Why Gold?

Gold — It is the oldest form of currency, universally accepted by the human species across the world in different cultures and different eras of civilization. This shiny metal has always been attractive by one and all for a variety of reasons. But we are in interesting times….and while we get more educated and complicate our monetary system, the more people tend to forget what gold even is. Is it a currency? A commodity? Or as some claim, is it a pet rock (Hint: No)? In this article, I visit and present a few reason to own gold.

Money vs Currency

Over the past few months, I have been spending a lot of time reading and learning about gold and its place in human history and our current monetary system. Our present state has become overly complicated where central bankers control every little aspect of our lives through the currency. The fiat currency is only a piece of paper, a promise from the government that the value you hold in your hand is worth something. We can argue all day long about which paper is stronger than other forms of paper from around the world, but the point is just that — its a piece of paper that is worth something today but may not be worth the same tomorrow. In fact, that is the hope — that it is worth less tomorrow.

A lesson in history will demonstrate how/why the central banks were invented and I will not repeat that here. There are far better resources online than what I can surmise in a short blog post. However, the conclusion we can draw is that the entire architecture of central banks is to devalue currency over time, i.e., inflation. The media portrays inflation as something great for the overall health of the economy and setting a 2% or 3% inflation target means that things are going great. But take a step back and look at what is really happening.

Inflation is nothing but a controlled reduction in purchasing power. The government gives you a piece of paper and says that this paper buys certain goods and services this year, but will hopefully not buy the same amount next year. That is the hope. Over the past 100 years, the purchasing power of $1 has been reduced to $0.03!

This brings us to the point of understanding the meaning of ‘Money’ as opposed to ‘Currency’. A piece of paper that is issued by a bank promising you something is a Currency. It is a unit of measure that isn’t really tied to anything and changes value on a day to day basis. The banks can alter the course anyway they wish and turn the dial up or down on its value. Money, on the other hand is a real measure of value that can translate to wealth/assets etc. Somwhere along the way, we started confusing and forgetting what the difference between Money and Currency is and started using them interchangeably.

Gold has stood the test of time for thousands of years when it comes to preserving value and is the reason why it is still considered ‘Money’ today, even though the central banks and mainstream media would want you to believe otherwise. Gold is portrayed as an antichrist, a barbaric metal, a pet rock because it doesn’t give the central bankers control for manipulation. It de-centralizes Money. It is the reason why its also classified as a commodity, so that it can be traded and more importantly, taxed. New forms of currencies (think, Bitcoin) are also quickly dismissed or re-classified as commodities because the central banks would lose control otherwise.

The following image from GoldMoney (affiliate link) illustrates how gold stores value over time.

cu16mzdweaaueys

Why Gold?

There are plenty of arguments that are parroted by folks over and over. These have no basis to what is reality about owning gold – either as a form of money, a value store and/or an inflation hedging investment. Some of the comments are presented with my response to them.

“Gold is a pet rock” No, its a metal.

“It’s a barbaric relic that has no use today” Start over to re-read this post.

“Gold does not yield anything” Money isn’t supposed to yield anything by itself. You do not get a reward without risk.

“But, keeping my cash in a bank yields something” That’s because its not yours anymore. You are risking the cash by handing it over to your bank. Read about Fractional Reserve Banking.

“Gold is a garbage investment” Start over and re-read this post + See the following chart.

gold-price

It is also not just a matter of owning gold looking at a US-centric perspective. Gold is internationally priced and quoted in US$. In addition, today’s media is also very US-centric, but citizens in other countries have to remember to think of gold in their own respective currency terms. The following image shows returns in various different currencies. I am a Canadian resident, so I think of gold in Canadian dollar terms. As you can see, the CAD$ has devalued quite a bit since the turn of the century.

Remember, gold is constant. 1 bar of gold today is 1 bar of gold in 10, 20, 50, 100 years. That does not change. It is the devalued currency that you pay for, that changes year after year.

gold-price-in-other-currencies

One of the strongest voices making a case for owning gold and spells it out for everyday investors in easy to understand terms is Jim Rickards. He has written numerous books and has been well ahead of his time about the current ongoing currency wars as countries try to outdo each other in devaluing currencies in order to boost their GDP numbers. The end game is that the population loses its savings as the purchasing power falls. The recent Brexit vote is a classic example. Once it was noted that the country had voted to leave EU, the British Pound — once a world renounced reserve currency, plummeted  overnight and wiped out everyone’s savings by 10% or so. Holders of gold were able to come out of this storm with their wealth preserved. Just look at the gold returns in GBP terms in the image above! I will leave this recent interview (run time: 53 minutes) from Jim Rickards featured on Hedgeye that touches on a lot of such topics.

What are your thoughts on owning gold? I have been vehement about owning gold, as regular readers may be aware. Do you hold any? Share your thoughts below whether you do own or do not own gold.

41 thoughts on “Why Gold?

  1. I have an ounce. But that’s about it. It’d just sitting there not earning me any dividend, no cashflow. It’d probably make more sense for me if I trade forex. But I haven’t had a clue.

    If I were going to buy some currency, I’d probably buying Mexican peso 20 peso =$1 traditionally, it’s been 15 pesos.

    Canadian dollars, euro, and British pounce, they are all going to go up along with gold once the market realize Trump is no good for the market. And everybody will seek for safe haven.

    • Hi Vivianne,
      I think you miss the point of the post — the point of gold/silver is capital/value preservation over the long term. It is not supposed to give you a dividend or provide cashflow (unless you use it as collateral and monetize it other ways). Going to other currencies are all short/medium term bets. Not saying that theres no money to be made by trading Forex, but the at the end of the day – you are still dealing with fiat currencies controlled by central banks who will do anything to decrease that purchasing power over time (read: inflation).

      R2R

  2. I would much rather buy and hold productive assets, which deliver goods or services that people need.

    Whether the currency of the land is sea shells, pieces of paper, some arbitrarily chosen metal, or a pet rock, is irrelevant.

    People will still exchange their units of labor for that currency, and then exchange that for the goods and services that the productive assets deliver.

    • Buying and holding productive assets makes sense when it comes to investment portfolios. Putting every last penny of your net worth at the whims of a stock market in order to make it “productive” may not be the most prudent move. But then again, its your personal finance and take on things.

      R2R

      • But the alternative you are proposing is to have your networth exposed to the price of a commodity (gold), which is driven by greater fool theory. In order for you to make a profit, you have to have a bigger sucker to pay more for your gold.

        The companies I own provide an actual economic value to their clients.

        If I own all productive assets in the world, and you own all the gold in the world, you would starve to death.

        It is true that the stock price fluctuates. But a portion of my total return is directly derived from the businesses earning profits, and sharing them with me ( dividends). These dividends are more directly connected to underlying fundamentals.

        With gold, all return is dependent on the moody behavior of market participants. With stocks, only a portion of my return is dependent on the moody behavior of stock market participants.

        So if people keep eating, drinking, getting sick, taking out loans, heating and cooling their homes, driving, spending, etc, those businesses will keep earning profits, and distributing a portion of those profits to me.

        If I have $1M portfolio, generating $30K – $35K in annual dividend income, its price could get down to $500K or up to $1.5M. I don’t care about stock price going up/down, as long as the fundamentals are in tact. If I generate my dividend income, that pays for my expenses, why would I care about a bear market? I remember 2000 – 2002, and 2007 – 2009 so I can sit through any correction there. I was invested in the latter.

        As for gold, its attractiveness depends on time frame used. 2001 – 2011 was a great time to own gold. If you start in 1980, Gold lost purchasing power and did worse than bonds.

        Gold makes sense if we get complete destruction of an economy, like we had 100 years ago in Russia, 70 years ago in Eastern Europe, or Europe in the 1940s, and if you have to flee with your wealth.

        Now, if our next commander in chief decides to throw all immigrants out, or wants to persecute minorities like that German guy in the 1930s & 1940s, that would be a bullish reason for gold. So would having a second passport 😉

        Anyway, you may enjoy the writings of Harry Browne, who invented the concept of the “Permanent Portfolio”.

        • Hi DGI,
          You seem to take a very black & white approach. I hope I was clear enough in my last comment that it is not prudent to go one extreme or the other. I hope my writing and communication skills arent that bad, if you got that I was recommending.

          I am not suggesting converting every last dollar you own into gold and sitting on it for the rest of your life. Same with your take (although you may feel otherwise….its your prerogative) — my recommendation is not to drive every last penny into stocks because its “productive” — investing comes with immense risks that most people seem to have forgotten over the past decade. My take is that there is a portion of a person’s nest egg that should have exposure to certain sectors and assets. There is more gray involved than simply black and white. Some people recommend 10% of your assets, but for me, I see more safety and have taken it close to 20% of my assets into gold and silver. I still hold a good 50%+ of my assets in productive companies. Heck, even my gold exposure is via productive assets via the gold mining companies.

          As for your take for gold returns — it depends on which sliding window you look at. If you look between 2011 and 2015, yes — it was a terrible investment to buy it close to $1900/oz. As for 1980, I am not sure what you mean that gold lost its purchasing power. What timeframe are you referring to. Again, you are looking at a peak of the market that got ahead of itself like it did again in 2011. If you simply keep buying without paying attention to the valuation and the animal spirits take hold in the markets, you will overpay (as investors are rushing to buy anything with a yield these days).

          cheers
          R2R

          • “You seem to take a very black & white approach”.

            I disagree. There was some nuance in my response. My individual investment approach has a little bit of a nuance as well. Or so I believe.

            “As for 1980, I am not sure what you mean that gold lost its purchasing power.”

            What I mean is that when you change your starting point, you reach different conclusions. There is an element of luck involved, and your gold investment is not guaranteed to keep its purchasing power during your unique holding period.

            For example, you used the bottom from 2001 to today, to illustrate your point of how great returns can be generated by gold.

            This is why I looked at how gold has done since 1980. It has not kept up with inflation ( assuming you held on for 30+ years), and has done worse than an investment in bonds since then.

            Anywho, I read your site, because I have been told to read stuff from people I disagree with. (based on my readings on fighting confirmation bias)

            If I am wrong, I can learn something new. If I am right, you can learn something new. So I see this conversation as a win-win. But I wish you good luck in your investment!

          • You are right, DGI. If you buy something when it is overbought and clearly overvalued like gold was in 1980 or 2011, the returns over the years do not keep up with inflation or other assets. This is why I keep harking about paying attention to valuation whether in stocks or gold or otherwise. Ignoring the valuation and simply buying at whatever the general market prices an asset at any given point in time is not the right strategy. Assets are almost always mispriced by the market and as investors we need to pay attention and hopefully pick them when they are more undervalued and not overvalued.

            There is definitely a matter of luck involved. I agree with you there. I just finished reading Michael Mauboussin’s book ‘The Success Equation’ which delves deeper into this topic and presents some very interesting points about the mix of luck and skill when it comes to sports, business and investing. I highly recommend reading it.

            Best
            R2R

          • Its an argument that has been repeated over and over which can go into economic theory and philosophy — as to how you as a human being would put a value on anything. Much has been said about it than I can ever put it, by people who are far smarter than me, so I’ll just leave this here.

            http://imgur.com/a/J3VOl

            cheers
            R2R

          • So based on your answer, you don’t know how to value gold either?

            I asked you how to value gold, because you mentioned above that it was overvalued in 1980 – when the highest price was $850 – $900/oz

            The price today is higher than the 1980 price – so does that make it a sell?

            How do you value gold?

    • I am with you on preferring productive assets over ways to store values. But perhaps I don’t have enough value to store and thus don’t correctly follow this well thought out argument – but I do respect it.

  3. Sam the Man says:

    Gold doesn’t pay me dividends, so I don’t see the point of owning it. I’m looking for a future retirement vehicle. I rather own $300k dividend growth stocks paying me $15k a year in dividends and growing than $500k worth of gold.

    • You didnt read the article, did you? 🙂
      When you go to the safety of gold, you dont get dividends. Thats the point. You are not going to reap a reward by going to the safest of the assets.

      See my comment in the article: “Money isn’t supposed to yield anything by itself. You do not get a reward without risk.”

      cheers
      R2R

      • Sam the Man says:

        I guess I want to reap the reward of my risky assets. That’s why I diversified my portfolio.

        Serious question , how are you planning to profit from your gold assets in let’s say 20 years from now since it’s not producing income ?

        • Gold is a value store. Its not supposed to produce and generate income by itself. It is a safety trade that stocks and bonds do not and cannot offer. If you do want to, you can still do it by using it as collateral and borrowing against it — I dont do it personally but I know a few people who do.

          R2R

  4. I can see the appeal of gold for capital preservation but as the other commenters have stated, it doesn’t pay me a dividend. Still gold could very well be part of a diversified investment strategy, thanks for the article!

  5. Rynlox says:

    Yes gold, but more silver. I have an IRA, 401k, and that grows and pays dividends (hopefully). My savings on the other end I keep an upper limit on. When cash on hand exceeds that threshold I like to turn it into precious metals for long term savings.

    • Hi Rynlox,
      Yes, most of what is said in this article also applies to silver. I should have added that in the beginning the article. Putting part of your nest egg into gold/silver is a very prudent move.

      R2R

  6. Sabeel,

    When it comes to gold, investors usually form a binary opinion — You either love it or hate it.

    I do my best to approach investing and asset classes with an open mind and agnostic approach. In other words, there is a time and place for everything. Right now, in an age of ZIRP and NIRP, I find is very peculiar (and troubling) that NOT more and more investors are seeing the value of holding physical precious metals and to a lesser degree the incredibly undervalued mining stocks.

    Seriously, do they think that holding fiat paper is going to preserve purchasing power over the long-term?!? Just use history as a guide; the proof is CLEARLY in the pudding!

    It’s funny, now that I’m living in HK, I have an even greater appreciation for gold and its place in an investment portfolio. Out in these parts of the world (along with say China and India and most of the east), owning gold isn’t an esoteric and strange thing… In fact, in HK there is literally a gold shop to be found on every corner!

    The west just doesn’t understand or appreciate gold much at all…

    But it is what it is… Just keep doing you and stick to your guns… Although the markets can be frustrating at times, you are definitely not wrong with your thesis here. In this juncture of the market cycle, I think it makes far more sense to own gold than to simply dismiss it because “it doesn’t pay a dividend”.

    That’s not entirely true either… Just look at a company like Franco-Nevada that has been consistently paying and INCREASING their dividend payouts for a number of years now… Yes, Franco-Nevada just so happen to be a GOLD streaming and royalty company… But unfortunately, most people are going to make blind assumptions about a sector/industry that they barely understand at all.

    Ultimately, as investors, we should be fixated on VALUE more than anything else… The gold haters wouldn’t touch gold if you offered them an ounce of physical gold for $10… In fact, just like with silver, they’d probably choose a chocolate bar over the precious metal!

    https://www.youtube.com/watch?v=G8qGDun4puM

    I say, if the DEEP VALUE is there, screw the stupid dividend (can you say Shiny Object Syndrome?) and buy hand over fist… With the current selloff, we are getting to that point again where DEEP VALUE can be found in spades within the gold sector.

    All the best!

    • Haha that video made me laugh. Its hilarious to watch people’s reaction when you say that its a silver bar. People really dont know the value of things these days lol

      You make some great points and that is why I enjoy discussing all things investing and psychology with you. Remaining agnostic about things is the best thing to do when it comes to investing. For most people, it seems to appear that I am going off the deep end and becoming a gold bug — but the fact is that the fundamentals simply points me in that direction and it presents a great opportunity that I find attractive. If that changes over the coming years, I wouldnt think twice about selling and going elsewhere. I have said it in the past on this blog — falling in love with one investment or even investment philosophy is the worst thing you can do to yourself. I try to stay neutral and try not to let me emotions drive my investment decision. Unfortunately, it cannot be said for most others.

      The eastern countries definitely put more value into real money. The west is too distracted by paper and have completely forgotten what the meaning of money is. Losing this meaning is not the first time its happened and wont be the last time.

      Thanks for stopping by and the comment
      cheers
      R2R

  7. Nice summary of some of the drivers of gold. And the multi-currency prospective is a good one.

    Personally, I think the days are numbered for the Euro. AndChinese capital flight isn’t going to slow down. Gold doesn’t seem like a bad place to be at all.

  8. There’s room for gold in every portfolio. I’ve been buying silver stock, not much gold. But gold just dropped a bunch earlier this week. I’m probably going to grab shares in the space. Which gold stocks do you recommend?

    • That is the basis of my argument — that each portfolio should have a little bit of exposure to gold. If you are looking for a safer venture into the gold market, streaming/royalty companies can be better. You need look no further than Franco Nevada — its the best of the breed. I believe it is the Berkshire of the commodity world. I wrote about it recently in this article: http://roadmap2retire.com/2016/10/3-recent-buys/

      cheers
      R2R

  9. I’m somewhere in the middle here. I’ve bought metals. No mining stocks, but actual physical bullion (mainly silver, but some gold and copper as well). I’d classify the mining stocks as buying “productive” assets rather than storing your wealth in precious metals since you are buying a business, but I digress.

    While I have diversified into precious metals, it’s the black sheep of my income-focused investment portfolio. I think the issue for me is that gold isn’t SUPPOSED to be an investment. It’s supposed to be money! And that’s a huge difference.

    As for gold vs dividend stocks, people (including myself) drift towards the latter due to its increase in INTRINSIC value, which is the key. It’s not just that one spits off income. Even if we were to take away the “dividend” part of the equation, buying stocks means buying businesses that grow each year. That increase their intrinsic value over the long term, not just their share price. With gold, it’s about preserving your wealth, but not growing it. Now of course as you said, gold isn’t SUPPOSED to build your wealth or pay you a dividend. But I think that when faced with declining real wealth, many people would rather take the (rather minimal) risks of dividend stocks that build and compound your wealth than to simply protect and preserve it.

    The debate also surrounds HOW you want your investment dollars to make money. A lot of total return investors don’t understand that dividend/income investors don’t care about net worth, capital gains, or stuff like that. They care about cash flow: dividends, interest payments, rent checks , royalties, tangible money/currency that can fund their lifestyle NOW, not in 30 years when it’s time to sell. As far as it’s a straight investment (for wealth preservation purposes or otherwise) and not money, I think gold falls under the former camp. It’s capital gains, leaving many income investors to ask “What the hell am I supposed to do with this gold as a long term investment? Sell it a decade from now? I want to replace/supplement my employment now or soon, not when gold doubles in price”.

    For me, like I said, I diversified into it a little bit, but only a little as it goes against my broader investment philosophy and end goals, which is to invest in assets that grow in intrinsic wealth and provide me a growing source of cash flow and income. Dividend stocks are, to me, a very minimal risk over the long run. I sleep well at night with businesses in my portfolio that survived, remained profitable, and grew their dividend during the recession. And as I’ve said in other posts, your portfolio is only as good as it’s ability to help you sleep well at night.

    And of course, this isn’t to say that you’re arguing against dividend stocks. You have said multiple times that you are still in them with at least a third of your portfolio dedicated to them. So to imply that you are suddenly against income producing assets is silly and out and out inaccurate. But like Dividend Growth Investor above, I like as much of my wealth as possible growing, compounding, and producing cash flow. Doing this not just provides a numerically similar return as a gold portfolio does (I assume), but also does so in a manner that I approve of (cash flow > increasing net worth or simply storing wealth) and with acceptable levels of risk and diversification (a dividend growth stock portfolio on its own can contain businesses across multiple industries and geographies, to say nothing of someone who also invests in rental properties, P2P lending, bonds, and who has royalty checks coming in from a licensed product idea, and ebook, or something similar).

    I would love to see fiat currency abandoned and gold or some other commodity become money again. On that topic, have watched anything by Mike Maloney? I never heard of there bring a difference between money and currency until I watched his videos about 6-7 months ago. Curious if you follow him at all.

    Sincerely,
    ARB–Angry Retail Banker

    • BINGO!
      You hit the nail on the head there, ARB. I think you get it — and put it more eloquently than I have in this or other articles.

      I see tremendous value in owning companies paying dividends and seeing that grow over the years and providing me with income. As you have observed, I still have about a third of my portfolio in such companies and am happy to see them chug along. Just because I am suggesting and making a case for holding gold in part of my assets does not mean I am abandoning the div growth stocks. Gold is a value store and allows you to hedge your risks for long periods of duration.

      Owning stocks comes with inherent risks that most people tend to forget — yes there are plenty of companies that have done very well over the years and may as well continue to do, but what happens when those companies face hardship and are hit with problems that they didnt anticipate? In addition to seeing a drop in share price (which I reckon many investors dont care about), we see shrinking earnings and dividend cuts. At this point, most investors tend to think its ok to sell those stocks — which is too little too late. They bought high and sold low after the carnage. When these problems are widespread, you tend to realize that owning safer assets may have been a good option.

      I have watched a few videos of Mike Maloney. Really well done videos and simple to understand.

      cheers
      R2R

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