Has gold lost its glitter?
Posted by adesigar on September 14th, 2006
Gold is a precious metal that for many centuries had been used as money, a store of value. Gold is an asset that it is rare, tangible and liquid (easily traded). Its high density and high value per unit mass make storing and transportation easy. Gold is unaffected by heat, moisture, oxygen and all corrosive compounds except aqua regia. This made gold the perfect metal for trading and eventually banking.
Gold prices have been soaring from its 1999 bottom at $252 to $730 in 2006. Prices have dropped off since, but the Gold bulls say the metal will move much higher. Most of them are proponents of Full Reserve banking with gold as the backing asset aka the gold standard. Of course they want full reserve banking, it would increase the value of the gold they own. It sounds good in theory but its not going to happen, lets look at some numbers. It’s estimated that all the gold ever mined totalled 145,000 tonnes, this equates to a value of $3 trillion in April 2006. The US Money supply known as M2 consists of cash, checking, savings, money market and CDs is 6.5 Trillion. So to back up its currency with gold the US would need to buy twice the amount of gold mined in history.
Gold lost any role it had as a form of currency with the end of the Brentton Woods system in 1971. Since then most banks have been selling their gold reserves. Now the only factors that determine gold prices are supply and demand. Excluding its past as a form of currency, gold has limited use. Its major uses are Jewelery, Dentistry and Electronics. Compare this with other metals and you realise that the metal is pretty useless. Unlike base metals gold never gets used up, its advantage of being non corrosive and unaffected by the elements means that virtually all the gold ever mined still exists and can come onto the market at the right price.
“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.”
Warren Buffett - 1998
The few positives for gold are. Its tangible so if the investment is made in the actual commodity the value will never go to zero. In times of war when hyperinflation takes over, currencies become worthless but physical gold will hold its value (Its for gold bugs that fear war, the second depression or armageddon is just around the corner). I personally dont believe in the future of gold unless someone finds commercial use for it. Whatever glitter gold may have had in the past it’s long gone.
For people looking to invest in gold I ve included the bull and bear arguments and the various options to owning gold.
Gold bull argument
- Demand from India, China and the middle east has increased because of increase in disposable incomes.
- Russia, China and a few other central banks may increase gold reserves to protect themselves from overexposure to a falling dollar.
- The huge US trade defecit means the dollar will lose value over the long term and Gold will move higher.
- There is increased demand for gold from investors that can buy small quantities thru ETF’s like Streettrackers Gold GLD
- International conflict, terrorism or uncertanity increases demand for gold because people buy it as a form of insurance.
- The new gold supply is 2500 tonnes while demand is 3500 tonnes. The difference is being made up by Bank sales, scrap sales and hedging.
Gold bear argument
- India, China and middle east economies are based on trade with the US. When the dollar decreases the disposable income in these countries will decrease which will in turn reduce gold demand.
- Currently the Chinese and Indians are in a transition period, their cultural belief of gold as a form of investments and a status symbol coupled with increased incomes has increased gold demand. Both these countries are getting increasingly americanised and in the not too distant future stocks will be their preffered form of investment and gadgets, sports cars etc will take over from gold as status symbols.
- There are better ways to invest against the falling dollar. Gold has doubled in value compared to the US Dollar but most of this gain in due to the dollar falling against currencies like the Euro. If your investments were in Euros the gains would work out to just 35%. Its better to invest in international stocks as a hedge against the falling dollar.
- Its best to buy gold when its low. For now the gold bull market is over. Gold along with energy usually peaks at the top of a stock market cycle. We’ve moved from that phase to the start of a bear when consumer non-cyclicals and healthcare are the new darlings.
- Banks still hold around 25,000 tons which could come onto the market at the right price. Currently all government banks combined are restricted to sell 500 tonnes anually.
- Gold was in a 20 year bear market and unprofitable mines were closed, very little exploration was taking place. With current prices of gold there will be a lot more supply coming online.
Investing options - There are different ways to invest in gold and the investment option depends on the reason for investing in gold. Some people buy it as a form of insurance, while others want to invest in gold as a hedge or to diversify their portfolio.
Insurance: If the reason for investing in gold is to hold it as a form of insurance against Inflation or Hyperinflation the best option is to buy gold Coins or Bars. Coins are easier to trade and they are easier to hide. Another plus for coins is they are gauranteed by governments v/s bars that are gauranteed by mining companies. The coin with the smallest premium over the gold price is usually the South African Krugerrand. The following 1 ounce gold coins are the most common.
- Australian Nugget
- Austrian Philharmonic
- British Britannia
- Canadian Maple Leaf
- Chinese Panda
- South African Krugerrand
- USA Gold Eagle
If you dont want to buy physical gold you could invest in Streettrackers Gold GLD which allows you to own gold without the hassle.
Low Risk Investment - Invest in a Gold or Metals and Mining fund. The safest way to invest in gold stocks.
- Vanguard Precious Metals and Mining (VGPMX)
- Evergreen Precious Metals (EKWAX)
- USAA Precious Metals and Minerals (USAGX)
- First Eagle Gold (SGGDX)
- Oppenheimer Gold and Special Minerals (OPGSX)
Medium risk Investment : Major or low cost Gold Producers, Diversified Mining companies
- Anglo American (AAUK)
- Barrick (ABX)
- Newmont Mining (NEM)
- Goldcorp (GG) - Lowest cost producer but extremely poor management in my opinion.
High risk Investment: Minor Gold producers which are usually takeover targets for major producers to increase their gold reserves.
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