Today’s guest post is from Andrew, who presents a view of gold generally opposite of mine — but worth understanding to better round out your personal finance knowledge. – Jason
“The desire for gold is the most universal and deeply rooted commercial instinct of the human race.” – Gerald M. Loeb
Gold may be the most misunderstood of all traditional investment vehicles.
Some say it is worthless because it lacks a purpose. Others say it is just a tool for scammers. In reality, gold is many things, but at the heart of it all is the fact that gold is money.
Dating far back into human history, gold has been treasured and used as a medium of exchange. Gold does not have the industrial value of other commodities such as oil, copper, or platinum, but is instead inherently valuable due simply to the fact that it is rare and nearly universally, people desire it.
Gold vs. Industrial Commodities
Why would anyone invest in gold when he could instead invest in a commodity with an industrial use, such as platinum? Platinum, for example, is used as a catalyst in a variety of chemical processes, most notably in catalytic converters, present in every automobile manufactured today.
What people fail to realize is that commodities whose prices are driven up by industrial demand can also be driven down by lack of industrial demand. For example, in 2008, a year in which industrial activity went into a deep slump, platinum ended the year down 41%, while gold was up 3% for the year.
This is a perfect example of why gold is an excellent hedge against economic downturns.
Gold vs. Stocks
It is common knowledge that stock values as a whole grow over prolonged stretches of time, whereas the prices of commodities are cyclical, but stagnant in the long-term.
This might actually be considered a misconception for two reasons.
First, since the Federal Reserve Act was passed in 1913, economic cycles have become painfully severe and prolonged. In fact, if given the choice in 1929 between investing money for the next 80 years either in the Dow Jones Industrial index or in gold, you would have more money today if you chose gold.
This is simply stunning for anyone who was taught that the stock market always goes up in the long term. It is important to differentiate between going up in dollar value and going up in inflation-adjusted true value, of which gold is a decent measure.
Second, stock market growth and commodity stagnancy have only been possible due to seemingly endless supplies of commodities. Industries cannot grow if there are no materials to use in production and commodity prices cannot remain constant if demand permanently outstrips supply.
This planet has enough resources in most categories to sustain growth for a few more decades, so there is no reason to panic yet, but it is important to keep in mind that industrial growth cannot continue indefinitely.
Gold vs. Cash
High-interest savings accounts have become all the rage in the last few years, especially among the yuppie crowd.
In reality, they are largely a fool’s pleasure.
The Consumer Price Index (CPI) is used to calculate the official government reported inflation data. It is deeply flawed and manipulated to underreport inflation, but for simplicity we will use it in the following example.
According to the official government CPI numbers for January through September 2008, up until the stock market crash, annual inflation was 4.59%. So even if you believe the government’s phony numbers, that 5% interest savings account you may have had at that time was paying you nearly zero true interest.
If your money was in a traditional savings account or a checking account, inflation was robbing you blind. Inflation is an invisible tax, constantly stealing from right out your pocket.
Unlike cash, gold has retained its purchasing power for decades. A classic measure is the price of an ounce of gold versus the price of a men’s suit.
In 1900, a fine men’s suit cost $7 to $16 and an ounce of gold was worth $20.67. Today, a fine men’s suit can be bought for $900 and an ounce of gold is worth $940. Gold is an excellent hedge against inflation.
Investing to Preserve
In tough economic times, investors are often happy to simply preserve their existing wealth rather than risk it melting away. Buying physical gold is the best way to accomplish this.
Gold coins can be purchased online or from a local coin dealer. For larger purchases, there are services such as GoldMoney that allow individuals to purchase gold and have it stored in a vault.
Investing for Growth
It is also possible to make money investing in gold by buying gold mining companies rather than gold itself. There are also exchange traded funds that track a host of gold mining company stocks, thereby providing a level of diversification within that sector, which is useful for investors who cannot afford to buy individual stock in several different gold mining companies.
Any long-term portfolio should have diversification among various asset classes, but gold and commodities in general should not be neglected from this mix. Hopefully, after reading this article, you now have a better understanding how gold can be used as a tool as you invest for your future.
