As you may know, there are a lot of articles written about Gold (both bull and bear cases) and there are numerous websites reporting on the latest headlines and price charts on a daily basis. Therefore, I decided to change the direction to focus on how we see gold and the effects it has on the lives of ordinary people around the world.
In the beginning, there was gold
For those who think I am going all biblical, I can assure you that I am not, but I am not far off because gold is the first metal in the world. It was used as early as approximately 6000 B.C., almost 2,000 years earlier than copper.
The properties of gold are fascinating, but briefly, it melts at over 1,000 degrees Celsius and conducts electricity and heat. But what you may not be aware of is there is another yellow metal, iron pyrite, which looks like gold and is also known as 'fool's gold'.
The Economics of Gold
Since we don't know how much gold is there in the world because estimates range from 155,000 tonnes to 2.5m tonnes, let's amuse ourselves and trust one of the media outlet, Thomson Reuters, and they estimated gold to be around 171,300 tonnes.
The next question you may ask is: "What is the total value of the gold in the world?"
Well, the answer is quite simple if we calculate one ton of gold equals to 29,167 ounces, then using the current price of gold of $1,300, we will get $37.9m per ton of gold. So the total value is: $37.9m x 171,300 tonnes = $6.5 trillion dollars. It may sound like a huge sum, and it is (this amount being bigger than the German economy or some other similar comparable metric we could think of), but in terms of the global wealth, it is just a drop in the ocean representing only 2.7%, according to a Credit Suisse wealth report in 2013.
Some people would say that nobody owns gold, and therefore, prices would only go higher. These are being echoed by people like legendary investor Jim Rogers and gold expert Jim Rickards, the latter mentioning that gold price would jump to $7,000/oz by 2015.
Let us entertain the $7,000/oz price and see what would it do to the world economy if gold were to represent 14.5% of total global wealth - this being $35 trillion. The thought that people would increase their gold holdings from 2.7% to 14.5% seems far-fetched, and if it were to happen, I would say people are going to buy government bonds and sell equity. Why? Because holding gold is like holding on to fear, or to put it in another way, is to preserve the value of your individual wealth.
Another thing to take into account when assessing the value of gold is to look at the two biggest holders of gold, India and China. Both these countries hold a lot of gold, though the real figure is very secretive, or in China case this being 'a state secret'. The latest available data we have are as follows:
1) The cumulative holding of gold in China is approximately 7,000 tonnes in 2013, up from 1,000 tonnes in 2000 (according to Gold Silver World website).
2) Indian households are holding TWICE as much as China, recording 18,000 tonnes by 2011 (according to research firm Macquarie).
It means in terms of asset allocation, the Chinese hold about 1% of gold in their portfolios, and the Indians hold roughly 12% of gold in their portfolios (note these may not include the central bank holdings). Some people would suspect the Chinese figures could be highly misleading as this is below the global average. Given the fact that China was the largest importer of gold last year, and the fact that gold is selling like hotcakes, Chinese holdings are more likely to be much higher.
Warren Buffett is bearish on Gold
The Sage of Omaha's analogy on gold is that you can buy 100 acres farmland that can produce cash flow for you every year (assuming normal weather conditions, of course) or buy gold where the only major purpose for it is to sit in the house looking pretty. This statement is a devastating indictment on gold from the legend himself, but is he right in saying that it is unproductive and does not contribute to society? We can see why he may have a point because in certain countries such as India, they need the infrastructure spending the most so that society can have a better future. But this is hard because gold is one of the highest imported products, causing a trade deficit to the country (meaning the Indian Rupee depreciates in value, reinforcing the buying of gold to maintain its value). I personally believe that some of that gold should be used to fund renewable energy resources such as solar, wind and others, instead of importing lots of oil, coal and gas that would continue to degrade their environment.
But on the flip side, gold is an asset that could preserve the value of your wealth. You may have heard many times and in particular from the gold bugs talking about how currencies lose value over time - for instance, the US Dollar has lost about 95 to 98% of its value since the 1920s.
Although it is true, Warren Buffett implies that people could increase the value of their wealth by investing in the stock market or more importantly you could invest in an asset that pays out a dividend, especially if that dividend increases year after year. And if you're a long-term holder, this dividend could return 100% of your investment in a year, just like Buffett's investment in the Washington Post where it now pays Buffett more than 300% in his investment as dividend each year.
Gold as a way of preserving wealth has that characteristic, but as it is cyclical, the price is very volatile. However, in my opinion, holding gold as an asset should be no more than 3% just in case QE would lead to future inflation. If you're bullish on gold, then you should be bullish on China. This is because the rise in the price of gold coincides with the rise in the Chinese economy and possibly a rise in the Chinese currency.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.