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When reading
stuff about the pros and cons of investing in gold we regularly come across
two misguided assertions, the first being that changes in gold's price in
terms of a currency do little more than offset changes in the currency's
purchasing power. To put it another way, the first misguided assertion is
that gold's purchasing power is roughly constant over time, meaning that
changes in its price are almost solely due to changes in the purchasing power
of the money in which the price is denominated.
The following
monthly chart of the inflation-adjusted (IA)* US$ gold price disproves the
notion that gold's purchasing power (pp) is roughly
constant over time. In particular, it is clear from this chart that there was
a huge increase in gold's pp during 1971-1980, a
huge decrease in gold's pp during 1980-2001, and
another huge increase in gold's pp during
2001-2011. It's likely that most of our readers were already aware of these
10-20 year swings in gold's pp, but what is less
widely appreciated is that gold's pp is in a much
longer-term upward trend. This ultra-long-term trend dates back to the
severing of the last official link between the US$ and gold in 1971.
The fact is
that an ounce of gold has about eight times more purchasing power today than
it did when the final US$-gold link was severed in 1971. Furthermore, even if
we make the not-unreasonable assumption that the first major leg of the gold
rally of the 1970s was primarily a reaction to the gold price having been
pegged at an artificially low level for a couple of decades, we still arrive
at the conclusion that gold's pp is in an
ultra-long-term upward trend. The reason is that if we take the top of the
1971-1974 rally as our starting point we find that
gold's pp more than doubled over the intervening
period.
In our opinion,
the main reason that gold is in an ultra-long-term upward trend in REAL terms
is that the overall cost of monetary inflation (creating money out of
nothing) is much greater than the reduction in the purchasing power of money.
Monetary inflation can make things look better in the short-term, but it
leads to the long-term destruction of wealth. The faster the rate of monetary
inflation, the greater the amount of wealth that eventually gets destroyed by
misdirected investment.
After the
ability of the banking system (the central bank and the commercial banks) to
create money out of nothing became unconstrained by gold, the average rate of
monetary inflation increased. A long-term effect was slower economic progress
(slower rate of improvement in living standards) and heightened desire for
more savings in terms of a monetary asset that can't be depreciated at the
will of banks and governments.
The other
misguided assertion is that owning gold is pointless because gold is a
sterile, non-productive asset. This assertion emanates from value investors
such as Warren Buffett, who like to compare the total market value of the
world's gold with the combined market values of a group of large companies
(Wal-Mart, Exxon, Intel, etc.) and pose a question along the lines of: What
would you rather own -- a big chunk of metal that does nothing except sit in
a vault or all of these phenomenal businesses? The question is meaningless,
because nobody is ever faced with the choice of owning the world's gold or
owning the 30 best companies in the world.
Most people
have a range of investments plus some cash savings. In a world where there
was no uncertainty there would be no need to maintain any cash savings, but
in the real world there is always uncertainty about the future and therefore
the desire -- on the part of most people -- to hold some cash in reserve.
Although gold can be a very good investment at times due to the large swings
in its pp discussed above, it is the portion of an
investor's portfolio dedicated to cash that gold bullion is 'tailor made' to
occupy. This means that gold isn't in competition with great companies such
as Wal-Mart and Apple, it is in competition with the US$ and the euro and the
Yen and the other national currencies.
So, the
question that some value investors have asked in their efforts to disparage
gold ownership should be re-phrased as:
In which form
would you prefer to hold your monetary savings -- in the form of money that
banks can create in unlimited amounts out of nothing, or in the form of a metal
that has been used as money for thousands of years and whose supply never
increases by more than 2% from one year to the next?
The answer to
the above question isn't necessarily straightforward. A lot depends on the
policies being implemented at the time by central banks and governments. Over
the past several years the obvious answer from our perspective has been
"the metal", because central banks and governments have been
rapidly inflating the supplies of national currencies and generally getting
in the way of real economic progress. As things stand today the obvious
answer -- again, from our perspective -- is still "the metal",
because the Fed is dominated by bozos who truly believe that the economy can
be strengthened by counterfeiting money and because the other major central
banks are no better.
Steve Saville
www.speculative-investor.com
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