Tuesday, January 26, 2010

The Gold Rush of 2010

[Note: I am not an investment counselor and you should not buy, sell, or hold anything based on my advice alone or anything I say in this column.]

It actually began in 2009, but the Gold Rush of 2010 is now in full swing. Haven’t you heard? There is gold in them thar hills; or is it in your jewelry box; or is it available for purchase from a number of different gold vendors. You can get it minted in coins; you can buy it in bars; or you can get it the old fashioned way—from a mine.

I find it curious that the gold dealers come out in droves every time the economy is down or there is even the mere mention of possible inflation. Listen to the ads on any one of the television business channels and you’ll get an ear full of doom and gloom. “Worst recession since the Depression.” “Out of control government spending.” “The falling value of the dollar.” “Inflation.” “Record unemployment.”

There can be no doubt, many of these claims may indeed be true, but I have never seen an industry rally around bad news more than the purveyors of gold. Well, maybe the mainstream media loves bad news, but I digress. It is as though the only way to sell gold is by creating and instilling fear. “Gold is the only asset that never has zero value.” “Gold is your hedge against inflation and a falling stock portfolio.” If the only thing we have to fear is fear itself, then I am convinced that gold brokers foment more fear than miners find gold.

In fact, the Gold Rush of 2010, driven by fear tactics, has pushed the price of gold well over $1,000 per ounce which is about twice as much as it costs to get gold out of the ground. If you are absolutely convinced that gold is your best investment, then for crying out loud, buy stock in a gold mine. Those guys are making good money right now.

But, let’s examine the underlying theories behind the Gold Rush of 2010.

The dollar is dropping in value compared to other currencies such as the Euro or the Yen. So, you put your dollars into gold. What are you going to do with the gold? Put it under your bed; bury it in your back yard? Heat your house with it? Eat it when you get hungry? Nope, just like any other investment, you are going to sit on it and wait for its value to go up, down, or stay the same. The problem is that you can’t spend gold. Just try going down to your local store to buy some groceries with the gold shavings you whittle off of your gold bar. When you get hungry or it is time to pay your property taxes, you are going to sell some gold and get dollars back. If the fear-mongering purveyors of gold are right, the dollars you get when you sell your gold are going to have less purchasing power than the dollars you used to buy the gold. If the value of gold went up more than the dollar went down, then you are okay. But if it does not, then you are no better off, or worse yet, you have lost money. This same logic applies if you are investing in gold to hedge against inflation.

Gold is a commodity and like all commodities it has real intrinsic value and it has psychological value. When gold supply is low and demand for gold jewelry, gold circuitry, and gold-tipped Ipod cords is high, then the price of gold goes up. What we are seeing today is that because fear is high, so is the price of gold. The first example is the law of supply and demand; the second is speculation. “Speculation” is nothing more than a euphemism for gambling.

But, the gold broker will tell you that gold will never be worth zero. Go tell that to Bunky Hunt who lost billions of dollars in the 1970s speculating that silver would continue to go up in value. He and his brother tried to corner the world market by buying close to 100 million ounces of silver. When silver prices crashed on Silver Thursday in March 1980, they lost everything and had to file bankruptcy. The price of silver may not have gone to zero, but they still lost their shirts.

Very few of us have the capacity to corner any market, let alone the gold or silver market. So, if you are buying gold because you fear the economy is going to collapse, ask yourself the logical follow-up question, what will I do with all this gold if the economy does collapse?

Much of the fear-mongering associated with gold goes back to the decision by the United States to take its currency off of the gold standard. Since ancient times, gold has been used as currency all over the world. Gold was more rare back then and it has always been available in finite quantities, thus its value was relatively stable. Moreover, gold is gold and no matter what language you speak or what your culture is, gold transcends it. People got tired of carrying gold around in their pockets and using scales when the printing press came along and they could paper currency. Paper currency then was the same as debit cards are today, more convenient. In order to build trust in paper money, government currencies were redeemable for gold or silver. This gave people the illusion of security. The reality is that the value of gold fluctuates, as does the value of paper currency, but few people ever redeemed their paper currency for gold or silver. Instead, paper dollars were doing what currencies are intended to do; they were used to buy goods and services and facilitate trade. When the United States went off of the gold standard, the value of the currency was based on the quantity and efficiency of the production of goods and services. Like gold supplies, the supply of goods and services produced can go up or down and the value of the currency follows.

I will always remember when the Federal Reserve Bank Chairman, Arthur Burns, was testifying on the value of the U.S. dollar and whether we should go back to the gold standard. A Congressman held up a five-dollar bill and asked Burns what he could get for that five dollar bill? Burns reached into his pocket and peeled off five one-dollar bills and said, Sir, what else do you need? Currency is just a medium of exchange. The value of currency is affected by changes in either the supply and demand of goods and services or by the supply and demand for money itself. Money Supply is managed by the Federal Reserve Bank, and ever since the inflation of the late ‘70s and early ‘80s, the Fed has done a masterful job of controlling Money Supply to keep inflation in check. A vivid example of this is that you can go to any fast food joint in town and buy for $1 the same burger you got for a buck back in 1980. Yes, prices of good and services have changed and that is to be expected as supply or demand fluctuates. With all the government borrowing, rising energy prices, spiraling medical costs, the overall U.S. inflation rate for 2009 ended up being only 2.9%.

There may be many warning signs out there today that could give the most optimistic of us pause about the future of our economy. Gold may indeed be an appropriate part of the mix of any investment portfolio along with mutual finds, bank certificate of deposits, and real estate. But, beware of snake-oil salesmen. The old maxim—there is no such thing as a free lunch—still holds true. I suggest we do our research, consult with sage financial counselors, and invest wisely, but I would not put my faith in any investment. As for me and my house, we will trust in the Lord, and not in a pot of gold at the end of the rainbow or under my bed.

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