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Four Reasons Why Gold's a Slam Dunk Investment

by: Andy Sutton August 31, 2008 | about stocks: GLD / IAU / SLV    

Andy Sutton

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You know there is something wrong when financial commentators are forced into becoming weathermen.

During the better part of this new century, we have dealt with tightness in oil supplies and dire warnings of woe that would befall us should a hurricane get loose in the Gulf of Mexico. During this same period, we have been bombarded by higher costs across the full spectrum of items that are considered to be staples of living the in United States. Yet officials and media pundits have stubbornly insisted that inflation is ‘contained’ or recently that it ‘will cool next year’. Common sense dictates that the US is in a recession of at least some degree, yet we get reports that the economy is now growing at a rapid pace. We are told all is well while jobs continue to disappear, defaults on all types of debt are skyrocketing, and a wave of bank failures appears imminent. Similar disparities exist in the housing market where the bottom is called monthly amid the reality that both sales and prices are plummeting. There is clearly a bull market in confusion.

For the past eight years, wise investors have chosen to ignore the confusion and in many cases unplugged themselves from the traditional financial system, opting to become their own central bank and invest in gold and silver. Others have used a hybrid model of investing partially in the physical metals and partially in shares of precious metal miners and related companies. This has undoubtedly been the right move. The recent correction included, gold prices alone are up an amazing 45% just since my Survival Guide was published on 10/23/2006. For those who have been in since the beginning of the move, the gains have been even larger.

Many in the mainstream press will quickly scoff at the idea of holding Gold and Silver, because they don’t pay dividends. So to be fair to their argument, I calculated the movement in the S&P500 Dividend Reinvested Index from 10/31/2006 to the last report at the end of this past July. Even with dividend reinvestment, the S&P500 is down 4.78% while Gold is up nearly 50%. This takes the primary argument against owning real money and blows its doors off. Granted, we’re only looking at a period of not quite two years here, but given the macroeconomic events that have transpired, it is clear that real money was the way to go.

The question we need to ask now is pretty simple: Is anything going to change moving forward that will reverse this trend? Or, put another way, what would need to happen to make precious metals unsuitable for investment? There are dozens of prerequisites, but we’ll stick to the Big Four.

•    Since precious metals, particularly Gold are proxies for inflation, we would need to see worldwide inflation slow dramatically. A quick look at the chart below tells us this is nowhere near happening. The global supply of money in US$ terms has increased by 12.4% since mid-2007 from $53.7 Trillion to $60.3 Trillion. We’re still inflating like crazy. (Chart Compliments of dollardaze.org)


•    Geopolitical risk would have to decrease. Risk tends to be friendly towards precious metals. This because deep down, most people understand that fiat money is not real money, but only has value because its backing government says it does. Its value is based almost entirely on perception. Wars and rumors of wars tend to undermine political and therefore financial stability. On the other hand, gold has been recognized as real money for thousands of years because it is desirable, portable, homogenous, and scarce. Scarcity and fiat money are 180 degrees diametrically opposite to each other.

•    Systemic risk to the financial system would need to be swept away. This is no simple task and, despite what Bernanke & Company choose to say, it is clear that the systemic risk to the financial system is nowhere near close to abating. Bank failures are on the rise and credit spreads are at record levels. The housing debacle has left many financial hand grenades in the portfolios of investment and commercial banks the world over and many have yet to go off.

•    Inflationary expectations would need to decrease significantly. Again, perception tends to be reality and if people are convinced that prices are going to continue to rise, then they will behave accordingly. They will seek out assets that protect their purchasing power. Commodities generally assume this role due to scarcity: they cannot be printed or digitally created like fiat money. And the more funny money that sloshes around chasing a finite quantity of goods, the more those goods will increase in terms of the fiat currency. To reverse this trend, people worldwide would have to get the idea that their money is going to buy more, not less. It is going to be difficult to accomplish that feat with the price of almost everything (except housing and stocks) going up.

Given just this cursory analysis, it is easy to see why Gold is a slam-dunk choice in terms of protecting wealth. Certainly, gold is prone to nasty corrections. Too often, people buy gold with the idea that they’re going to get ‘rich’. These folks fail to properly understand why it is they should own gold in the first place and are easily shaken out when a correction occurs. Gold should not be purchased with the expectation that it will make you rich. It should be acquired to protect your purchasing power. The recent rout in precious metals presents a fantastic opportunity for new buyers to get on board and for people who already have positions to add to them as circumstances permit.

One caveat that needs to be mentioned is the fact that the precious metal markets are prone to intervention and manipulation. These activities are disruptive to normal market function and can create disparities between the price of futures contracts and the actual metals themselves. GATA covers these activities in great detail and has done a masterful job assimilating a vast array of resources, articles, and other materials related to this topic. I highly recommend getting up to speed on this important issue before investing – particularly if you’re new to these markets.

In totality, the recent correction in precious metals should be viewed not as a tragedy, but rather as the opportunity of a lifetime.

Disclosure: No positions

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This article has 28 comments:

  •  
    Aug 31 08:34 AM
    Gold is a trade always!! In the long run it never goes up. If the dollar goes down 10% and the gold goes up 10%, you have made no money.

    I trade gold but am out of it now as the dollar goes up.
    Reply
  •  
    Aug 31 09:48 AM
    "If the dollar goes down 10% and the gold goes up 10%, you have made no money. "

    This is the most idiotic statement I've read....today. If the dollar goes down 10% and gold goes up 10% you have LOST no purchasing power. If everyone else HAS lost purchasing power, are you better off than you were?

    Another thing CLH is famous for is cherry-picking a starting point for a statistic about how gold hasn't gone up since 1980. Figures lie, and liars?

    If by "gold is a trade" you mean in terms of over years then I might agree with you. But if you mean short-term then we disagree.

    Dollar fundamentals are horrid, and worsening. Wait, let's change that slightly. FIAT fundamentals are horrid, and worsening. As fiat currencies undergo their own individual waves of revealed weakness, expect their values to wax and wane w.r.t. each other.

    The Bretton Woods system ended on August 15, 1971. Fiat currencies floated, and then we had a oil shock in 1974. During this oil shock, gold went from $35 to about $190, then fell back to around $100, settling on a triple. Interestingly, gold started this current run at about $250 and has recently settled in at about $800, a triple. We had a spike in oil and gold; the gold shock was contained by CB selling and shorting by the unholy alliance of JPMorgan / Barrick.

    Many have pointed out that the commodity backing of the USD seems to have been merely switched from gold to oil. The US Strategic Oil Reserve is in effect a market stabilizer which can be used to manage the oil market to protect the USD, like CB gold reserves can be used as a market stabilizer to protect the USD.

    IMO we have just had a similar shock to the belief system in fiat currencies similar to 1971, and it will take a similar amount of time for this bull to run its course. We may have just experienced 1974. History doesn't repeat, but it rhymes.

    This generational bull in PM's is just starting. Public awareness is beginning to build; should I mention the recent 5000 ounce gold purchase from Rand Refinery that wiped them out for a week or so?

    We have only just now succeeded in buying up all the investor-sized PM's left over from 1979. J-M is whining about silver 100-ounce bar orders overwhelming them. The physical PM industry is only starting to gear up to feed this bull. We ain't seen nothing yet, CLH's constant dollar-pumping notwithstanding. THIS IS ONLY THE BEGINNING.
    Reply
  •  
    Aug 31 11:15 AM
    CLH is just a cheerleader. The sort of person who'd be fine to be on your side but doesn't add much value as to why you should root for his team.

    I find it interesting that Andy Sutton apparently doesn't own any positions in Gold? Rather odd considering the article.
    Reply
  •  
    Aug 31 12:16 PM
    SWRichmond, it's best just to ignore CLH and his twin JasonC. They either work for the government or are well qualified to do so. Keep your backside covered when they're around unless you want a hefty dose of sunshine blown up it.

    In the meantime I'll continue using gold (which is neither an investment nor a trade) as my functional store of value and my metric for the worth of investments. Gold does not "go up" or "go down"; it simply stores value. Paper money goes up and down, and the prices of goods and services denominated in that paper lag the paper's moves (wrongly leading people to believe it's the metal what's changing in value). In the long run CLH and his kind will be broke and the government they worship will have only more worthless paper to offer for their sacrifices. Those of us who saw through their lies and impossible promises will still have about the same amount of purchasing power we have now, which is to say the same amount of purchasing power we'd have had in 1975, 1925, or 1725.

    Yes, really. The first US gold coins were struck in 1849, had a value of $1, and contained .04837 oz t gold; today that gold is worth $40.15. Between 1849 and 1971, the value of the dollar with respect to gold changed slowly; various forms of gold and/or silver standard were in place. Had you kept the 1849 coin until 1970, you would find that the dollar had declined by about half, so that the coin could then buy $2.04. The coin's purchasing power would have been little changed from 1849, but so too was the dollar's - the government forces setting the value of the dollar in those 122 years did a rather poor job of debasing the currency. Since then, however, the dollar has depreciated rapidly. The coin, ignoring historical value, has not. It remains about as valuable today as it has been every day since it was struck - but no moreso. This is why gold is not an investment; it is unlikely to experience a significant increase in real value, nor does it produce income.

    By comparison, a Jan 20, 1880 New York Times article suggests that shares in the newly-formed Union Pacific Company, then worth 4.7 oz t gold ($96.50), would now be worth about 147 oz t gold ($122,000), a 2.7% annualized real return not counting the substantial dividends. A good investment creates value; gold merely stores it. This also highlights both the importance of dividends and the tiny real rates of return on even quality investments. Most of the "capital gains" associated with equities are nothing but debasement at work. For example, had you bought GOOG at $96 in August '04, you would have a nominal annualised return of 48% (367% overall). In real terms, however, that's a somewhat less impressive 24% (135% overall) - for buying on the ground floor of a huge success story. Future returns will surely be much lower. Had you bought the S&P 500 in 1970, you would have paid 2.01 oz t ($85). Today it's worth 1.55 oz t ($1283). This reflects the reality that most companies are not very good investments (or perhaps that unsound money weakens any investment). It also means that dividends matter, a lot. Had one either reinvested the dividends or stored them in gold, the outcome would be dramatically different. Conventional wisdom holds that dividends account for 30-35% of total returns. In fact they account for most or all of the real return. Dividend yields in gold are the same as yields in dollars, but capital gains over time are subject to debasement. This is one of the main reasons I prefer dividend-paying stocks: I have the ability to store my income in gold. Most companies that retain earnings do so in their home fiat currency, so that they lose value over time. With a sufficiently long horizon, the average investment will return no capital appreciation in real terms. Therefore, when considering broad market total returns, dividends are in fact the whole story; this is a natural and expected consequence of a free market (capital will be allocated to those investments that produce greater incomes, expanding capacity and lowering incomes, thereby reducing the equity value greatly). That does not mean that the average investment produces no income, however. Choosing good businesses that generate consistent income, capturing and storing that income (in gold, of course), and reinvesting a portion of it selectively (good businesses at good prices), is how an investor creates long-term growth of real wealth. Everything else is speculation, including owning gold in the hope that it will over some period of time "go up" more rapidly than the dollar declines in purchasing power. You can be assured that such imbalances will be arbitraged away; you are doing nothing more than playing a game of chicken with the market.
    Reply
  •  
    Aug 31 07:35 PM
    Gold is a trade. Buy and hold at $800 and then see it go to $80. It took twenty years for it to get back to $800. Do you think the people that bought gold then and held think it was a good idea?
    Reply
  •  
    Sep 01 03:08 AM
    All I know is I started buying all the gold I could get my hands on starting in 2002 at $250 and sold 80% of what I had accumulated when it broke $1000. I sure feel like I made a profit. I don't know what else you could call it if not a "gain in value".
    Reply
  •  
    Sep 01 05:13 AM
    Gold is so fascinating to some people that they forget that there are other "hard assets" which can be used to protect against the debasement of paper money by inept politicians. And contrary to gold these other "real assets" can produce dividends the value of which has been very well put by "bearfund" above.
    Reply
  •  
    Sep 01 06:01 AM
    > The first US gold coins were struck in 1849, had a value of $1, and contained .04837 oz t gold

    Oh, really? I think you need to take another look at the history of US coinage!

    KJ ---> 1st bought gold at 140.00/oz
    Reply
  •  
    Sep 01 09:35 AM
    Ultimately, gold always be worth somethin'; eventually, fiat money be worth nuthin'.
    Reply
  •  
    Sep 01 09:55 AM
    While I agree gold over long periods is not an "investment"... it certainly does have periods where it rises in value far faster than fiat currencies decline.

    Compare it to a life raft. A life raft isn't an investment either. But when the ship is sinking and you own the life raft, you could get rich really quick as the ship's occupants bid for your raft.

    As the world wakes up to the bleak future of fiat currency, it could cause a rapid runup in the price of gold. What else are they going to buy?

    cash? - What if they're losing 10-20% there over the next few years of a fiat currency meltdown? Will they "park" their money there for an extended period?

    US stocks? - what if we see continued bleak earnings figures and a severe recession? Will they stick it out? They haven't done so in the recent past. And those dividends are paid in ...fiat currency! And if you do see capital appreciation it is in....fiat currency! So your stock has to rise more than 10-20% just to pace REAL inflation after taxes. So that stock that loses "just 10%" for a few years might in 2-3 years be worth half its original value in buying power. If investors wake up to this they might decide gold is a better "investment"... What happens to gold prices when massively larger amounts of money flow into it?

    Bonds? Ha. In a period of high inflation this is super risky.

    Real estate? A tangible asset, right? Hey, if you think the bottom is here, go ahead. You'll get burned most likely. Good luck selling it when buyers can't get loans soon w/o 20% down and stellar credit. These are the same people who couldn't scrape up 3% before. Few will be able to save the down payment in a recession if they couldn't do it before in a boom.

    And cherry picking timelines as "proof" of an investment's poor performance..... Puhleese. What if one took a look at the DOW over the last 8 years or so? Or Real estate since 2006? Silly.
    Reply
  •  
    Sep 01 01:12 PM
    heard government is going to recall gold to pay down the debt. make comments.
    Reply
  •  
    Sep 01 02:15 PM
    "heard government is going to recall gold to pay down the debt. make comments. "

    Anything to dissuade people from buying it...rumors, threats, dezinformatsia. I am unimpressed. Source?
    Reply
  •  
    Sep 01 02:47 PM
    Gold , physical or paper are considered collectibles by the IRS. Capital gains will be taxed at 28% instead of stocks 15% rate. Outside of a tax advantaged account precious metals tax rates are a turn off. Unless of course you feel another monumental leg up in prices is coming.
    Reply
  •  
    Sep 01 03:11 PM
    Gold Bugs at it again! Can't talk to 'em.
    Reply
  •  
    Sep 01 04:06 PM
    Well then Jake2, take some speaking lessons and find some information to share that is at all useful, cuz the "goldbugs" I know hear quite well. What you mean is that they tend not to listen to stupidity and ignorance, they don't accept that 2+2=5, they don't believe that something created out of nothing (by man) has more value than something that is finite with many valuable and necessary uses, or that 14 pieces of green paper are worth more than 1 oz of silver outside of some momentary trade. What you mean is they find nothing much that comes out of your mouth to be worth listening to. Well then, I agree...you can't talk to 'em.
    Reply
  •  
    Sep 01 07:44 PM
    I read that the US Mint has stopped selling gold coins. Is there any meaning to this?
    Reply
  •  
    Sep 01 08:52 PM
    “In times of universal deceit, telling the truth is a revolutionary act” – George Orwell.
    Reply
  •  
    Sep 01 10:45 PM
    I don't see Warren investing in gold. In my view stocks remain the best hedge against inflation as well are "wealth creating". Proper selection is of course key.

    The price of gold has defined by brief and dramatic price spikes (following deflating bubbles, wars and other financial panic) followed by periods of long slow declines.

    Notwithstanding recent history here is an interesting post to keep things in perspective.

    www.fool.com/investing...

    Reply
  •  
    Sep 02 01:17 AM
    Up above, mbr mentions "other hard assets" and E.Neff Sed likes stocks.

    Use your favorite fin'l engine -- Yahoo Finance works fine -- and compare CCJ and BHP with gold.

    My friends here -- whose daddy-in-law is an old FOW .. that be Warren .. think stocks are just fine too.

    Nonetheless, I AM buying a bit of hard and shiny ... but I doubt it'll ever get to the "5 to 10% insurance" that some pros recc.
    Reply
  •  
    Sep 02 01:18 PM
    about the only need/use for hard metals is for one (or more) $1000 bags of silver quarters to have something to spend after the apocalypse (whatever form it takes). As far as the story line here, I read the same lines in '77-'78 just before gold went from $800 down to $100 over the next 20 years.
    Reply
  •  
    Sep 02 02:18 PM
    In the short run gold will decrease as demand for jewerly, cars (used in catalyic converters), computers, and other non-necessary items is decressed. Long term we may never see gold at $80 again. Long term it should move higher for the reasons outlined, risk of geopolictial events continues to increase (One reason is protectionism, cause less trade equals more conflicts, you dont bomb your trading partners unless you have a override reason like religion). Terrorism is not going to shrink till we deal with the poverty and mid east issues, Inflation is clearly above where it needs to be and Bernake does not care about it.
    Risk of a major issues in the finacial markets could drive people to safe heavens of physical gold.
    So before you call each other names consider the long run before you place bets on either side. And anyone with one investment (Stocks or gold is looking to be burned by the black swan)
    Reply
  •  
    Sep 02 02:21 PM
    not like oil which will not be recovered once consumed, the worldwide storage of gold increases over time. Also, the elasticily of demand is high which means the higher gold price will result in corresponding lower demand. so, the price appreciation of gold should be milder than oil and other base materials. any price pegging between gold and oil as an FV estimate is misleading.
    Reply
  •  
    Sep 02 02:54 PM
    Bugs,

    What do you think the LT tax rate will be when Obama takes office on any investment? 25% which is 3% from gold? Also, physical gold often isn't reported once sold. Some people aren't paying any taxes on gains.... Much better than the "current" 15%!
    Reply
  •  
    Sep 02 02:59 PM
    old rick,

    I hear nothing but bashing regarding commodities in the media. You do realize that you're in a gold message board where some people may actually believe in the upside don't you? Also, hopefully you know $800 then is like $2300 now. If you think it's going down that's fine, but make better arguments.
    Reply
  •  
    Sep 02 11:28 PM
    barrick, sure, the "gold/oil ratio" is nothing but measuring the true price of oil. Why should it be constant? As you note, oil is being consumed and not replaced. That does not mean that the value of gold falls; the supply of gold does indeed rise over time, but the real economy grows as well. What grows fastest of all? The supply of fiat money, of course. Gold priced in goods and services is unlikely to appreciate or depreciate much at all. Gold priced in fiat money is holding a one-way ticket to infinity. Does that mean you should "buy" gold? Meh. Hold gold, hold dollars, it's all the same to me. If you don't care about preserving your purchasing power over time, the dollar is great for making you feel wealthier while you become poorer. If you do, gold is really the only game in town. Your portfolio, your call. I know where my wealth is, and I'm quite happy with gold, thanks.
    Reply
  •  
    Sep 04 01:01 AM
    Bearfund, that was one of the best analyses of the contributing factors of the price of gold and it's role in one's portfolio that I have ever read. Both gold bears and bulls have a tendency to believe that gold is anything but a store of wealth, and that it's no the value of the gold that changes over time, but the value of the fiat currency. Good job.
    Reply
  •  
    Sep 04 01:02 AM
    Oops, the last sentence should have read:

    "Both gold bears and bulls have a tendency to forget that gold is only a store of wealth, and that it's not the value of the gold that changes over time, but the value of the fiat currency."
    Reply
  •  
    Sep 18 06:33 AM
    It has been said: a) that gold does not produce income it is simply a warehouse for wealth, and b) it is not the value of gold that fluctuates but the value of the fiat money with which it is bought and sold.

    If that is the case, why bother with gold? Why not just stuff your mattress with fiat money and let it fluctuate? When the time comes you will have an easier time buying a head of lettuce with a dollar bill than with a gold coin.
    Reply
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