photo by Mark Herpel
Five or six years ago, a teenage cousin who had a little money to invest came to me, the family's financial guru, with a question: What did I think of gold?
Gold is for people who fill their basements with canned goods and bottled water, I told him. It is a refuge for folks who lose faith in the financial system’s ability to create wealth and preserve value. It is money for someone who does not trust other forms of money.
It certainly was not a suitable investment for a young person with his whole life in front of him, in my view. Gold does not amuse children or cure dread diseases. You can’t eat it. You can’t wear it, except ornamentally. It costs money to store, and it does not even pay interest. People who covet gold are afraid of all the bad things that can happen to them. I wanted my thoughtful, business-minded relative to approach the world with an open mind and open arms, looking ahead to all the good things that could be built in his lifetime. Imagine if, amid the economic darkness of the 1970s, Steve Jobs and Steve Wozniak had decided to buy a few Krugerrands rather than some electronics parts.
Gold must have been around $700 an ounce when my cousin asked his question. Over the next few years it soared past $1,800 as the financial crisis unfolded and central banks around the world cut interest rates to rock-bottom and tried to unleash floods of cash into the economy.
Suddenly “gold bugs” were everywhere. People who had never previously wanted to own gold (or who had lost their taste for it when the market collapsed at the start of the 1980s) now poured millions of dollars into it The push for gold was helped by the fact that nowadays there are financial instruments that track the metal’s price without making their purchasers take direct possession of all that bulky bullion.
Stocks, it seemed, were too risky after the turmoil of 2008-2009, though of course after the markets had fallen so far, the greatest risk was that prices would rebound (as they have). Real estate had shown itself to be risky too. And with central banks deliberately trying to inflate asset prices and drive down the value of currencies to get people to buy other things, it is no wonder that anyone with a lot of idle capital wanted to put it in something that the Federal Reserve could not create on a whim.
That finite supply is gold’s strongest attribute. There is only so much of it in the Earth’s crust, and only a fraction of that is economically recoverable, even at high prices. As long as people covet gold, its value has a certain floor.
But its value also has a ceiling, because the supply of gold never goes down - it always goes up. Gold is not a commodity we consume as we do oil or wheat. Virtually all the gold that has ever been mined is still with us today. The greatest share is in the vaults of central banks, but it is also held by businesses and individuals, especially in parts of the globe where financial structures are rickety. No resident of a developed nation would ever wear jewelry of 24-karat (pure) gold, because it is so heavy and soft, yet such jewelry is prized for dowries and wedding gifts in India and elsewhere in Asia.
Whenever gold’s value gets high enough, there is a strong incentive to pull it out of storage and use it to bolster a currency, pay a nation’s debts, put a roof on a house or pay a doctor bill. The gold used for such purposes then goes back into storage under someone else’s name and the cycle repeats, generation after generation.
Gold can buy a roof, but it cannot be used to make a roof (excepting state capital buildings and other forms of conspicuous sovereign consumption). It can pay for a medical scan, but it cannot perform one. It can buy a vehicle, but it cannot take us anywhere.
This is why I say gold is just another form of money. Money serves two purposes: as a store of value and as a medium of exchange. Gold’s effectiveness at both functions is middling. We don’t use gold coins anymore, but we could, so it serves an exchange function. Gold’s value will never go to zero, so it can store wealth - but because its value is based purely on emotion rather than its intrinsic usefulness, it is not as good a store of value as, say, a sturdy home on a desirable piece of land.
Gold’s price has been in free-fall recently, slipping from nearly $1,700 at the start of this year to just over $1,200 an ounce last week. I think several factors are responsible. One is the recent spike in interest rates, fueled by the Federal Reserve’s hints that the super-easy-money era may be slowly approaching an end. When interest rates rise, the opportunity cost incurred by holding non-interest-bearing gold rises as well, so the price of gold falls.
At the same time, growth is slowing in China and much of the rest of Asia. China has recently experienced its own financial-system squeeze. I suspect a lot of the run-up in gold’s price during the past few years has been fed by Asian buyers. Right now, cash is at a premium in the Far East, and while there may not be a rush to sell gold, there probably is no great rush to buy it either.
A client asked me last week how far I think the decline can go. I think it can go a long, long way. Just a few years ago, when my young cousin approached me, a price of $800 or $900 an ounce seemed sky-high. Then a tide of speculative money drove the price far higher. We have seen, time after time, that when such tides turn, they can leave all sorts of investments on the rocks.
It is not certain to happen. We still have a lot of easy money in the world, and governments with staggering debts will be sorely tempted to inflate their burdens away. People buy gold to protect themselves in such circumstances. If we frighten the world about the financial system again, gold could recover its lost ground. But more likely, people will realize that financial Armageddon is not upon us.
We ought to get back to thinking of gold as a financial lifeboat, not a cruise ship. It is a form of insurance; it will not take you anywhere in the long run.
I am sorry to say that my cousin died tragically last year. He was a lovely, modest young man, much too kind to point out that, from his point of view, I gave him a bum steer. But I don’t think I did.
I probably will never be able to think or write about this topic without remembering Alex. I would not have wanted him to grow up in a world where teenagers ought to stash their savings in gold. That would be a world of hopelessness and fear. Young people should invest for a world in which they can combine small amounts of capital with large amounts of energy and vision to create a future whose glitter is not hidden away in a vault.
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