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.

19 Comments

  1. Bullion Vault is a poor recommendation. They charge high storage fees. Buying gold via Bullion Gold and keeping it there for 6 years is more expensive than buying a bullion coin from an online dealer at 3% premium over spot. The devil is always in the details.

    1. Yes the devil is in the details, and it’s beguiled you. BullionVault doesn’t charge high storage fees. They charge just 0.12% per year. Plus the premium over spot is typically less than 0.1% (looking just now it’s a staggeringly low 0.03%). And the commission is max 0.5% and much lower for large purchases. A buy and hold at BullionVault would be cheaper than coins for at least 20 years. Longer if you include the cost of selling as well.

  2. Forgot to mention: Goldmoney.com is much cheaper than Bullion Vault. Free storage and insurance for up to 1 KG of gold.

    1. Not true. The price spreads at GoldMoney are 4-6 times higher than BullionVault. For smaller orders the commissions are the same. But for larger orders GoldMoney’s commissions are five times higher (0.5% vs 0.1%). This more than compensates for the free storage – for many years.

      1. I just checked Buillion Vault and Goldmoney for their fees. They both charge 0.5% when buying and selling gold up to $75,000. Since Goldmoney offers free storage, clearly Bullion Vault is the inferior deal.
        However, when investing large amounts (millions), Bullion Vault is indeed cheaper for trading.

        1. Correct on commissions for small amounts. But BullionVault commission drops to 0.1% above $75,000 traded within 12 months (not “millions”) and 0.05% above $825,000 (close to millions). But don’t forget the price spreads as well. GoldMoney is much higher (and the pricing is intransparent). BullionVault has live prices and very small spreads, which more than make up for the free storage, since their storage is already ultra cheap (0.12% per year).

  3. Regarding the question whether gold is money, I quote J.P. Morgan who at a congressional hearing 100 years ago in the US congress said “Gold is money. Anything else is credit”

    Let me also recall that the word credit comes from Latin and had the meaning “Creditors are those who believe that they will be repaid in the future.”

    Why do central banks hoard gold if gold is not money ?

    1. Yes I’ve heard that quote before. But it’s from a century ago when gold actually was used as money. It’s no longer relevant. Some (not all) central banks hold gold probably because they still think it has some place in the money system. But that doesn’t mean their view is correct.

      1. The central banks of US, Germany, China, Switzerland, France, Russia, Italy store more than 1,000 tons of gold each. The central banks of the European Union store more than 10,000 tons of gold in total.

        Perhaps you should explain to them why their holdings are obsolete. But I doubt that they will listen to you.

        Regarding old quotes being more than 100 years old, the theorem of Pythagoras is more than 2000 years old, yet it is being taught in every school. So something being 100 years old, does not mean it is obsolete or wrong. There is lots of nonsense published today on the internet.

        1. Pythagorus theorem is still being used in mathematics. Gold is not being used as money.

          Perhaps the central banks realise that gold is a valuable raw material, with low price volatility, and modest storage requirements (small volume for high value). But whatever their motivations (which vary) don’t expect them to start minting gold coins for daily circulation any time soon. Or, for that matter, to peg their currencies to gold.

          1. Gold is being used as money. Please read the most recent news about trade between China and Russia to be settled by physical gold delivery. A few years ago, after US sanctions on Iran and a blocked access to the SWIFT system, the Turks paid for oil imports from Iran with gold delivery to Iran. There are other recent instances of gold being used for trade settlements, but I forgot the details.

          2. That sounds more like commodity barter between nation states – but interesting nonetheless. I’m referring to day to day transactions between ordinary people. Haven’t seen any of that.

          3. You are right. Gold is not being used in day to day transactions. The trend is to abolition of cash with transactions settled digitally. Since digits have no intrinsic value, the question is what asset people can use in order to store value long term, say for 50 years and not just 5 years. The speed at which things are evolving, there may not be any Dollars or Argentinian pesos for that matter in 50 years. Gold is a traditional asset for storing financial wealth independently of the banking system. In the past century, Germany went through 6 different currencies. At the transition to each new currency, people lost a substantial part of their savings. I am afraid these things will happen in the future in other countries as well.

  4. A US$100 paper bill will not be accepted at every place in the world. However, a gold coin can be sold all over the world, including Argentina.

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