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The Case Against Gold

September 08, 2010
Josh Zachariah

Josh Zachariah

37 followers
Putting aside comments by George Soros that gold is in a bubble, consider the following quote from the Wall Street Journal: "historically, investors accounted for a relatively small portion of gold demand, with the majority driven by the needs of jewelers, dentists, and electronics manufacturers. In 1998, investors represented 6.9% of demand, in the second quarter of 2010 investors accounted for 51%." Investors now account for a greater share of demand for some good rather than its own consumers.

In 2005-2006 a similar phenomenon existed in Stockton, California. During that period more homes were owned by investors than actual homeowners. As was the case throughout the U.S. many people owned homes as investment properties and in Stockton, the city was awash in investment properties. This should make any investor concerned. When investors are crowding out consumers for a good you have to wonder; is this sustainable? Perhaps daytime TV ads could be a barometer for speculative investment. During the housing bubble lenders pushed their mortgages, now gold resellers advertise their want of your jewelry.

Investors in gold may retort that gold is a store of value. Unlike the U.S. dollar no government agency can debase the value of gold. The fed can print money to pay ballooning debts, but as long as a sizable gold deposit is not discovered, there should be no concern of a sudden increase in the supply of of gold which would diminish the value of your holding. True enough, but gold is a not a monopoly in store of value. There exist valuable art paintings, silver, platinum and other currencies like the Swiss Franc or even the Chinese yuan which is ostensibly undervalued relative to the U.S. dollar. So why not purchase one of these competing stores of wealth? A commodity is a commodity is a commodity. And one that has increased 400% in 10 years is not one you're buying on the cheap.

Gold has also been reputed to hedge against inflation. Gold, however, has tripled in price over the past 10 years (growing over 10% per year) even though inflation (CPI) has run at around 2%. On that basis alone, gold does not appear to correlate to inflation. The CPI is not the perfect measure of inflation, but it is fairly accurate. However, there are securities that are perfectly indexed to inflation. TIPS (Treasury Inflation Protected Securities) and Series I Savings Bonds are a few. If the dollar is your concern, buy stocks that make the majority of their revenue internationally. Intel and Exxon are perfect examples of companies that get more than 70% of their revenue from abroad.

As foolish an argument was for housing a couple years ago, housing can at least be measured against the rents it earns. By that measure it had gotten out of whack in the mid 2000's as the Economist had reported. Gold and other commodities have no such feature. Instead the price of gold can only be determined by speculative activity determined by supply and demand. India is currently one of the largest consumers of gold for both the sake of jewelery and as a store of wealth. Since the rise in the price of gold a significant amount of selling has been going on in the country. This is just a rational response. Indians, like Americans, have budget constraints which cannot be exceeded. Further, there exist substitutes to gold. Silver, platinum and diamonds can all be used as jewelry.


Warren Buffett opined about gold's contribution to value, "it gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head."

About the author:

Josh Zachariah
I credit my father and Warren Buffett for molding me into the investor I am today.

Rating: 3.0/5 (14 votes)

Comments

bertens
Bertens - 4 years ago
what Warren really misses here, is that Gold has the function of money. Rulers can't artificially print Gold and if all the other paper currencies are artificially inflated, gold becomes very very useful. Most of Warren's quotes are brilliant, the one cited above is not, especially in the current context.
batbeer2
Batbeer2 premium member - 4 years ago
I more or less agree with your comment; but I think it's important to think about this clearly.

The dollar (or any other cuurency) is already inflated. Ask anyone older than 50. This means nothing for the relative desirabililty of gold. It's the proces of inflation and its pace that drive the demand for gold.

Take the Brittish pound.... it is not more or less desirable now that you get more pounds per dollar. However, a Brit buying gold or dollars three years ago would be feeling quite smart now. Gold is not now more valuable in Brittain than it is in the US.

Getting wealthy trading gold is speculating.... nothing wrong with that, just incredibly difficult. Much more difficult than value investing.


Josh Zachariah
Josh Zachariah - 4 years ago
Not all currencies are inflated. It does seem like that, but take Norway for example. That country is running a budget surplus of 11%[font= arial, sans-serif]. It is certainly a developed country and that currency buys everything gold will and it hasn't seen the kind of run up against the dollar like gold has.

Brazil is another country that is both growing and has a budget surplus. Gold is insulated from being debased by governments, but at this particular moment where everyone is buying it and driving the price up, I think the possibility of a collapse in the price to be increasingly probable.

I also find it troubling that people who don't have the mental caliber to differentiate between a cash flow statement and an income statement make an argument that gold is a good investment. Certainly no one reading this website is, but whenever the laymen gets into an investment, be it dot-coms or housing it has a tendency to end disastrously. For that reason alone I would not buy gold.

I do appreciate the comments, but we will have to agree to disagree

Josh Zachariah

bertens
Bertens - 4 years ago
I have to agree with you that there are some currencies like the Norwegian krona or the singapour dollar which offer some stability. The layman will not put his money into these currencies but rather invest in gold if he sees inflation on the horizon. Speculating or putting money into different currencies is mostly done by the sophisticated investor.
superguru
Superguru - 4 years ago
Gold in India is a traditionally very important asset class. It belongs to women and women only and men to do not take it away from them and do not spend it unlike cash. Only in case of extreme difficulty is family gold sold and selling family gold is considered very shameful for men. So when all is lost Gold comes to rescue. So it really serves as an important and legitimate asset class. It is like buying an inflation protected 100 year bond 0% coupon which does not devalue or dissappears based on whims and foolishness of kings and governments.

Josh Zachariah
Josh Zachariah - 4 years ago
But in response to gold in India, there are limits as to how much can be purchased. Even as valuable as it may be, if the purchasing power of the average Indian does not keep up with the inflating price of gold, then those people will be priced out. Those that have it may retain it, but the price will not move infinitely upwards. Demand consists of "willingness to pay" as well as "ability to pay."
superguru
Superguru - 4 years ago
My point is - Gold is an important asset class much more stable than any currency.

"It is like buying an inflation protected 100 year bond 0% coupon which does not devalue or disappear based on whims and foolishness of kings and governments/central banks."

If choice is between buying long term treasuries and gold - which do you think is a better investment at this point?

What if currency devaluation is a high probability in the country where you live - what would prefer - cash, govt bonds or Gold?

People in this forum has been arguing against gold for few years now while many gurus have been accumulating it. A paradox I am unable to resolve.

I think people in this forum including myself do not understand Gold as an asset class well. Though I have been trying to wrap my mind around it.

I have no opinion on if Gold is overvalued or undervalued.

And not understanding something is IMO a good reason to not buy it.

Josh Zachariah
Josh Zachariah - 4 years ago
Well I'm not considering investment options between treasuries and gold, but if I had to, yes gold would probably be preferable. But when you throw in stocks, residential real estate and other cash flow producing assets I think those are fairly valued and are likely to be better investments.

In regards to your quote, gold is not necessarily insulated from the whims of kings/governments. The word debasement comes from the act of kings and monarchs whom literally shaved off parts of coinage or diluted the metal with lower quality metals. Of course they were able to pay of their debts with greater ease.

Personal holdings of gold have also been outright banned by the government. Its an unfortunate fact that no asset is safe from the long, taxing arm of the government.

superguru
Superguru - 4 years ago
Thanks pepper99. Very interesting facts



In regards to your quote, gold is not necessarily insulated from the whims of kings/governments. The word debasement comes from the act of kings and monarchs whom literally shaved off parts of coinage or diluted the metal with lower quality metals. Of course they were able to pay of their debts with greater ease.

Personal holdings of gold have also been outright banned by the government. [u][/u]

batbeer2
Batbeer2 premium member - 4 years ago
Not all currencies are inflated. It does seem like that, but take Norway for example. That country is running a budget surplus of 11%.

The relationship between a budget surplus and the value of the currency is at best indirect.

... Not all currencies are inflated. It does seem like that, but take Norway for example...

LOL.. ask any Norwegian over 50 what he/she earned when he/she was 20 and what your average 20 year old earns now. Brazil would be too easy.

If you prefer, look up the price of a hamburger in 1975 in any country. Or coca cola, gas, houses....

Some may be able to predict relative movements with a reasonable degree of certainty.... Gold against the dollar or the Yen against the Euro.... In fact the case for gold in India is such a thesis.... supply and demand....

It's possible to get rich doing that but again, IMO it's sooo much more complex than value investing. Why speculate with gold if you can invest in a dozen net-nets.






bertens
Bertens - 4 years ago
Even though gold was banned by government I know of no incident that someone was thrown in jail for holding gold. I do not even know of any case that somebody was prosecuted for holding gold. Yes it was illegal, but only those who turned their gold in suffered. Well I do not really know how the government can debase my gold holding if I store it in a safe deposit. If I buy an ounze of gold or a kg of gold from a very reputable dealer I can be sure for most cases that the gold is not debased in any form (at least in the western hemisphere, there seems to be a case in Russia, which is kind of dodgy). Anyhow partial gold holding in physical gold/silver and or mining stocks seems to be a good idea for risk diversifikation in these times.
LwC
LwC - 4 years ago
Bertens, I guess it depends on how you define "debasement". Some investors might define debasement to include the premium over the market quoted price that one must pay to acquire the gold and the discount to the market quoted price that one must absorb to sell the gold. In some cases the combination of premium and discount for the round trip can amount to 30% or more of the original purchase price of the gold. In that circumstance the price of gold might have to increase by 40% or more for the investor to just break even.

superguru
Superguru - 4 years ago
It might be that Gold is overpriced now after the 400% run up.

or may be Gold's price just caught up to the devaluation and inflation in last decade. And it is actually fairly valued now and was under-priced earlier.

Any studies on price/valuation of gold, anyone is aware of about?

(As per some formula here in US there is no inflation but I can see in our expenses we are spending more and more to maintain a lower living standard than few years before. If you do not see any inflation tell me where you live and I will move there.)

"Anyhow partial gold holding in physical gold/silver and or mining stocks seems to be a good idea for risk diversifikation in these times." - Bertens

I am also getting more and more convinced that Gold is a very important asset class in it self and should be part of the portfolio although at right price. Though I wish I had thought about when gold was cheaper and my wife said so.

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