Gold Rush

Oct. 27, 2009
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?

Well, gold settled in around $400 an ounce in 1982 and 1983. If you purchased in 1980, you would have lost 50% of your investment in just two years. This loss isn't as dramatic as the total lack of movement over the next twenty years. Most of 1998 saw gold prices in $300 range. In fact, gold prices do not remain over $400 ounce until 2006. Even the small recession after September 11th did not drive gold prices to new highs. So, if you had bought gold in 1982 and held it for 24 years, your investment would have netted you zero profit. You would have actually lost money if you consider that $400 in 1982 bought a heck of a lot more stuff than $400 today.

The reality is that gold is a gamble, not an investment. Every peak in gold prices is due to an economic crisis, whether the one we suffer today or the one we suffered 30 years ago. If there is no crisis, most investors realize it makes more sense to put money into stocks and bonds. As a result, they sell their gold, dropping the price, and buy stocks and bonds (raising their prices).

Gold prices today are at an all-time high. Will they keep going up? Maybe. Gold prices are up almost 20% this year alone. But how much higher will they go? Could today be the record? Is it tomorrow? None of us know the answers and the bad part is there is no method for predicting it. At least with stocks, you can look at their profits, their business plans, their debts, their management and make conclusions about whether the company can do better in the future. With gold, it's a crap shoot. Will you roll a seven or a three?

Conclusion

Gold has a long history of monetary value, although its use as a money has all but disappeared. Since 1971, when the value of gold was allowed to float in the market place, its price has gyrated through numerous peaks and valleys. However, it is has spent most of the past 38 years in a plateau of $300 to $400 per ounce. Does that make the $1000 or more an ounce costs today a bargain or a rip-off? Frankly, no one knows, but I'd be leaning towards the latter. The reality is that buying gold is a gamble; you are gambling that you are smart enough to buy before the price tops out and even smarter to sell before it drops.

That places it in the same category as the craps table. Only at the craps table, the odds are fixed, the payoff ratios are known and you can buy insurance for a crap roll. Plus, the drinks are free. Given the history of gold values, I'd say if you want to invest $1000 in gold, you'd be better off taking the money to a casino. Your odds are just as good and you'll have a lot more fun.

Be safe.

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