Gold Will Rise, If It's Money

At the heart of the wild volatility and trading volume we saw last week is the underlying credit and monetary crisis: the value of many debts is becoming increasingly difficult to identify, and as the US government continues to agree to expand the money supply to bailout overleveraged banks and brokerage houses, the value of the US dollar is becoming suspect as well.

In times of monetary uncertainty, gold has historically been viewed as a safe haven -- and so, unsurprisingly, we saw gold make a record jump as well. Many economists, particularly those who subscribe to the Austrian school of economics, believe these problems are far from over, and view gold as a sound long-term investment.

This begs the question: why is gold a safe haven investment? And will it continue to be one?

Gold has historically been thought of as a safe haven currency because it was, for much of history, real currency in virtually every part of the world. There was sufficient global demand and supply to make it easily exchangeable -- a key quality of any reliable currency. Even up until 1973 the US dollar was backed by gold, meaning dollars could be exchanged for gold at a fixed rate.

Many economists predicted that with the end of gold convertibility, the value of gold would fall. Instead, the opposite happened: gold rose, and the US dollar fell. That trend still is intact today, and gold continues to be viewed as a safe haven investment -- in spite of the fact that it has declining utility value (meaning real use value), as well as the fact that no currency with significant circulation is pegged to gold.

So will gold continue to rise in value? In the event of a global monetary crisis, something that seems increasingly likely, will gold become a currency?

Certainly there are some indications that this may be the case. One such example is in Vietnam, where a volatile currency is causing some assets to be priced in gold.

I personally do not like to bet against thousands of years of history, and thus view gold as a key part of any wealth preservation strategy in a turbulent economy. With that said, below are some arguments why gold's status as a safe haven investment, and thus its rise in prices, may be in question:

1. We live in times of great speculation, as evidenced by the record setting trading volume we saw this past week. With speculation so accessible, it could be argued that the best form of wealth preservation is diversification. If diversification via speculation replaces buy and hold as the dominant investment strategy, gold may benefit -- but not as much as those who are very bullish on gold would suggest.
2. Synthetic investments, like ETFs, are a natural by product of an increased appetite for speculation. Moreover, synthetic investments create a new opportunity to diversify risk across an array of assets, and thus could be viewed as an increasingly valuable risk management tool.

Which begs the question: with the ability to enable greater liquidity and risk-diversification, could a well structured synthetic investment be a safe haven? Moreover, could the right synthetic be a currency? Some may say fiat currencies -- currencies like the US dollar and Euro, which are unbacked by "real" assets -- are already synthetic investments, just not ones that are diversified well enough, and where supply and demand are not balanced enough.

Certainly we are in revolutionary and unprecedented economic and financial times. Many compare our current climate to the stagflation environment of the '70s or even the Great Depression of the '30s -- though there are some key differences, most notably the increased role of credit in today's markets, increased globalization of trade, and greater securitization of assets. As such, these factors may suggest a radically new form of monetary policy is necessary.

Of course, as noted earlier, I am reluctant to bet against history, and thus remain very bullish on gold over the long-term -- I would imagine for at least three years. Though I'll be on the lookout for new synthetics. Maybe a starting point is the gold ETF (GLD), which jumped last week as well.

Disclosure: I have a long gold position.

Comments

[User 267182:]

Gold has no counterparty risk. Can any derivative (including the US dollar) say that?

2008 Sep 22 12:36 PM

[GMiki1:]

Vietnam has become the world's largest importer of gold, over India. Gold is definitely money. Silver is golden.

2008 Sep 22 01:03 PM

[buyitcheap:]

It has always been money.

2008 Sep 22 01:23 PM

[No saturation:]

Your definition of long term is "at least three years"?

2008 Sep 22 01:36 PM

[Larry House:]

I never, never thought I would get to this point, but I am so sick of the greed that has ruined our economic system that it makes me want to never put another penny in a stock or bond. And now greed and corruption is surfacing with 401 plans. I would put every penny I have in gold bullion, but then my dear government would probably confiscate it all. Where is one to turn?

2008 Sep 22 02:17 PM

[css1971:]

Gold isn't an investment. It doesn't grow in value, what a gold coin could buy you in 200AD, a similar gold coin can pretty much buy you today. Gold is a store of value, not an investment.

That said, most of what are considered "investments" today are not investments either, they only appear to increase in value because the currency is devaluing at 10%+ per year.

2008 Sep 22 03:01 PM

[Heph:]

Try silver or platinum or Rhodium if you are afraid of the gov't taking your gold. They are pool accts. available at kitco.com in the above, gold as well. Or you can take physical delivery. There are still some options.

2008 Sep 22 03:05 PM

[bearfund:]

LarryH, save $1000 or so out of that "every penny" and buy some guns. Sad but true. And don't be afraid to use them. What's the alternative?

2008 Sep 23 03:15 AM

[iknoknot:]

as much as the wall-street elites hate the metal and try to make it go away, every couple of years the rest of us get reminded how well gold stands up to the tests of time. this is as it should be. kind of a market watchdog.

it will fluctuate - sometimes more than we like - but it will never go away.


--ikk

2008 Sep 23 04:36 AM

[D-D:]

What online broker do you recommend to buy gold from?
valuestockinvestors.bl.../

2008 Sep 23 09:30 AM

[goldis4ever:]

>>>>What online broker do you recommend to buy gold from?<<<<&...

try goldline.com/

2008 Sep 23 05:39 PM

[User 30121:]

Thank you for the article!

I, like you, believe gold is a KEEPER! I like your word: synthetics describing ETFs. I wouldn't touch one, period. Its just a piece of paper, like a stock or bond, and its WORTHLESS! Why? When the s..t his the fan, WHO DO YOU TRUST to give you your gold or silver from ETFs? Theres your answer!

2008 Sep 23 06:35 PM

[User 30121:]

To LarryH: The way ANY confiscation will take place is when UNCLE will rape your safety deposit boxes. So, don't keep any PMs there. Otherwise, they can't get at it, since they don't know you HAVE it!

Buy Gold and Silver bullion and, of course a safe. And as bearfund suggests, a gun, too.

Your local coin shops, precious metals dealers, Ebay, and the bullion dealers. BUT BEWARE of the latter. If they can't deliver WITHIN five days, run, don't walk away! Never, I mean NEVER get into a POOL ACCOUNT with a bullion dealer. That is just another way of giving your money AWAY!

2008 Sep 23 06:39 PM

[User 30121:]

To: DD, goldis4ever:

Tulving is a solid choice. Sound, dependable, HONEST!

2008 Sep 23 06:41 PM