For all the sophisticated “gold bugs” out there, there are not a lot of “revelations” in this commentary – so you might want to move along in search of something deeper. However, as retail investing in precious metals increases (it rose by nearly 400% in 2008), there are obviously many new, novice “gold-bugs” - and even larger numbers of the “gold-curious."
These are people who are shocked and worried by bleak economic conditions and the global monetary crisis. They are now looking at investing in gold (and silver), possibly for the first time – but are unclear as to why precious metals investments are becoming so popular.
Most novices to this sector have been programmed to view gold and silver as simply two commodities. However, it is impossible to understand and appreciate the tremendous appeal of precious metals today without understanding that gold and silver are also currencies.
What is money?
This seemingly simple question is a necessary starting-point in understanding precious metals, precisely because very few people have ever been given a precise and comprehensive definition of “money”. Real “money” must possess the following four, central properties:
It must be a “store of value”
It must be “precious” or scarce
It must be “uniform”
It must be evenly divisible
Clearly, it is the first two properties which are of paramount importance, and which exclude most of the “candidates” as possible forms of “money”. The criterion of money as a “store of value” is self-explanatory: real “money” must be able to retain its value over the long term. This is precisely why no paper currency currently in existence qualifies as “money”.
This can be demonstrated simply by looking at the world's current (and discredited) “reserve currency”: the U.S. dollar. Since the time the U.S.'s “central bank” was created, less than century ago (the Federal Reserve), the world's “reserve currency” has lost 97% of its value!!
Thus, based on analysis of only one of the properties of money, we discover that none of the scraps of paper which people carry in their wallets is actually “money”. So what are these currencies, then? They are nothing more than government I.O.U.'s.
This truth is of huge significance for two reasons. First of all, many governments (including many of the so-called “wealthiest” nations) are of questionable solvency. In the case of the United States, there is no “question”. The U.S. is hopelessly insolvent. As is common knowledge to many, the U.S. is currently being crushed by a mountain of public and private debt which exceeds $50 TRILLION. Separate to that, the U.S. has another $50 TRILLION in “unfunded liabilities”. This comes at a time when the huge bulge of retiring “baby-boomers" are about to make claims on that additional $50 trillion.
For those holding U.S. dollars, or assets priced in U.S. dollars, how comfortable should you be in holding the I.O.U.'s of a hopelessly insolvent entity?
Gold and silver, on the other hand, clearly qualify as “stores of value”. A commonly used example is that an ounce of gold should be able to buy a man's suit, of good quality. This remains as true today as it was a century ago. Compare that to the disintegration of the U.S. dollar.
Let's move on to the other three properties. Money must also be scarce or precious. We could not use chips of plastic, or coins of wood or iron (or scraps of paper) as “money”, because the supply could be increased so rapidly (in virtually infinite quantities) that the world would quickly be “flooded” with such currency (not to mention counterfeiting) – diluting its value. Thus, “money” must be precious/scarce or it will eventually/inevitably fail to meet the first criterion of a “store of value”.
Gold and silver pass this “test” precisely because they are relatively scarce in comparison to other commodities and elements. There are many commodities that qualify as scarce, however, so to further distinguish gold and silver we must move on to the final two qualities.
Gold and silver are “uniform”, meaning that if you held a handful of gold and silver coins, each coin would be identical. By comparison, diamonds and other gemstones are clearly “scarce” and “precious”, and have been used in a similar manner to gold and silver, at times during history. However, they never acquired wide popularity as “money” because of the wide variation in quality/value of different specimens.
Finally, being “soft” metals, gold and silver are easily divisible. It is this property which allowed ancient human societies to begin to use gold and silver as money as far back as five thousand years.
We can now see that not only are gold and silver “real money”, but they are the best forms of money to have ever been devised by our species. With many people having been frightened into liquidating their assets in order to feel the security of holding “money”, how “secure” do you feel holding scraps of paper, in comparison to the security you would feel through holding gold and/or silver?
Why buy bullion today?
There are an enormous number of reasons why gold and silver become more attractive (and necessary) in times of economic turbulence. To keep this commentary simple, and relatively brief, I will restrict this analysis to an explanation of why gold and silver have unequaled qualities in either an inflationary or deflationary crisis.
The appeal of gold and silver during inflationary periods is simple and obvious. Recalling the previous discussion of gold and silver as “stores of value”, it is during times of high inflation that gold and silver are most superior to other assets in holding their value. This is true regardless of whether we consider precious metals as commodities or currencies. Indeed, it is the fact that gold and silver are commodities and currencies which is why they have always been preferred assets in times of high inflation.
The appeal of gold and silver in a deflationary crisis is only slightly more complex. As we have seen, many people have regressed to holding cash as a response to the deflationary spiral currently taking place in the United States. Why have they done this? Because this deflation has been caused by a plunge in asset prices, and severely aggravated by mounting defaults in a broad range of asset categories.
Conversely, gold and silver have zero “counterparty risk”. In other words, as assets, gold and silver can never “default”. More importantly, we now see that even the world's (supposedly) wealthiest nation is now on a clear path to default and bankruptcy – due to a massive accumulation of debt which could never, possibly be repaid. If you think U.S. dollars have been losing their value rapidly over the last century, consider how much more quickly they will lose their value as the U.S. moves closer and closer to outright bankruptcy.
Do NOT purchase “bullion-ETFs"
When first unveiled to the market, bullion-ETFs (such as GLD and SLV) seemed to be the perfect investment vehicle for small investors wishing to “hold” gold and silver, in a form which could be easily sold, and did not impose any storage costs on buyers.
However, as the (supposed) holdings of these bullion-ETFs have soared, their obvious flaws are now apparent. In just the first quarter, numbers released by the World Gold Council show that over 400 tons of “gold” was purchased through ETFs. Indeed, total holdings in bullion-ETFs now exceed the national holdings of almost every nation on Earth.
Consider this: the United States claims to have the largest reserves of gold in the world (supposedly over 8,000 tons). A battalion of its army is permanently assigned to guard Fort Knox – despite the fact that this purported hoard of gold has not been independently audited in more than 50 years and many “gold bugs” strongly suspect that its vault is empty (see “GATA seeks audit of MYTHICAL, Fort Knox gold”).
Furthermore, as gold (and silver) demand has soared, even established dealers have been forced to pay record premiums for the purchases of gold and silver bullion.
In contrast, bullion-ETFs claim they can purchase gold and silver with no premium, and in infinite amounts – and then store these vasts hoards of gold and silver at zero cost. How can this be possible?
With only a few, rare exceptions, no “bullion-ETFs" hold any gold or silver. Instead, all they hold are “paper promises” to deliver gold. These promises are being made by the same bullion banks who have been directly involved in dumping vast quantities of bullion onto the market to suppress the price of gold and silver (see “Silver Manipulation the worst in history...”).
As with the supposed gold-hoard of Fort Knox, none of these bullion banks are ever audited, and forced to demonstrate that they actually hold enough bullion to satisfy any and all obligations.
Thus the same bullion-banks who have been dedicated to destroying the gold and silver market also claim to be willing to “sell” (and hold) infinite quantities of gold and silver for bullion-ETFs – with zero profits for themselves. How many people think any bank would do anything for free?
The reality is that bullion-ETF's are just another Wall Street scam (see “Bullion-ETFs: a multi-purpose scam”), with the exception of the small number of reputable bullion-ETF's, whose prospectus clearly states that they buy and hold real gold and silver. Naturally, these entities do charge premiums – to pay for their purchasing and storage costs.
Don't forget about silver!
Even many hard-core "gold bugs” are now openly predicting that based on current prices it is silver which has a brighter future than even gold. There are two central reasons for this belief.
First, there is the gold/silver price ratio. For most of history, this ratio has averaged roughly 15:1. However, currently, this price ratio has swung to an extreme ratio of nearly 70:1. This alone should make silver an automatic first choice among investors.
The case for silver becomes much more compelling when we consider how most silver is used. Many people currently refer to silver as an “industrial” metal, despite its obvious status as both a precious metal and a currency.
The reason for this is that silver is also a superior input of countless goods and products, which are increasing demand every day (see “Increasing demand for Silver comes from many sources”). Not only is this a large component of demand which does not exist with gold, but because most applications use silver in small quantities (per unit), most silver used “industrially" is permanently “consumed”.
Therefore, at the same time that the gold/silver price ratio has swung to an extreme, favoring gold, the actual supply of silver (compared to gold) has never been lower in 5,000 years.
Hopefully, this will serve as a good introduction for novice investors to this sector. However, precious metals investing is not limited to direct investment in gold and silver. In “Part II”, I will endeavour to explain the appeal of gold and silver miners as investments – at a time when the valuations of these companies has never made them more attractive.
Disclosure: I hold no position in GLD or SLV.