Reprinted from InternationalMan.com
A meme is now circulating that gold is the investment equivalent of a pet rock, and that the smart investor should sell gold, and buy stocks. That’s a ridiculous notion. In fact, if you believe in buying low and selling high, this is the time to buy gold, and sell stocks.
It pays to remain as objective as you can be when analyzing any investment. People have a tendency to fall in love with an asset class, usually because it’s treated them so well. We saw that happen most recently with Internet stocks in the late ’90s and with houses up to 2007. Investment bubbles are driven primarily by emotion, although there’s always some rationale for the emotion to latch on to. Perversely, when it comes to investing, reason is recruited mainly to provide cover for passion and preconception.
In the same way, people tend to hate certain investments unreasonably, usually at the bottom of a bear market, after they’ve lost a lot of money; even thinking about the asset means reliving the pain and loss. Love-and-hate cycles occur for all investment classes.
But there’s only one investment I can think of that many people either love or hate reflexively, almost without regard to market performance: gold. And, to a lesser degree, silver. It’s strange that these two metals provoke such powerful psychological reactions – especially among people who dislike them. Nobody has an instinctive hatred of iron, copper, aluminum, or cobalt. The reason, of course, is that the main use of gold has always been as money. And people have strong feelings about money. Let’s spend a moment looking at how gold’s fundamentals fit in with the psychology of the current market.
What Gold Is – and Why It’s Hated
Let me first disclose that I’ve always been favorably inclined toward gold, simply because I think money is a good thing. Not everyone feels that way, however. Some, with a Platonic view, think that money and commercial activity in general are degrading and beneath the “better” sort of people – although they’re a little hazy about how mankind rose above the level of living hand-to-mouth, grubbing for roots and berries. Some think it’s “the root of all evil,” a view that reflects a certain attitude toward the material world in general. Some better-informed people (who have actually read Paul of Tarsus) think it’s just the love of money that’s the root of all evil. Some others see the utility of money, but think it should be controlled somehow – as if only the proper authorities know how to manage the dangerous substance.
From an economic viewpoint, however, money is just a medium of exchange and a store of value. Efforts to turn it into a political football invariably are signs of a hidden agenda, or perhaps a psychological aberration.
But, that said, money does have a moral as well as an economic significance. And it’s important to get that out in the open and have it understood. My view is that money is a high moral good. It represents all the good things you hope to have, do, and provide in the future. In a manner of speaking, it’s distilled life. That’s why it’s important to have a sound money, one that isn’t subject to political manipulation.
Over the centuries, many things have been used as money, prominently including cows, salt, and seashells. Aristotle thought about this in the 4th century BCE and arrived at the five characteristics of a good money:
- It should be durable (which is why, say, wheat isn’t a good money – it rots).
- It should be divisible (which is why artwork isn’t a good money – you can’t cut up the Mona Lisa for change).
- It should be convenient (which is why lead isn’t a good money – it just takes too much to be of value).
- It should be consistent (which is one reason why land can’t be money – each piece is different).
- And it should have value in itself (which is why paper money leads to trouble).
Of the 92 naturally occurring elements, gold has proved the best money (silver is second). It’s not magic or superstition any more than it is for iron to be best for building bridges and aluminum for building airplanes.
Of course, we do use paper as money today, but only because it recently served as a receipt for actual money. Paper money (currency) historically has a half-life that depends on a number of factors. But it rarely lasts longer than the government that issues it. Gold is the best money because it doesn’t need to be “faith based” or rely on a government.
There’s much more that can be said on this topic, and it’s important to grasp the essentials in order to understand the controversy about whether now is a good time to buy. But this isn’t the place for an extended explanation.
Keep these things in mind, though, as you listen to the current blather from talking heads about where gold is going. Most of them are just journalists, reporters that are parroting what they heard someone else say. And the “someone else” is usually a political apologist who works for a government. Or a hack economist who works for a bank, the IMF, or a similar institution with an interest in the status quo of the last few generations. You should treat almost everything you hear about finance or economics in the popular media as no more than entertainment.
So, let’s take some recent statements, assertions, and opinions that have been promulgated in the media and analyze them. Many impress me as completely uninformed, even stupid. But since they’re floating around in the infosphere, I suppose they need to be addressed.
Misinformation and Disinformation
Let’s examine some memes floating around.
“Gold is expensive.”
This objection is worth considering – for any asset. In fact, it’s critical. We can determine the price of almost anything; that’s easy. The hard part is figuring out its value. From the founding of the U.S. until 1933, the dollar was defined as 1/20th of an ounce of gold. From 1933 to 1971, it was redefined as 1/35th of an ounce. After the 1971 dollar devaluation, the official price of the metal was raised to $42.22 – but that official number is meaningless, since nobody buys or sells the metal at that price. More importantly, people have gotten into the habit of giving the price of gold in dollars, rather than the value of the dollar in gold. But that’s another subject.
Here’s the crux of the argument. Before the creation of the Federal Reserve in 1913, a $20 bill was just a receipt for the deposit of one ounce of gold with the Treasury. The U.S. official money supply equated more or less with the amount of gold. Now, however, dollars are being created by the trillion, and nobody really knows how many more of them are going to be shazammed into existence.
It’s hard to determine the value of anything when the inch marks on your yardstick keep drifting closer and closer together.
“The smart money is long gone from gold.”
This is an interesting assertion that I find is based on nothing at all. Who really is the “smart money”? How do you really know that? And how do you know exactly what they own (except for, usually, many months after the fact) or what they plan on buying or selling? The fact is that very few billionaires (John Paulson perhaps being the best known of them) have declared a major position in the metal. Gold is only a tiny proportion of the financial world’s assets, both absolutely or relative to where it has been in the past:
“Gold is risky.”
Risk is largely a function of price. And, as a general rule, the higher the price, the higher the risk, simply because supply is likely to go up and demand down – leading to a lower price. So, yes, gold is riskier at $1,100 than it was at $700 or at $200. But even when it was at $35, there was a well-known financial commentator named Eliot Janeway (I always thought he was a fool and a blowhard) who was crowing that if the U.S. government didn’t support it at $35, it would fall to $8.
In any event, risk is relative. Stocks are very risky today. Bonds are ultrarisky. Real estate, at least in many major cities, is in a near mania. And the dollar, although it’s cyclically popular, is on its way to reaching its intrinsic value. In fact, stock, bonds, property, and the dollar are all in bubble territory.
Yes, gold is risky now. But it is actually much less risky than most alternatives.
“Gold pays no interest.”
This is kind of true. But only in the sense that a $100 bill pays no interest. You can get interest from anything that functions as money if it is lent out. Interest is the time premium of money. You will not get interest from either your $100 or your gold unless you lend them to someone. But both the dollars and the gold will earn interest if you lend them out. The problem is that once you make a loan (even to a bank, in the form of a savings account), you may not even get your principal back, much less the interest. And, of course, many banks around the world now pay negative interest for loaning them money – an absurd inversion of reality.
“Gold pays no dividends.”
Of course it doesn’t. It also doesn’t yield chocolate syrup. It’s a ridiculous objection, because only corporations pay dividends. It’s like expecting your Toyota in the driveway to pay a dividend, when only the corporation in Japan can do so. But if you want dividends related to gold, you can buy a successful gold mining stock.