Gold and Precious Metals

Is gold really “money”?

Gold had a great start to 2017. As we edge over the line of the first quarter the gold price is US$1,250 per troy ounce. That’s up 8.5% since the last day of 2016. I recommend that investors own gold, but for different reasons to most gold advocates. In response to some recent messages from readers, today I’ll cover some important points about why and how to invest in gold.

Prompted by my last article about the potential collapse of US growth (see here), Robert S…who tells me he holds a lot of gold…had this to say:

“Under a gold standard, it would be impossible to run budget deficits approaching US$1 trillion per year and doing this year by year. Financing terrorism and military bases all over the world on such a grand scale would be impossible under a gold standard. Under a gold standard, we would have fewer wars simply because governments would not be able to afford to go so deep into debt in order to pay for all these wars.”

Also another reader called Charles D. asked me this specific question:

“Which type of gold would you buy, pre 1933 US gold coins or US 1oz gold eagles? Thank you.”

I’ll get back to Charles in a minute. First here are some thoughts about Robert’s comments.

Robert may be right. Perhaps going back to a gold standard – meaning using gold as money or using money backed with gold – would solve some problems.

But I have my doubts. After all there was plenty of lending – not least to finance wars – when gold was used as money.  I was reminded of this a few years ago when I read a book called “A Great and Terrible King” by Marc Morris. It documents the life of the English king Edward I (1239 to 1307). It’s a good read.

King Edward, known as “Longshanks” due to his height, liked nothing better than a war. He took part in the 8th crusade, conquered Wales, fought the French and invaded Scotland.

It was Edward’s armies, helped by certain Scottish lords, that subdued William Wallace. Edward’s tomb, in London’s Westminster Abbey, still carries the moniker “Hammer of the Scots”. In fact he died of dysentery on his way to fight a later rebellion led by Robert the Bruce. It seems the Scots had the last laugh.

A lot of the funding for these wars came from taxation. Edward was good at that. But there was also borrowing involved, typically from Venetian bankers. This was the time when Venice was the centre of the financial world (please take note London and New York…nothing is forever). And all of this was most certainly happening when gold was used as money.

The good news for all involved was that there were no standing armies in those days. If the king wanted a war his lords had to supply a number of men at arms, but only for a certain period of time – typically a few months. And fighting was mostly restricted by the seasons. It was no use fighting during a muddy and cold winter, or when there were crops to be harvested.

The point is that using gold as money isn’t necessarily a panacea for peace or prosperity. But even if it would be in the modern era, it doesn’t matter.

Is gold really “money”?

In other words, Robert may be right about the desirability of using gold as money. But I’ve concluded that it’s so unlikely to happen in any case that it’s better to think of gold in a different way.

Gold was certainly money in the past. But, for practical purposes, it no longer is. Nor is it likely to be money in the future, except in brief and extreme circumstances.

Governments and their central bankers like the control – or illusion of it – that fiat money systems give them. “Fiat” is the Latin word for “it shall be”.

Hence fiat money isn’t backed by any physical asset, such as gold. Instead it’s simply declared as being money by the authorities.

Under a fiat money system the authorities have a load of levers and strings they can use to control the money supply. Things like raising or lowering interest rates, printing more or fewer paper notes, tightening or slackening bank regulations, and…especially in the last decade…directly creating bank deposits via the process known as “quantitative easing” (QE).

Who would want to give up all that power to fiddle with the economy? Surely very few politicians or central bankers in the present day. So, like it or not, there will be no return to a gold standard, whatever the potential merits.

Gold is essentially “ex money”. But that doesn’t mean it isn’t highly useful, or desirable, or investable.

Nowadays gold’s principle use is as a recyclable raw material for jewellery, a luxury consumer product. Quite a bit also goes into consumer electronics, which mostly ends up as landfill a few years later, and steadily less goes into people’s mouths as replacement teeth (also ending up as “landfill” in the end).

That’s why I refer to gold as the “ultimate consumer good”. Not because it’s literally consumed, except in the case of gold leaf added to certain overpriced burgers and tequilas. It’s because most of it ends up used in consumer products.

Of course that’s not to deny that a lot of gold is also used for investment. As I’ve explained, a lot of people see it as the only true money, which is what motivates them to own it. But I take a different view.

Ultimately the potential end use is what makes any physical asset valuable. Gold’s main end use is jewellery. So an investment in gold is really the long term stockpiling of enduring raw material for decorative items.

Gold coins themselves are decorative, and sit somewhere between investment and adornment, with a nod to gold’s past role as money. At least this is the way I see it.

Of course there are extreme circumstances when gold coins could end up used as money again. Wars, revolutions and financial meltdowns are examples. But these situations tend to be short lived.

Aside from physical gold markets there are the huge financial markets for paper gold contracts and derivatives such as options. The main ones are based in London and Chicago.

The exact size of these markets is hard to quantify. But evidence suggests that when combined they trade over 20 times the value of the wholesale physical gold market, and perhaps more.

These financial markets drive short term price swings, depending on which side of the bed gold speculators roll out of each morning. But in the long run it’s the demand for physical gold that counts.

That’s what keeps pushing gold higher, as the slowly growing, but ultimately finite, gold supply meets fast growing and infinite fiat money supply. Especially in those gold hungry and fast growing emerging markets such as China and India.

What about coins…and bullion?

I’ll now turn to the question from Charles about which coins to buy. Coins are a good way to own gold for the ultra long term, but not something you should trade. That’s because buying and selling them is expensive.

Also they’re not suitable for very large gold investments. If you want a lot of gold then allocated bullion is the way to go. That’s because, if you go to the right place, it’s much cheaper to buy and sell (more on that below). “Allocated” just means it’s your direct property, even if someone else stores it for you.

In the US there are people who believe pre-1933 coins offer some protection from potential future government confiscation. I won’t go into a full explanation here, but see this link for a debunking of that idea.

Basically, if you’re in the market for gold coins I recommend you buy standard bullion coins with the minimum mark-up you can find to the current spot gold price. Mark-ups vary with supply and demand, but are typically a few percent.

Common one ounce coins include American Eagles, Canadian Maple Leafs, South African Krugerrands and Chinese Pandas. Smaller coins include American Half-Eagles (half ounce) or British Sovereigns (roughly 0.282 ounces). Any will do.

Also there are rare collectible coins, which cost more in relation to their gold content. But you need specialist expertise before getting involved in numismatics, as the field of coin collecting is known.

For larger investments I recommend allocated gold bullion bars, or part bars. These days it’s easy to buy bullion online and store it in vaults around the world.

The best place to buy gold online

If you’re interested in buying gold bullion then the service I recommend is BullionVault. The main reasons for that choice being full price transparency, an excellent website, responsive customer service and much lower costs than competing bullion providers. For almost all gold investors – large or small, long term or short term – it works out cheaper to buy, sell and store gold there than with any of the competing services that I’ve found.

Stay tuned OfWealthers,

Rob Marstrand

robmarstrand@ofwealth.com


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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.