“Gold looks better every day with growing sovereign risks.”
– Hussein Allidina, head of commodities research at Morgan Stanley
“Paper eventually returns to its intrinsic value — zero”
– Voltaire
Gold recently closed near a record $1,400 per ounce, about 25 percent higher than its level at the end of 2009 and up from $250 in 1999.
Gold’s run-up reflects demand by investors who are fearful about inflation and fret about the ability of paper currencies to retain their buying power. But until gold returns to its former role as the method of settling international transactions, its value will be determined by the “eye of the beholder.”
Paper money is “faith based.” Its acceptance as a medium of exchange depends upon the public’s belief that their government will implement fiscally sound practices. In the Weimar Republic in Germany after WWI, citizens lost so much confidence in their currency that it took a wheelbarrow of German marks to buy a loaf of bread.
Paper money is again under siege. Worldwide terrorism, sovereign debt risks and the fiscal woes of developed countries have undermined belief in modern day monetary systems in which money can be printed without any constraints.
This kind of system did not exist in the U.S. until not quite 40 years ago. On Aug. 15, 1971, President Nixon “closed the gold window,” ending convertibility between U.S. dollars and gold.
Gold then traded at $35 per ounce. But gold enthusiasts feel we should not focus on gold appreciating almost 40 times since 1971. Instead, they say, we should recognize that the dollar’s value has declined to one-fortieth of its former value.
A ‘crisis commodity’
Gold has often been called the “crisis commodity” because it tends to outperform other investments during periods of world tensions. Gold is popular because it:
Could be used to make payments.
Is a hedge against both inflation and declining confidence in paper currencies.
Is a safe haven during periods of geopolitical or financial turbulence.
Diversifies portfolio risks because of its negative correlation to other asset classes, such as fixed income and stocks.
The flip side of liking gold as an investment is represented by those who are bullish about the U.S. dollar. These people argue that the dollar is:
The world’s reserve currency.
The primary medium for settling international transactions.
The currency primarily held by the world’s central banks.
Those who are bearish about the U.S. dollar, however, make the following arguments:
The U.S. is the world’s biggest debtor nation, owing trillions of dollars. America expects to run major fiscal and trade deficits for the foreseeable future.
The U.S. central bank’s implementation of quantitative easing is designed to increase American inflation and lower the dollar’s value.
Investing in gold
Gold investors range from savvy billionaires such as George Soros and John Paulson to the lay public. Central banks of India, Russia and China have all bought gold in recent years.
There is a time-value cost to holding gold, because it does not pay dividends like stocks, the coupon interest of a bond, or rental income. Since gold offers no income, it needs to double in price in about 10 years to match the return of a bond that pays 7 percent annual interest.
To profit from gold, one can choose several alternatives, including buying gold coins, exchange-traded funds or equity in mining stocks. The exchange-traded fund SPDR Gold Trust possesses almost $60 billion in gold assets.
Purchasing gold solely for investment purposes is risky. Gold prices can experience wild price fluctuations or, even worse, remain in a bear trough for decades.
On the other hand, its allure is more than a passing fad. Love of gold is both ancient and ageless. Simply said, gold is money. And money is always in fashion!
Originally published in the Sarasota Herald-Tribune
