Every time the market fluctuates to the down-side, we seem to get inundated with Gold advertisements – with all sorts of theories including:
a. One that gold’s price – after accounting for inflation is at a fraction of (your favorite year here)’s quotation.
b. The Dow/Gold theory that one unit of gold will equal the DJIA – in other words, either gold is worth ten fold what it is now, or the DJIA is worth 10x less than where it is now. Both scenarios are not just unlikely, but stupid, and sophomoric at best.
Let’s get to the specifics of gold. A good seventy percent of gold production is used for the manufacture of jewelry – with my fellow Indians being the single largest purchasers of auric adornments. A smaller fraction is used by China for similar purposes. A mere 20% of this world’s production is used in industry – where heat and electricity need to be conducted as rapidly as possible [electronics and the automotive industries is where it is used extensively]. Thanks to gold being a NOBLE metal, it reacts with almost nothing, and dissolves in cyanide and aqua-regia – making the extraction [to spec] of Gold, one of the most difficult and toxic processes in the whole world.
Since gold is a noble metal, it is never consumed by industrial processes. It is used to bond chips to packages [bond-wire] – and conduct electrical signals from silicon to the external pins of a chip. It is used in exotic cars for radiating heat from engines/exhaust systems, etc. None of this “consumes” the gold. In fact a lot of chips are processed – to re-extract the gold contained in them.
For centuries, gold was the standard by which all else would be measured. In fact most currencies were pegged to the amount of gold that their treasury had in store. But all of that changed when FDR signed an executive order to ban US Citizens from owning/hoarding gold – and mandated them to use fiat currency [the dollar]. The Bank of England followed and in the early 1900′s, stopped the conversion of pounds to gold.
Thanks to a liquid market, gold prices are quoted every day [bid and ask], and are actively traded on the Nymex [now a division of the CME]. While buying gold stocks and gold mining companies is easy, buying and storing gold [as an investment] is in my books, a lose-lose proposition.
First, you pay a large bid/ask spread for the commodity – which in this case is HUGE.
Second, you often pay for storage and insurance of the gold that you bought.
Third, you wait years for it to go up – while stocks out-pace your returns, and often, pay dividends
Fourth – there is not much leverage you can use – unless you are “playing” with options or futures, and that is not the same as investing in gold. It is more of speculating in gold.
Fifth, it is the fact that if you randomly pick ten year horizons, only the most carefully chosen time-frames will result in a better outcome than an investment in the S&P [or DJIA].
Sixth, and most importantly, if currency were pegged to gold, sure there will be little inflation, but it definitely would have frozen the flow of capital, and the expansion of capital markets [which has been a good thing in the last half a century despite some recent setbacks]. Since this is an academic detail at this point, and the latest misguided attempt to create a gold-based islamic currency was a failure, I declare gold – as a currency, dead. It is a commodity, and in the past month, the US dollar has been deemed by markets as a safer haven than gold. Long live the dollar – and the full faith and credit of the US.
Bottom-line: Wear it, enjoy it, buy it for fun, but do not invest in gold. It is NOT an investment now, nor is it in the future.
© Bapcha’s Stocks, Oct 27, 2008.