got one thing right in this article: You don’t understand economics. Thus all of your other conclusions make sense, for someone who doesn’t understand economics.
I suggest you go to http://www.mises.org and start learning.
By the way, one of the ways I will know when the gold bubble has started is when we stop getting articles like this, and we’re seeing articles (from people who don’t understand economics) advocating gold using faulty reasoning.
For instance, the inflation rate is closer to %20 than %2. TIPS does not protect you against inflation. You’d understand this if you understood that inflation is an increase in the money supply, not a growth in prices. (It is trivial for the government to manage “growth” in prices by changing the basket of goods, and simply excluding the areas where prices rise first due to increases in the money supply– energy, which they exclude completely from their claims about “inflation”)
Unfortunately, this ignorance of economics is widespread and results in people thinking their wealth has gone up when they invest in stocks whose price has gone up. The error is assuming the dollars they put in were worth the same as the dollars when they liquidate.
Right now we’re seeing the US Economy shrink, but inflation is so high the stock market and GDP figures are still going up.
It will be extremely painful when people realize the truth of the situation.
After that happens, they will rush to gold and silver and the gold bubble will begin.
Ah yes… A wise man indeed. At the mere mention of http://www.mises.org, I can exhale with confidence that you know what you’re talking about. The author of this article would do good to spend some time on the web site.
Keep up the study of true Austrian Economic principle and you will continue to advance yourself in your community as you explain (correctly) why the dollar is crashing and gold is 5,000 dollars an ounce. Long live Mises/Rothbard/Dr. Paul!!!!
This blog couldn’t have been timed better. Adaptu just released an infographic on investing in gold. Would love to hear your thoughts: https://www.adaptu.com/community/visualize_money/blog/2011/05/09/a-golden-investment
It’s nice to see someone NOT pushing gold/silver/copper etc. I couldnt agree more that if the world was ending, I doubt someone would care about a bar of gold over a piece of food or clothing. We have too many doomsday speculators out there pushing inaccurate knowledge and advice.
“Right now, I’m willing to bet on the side of history”
Not, unless you are shorting it. Otherwise your are just sitting on the sidelines. If you know gold is in a bubble then short it. Otherwise, you just don’t know whether it is or isn’t or are not willing to walk the talk.
Suspecting or even believing that a bubble exists doesn’t give you the ability to predict when said bubble will burst. There is inherent risk on either side of the board in that scenario – either you buy long, and risk that there really is a bubble and it bursts, or you go short, and risk that there isn’t a bubble, or it doesn’t burst when you think it will. Sometimes, the only winning move is not to play.
If the bubble bursts and you short..you will eventually win unless of course the price you buy in at is not in the bubble stage after all. So the point remains, if you have no skin in the game then you’re not willing to back your opinion up. Now, if you say I don’t know whether gold is in a bubble or not so I am staying out. That’s a perfectly acceptable position. But you never “win” with that position you neither win nor lose
Not knowing when the other shoe is going to fall doesn’t mean you have to stop believing in gravity. 😉
“Eventually” is the key word. There’s no such thing as a “buy and hold” short position – eventually, there’s going to be a margin call, and you either have to buy the (stock/commodity/widget), or pony up the cash difference. Even if the value stays the same, you wind up losing money on transaction costs, interest on the margin account, or even the opportunity cost of having your capital tied up. The only way to win is for the price to decline in the time frame during the period you’re invested, and decline enough to cover the costs mentioned previously. Shorts are an okay hedging position, but I’m not terribly enthused about an investment vehicle with limited potential for gains and unlimited potential for losses. You need luck or some very concrete information to consistently profit on shorts.
Though investing in gold may not be such a great idea, certainly selling it to a reputable dealer works well right now with the price high. I just sold a few pieces of 14k gold (scrappy jewelry I inherited) and made an easy $375. I would caution anyone from mailing their gold to distant gold buying companies many of these are shams and you’ll never get the value you should, but in person you can shop around to get the best price and I was actually able to negotiate the price a bit.
There’s a great, old Twilight Zone episode that’s really relevant to this topic, “The Rip Van Winkle Caper” in which gold bar thieves go through suspended animation and wake up in the future to find that their gold stash is worthless and irrelevant. If the link works, you can read the synopsis on Wikipedia. http://en.wikipedia.org/wiki/The_Rip_Van_Winkle_Caper
Another consideration is that gold mining is some of the most harmful mining both to the environment and to people. Mercury is used to separate gold out from other material when it’s being mined. I can show you a picture of miners in the Congo holding mercury in their bare hands. Since there are practically no real gold veins left anymore, gold miners will mine tons and tons of rock volume, producing tons and tons of waste (not to mention completely destroying the area being mined), to extract very small amounts of gold. Cyanide can also be used to leach gold from ore, and this releases naturally occurring arsenic in the rock, which can and does enter the environment at levels toxic to humans and other animals. This occurs in the US, where the mining corp is monitored and has to clean up – imagine what they in places where there aren’t strict environmental regulations. In Africa, thousands of children work in gold mines.
For something with so little intrinsic value (the only practical use I can think of is for dental crown material), its popularity and the lengths we go to in order to get it, just boggles the mind. It reminds me of the diamond engagement ring tradition started by the De Beers. In a way, I have to admire them for finding a way to invest in human gullibility.
Comments in-line:
U.S. dollars – and other world currencies – were once backed by gold. Under the Gold Standard, you could ask a bank to convert your paper money to gold at the legal rate (whatever that might be). In order for the government to print more money, they had to have the gold to back it.
In the U.S., the dollar wasn’t backed by gold, it was gold. The dollar was defined as specific weights of gold and silver.
http://en.wikipedia.org/wiki/Coinage_Act_of_1792
The government had to actually have gold and silver in order to do any business. Politicians hated this, because they had to take your gold in order to spend it, and people hated having their hard-earned gold taken.
This is why they and the bankers push for “gold-backed paper,” which they could re-value at will; see below for this in action during the depression.
Proponents of the “Gold Standard” argue that since the U.S. abandoned it in 1933, the dollar is more susceptible to inflation. That’s true. But the Gold Standard didn’t eliminate inflation, and it created other problems besides.
Inflation is an increase in the money supply. The only way to inflate gold is to dig more out of the earth. Gold is rare, so this doesn’t happen very quickly, and the supply is finite, so there is a physical limit to how much can be in circulation.
Paper money can be printed as quick as the presses can be run, but modern day fiat money doesn’t even have to be printed – the Federal Reserve simply declares $1.2 trillion new dollars now exist, and electronically transfers them to payees around the globe. They can create inflation on a scale previously unimaginable since they are not limited even by time constraints to run a printing press.
I am not an economist, and I struggle when it comes to economic theory, but my understanding is that much of the run-up to and aftermath of the Great Depression was thought to have been caused by the Gold Standard. Under the Gold Standard, currencies were much more susceptible to speculation and devaluation, which could lead to runs on the banks. That’s why the U.S. abandoned it. And it wasn’t only the United States that did so. Not a single country in the world uses the Gold Standard anymore. Until recently, most economists and politicians considered it a deserved relic.
You need a basic understanding of the two major schools of thought regarding economic theory: Keynsian and Austrian. Have a look at http://www.youtube.com/watch?v=GTQnarzmTOc
Bank runs are not caused by the gold standard – they are caused by fractional reserve banking, where banks figure what percentage of deposits they need to keep on hand for customer withdrawls, and loan out the rest.
In effect, they cook the books so that while claiming your $100 is in the safe, they loan out $90 of your money and hope you don’t try to get all $100 back. There is now $190 in circulation – your $100, and the $90 loaned out. If that $90 is deposited at your bank, it now has $190 in deposits on the books, and only $100 in physical money.
If you both go back to the bank on the same day and try to withdraw all your money, whoever gets there first, wins, and the other goes home hoping the FDIC will pay up.
During the Great Depression, Roosevelt would literally wake up each day and devalue the dollar in respect to gold. Read Garet Garrett’s The People’s Pottage. Tuesday, gold would be $25 and oz.; Wednesday, they’d declare gold is now $35 an oz. This allowed the government and Federal Reserve banks to print an additional $10 for every oz of gold they had without having to get more gold.
This is why central bankers and politicians around the world have pushed every nation off the gold standard — so they can print as much money as they need to fund whatever activities they want to do. Nearly all politicians, and all central bankers are Keynsians. They want central control over the economy, with them at the center.
Every article you linked to about the gold standard and the depression was Keynsian. They all assume that when something “goes wrong” with the economy, “someone” needs to be able to create money out of thin air and “fix it.”
The problem is, Keynsians often have no idea how to fix anything — illustrated by how every single one of Bernanke’s predictions about where the economy, housing market, stock market, etc, would go since he became Fed chairman has been wrong.
And the booms and busts “complained” about by the Keynsians which they claim shows the need for central control and elimination of the gold standard, are created by central banks inflating the money supply through fractional reserve banking and artificially fueling demand, speculation, and price increases.
Goldbugs would have you believe that when diaster strikes – we enter a post-oil economy, we’re nuked by terrorists, dinosaurs escape from Isla Nublar – that paper money will be worthless and we’ll all be trading in gold. Because of its intrinsic value, it’ll become a form of currency. I’m not convinced.
Study history – gold has been the preferred medium of exchange for thousands of years in thousands of civilizations. It has been the preferred medium in this country every time the fiat currency in use had been inflated to worthlessness.
Let’s say I’m a shopkeeper. I have a minimart and I have a shotgun to defend my stock from looters. If we’re in some sort of post-crisis world where dinosaurs roam the earth, I doubt I’ll want your gold. It’ll be just as worthless (or as valuable) as paper money. Why? Because in reality, gold too is fundamentally a fiat currency. That is, people have assigned it an arbitrary value. That value vanishes in a crisis, just as the value of paper money does.
The value of gold does not vanish. It will always be a rare earth metal with multiple uses and always in demand. Even in a barter economy, you may accept payment in, for instance, pre-crisis bicycles, even though you don’t need one, because you know someone else will, and all the bicycle manufacturers got blown up, so noone is making bicycles anymore and you can trade it later for something you do need.
So it is with gold. It is durable, has multiple uses, is easily portable, can be fashioned into handy shapes, and is hard to come by.
Let’s think for a moment. Have we seen any price bubbles before? Maybe even in recent history? Over the past fifteen years, we’ve seen three bubble economies:
And those bubbles are all caused by the Fed printing money and loaning it out at extremely low interest rates. Nearly-free money encourages borrowing and spending at in ways unthinkable at true market rates. You would not borrow $400,000 for a 2-room condo at 20%, but you wouldn’t think twice at 6.5% when you know some sucker will buy it from you a few months down the road for $450,000 at 5.5%.
With a gold standard and without fractional reserve or central banking, bubbles are small and localized. When they burst, a small region is affected, and everyone quickly recovers. It is documented in our nation’s history.
But finally, gold isn’t an investment. It is a store of value. An ounce of gold will almost always be the amount required to purchase a nice tailored suit. Wherever the economy goes, that will hold true, and gold’s “real” value will remain.
We are not seeing a bubble in gold, we are seeing massive inflation from the Fed’s loose money policies. The Fed and our government show every intention of further debasing the dollar, which will make the “dollar value” of gold shoot higher, but will not increase it’s “real” value. If or when the dollar collapses, gold will still have the same value.
J.D.’s note: Mark’s comment is a great example of how you can disagree with someone and still carry on an intelligent conversation. Actually, most of the comments on this post are pretty good. I just wanted to highlight this one because he’s given me some food for thought, and I plan to spend some time reading the links he provided.
Good information. Appreciate the input!
I really appreciate this thoughtful argument. I would like to point out that it is a false equivalence to compare the barter of gold to the barter of a bicycle in a barter-system economy. Bicycles have a practical use, they need no fuel and they can maneuver narrow pathways and go off-road. I know I could trade someone a bicycle, or even the parts if the market is saturated. What practical use would gold be to my customers, unless they have agreed upon an arbitrary value for it?
The only difference I can see between what you call currency with stored value, and currency with value by fiat such as the dollar, is that the stored value currency can be divided into smaller pieces of proportionally smaller value amounts.
Also, if the extreme run on the price of gold is NOT a bubble but rather an accurate reflection of inflation, then why haven’t prices for goods and services gone up proportional to the rise in gold prices? To look at things in this way, I can say that the value of a dollar has increased relative to the real estate market.
Think about it this way. Gold and paper became currency because a barter system is inconvenient.
Say Mary has a set of dental tools but wants a bicycle, John has a bicycle but wants apples, Sam has a bushel of apples but wants a cow, and April has a cow but wants dental tools, and they are each worth approximately the same amount. If they try to do a four way trade, they have to somehow a) know about each of the four people and find a way to meet up, or b) happen to come across each other.
Also, transportation of the items becomes an issue. A small pouch of dental tools is a lot easier to transport than a bushel of apples or, say, a herd of cows, so the more complicated or distant the meet-up, the harder it is.
Plus, the more complicated the trade, or the more rare the demand for the item, the harder it gets. For example, the dental tools. While Sam’s bushel of apples is something many people might want, only dentists need dental tools. That doesn’t make them not intrinsically valuable, but in a barter system it does because of the difficulty of finding a buyer who conveniently also has something that you need.
Additionally, imagine how much MORE difficult the trade gets if the items are all worth different amounts. You might be able to trade a fraction of a barrel of apples, but you can’t trade a fraction of a cow if you intend to use the cow for milking or breeding.
Gold evolved as currency because it was a convenient middle man. Now all four people can sell their items to the local grocer, who gives them gold for their items, and they can spend that gold on whatever it is they need. No coordination necessary, since with currency there is no need for the grocer to have the item they need as long as they have enough currency, and it’s easy to create fractions with gold since it’s so easily shaped, and it is light and easy to carry.
This isn’t an argument for a gold standard or investing in gold, mind you, but I think it’s easy to see how an apocalyptic world COULD end up back on the gold standard or some other common currency.
I understand this. That’s why I said, “What practical use would gold be to my customers, unless they have agreed upon an arbitrary value for it?”
I disagree strongly that there are two schools of thought. There are hundreds of schools of thought. The Austrian school is not a major school by academic standards, though it has many proponents on the internet. Like wikipedia says, “it is outside the mainstream.”
The two mainstream competing schools of macroeconomics are Keynesian and the Chicago School, though neoclassical has been mainstream in the past and may surge up again.
This quote is telling, “Austrian economists reject empirical statistical methods, natural experiments and constructed experiments as tools applicable to economics, saying that while it is appropriate in the natural sciences where factors can be isolated in laboratory conditions, the actions of human beings are too complex for this “numerical” treatment as passive non-adaptive subjects. ”
If you don’t believe in empirics, then nothing you do can ever be disproven.
“If you don’t believe in empirics, nothing you do can ever be disproven.”
True. But conversely, if you put faith in empirics in a situation like economics where it is virtually impossible to separate all the variables, is that any better?
This (long) comment is just sad. The Austrian School is the economic equivalent of Intelligent Design, and taken just as seriously by anyone who knows what they’re talking about.
Actually, taken a bit literally, the Austrian school would argue that economics is organic (spontaneous order) and the Keynesian school would argue for design.
THANK YOU for this post! I’ve been a reader for about 6 months and haven’t commented, but felt compelled on this one. I appreciate the time and effort put into this post. Last year I took a economic class where I learned about gold investments, and all this gold talk has driven me crazy since then! My professor liked to say that by the time everyone is talking about buying gold, it is a bad investment. I 100% agree with you on everything and I am going to forward this article onto several family members who I’ve been arguing with about gold for a while. 🙂
I’ve always been a little leery of the “gold has intrinsic value, so it will always be worth something, even after the end of civilization” argument. Ultimately, gold does have some use in industrial and electronic applications, but if you’re sitting in the post-apocalyptic wasteland, how much use will you get out of the ability to make integrated circuits (without the machinery to fabricate them), thermal protection for satellites, or the like? You can’t eat it, it’s too soft to fashion into a useful tool, it’s too heavy to lug a lot of it around even if you do find a good use for it.
In the event of total societal collapse, food, ammunition, and toilet paper are going to be much better storehouses of value than a relatively useless metal that people value because it’s shiny.
To me at least, it seems like gold is really only of value if there were a PARTIAL collapse of the global economy – if, say, only your country’s economy collapsed. In that case, you could get the same result by allocating some portion of your investments to a basket of foreign currencies – if you are in a scenario where ALL currencies are losing value relative to some arbitrary benchmark, you’re back at the total global collapse, stock up on toilet paper and shotgun shells scenario.
Personally, I say if we’re going to declare an arbitrary “storehouse of value”, I say we go with tulips. It worked for the Dutch back in the 1600s…
I would suggest Howard Marks of Oaktree Capital:
http://www.oaktreecapital.com/MemoTree/All%20That%20Glitters%2012_17_10.pdf
JD,
Thank you for this well written, level-headed approach to the silver/gold boom. I admit, I recently caught “the silver bug” and overbought silver in relation to my personal net worth.
This article made me seriously reconsider proper diversification, and as a result I am redistributing my investments. The Permanent Portfolio approach is exactly what I have been looking for, and nearly matches my current strategy, while articulating it a lot better.
I’m a long time lurker, but felt the need to praise you for this great, well written article!
Thanks, everyone, for a thoughtful discussion. I especially appreciate Mike S (#82) for his thoughtful rebuttal to my article. Mike, I’ll spend some time this weekend looking through the links you supplied.
I especially like the “gold is a store of value, not a hedge against inflation” responses. That’s an interesting way to look at it.
Finally, to the point that gold prices are rising because of inflation — I’m not sure I buy that. Why then did gold prices decline for twenty years after the inflation in the late seventies and early eighties? We sure weren’t experiencing de-flation then. If gold rises due to inflation, I’d expect it to do so in some sort of systematic fashion. Instead, the current prices are all out of whack with anything. (And are you arguing that we’ve had rampant inflation since 1999, which was when this surge in gold prices began?) No, to me this still looks like a bubble. I can’t see any way around that. Sure, there may be some legitimate gains in the price of gold over the past decade, but much of it is pure speculation.
RE: gold as an investment… I think the problem is that while it is true that the “inherent” value of gold as a value store remains relatively steady, the stock price isn’t just a reflection of that value against the dollar… it also has the human speculation built in, which is subject to a lot more whim than we’d like to think. Just my two cents.
I’m personally not convinced either way on the benefits of investing in gold (stock or bars), but I do agree with Mike that there is in no way a consensus in economics on some of the things you referenced in your article, like the gold standard being the cause of the Great Depression.
After reading this article, I put a stop to my hoarding of gold because this article allows you to think rather than just push an idea at you. I do think we have gone to the next stage of a bubble but not the stage where it will burst and there will be more upside. However, I am satisfied with the amount of metals I have and have bought at the 2009 prices and have since tripled to quintupled my nominal value.
As an economist though, I don’t agree with the history of the Great Depression and the Keynesian economics. It is the Keynesian fiat currency reserve system that puts us into bubbles because of the oversupply of money. The Roaring 20s was the artificial “propserity” that came from devaluing the dollar by printing more notes than we had gold to repay for World War I. World War II created another smoke and mirror “propserity” by FDR confiscating gold and then devaluing the dollar in terms of gold for the first time in history by half. The dollar was $20 an ounce down to $33 an ounce in 1933 to repay the high cost of World War I. FDR set the stage for more borrowing to finance the second World War. World Wars are like alcohol in that you think you need more but it is really doing your body more harm. By creating the need to finance another war, bad money chased out good money and we were no longer able to afford a gold standard. We became more and more in debt from the following Korean and Vietnam Wars so in 1971, we no longer were able to even honor the exchange of notes for even silver so Nixon closed the gold and silver window and Keynesian economics took it’s full effect on the US debt ceiling. The debt ceiling along the years went from millions to billions to trillions.
I don’t see gold as an investment or an insurance but as a barometer of the US economy. And $1500 says that we have printed too much money. During the times when gold was at $250 or lower, we had a surplus and less money in the economy chasing and bidding up goods.
The notion that Gold is not a good buy due to its being at an all time high price is fundamentally flawed. Yes, Gold is at an all time high… and it has steadily been at an all time high for the last 10 years. Todays all time high has consistently been lower than tomorrows price.
I’m no Goldbug I’ve only RECENTLY started SCALING into physical precious metals (I’ve found that the best place to buy and sell is apmex.com, FWIY)
The VALUE of Gold is the same as it has ever been, the reason it is going up in PRICE is that dollars are becoming worth less and less. They are printing money, so it takes more money to buy the same thing, that’s why the PRICE of gold is going up.
Ask yourself this, is the value of a dollar going up or down? If you think it’s going up, Gold will go down in PRICE. If you think the dollar is going to continue to go down in value, Gold will continue to go up in PRICE.
It’s quite simple. My 2 cents, as long as Presidents continue to deficit spend, Gold will continue to go up. As long as QE continues, Gold will continue to go up too.
Gold hasn’t been at an all time high for the last ten years. Gold was trading at less than $300 an ounce until about 2002, as low as it was pre-1980. It didn’t reach an all-time high until about 2007. Here is a graph (please ignore the weak attempt to link gold dips with recessions):
http://goldnews.bullionvault.com/files/GoldRecession.png
Actually, since prices are up, Im more interested in SELLING my gold. Can you tell me the best place to go to do just that?
I agree with JD. I believe gold is in a bubble and will crash sooner or later.
However, if you do like gold as an investment I think that its smart to limit your exposure to gold. Don’t put more than 10-20% of your assets in gold. Diversifying your assets is always smart and this is no different.
There was a good article on this topic in the Toronto Star this weekend: http://www.thestar.com/business/article/987438–olive-what-s-good-about-gold
(As you can probably tell from the title, the author is also pretty skeptical.)
I had sent this to J.D. in an email, he asked me to paste it here for the discussion. (I love these discussions!)
MBA grad here, so hopefully that gives me enough credibility to keep you from just deleting my email!
First of all, great article, you hit most of the major points, and most of your reasoning was very sound. I did have one thing to add though.
For most people, gold usually isn’t a very good investment. It doesn’t offer dividends, and there are better ways of protecting against inflation, so as an investment the only way to make money off of gold is to sell it for more than you paid for it.
However, for some people it might make sense to have it as part of your asset allocation. The underlying idea of a well planned out asset allocation (used in conjunction with rebalancing) is to (a.) get better returns (b.) reduce risk.
Gold’s best function is to reduce risk, NOT get better returns (although if you had bought a lot in 1999 at $252.80, and are just now rebalancing you would have gotten a large return..).
In your example you pointed out in a world disaster and how gold wouldn’t be a good hedge against disaster because you’d rather have food, clothes, or shotgun shells if the world was in chaos. And in that example you’re exactly right! However, imagine a smaller scale disaster. Where it’s only one country, or one region that experiences economic collapse.
Just hypothetically, let’s say you lived in Mexico and to keep the math easy, 1 peso is worth $1 USD. You’re a wealthy business owner. You’ve got $10 Million peso’s in stocks/bonds/and MIPS (Mexican Inflation Protected Securities), and you have 60% in stocks and 40% in bonds, and are doing all the smart investment things watching out for fees, minding inflation, and generally just using index funds to get the average return… (note assumptions here are all localized to the Mexican total stock market, etc, not the US total stock market).
But then disaster strikes, and Mexico’s economy collapses, the government starts printing money, just like during WWI and WWII where people are pushing wheelbarrows full of money around to buy bread. Your $10M pesos are now worth $10,000 USD, a 99.9% loss and it gets worse day by day!
Now imagine that you had $10million pesos of stocks/bonds/MIPS/and some gold as a hedge against disaster, in fact you had 5% of your assets in gold, the equivalent of $500,000 USD. The economy collapses the same, and your Mexican investments and currency lose 99.9% of their value… but gold doesn’t drop in its value! It’s still worth $500,000USD, because ***other countries and people*** will still trade in gold even though they don’t value the Mexican peso as much. Sure it’s not as good as $10 million USD, but half a million USD is nothing to sneeze at.
This hedge makes more and more sense the richer you are. If you’re a $100M net worth individual in my example, then 5% of gold is still worth $5,000,000 even though your country collapsed. That’s right, total economic devastation of your nation, and you’re still a millionaire. That’s the real risk you’re hedging against in my opinion.
So this example also showcases why it’s not as great of an asset allocation choice for many smaller net worth individuals. Yes, the percentages still apply, but if you only have a $100,000 net worth, and have $5,000 in gold, when the economy completely tanks it’s better than nothing… but $5000 is not going to sustain you and a family for the rest of your life, it will go quick!
So this leads us to where we are now, everyone worldwide tends to invest in the U.S. stock market, and everyone likes TIPS and U.S. bonds because they have a lot of faith that the U.S. government won’t default on its debt and that the u.s. economy as a whole won’t completely collapse… but if you are worried that it might, and you wanted to protect against that possibility, what would you invest in instead?
Most countries are fairly instable (Greece), or at the least not as stable as the U.S. (Japan), and other stable countries are closely tied to the U.S., it’s very possible that any economic disaster that hits the U.S. could conceivable also take out the U.K…, so that’s why many people flock to gold, it’s very tradable on a world wide scale, and you don’t have to figure out “who’s the 2nd most stable country after the U.S.”.
Some people are getting on the gold bandwagon because ‘look at the price go up!’, this is dangerous. However some people are just putting it into their asset allocations as an alternative asset class to hedge against risk. When a lot of people do this it’s called a ‘flight to safety’ in economic terms.
That makes so much sense, thank you for posting this comment! I would only like to ask, if you are an investor in the US and the US economy collapses, is it realistic to expect other nations’ economies to remain stable? Haven’t we seen that the US subprime lending meltdown/the bursting of the US housing bubble caused the 2008/2009 worldwide economic crisis? Or was this not actually caused by the US economic crisis? It seems to that the US economy has much potential to drag the rest of the world down with it because the NYSE is used globally.
I mean, I know that you touch on this, but it doesn’t seem like there would be any nation in line behind the US, as you say, if the worldwide economy collapsed. I’m just arguing for the sake of argument here. Your point is very well taken.
this is pretty much the only sensical argument/scenario I’ve heard for investing in gold. Thanks JD and JRC!
Gold has some real industrial usages, be it electronics, pigment in glass making, or even in medicine. Read more about that here:
http://geology.com/minerals/gold/uses-of-gold.shtml
Most gold bought and sold today is of course not used as a raw material. It is stockpiled in a belief that it will retain some value no matter what happens in the world. You may have noticed i said ‘some’ value.
At this moment the people thinking it is a good idea to buy gold outnumber those who think it is a bad one. This is my amateur, simple view on economics. It gets more complicated when you think where the money comes from.
An investor has options. Where are the money not going? What are people not investing in. What investments are people selling, to put the money in gold? Maybe it is something boring like farmland? I sure hope not.
Whoever has gold right now, and is interested in selling it may have gotten lucky, or more likely they knew what they were doing when they bought it. Why are they now selling at all? If gold is such a great investment, and since people have been buying it for a good while now you would expect the supply to run low, there is a limit to how much gold can be dug up from the ground, so i doubt new supply explains it.
What i really would like to know is, what the people who have been selling gold for the past year or two have been investing the money in?
“What i really would like to know is, what the people who have been selling gold for the past year or two have been investing the money in?”
Real estate.
Planet Money did a great series on the gold standard recently. There are a number of episodes, but here’s one about why the US abandoned the gold standard: http://www.npr.org/blogs/money/2011/04/27/135604828/why-we-left-the-gold-standard
JD opened this article by saying he would like to discuss the pros and cons of investing in gold. The article presented half of the story, and it would have been nice to see his pro-gold investment opinion. Here are a few points he might have used:
-Gold, silver, etc are commodities and are used in a variety of objects: electronics, jewelry, photo voltaic cells, among others. My point is commodities DO have intrinsic value.
-Pretending that gold has never reached these levels is ridiculous. In 1980, it hit $850 -which is $2,400 in today’s dollars when adjusted for inflation.
-Central banks around the world as well as investors are worried about paper currency, especially with the EU and the US. Gold has been something to revert back to should governments default on their debts or the people’s faith in currency fails.
This last point is the reason I choose to invest in gold. The economy is straggling under the weight of an unbalanced budget, real estate is floundering as more homes foreclose, and the dollar is losing strength. All of these (maybe in a week, maybe in 5 years) point to a decline of the US dollar and an increased value in gold.
So hop aboard, because if you’re like me, you’d rather have a little fun watching the commodities market than having my money in equities right now!
Here’s a great pro-gold article: http://finance.yahoo.com/news/5-Reasons-Gold-Will-Continue-tsmf-2133017994.html;_ylt=AvQ3GFkIoSDDR8czHJewUvW7YWsA;_ylu=X3oDMTFhamUxdTUzBHBvcwM5BHNlYwNzcGVjaWFsRmVhdHVyZXMEc2xrAzVyZWFzb25zZ29sZA–?x=0
Thanks for the thoughtful post. I’ve started reading you recently, and find your writings invaluable.
I mostly agree with your viewpoint on gold, and the theory of ‘fiat currency’. One reason I don’t wear any ‘bling’; what’s the point of (possibly) getting mugged for wearing a useless hunk of rock?
More to the point, I just wanted to say that gold IS used in electronics these days. I believe it’s used in circuitry because it conducts better then other things. Of course, if the Dinosaurs do rise again, we won’t need our iPhones and laptops anyways.
This is one of the reasons there is some payoff for the recyclers of the electronics.
Just wanted to leave this thought.
My two problems with gold.
1. Even if it becomes a trusted commodity in an apocolypse, how the heck am I supposed to buy food with it, if its worth thousands of dollars an ounce. I’m going to have to have some super accurate scales.
2. Every time hyper-inflation has happened, (East Germany, Recently in Africa, several years ago in Turkey).. Nobody turned to precious medals. They would barter. I will sell you this chicken for that sweater.. etc..
@Brian:
Actually, recently in Africa (Zimbabwe), US Dollars AND gold became the preferred means of payment.
As for thousand dollars an ounce: one of the commonly used criteria for money is that it should be divisible, which gold more than fully satisfies, it is divisible and of a predictable standard (gold is quite a soft metal, and very easy to divide).
It’s divisible to a point…at $1000 an ounce, you’d need to be able to accurately and quickly come up with a cube of gold 2mm x 2mm x 2.625mm to pay for a $5 footlong. Unless the exchange rate fluctuated that day, and the .005 ounce footlong became a .0046 ounce footlong…
@Eric:
“Unless the exchange rate fluctuated that day, and the .005 ounce footlong became a .0046 ounce footlong…”
Yes, and?
What’s the difference between that and if you have an account in USD and happen to buy a footlong in Paris? The price may fluctuate with the USD/EUR exchange rate during the day.
You’re kind of arguing a futile point.
_EVERYTHING_ fluctuates. All the time. If you think the USD holds some sort of magical constant value, you’re dangerously deluded (in fact, the purchasing power of a USD has lost some 98% since the introduction of the Federal Reserve).
Would you argue that a weak dollar is better because it is easier to more accurately divide $10000 at a 100th of the value of what it was in 1917? Because that is effectively what you are saying.
I hear Zimbabwe dollars are great. You can divide them down to a billionth without even having to resort to cents…
@Willie
I believe you may have missed my point – the exchange rate is relatively meaningless, but how easy would you find it to accurately shave off 4% of the mass of a piece of gold the size of a kernel of corn? I don’t know about you, but I’m not in the habit of carrying a triple beam scale with me.
I would argue that a weak dollar does have value, by making it relatively cheaper to export US goods, thus reducing trade deficits, but my post was referring to the relative difficulty of paying for purchases with a currency an order of magnitude more valuable than a typical purchase, especially one denominated by weight.
Again, the “you can’t eat gold” point is not a very valid one. The same is true for your house, your stocks or your (then worthless) cash. Gold is more a store of value and not necessarily something that allows you to buy food in the middle of a crisis.
First, commentators, please stop with the “end of the world” analogy. A far more likely event will be “end of civilization as we know it,” which is a far cry from end of the world. When Rome fell, when the German Empire fell, when countless other civilizations fell, gold never lost its value because there was always someone somewhere (usually nearby) who wanted it. Stories abound about people using gold to buy their way to freedom from Viet Nam, Korea, etc. during those upheavals in their civilization.
That said, gold experts and those who sell gold will be the first to tell you that it’s only for a part of your portfolio. It’s complementary to your stocks, bonds, cash, annuities, and other investments, not a replacement. Central banks around the world are stocking up on gold. They realize that the dollar (world’s reserve currency) is being abused by our government’s profligate ways, and that it’s BUYING POWER, is diminishing year after year and that one way to protect the buying power is through the possession of gold.
And as far as using it to buy things, you will have to convert it to a legal tender. Just the way you sell stocks or bonds to be able to utilize the value, so too will you have to sell the gold. That’s just the way it is. You can buy gold in fractions of an ounce, so you do not have to do the equivalent of breaking a $100.00 bill for a $0.05 piece of candy. You just sell that 1/10 ounce coin or bar, or that 1 gram bar if the value goes to $5000 an ounce.
Since so much is opinion, in my opinion, having exposure to gold in your portfolio is no different from having an emergency fund for your other financial plans. How much or how little is ultimately up to you, but just be mindful that since Biblical times, gold has had value and has never gone to zero worth, unlike stocks (Lehman Bros, etc), fiat currency (Confederate dollars). Outside of an end of the world scenario, in which only food, water, shelter (and an AR-15 w/ ammo), will be worth anything, gold will always have worth — and will again not long after the world is reborn from the ashes of the old.
I’m glad Siegel came up in this post since I would have referenced it anyway. Stocks way outperform any other asset class in history and gold has done practically nothing in terms of appreciation in the long term. And the short term is way too volatile for me to look into investing. I also take a similar stance with Buffet in putting my money into companies who can create real value instead of into a shiny rock that has little worth outside of what people perceive. That’s not to say you can’t make money off it, but I believe there are better places for your assets.
I’m glad you brought up Siegel and his book, because I would have referenced it anyways. Stocks are much better to invest in for the long run and gold has barely had any appreciation through extended periods of time after adjusting for inflation. The short term volatility isn’t something I would personally want to get into, but I do believe that some people can make money off of it. I take Buffet’s advice by sticking to companies creating real value instead of a shiny rock, the perception of which depends on the whims of people.
I would encourage readers to watch this video:
http://www.youtube.com/watch?v=iYZM58dulPE
I think it does an excellent job of explaining what our current money is, and how gold became money in centuries past, and why gold can provide us with more benefits. It is a touchy topic, but I think this 1996 42 minute “movie” is coherent and thought provoking. Enjoy.
I think investing in a house and a good garden is better insurance against disaster than gold any day, and you point out that the returns are the same. Thanks! You can’t eat gold or sleep inside of gold.
Nice job JD on this article. Entertaining read. I think you should keep this one in the back of your head for 2012 or 2013 when the bubble bursts as a referral.
I think that gold is a pretty solid investment because it is something that can’t be reproduced once it is gone.
That is not a character of a solid investment. What you should look for in an investment is a steady return on your investment. And gold gives you no return at all. (Except of course for the occasional bubble if you get out on time.)
You misunderstand the problem with the Gold Standard. The Gold Standard required a government to have the exact amount of gold to back up any notes that it issued. That is why gold was such a valuable commodity. Unless more gold was acquired, under the Gold Standard, more notes weren’t supposed to be issued. The problem with the Gold Standard is people became accustomed to using a note that represented Gold instead of the actual Gold.
Since, it was uncommon for people to actually cash the Note in for Gold, Governments committed fraud by printing more money then there was Gold. If governments didn’t have enough gold, they’d print more notes and pay for debt knowing there wasn’t actual gold to back up the notes. Since people rarely asked for the notes to be redeemed, people were not the wiser that there wasn’t enough gold to cover the notes.
So, in the Great Depression people rushed to the banks to cash their notes in for Gold. The banks, however, didn’t have enough gold to honor the notes because more notes existed then their was gold.
The governments didn’t want to get caught cheating so they’d locked the banks down, took the gold, and changed the system.
Governments prefer the new system because it provides them more means to cheat the little people. The money has no intrinsic value so it can be manipulated more easily.
A friend sent me this article and this is my response to him.
Thank you for sharing this article. Â I enjoyed reading it… of course I do not consider myself an expert, however I can refute all his arguments very very specifically (and point out many of the facts he is dead wrong about). Â We went off the gold standard in the 1970’s not the 1930’s. Â There were different levels of us detaching our currency from gold. FOREIGN governments could still exchange their dollars for gold until the 1970’s (the end of the true gold standard). Â I’ll give you one specific argument against this article and I’ll keep it at that for now because it would take too long to hit all of his points.
With response to the “intrinsic value of gold/silver” fiat currency and a precious metals standard…Â
After 1965, the government stopped using real silver to create the coins we use in circulation. Â They did this because they knew their inflationary policy of devaluing the currency would make the intrinsic value of say “dimes” more valuable than the face value of the coin (or the actual purchasing power of a dime). Â Basically, one could melt down the pre 1965 dime, extract the silver and hold about 5 dollars in todays money worth of silver with the metal. Â
The great Peter Schiff articulates this well as he explains that gasoline is actually cheaper now than it’s been for many decades, when you compare it to the Constitutional money we originally minted. Â Here’s his quote:
“In 1931, gasoline got to 17 cents per gallon during the great depression. But for most of the 50 years 1920-1970, gasoline was between 20-30 cents per gallon. It wasn’t until the 1970’s that we left the gold standard that gas prices really started to rise. But today, right now you can buy a gallon of gas for less than one dime, less than ten cents. So in terms of real constiutional money, silver that was coined by the US Mint, gasoline has never been this cheap. It’s only when you have fiat money, the paper money the FED is running off the printing presses… that’s the only reason prices are rising.”
“If you can find a dime coined in 1964, you can take that dime and purchase a gallon of gas. That proves that gasoline is not getting more expensive, our money is losing its value.” Â
(I know I said I would keep this to one specific point but I gotta keep going) Â Wars have been waged over gold and silver. Â Entire indian tribes in America were displaced because gold was believed to be found in the land held by the natives. Â As far as recorded history tells us, gold and silver are real money because of the restraint and honesty it forces between those who chose to use it as a means of exchange.
Gold/silver are elements found on the periodic table.  They do not burn, tear, or degrade. Because gold and silver dug up off the ocean floor from a 1400’s ship wreck is exactly the same stuff we mine today, humans associate value to it. Heck, oil was worthless to a pre-industrialized existence.  Water is precious depending on geographical location, but what makes gold and silver unique is that they are impossible to “create.” Â
To poses these metals, you must exchange true goods and services that others want. Â Eggs, shotgun shells and paper money will never be a sound currency. I can make a chicken farm and harvest eggs to become a rich man (if eggs were currency). Â I could assemble gun powder and shells to create an endless supply of ammo, and if I’m the federal reserve, I can supply the world with endless amounts of paper money.
Gold and silver always have and always will be immune to such creation. Â This is essential in understanding the role of the word “money.” Â Money is a medium of exchange. Â It stores value in terms of labor and ingenuity… of production and savings. Â Technically, anything can be deemed “money” as long as two parties agree to exchange it for goods and services. Â But what makes gold and silver REAL money in terms of our existence here on earth is its enduring qualities and its inability to be “created” by humans.
To the extent that the author speaks of a crisis in which shit completely hits the fan in an “every man for himself” type scenario, of course people aren’t going to trade their basic survival tools for gold/silver or “money” because “money” is simply a representation of labor or production and used for exchange. Â Â
You know about our hierarchy of needs.  NOTHING comes before our basic necessity to survive and I have never claimed that money would take precedence over those needs in dyer situations. That’s an unfair argument against any “store of value” or “medium of exchange” but the author tries to use it in his attack of gold/silver.  What the hell would I want to exchange for the basic food and water needed to survive the current day? Nothing, so the authors argument against gold/silver in the most dyer crisis is bogus. Â
I would like to ask him this, “What fiat currency would he choose to hold in a true crisis OVER gold/silver?”  If he had to pick one over the other when shit hit the fan and could hold any currency on earth, would he pick silver/gold over Dollars/Pesos/Yen? Of course he would… Â
I know you’re probably tired of reading this, but let me hammer home one last scenario I just thought of…. Lets say it’s 1800’s America and I have nothing. Â I walk into a town where a farmer owns a restaurant and a pub. Â I could conveniently offer to work all day on his farm in exchange for a big meal and some beer at his pub. Do I need money? Absolutely not. As long as the Farmer tells his bar and restaurant manager to let me eat because I’ve worked for him all day… So in that instance, the word of the farmer is the medium of exchange between my labor and the beer and food I receive for such labor. Â
In such a situation, I would never need money until I decided I wanted to cut back on my beer intake, save some of my labor for other resources for other endeavors. Â Over the period of a month, I could work hard, eat and drink less and eventually the farmer would be in debt to me! Â Or, he could simply give me something that represents the labor I haven’t spent at his restaurant and pub. Â But if I can only spend it there and nowhere else I am kinda screwed. Â If he uses tobacco leaves to represent that labor, I could just skim some off the harvest and screw him, if he uses paper money and it rains one night and the money is ruined, I get screwed. Â In this instance and every other in recorded history, gold/silver would be the best medium of exchange because for the farmer to poses it, he would have had to exchange true goods/labor to receive the gold/silver. Â For the farmer to give it to me, then I had to give him useful labor. Â ANYTHING ELSE representing such an exchange can be compromised.
The gold standard was abandoned because the government couldn’t pay its bills, paving the way for our current predicament of a $14 trillion national debt. Waging wars and bailing out banks is much easier when the cost can be borrowed and inflated away with fiat money.
Gold cannot possibly be considered an investment. Why? Because it has proven, over the longest track record of nearly any commodity in history, to have an internal rate of return of… 0.00%. It is a fantabulous *store* of money, and thus a great commodity to act as a cornerstone for a currency (in some form or another, perhaps with accompaniment). But investments have internal rates of return. Everything else is speculation. You can make a lot of money speculating, but the fact remains that you are only market timing and that is a zero-sum game.
To make matters worse, gold is highly volatile for personal usage purposes. Over centuries its volatility is impressively low. Over decades it is disturbingly high. This is why currency-backing is one of the few things gold is great at, because currencies, if set up in certain ways, can ignore quite a bit of volatility in their backing and can ensure that only the medium- to long-term averages matter.
As a great store of money, gold is also a good place to go to avoid the effects of a currency’s utter and permanent collapse, though if you know so much about the future you could also just go to a currency that isn’t going to collapse.
J.D.,
Although My Comment Is Quite Tardy,
I Personally Want To Thank You For Your Recent Displays Of Journalistic Online Courage To Put Forth Your Opinion On Known Controversial Topics — Such As The Lottery And Gold — Because Although You Are An Experienced And Highly-Talented Writer, It Can Be Quite Disparaging If Your Opinion Peice Recieves Many Negative Remarks.
In Addition, I Also Want To Thank ALL Of YOU, The Faithful GRS Readers, For Keeping The Tone Of These Discussions Quite Civil. This Context Of ‘Respectful-Debate’ Allows Us To Further Our Knowledge & Expand Our Understanding Of Opinions & Facts Foreign To Us; This Often Insights The Essential Sentiment Necessary To Benefit A Contemporary Developing World: Change.
What I see here are people discussing gold from an investment point of view, but there is another form of hedging against the future and that is survival if the whole system collapses or breaks down. Having land and being as self sufficient as possible is my goal. Barter and trade will be the mainstay. If society is broken down and you are using gold to buy with, rest assured that someone will attempt to relieve you of your stash and it may prove harmful to your well being.
Great article, now if you would only write one on selling gold jewelry and things right now that would be helpful. After attempting to sell old jewelry to raise money to pay for 3 kid’s braces I have decided it is a ripoff. But would love another opinion.
Great article.
I feel you nailed it with the fact that even gold as currency will have an IMPLIED value, just as paper money does.
In a disaster, actual food, water, and safe shelter are the only things of real value.
Interesting reservations, and a lot of them make sense. But “not owning gold for the last few years” means you have been wrong. Gold has been the best-peformaing asset of the last ten yeras, a trend that’s likely to continue.
FYI, I am the author of “All the Glitters: The Ultimate Gold Report” and would like to share some of my analysis:
1) Your gold stats are misleading. You go back to 1926, yet most of the years you include are when there was a gold standard and the price of gold was fixed. Of course, there can be no market appreciation when the government sets the price. Isn’t it interesting though that as soon as the government junked the gold standard the price shot up 10X in a number of years?
2) Gold has gone up nearly 2,000% since the U.S. went off the gold standard in 1972. This appreciation beats the annual appreciation in the stock market.
3) Hmmm. is it coincidence that gold took off after the government felt that it should go off the gold standar? I think not. The market is telling you something. Seems like cause and effect to me. Democracies with politicians love to print money.
4) I analyzed 5 historical quantitative metrics, including global debt, money supply, commodity price increase, negative real interest rates, and I could find no evidence that gold is “overvalued.” Gold price gains have been driven by all of these factors, which are positively correlated to gold. For gold to stop going up, at least half of these trends would have to change. And debt would need to be reduced.
5) Using historical metrics valuing gold against numbers such as global debt and money supply, it is still not overvalued, according to my studies. In fact if you take the 300-year mean of the gold price against money supply that number is $2,200. /oz
6) Everybody talks about a “gold bubble” but to have a bubble everybody has to own it and it needs to be overvalued on fundamentals. Emprical evidence points to neither situation (despite all the chatter, I actually know very few people have have any sizeable amount of their portfolio dedicated to gold).
7) China will buy more gold. Definitely.
8) Do you really think you are right and that billionaires John Paulson, Carlos Slim, Marc Faber, Jim Rogers, and Paul Tudor Jones are wrong?
That’s really how I analyzed the market. I have published a report and if you are interested in reading you should go to http://www.investoruprising.com/iuconfidential
Feel free to contact me with any questions.
Scott Raynovich
Scott,
2) To say 2000% gain since 1970 is kind of misleading. If you look at this graph ( http://investletters.com/blog/some-perspective-on-the-price-of-gold/ ) you could also say “Did you know that Gold is worth even less today than it was in 1980?”
5) Really? a 300 year mean? You want to include three centuries in a calculation? Except for how incomparable economies from that time are to today’s economy, did you consider how a lot of the world’s Gold supply might not have been found yet?
7) Why does China need gold?
I doubt any of those billionaires became billionaires by investing in gold. I bet they invested smart in companies. And how about the richest one of all? Warren Buffet. He is calling this Gold rush crazy: http://blogs.forbes.com/greatspeculations/2011/05/11/what-if-warren-buffett-is-right-about-gold/
I think the Warren Buffet argument is silly becusae he has underperformed the market for the last ten years and gold has outperformed the market. So are you saying he didn’t wich he had bought something that has averaged 15% a year for the last decade.
The point of my analysis is that gold is currently in a primary bull market (unlike stocks), and that is likely to continue until at least 3 of the 4 driving factors are eliminated. It will continue to rally until there are signs of this happening. Right now there are no signs of this happening.
China: The central bank is buying a ton of gold. They are a buyer in scale. They are accumulating reserves at a rate of almost $1T USD ever two years! They obviously will want to diversify out of hits growing pile of dollars and gold will be one of the key assets that they will buy (among other things).
In the late seventies, I was living at home, putting myself through college and working two part-time jobs. When gold fever bit, I proudly bought my first Kuggerand with my hard-earned savings. I think I paid about $375 for it, back when I was earning $2 per hour. For safekeeping, it went into my mom’s jewelry drawer. A couple of months later, we had a big family party. The next day, something made me want to see my lovely gold coin. Of course, it was gone. It was an expensive lesson at the time, but I figure it has saved me a bundle in the long run. My first Kugger was my last and I’ve never been tempted by “precious metals” again.
Diane,
So let me get this straight: Because you did not secure a valuable gold coin that you bought for $375 which would now be worth $1500, that was a bad investment?
I don’t quite follow the logic. That would be like saying if you crashed your car in a careless accident, cars must be totally worthless.
–Scott
I agree that Gold is not an investment. I consider it a store of value. I use it as a part of a strategy for longer term savings.
I would recommend two books. Both are available for free as a pdf. Let me know what you think of them if you read them.
http://mises.org/books/whathasgovernmentdone.pdf
http://mises.org/rothbard/agd.pdf
Thanks for your post. It’s always good to read differing views.
Not everything that goes up is a bubble. When we retreat back to the gold standard, gold will rise to $5,500 an ounce.
I didn’t read all of the comments, so hopefully this wasn’t covered yet. But I wanted to throw in my $0.02.
I remember reading an article online (which I can’t find now) that historically looked at situations where “the dinosaurs escaped”. The only example I remember specifically was the Warsaw Ghetto siege during WWII. The summary of the article was that in situations like that, life skills were far more valuable than any gold or currency. Barter of skills such as hair cutting, preserving food, sewing clothes, raising and slaughtering animals, etc. became the norm for their society.
So level up those life skills and invest your money elsewhere.
I invest in gold.
The Fed and the US government have painted themselves into a corner. They can either raise interest rates, destroying the bond market and putting a temporary strangle hold on the economy…or they can continue to deflate the currency. They will choose to deflate the currency. We’ll have QE3 as soon as QE2 wraps up.
Inflation is here. Its not just gold, pick any commodity.
The more dollars they print…the more purchasing power your gold investments can protect.
I will be referring to this blog post for years to come!
In ‘One Second After’, a book about what would happen after terrorists detonate a EMP bomb on the US, cigarettes become the new currency.
Hmm great effort put into this article but there’s a lot here I don’t buy into. I’ve been reading a lot of arguments against gold online and a lot don’t make sense to me.
Here are the common trends in anti-gold buying reasons and why I don’t agree with them:
1) Zombie Apocalypse scenario – This is worst of the worst case scenario… in a movie! With billions of people on earth the chances of most people being in a situation where the options are food or gold…weapons or gold… are pretty damn low. In the real world, people have more options than that.
2) No intrinsic value – I’d say the fact that it’s rare and can’t be created by humans is already an intrinsic value in itself added to the fact that gold is beautiful. There is a high price in beauty. People die over beauty and go crazy over it. I’m surprised I don’t read about gold’s beauty and an innate love of gold held by many many people.
Demand = Value
3) Comparing a gold bubble against tech stocks of the late 90s – If the stocks plummet you have nothing but paper and excuses from the people who failed. With gold you have gold. And the other 2 reasons I mentioned above why it has value.
Just like beachfront properties are higher in value than most other kinds of residential properties, emotions play a huge role in demand (therefore value) of gold. We’re humans not robots. Until the day comes where people won’t find beauty and appeal in gold, gold will always have high value against fiat currencies and even raw commodities. Anyone can grow more corn and raise more hogs but never gold.
There’s a huge difference between price and value. Precious metals are finite resources where as paper currency can be printed into infinity. Paper fiat currencies don’t grow on trees, but they are printed out of thin air. If central banks (another scam) can print them at will, what value do they hold? All fiat currencies have a shelf life. Keep holding onto that shit and all your asses will be broke. Apparently ancient wisdoms have been lost on modern societies. Y’all bagged on gold and silver out of fear and ignorance but y’all failed to see their real values. Go open up your fucking computers, tablets, smart phones and other electronic devices and see what they’re made of, then go consider PM’s contributions to modern societies. There are many reasons why they fucking call it precious metals. It’s god’s money. Fiat currencies come and go, but gold and silver are forever. PMs are universal money. You go back 5000 years or forward 5000 years, they’ll still be recognizable. But no one will recognize your fiat currencies. My guess is that when our current fiat currency system fails, all your asses are gonna sink along with it. Good luck! And Bob’s your uncle!
For current readers (in 2020), this is the dividing line between comments on the old version of this article and comments on the new version. I’ve removed a dozen spammy comments from the past decade, but now I have to go work in the yard. Later today, I’ll read through ALL of the comments to make sure the conversation is coherent and relevant.
So, J.D. did you end up adding gold to your portfolio as you suggested at the end of the post? Up to 25% as suggested by the Permanent Portfolio is quite a lot.
I’m also curious as to what people consider as “buying gold”. Some people mean actually buying the metal, while others buy stocks in mining companies or some other type of gold back investment vehicle. There’s a pretty big difference between the two, I think.
I did not add gold to my Portfolio over the past decade, and was never tempted. That said, the primary reason I didn’t was because I haven’t really had an income for the past ten years. I’ve been in semi-retirement mode, and any money I make is used for living expenses. That said, if I had been investing, I might have considered moving toward the Permanent Portfolio after gold dropped following the last bubble.
To bring this discussion current and on to the really important stuff a) I like your new thumbnail sketch and b) you hit it squarely on the head about the dinosaurs escaping from Isla Nubar.
Did you see the last Jurassic Park? They are now loose on our mainland, specifically California. How the heck are we supposed to outrun dinosaurs while wearing masks? I can hardly wear them and walk.
Your approach on inflation seems very incomplete. What caused the steep rise in gold prices after the monetary crisis was related to the money creation and the value of the dollar. The reason why gold is rising today and probably only at the beginning of a next wave up similar to 2010 is de unstoppable money creation of the central banks. The money printing at the scale that his happening now is unseen in history since 1930. In that sense, not studying the relation of money creation, volatility of money and the dollar/gold price, is in my view pretty superficial. I lack the real analysis and the debate on money creation and asset prices in general, gold in particular. That explains what is happening and going to happen with the gold price for the future. And that is why all experts, including bankers like Bank of America and all other major banks (who usually do not put their money on gold), are now pointing to gold as the best possible investment for the future. Hope that adds to the discussion.
The reason to invest in gold is not for the value that it has but for its volatility and for its negative correlation with the stock market. The stock market goes down the value of gold goes up, you sell your gold and buy stocks. The stocks go up you put a little back into gold. It doesn’t take much to positively affect your portfolio, even 5%. Take a look at portfolio charts and see how 95% SCV and 5% gold tightens the financial independence graph and makes the worst case scenario one year better and the best case scenario 1 year better.
Who cares if there is any rationality behind gold. All that matters is that other people, including governments, value gold as a safe haven. It’s all psychological, even if you think the psychology is stupid, it doesn’t matter, it makes you money. You don’t even need to own the physical stuff, just an ETF. The gold bugs are right, partially, owning gold is a good idea and now is a great time to be selling!
I actually agree with your point, Jon. It’s this negative correlation to the stock market that actually makes me consider something like the Permanent Portfolio, which is so heavily weighted in gold. (The Permanent Portfolio is deliberately constructed from four non-correlated asset classes and is meant to provide a relatively high rate of return without wild gyrations.) And I could absolutely buy the idea of a rational 95% stock/5% gold portfolio to reduce volatility.
Thanks for pointing this out! I’ve only just come to realize that “rebalancing” is a thing, before about a month ago I thought everything was just “buy and hold”. I found a relatively recent GRS article on it, so I’m gonna go read that next and edumacate myself. I do see this article’s point though since it’s focusing on Gold’s suitability as a simplistic long term investment.
I will say this topic was really timely for me as it was actually on my mind a couple days ago.
Any opinion on the Dragon portfolio as explained by Artemis’s research? https://taylorpearson.me/thedragon/
tl;dr: According to Artemis’s research, the optimal portfolio from 1929 to 2019 was:
Domestic Equity (24%)
Fixed Income/Bonds (18%)
Active Long Volatility (21%)
Commodity Trend Following (18%)
Physical Gold (19%)
Never heard of this before, but I’ve opened the page for later reading. My initial inclination is that it’s far too heavily weighted in gold/commodities with not nearly enough in equities. But I’ll read the article to see if I can parse the logic.
With the interest rate at zero, quality companies trading at outrageous price multiples no sane person would ever pay for a business in their neighborhood, and a year or two before we can even dream of something resembling full employment, I feel alternative investments are warranted. The chance of inflation is low in the US at this time, so gold isn’t a great bet. But I’m holding some GLD anyhow, specifically because of the uncertainty. Inflation anywhere in the world could impact the price of gold. What if Brazil prints too much money, wouldn’t that drive up the price of gold as rich Brazilians look for a way to preserve their capital?
I grew up in India where gold was/is considered the pinnacle of investment. People who have trouble keeping a roof over their heads would buy gold coins stitched to a cheap gold chain and keep adding coins to it. I have relatives who say that selling gold is what you do just before you go dumpster-diving. This is the reason that when India had to fly a 747 loaded with gold to London to prevent a default (in 1992) that liberalization of the economy could be started.
Having said that, relatives of mine who have invested in houses, stocks and other such investments have come out way ahead. In US, the comparison is even more stark. Every time I have met someone advocating buying gold, I tell them “I am ready to buy gold coins the moment those coins start producing baby gold coins”
A few thoughts on why gold (bullion) is a good hedge asset against your equity portfolio:
1. correlation of gold to equities are strongly negative during steep equity crashes (and are otherwise uncorrelated). This provides downside protection.
2. the gold price is usually inversely related to real interest rates (which are going to be low to zero for the foreseeable future). When “risk free” sovereign debt has no yield, the opportunity cost while holding gold is lower.
3. gold has little intrinsic value (its an inert material) outside of the commercial jewelry market, which is a good thing… unlike other commodities that have industrial uses, the price volatility is less tied to the economic cycle.
4. gold has been around (in an economic sense) for thousands of years – many times longer than even the most stable countries/governments today… that is to say, regardless of its intrinsic value, people have believed in its value for a very long time. Its a undeniable track record.
5. the rate of gold extraction from the earth is stable and predictable, which helps stabilize the price.
6. Bullion, though harder to access, lacks the counter-party risk ETFs carry. And, as we’ve seen with COVID-19’s impact on gold future prices in recent months (due to issues of guaranteeing physical delivery, with many parts of the global economy on lockdown), holding the physical asset vs. derivatives of it is often a safer bet.
I’m not sure I would personally own gold “instead of” any asset classes, its more about the diversification benefit of gold within a broader portfolio. Because of the characteristics mentioned above, its a good exposure to maintain long-term, to balance equity risks. Buying now versus the depressed prices we’ve seen in recent years might be unfortunate timing, but it doesn’t diminish the hedge case for gold in the long-run.
*I’m not a professional financial advisor. These are my personal opinions.
Exactly this! Gold is the original form of money and not a substitute for stocks. Instead, it is a hedge for a currency/financial crisis (in which almost all assets, including stocks, lose value). So don’t exchange your stocks for gold, but exchange your cash in the bank for gold and digital gold (= bitcoin).
I was in Canada in the late ’70s, when the Vietnamese boat people came. They’d had to escape from Vietnam in small boats, often being attacked by pirates, make it to Thailand, and then to North America (Canada took more boat people than any other nation). Some of them were alive because they’d had some gold to buy their way out of harder spots than most any American alive today has ever been in. And a lot of them bought guns when they got to Canada – which was quite difficult to do compared to the US. Made me think that a little gold and a gun weren’t a bad idea.
My goodness, more than 10 years later, I discovered you answered my question with an entire article! I’m just coming around to the idea of the permanent portfolio, whether exact or slightly tweaked.
I have heard that many gold sellers have run out of gold to sell, it may be difficult to even buy some. Gold ETFs are always available, but that is just not the same as owning physical gold.
This really captured my feelings about gold investments for so many years. I never understood the thought process of buying gold. And typically easy magical solutions don’t work out.
I just try to buy low and sell high. Perhaps I make a mistake and switch it occasionally.
How’s that narrative working out for you !!! JULY 2020 GOLD =$1903.00
LOLOLOLOLOLLLLLLLLLLLLLLLLLLLLLLLLL
The narrative is working just fine. It’s been three months since I published this article. That’s a blink of an eye in investing time. Come back in three years, and let’s have a chat about where gold and stock prices are then. Better yet, let’s chat in thirty years.
Found this article on gold. The fact is, is that we have over $150 trillion dollars of unfunded liabilities. If you look at the budget projections from the treasury department, in a few decades, our fiscal situation is a disaster. Complete. Disaster. The easiest and only way out for a government is to “print money” and have the FED buy assets. Gold may not perform that well in 5 or 10 years. But if I live to old age (another 50 years), I suspect that Gold will be much more valuable in dollar terms. Also, if I sell it for less than a $10,000 transaction, it doesn’t get reported to the government. If you have stocks, then have inflation, and sell your stocks at a higher price…you are really paying taxes on a nominal gain. It will destroy any true increase in purchasing power increase.
Precious metals are INSURANCE, not an investment. My goal is to have 10-15% of my portfolio in gold and silver by the time I retire (early). We are in unprecedented times and IMHO we need some unprecedented percentages of our wealth in precious metals.
Gold is not neccesarily an investment, it preserves wealth. If you want to make a short-term (quick) buck, gold is not for you, which is 100% perfectly fine. It stood 5000 year for a store of value, and it will keep doing so. It is able to stand the test of time.
Many just want that their value (=hard work) has the same price. Inflation, QE, and other stuff dillutes your value in terms of price. How is that even possible? One hour of your work still is that, one hour.
We have become so accustomed with price instead of value.
Please learn the difference between an asset and an investment. I assume that you have never came across an inflation like the one happened in Weimar republic or most recently Zimbabwe. Rather than seeing an ounce of gold costs 1700$, see it as 1700$ gives you an ounce of gold. Currency values are susceptible to change but not the ‘weight’ of gold. In other words, gold is a security, not a money maker.
The Bible tells us that the day will come when people will throw their gold and silver into the streets. Revelation states no one will be able to buy or sell without the mark of the beast which seems to be digital currency. So gold and silver will be useless.
When you are starving, gold and silver will not feed you. That’s why the best investments are the things you will need that will keep you alive.