Dollar vs Gold
What is the Deal With Gold?
"Gold is a great thing to sew into your garments if you’re a Jewish family in Vienna in 1939, but I think civilized people don’t buy gold, they invest in productive businesses."
-Charlie Munger, Vice Chairman of Berkshire Hathaway.
"In Truth, the gold standard is already a barbarous relic."
-John Maynard Keynes, economist.
Gold. Nothing creates more controversy than mentioning gold in relation to investing. Many investors claim that gold has no value, that it does not produce wealth, and therefore one should not invest in it. As the quote above by John Maynard Keynes alludes to, he thinks that gold is a barbarous relic. He is talking, in this sense, about how gold has a minimal role in the economic model set up by the Bretton Woods agreement (established in 1945 after world war two. It made the dollar the reserve currency for the world, and made gold a secondary player as money).
Should investors consider gold as an asset for a portfolio? To better answer that question, I would like to show you two charts:
The Devaluing Dollar
Both these charts clearly show a trend: gold is going up in value while the dollar is going down. This is not a recent trend. Ever since the Federal Reserve was established in 1913, the dollar has lost over 95% of it's value in relation to gold. Why? The dollar is not tied to any backing. It is a fiat money that can be printed at will by the government...and it has been. We now have Trillions of dollars in the system. As more dollars are printed, the value, or purchasing power of each individual dollar drops.This is inflation. For this reason alone, it may seem that gold has a place for investing, but there is more one must consider.
Saving and Investing
The distinction between what is saving and what is investing also needs to be understood. If someone produces more than he consumes, and refrains from spending the excess, he is saving (sometimes referred to as hoarding...as if it is a bad thing). This is a form of growing wealth. If someone produces more than he consumes and decides to take the difference and lend it to a business or the government and expects a return of his initial money with compensation, such as interest payments or capital gains, he is investing. It is also another potential for growing wealth. Investments are usually done from savings, but people or institutions also borrow money to invest as well (still, someone somewhere had to save for there to be investing capital...unless it is simply printed money, but that is a point to expand on another day).
In essence, savings are simply holding onto excess reserves, while investing is putting those excess reserves "to work". It is important to realize that when one invests, one exposes his capital to risk. Instead of making gains, he can lose all or a portion of it. As a matter of fact, investing is much more risky than most people realize. Take stocks, for example. An investor, before buying a stock, should examine the balance sheet and cash flow statement of the company. Does it have too much debt? Does it have a positive cash flow? If not, why not? What is the company doing to insure future positive cash flow? What are the long term trends of the industry? Does the company pay dividends? These, and many other questions should be satisfactorily answered before the the investor buys the stock. I guarantee you that most investors do not delve this deeply into their investments. He leaves too much to chance...and he will most likely see a loss of his capital.
One other point investors need to be aware of is that his investments must at least match the rate of inflation just to break even. The mainstream economists say that inflation is running between 2 to 3 percent annually. I beg to differ. Shadowstats.com measures the rate of inflation the way the government used to back in the 1970's. This organization shows that inflation is actually closer to 10%. In any case, an investor must make a return on his money of at least 3%, every year just to break even. This, in and of itself, is a risky proposition.
To invest properly, one also needs to be aware of counterparty risk. The free-dictionary describes counterparty risk as follows:
Counterparty risk is the risk that the person or institution with whom you have entered a financial contract -- who is a counterparty to the contract -- will default on the obligation and fail to fulfill that side of the contractual agreement.
All paper investments have a counterparty risk. It may be big, it may be small, but the risk is there. Companies could go bankrupt. Municipalities may not be able to pay their bonds at full face value. Financial institutions may go under. And yes, counterparty risk applies to the dollar, along with all fiat currencies. The fact that the dollar has steadily lost it's value is a symptom of counterparty risk.
Gold, on the other hand, does not have a counterparty risk. It is an asset in it's own right. It will hold it's value, whatever it may be. Take heed, though, for if one decides to use a financial institution to hold his gold, that is exposure to counterparty risk. One must weight the risks and benefits of personally holding his gold or using a third party institution. There are trustworthy institutions, but one must do his due diligence to minimize his risk. As an example, Gerald Celente of trends research lost $200,000 worth of gold because the institution he used did not hold up it's end of the bargain (this happened to a man who does his due diligence..showing that there is always risk).
How Investors View Gold
Many successful investors do own gold. Typically, they own anywhere from 5 to 10% of their wealth in precious metals, mainly gold, but also some in silver and platinum. The reason? Simply as a hedge against inflation. Generally, there is an inverse relation between the devaluation of a fiat currency and precious metals: as more dollars are printed, gold goes up in value; and if there is a contraction in the money supply (dollars), the value of gold will go down. The remainder of their portfolio will be in businesses,stocks, real estate, bonds, and some in cash for liquidity.
My Two Cents Worth
I think the view of successful investors in relation to gold is a prudent one, but I have a different take that makes more sense to my situation. I am middle class, which means that I have some money left over at the end of the month, but not much. I cannot muster enough capital to make investments in stocks or real estate pay off, much less afford the risk. I am simply looking more to save my wealth (yes, that means I am hoarding), but by holding my wealth in cash, or bonds for that matter, I will lose purchasing power over time (bonds are paying rates that are below the rate of inflation). As an example, if we are seeing just a 3% inflation rate, money (in dollars) I have saved now will only hold 70% of it's purchasing power in 30 years. That is a losing proposition. As a matter of fact, I am willing to bet that is a reason we see such low savings rates in this country lately. Most people know on some level that their dollars simply will not be worth much later on.
It seems to me that the best bet I have for maintaining purchasing power of my hard earned savings is to buy and hold precious metals. I have better faith in that over government bonds or a savings account whereby I am holding dollars. This does not mean that I will only hold precious metals, for if I see a good investment, I will sell off some of my metals and put my capital toward that investment. I also do buy some stocks, and when real estate is a better investment, I will consider that too.
This brings us back to the original question: Gold vs. Dollar? With all things considered, gold plays an important role in wealth preservation and savings. If the last 100 years have anything to say about it, gold is the best place to put your wealth to maintain purchasing power with very little risk. As long as an investor buys a little at a time to smooth out the highs and lows (this is dollar cost averaging), he can confidently preserve his wealth.
Right now, gold is going for over $1,500.00 an ounce (wow! it used to be $35.00 an ounce in 1945). This is out of many people's price range, but silver can be bought for roughly $30.00 an ounce. It has many of the same qualities of gold. It is a bit more volatile, but it can still be used as a form of wealth preservation as well.