Note: This article was originally published in May 2011. Given that gold’s featuring prominently in the news, we wanted to show how much — and how little — has changed in two years.
Jason M. Pereira, MBA, CFP, CSWP, FCSI, FMA is Financial – Consultant at IPC Investment Corporation
Why gold? I do understand why people are bullish on gold, but in the end it’s just a shiny yellow metal. With any other metal, price is dictated by metallurgical value, utility, and the laws of supply and demand. But precious metals such as gold are treated as an alternative currency, driving the price to a level where almost every possible use for it is no longer cost-feasible — it gets priced out of the utility market.
Whenever I ask, ‘Why gold?’ I always get an answer packed with references to ‘thousands of years of history.’ But history in itself does not constitute proof if the premise is false. At one time in history, seashells were used as currency and tulip bulbs cost more than houses. Does that validate their monetary value today?
True, pre- and post-Bretton Woods, the gold standard was used to back national currencies. But that system was still based on the premise that gold is worth something beyond its metallurgical value. Besides, we’ve been off the gold standard for over 40 years and the only reason we went on it was as a means of rebuilding post-World War II.
What a lot of people aren’t aware of is the alternative to the gold standard put forth at Bretton Woods by Ben Graham. Graham is the father of modern financial research, and Warren Buffett’s mentor. Graham suggested useful commodities like steel and wheat, which have real utility, rather than gold, should be used to settle trade imbalances. He went back to the foundation of transactions — the barter system.
People will say this is inconvenient, because you’ve got to send all this wheat and steel halfway across the globe. But is this not what nations do with their surpluses of these commodities? They sell them to other countries — or they just go to waste. Why not trade things with utility?
On this model you can bring in whatever you don’t have, and sell off whatever you have a surplus of. That’s pretty much how trade imbalances are settled these days. If you have too much of something you end up lowering the price and selling it on your national market, which lowers your trade imbalance.
Read: Faceoff: Precious metals
Graham advocated formalizing this structure.
I’m not saying Graham’s approach would have been better than the gold standard, but at least it makes sense from a utility standpoint.
Gold and God
I once heard someone say gold and God are one letter apart and that both require a leap of faith for either to have any value to you.
So why was gold ever valuable? It’s yellow, a rare feature versus other metals, making it sought after for jewelry. And 3,000 years ago it was probably harder to counterfeit coinage made of gold. So are these the reasons we attach so much value to it? I have yet to get someone to provide me with a convincing explanation either way.
Warren Buffett once said something to the effect that gold gets dug out of the ground, melted down, and thrown down another hole. People then get paid to stand around and guard it. On another occasion, Buffett stated the estimated size of the world’s gold reserves was a sixty-seven foot cube valued at over $7-trillion dollars. For $7-trillion dollars you could either have a shiny metal cube or buy 100% of the TSX three times over, all the farmland in the U.S., or eight Exxon Mobils. Which would you choose?
[The gold craze] is a lot like the tech bubble. People were buying companies valued at millions of dollars that hadn’t turned any profit. In the end they had no functional utility. [By the same token,] gold pays neither dividend nor interest, and has little value at the price we inflate it to. All you’re doing is hoping that down the road someone buys the shiny metal for more than you do.
It seems to increase in value in times of inflation, but only in times of inflation. In the last 20 to 30 years it’s gone from $1,000 to $400, and back to $1,000. I don’t recall deflation of 60% in that time. But gold will probably continue to increase. Somehow people think gold is an inflation hedge because it’s pretty and in limited supply.