Gold Rush

With the market still off its high mark, advertisements for gold have flourished. Is it a good idea to buy?


I work third shift, 2200 to 0800. I'm too cheap to buy satellite radio, so I channel surf during my shift and inevitably end up listening to talk radio for a few hours. It seems like every show has endless advertisements touting the value of adding gold to your investments. This month, we'll look at the facts about gold and its history, and examine whether or not it makes sense for you to invest in this metal as part of your portfolio.

History

Gold is a very rare, but useful, metal. For centuries, people have considered it a valuable commodity and have used it in trade. Its use as money started thousands of years ago as a means of expanding trade. For example, if you built a boat for a fisherman, you could not take all of his fish in return for your labor. The fish would rot before you could pass on fish to the guy who made your nails, provided you the sail, or cut down the lumber you used. So money, originally in the form of various metals, facilitated trade buy allowing you to take something of value (gold coins) and trade them with other people to buy supplies or the food your family needed to live.

For most of human history, money was made of metal: gold, silver and copper being the most common because they are more rare than, say, iron. Gold is so rare that most estimates are that approximately 150,000 metric tons have been mined in all of human history. But metal money caused problems as economies grew. First, governments had budgetary problems during times of crisis and war, as their spending was limited to the amount of gold and silver they owned (some may argue that's a good thing, but that's a different article). Second, transporting large quantities of money was difficult. Gold is very dense (more than 70% denser than lead), with a pure nugget the size of a golf ball weighing over two pounds. As costs increased over time, the challenge of carrying enough gold or silver to pay for an item became burdensome.

In the United States, we had our first experiment with paper money during the Civil War (according to the U.S. Treasury website). This paper money was still backed by gold, but obviously was much easier to transport. It also brought flexibility to the nation’s ability to pay for items, as it could print money more easily than it could mine more gold or silver. Up until 1933, the federal government printed gold certificates, which could be exchanged for a specific amount of gold. Up until 1964, the government was still printing silver certificates, which gave the bearer the right to go to any federal reserve bank and demand silver in exchange.

In 1971, President Nixon formally moved the U.S. away from the gold standard. Until that time, the price of gold was fixed at $35 per ounce. Since then, the price per ounce of gold has fluctuated with market demand. Recently, it was about $1050 per ounce. Compared to the $35 or so gold cost 38 years ago, that may sound like a good investment, but let's look a little closer.

Pricing and Demand

If you look at the history of gold pricing, there is normally a spike in pricing during times of economic uncertainty. Economic crises normally mean poor stock performance and uncertain interest rates, so investors tend to flock to something stable. Since we all know people are creatures of habit, people have flocked towards gold.

Some of you are old enough to remember the OPEC oil embargo in 1973. During that crisis, the price of gold jumped 60% in a year, going from about $100 an ounce in May 1973 to $160 an ounce in May 1974. Stagflation followed in 1979 and 1980, with gold hitting a high of $850 an ounce in January 1980. So far, gold looks like a guaranteed winner, doesn’t it?

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