Friday, April 03, 2009

Going for Gold

A friend of mine is absolutely confident that the nation’s monetary model will completely crash within five years. Most people that say this are simply engaging in idle philosophy. Not him. He has taken a large amount from his 401k and has used it to buy gold.

When my friend explained this to me, I couldn’t help but think of another acquaintance that had said the same thing, almost verbatim, during another economic downturn. This man strongly affirmed that the U.S. monetary system would collapse within five years, rendering all dollar denominated assets completely worthless. Gold, he assured me, was the only logical answer.

That was more than 20 years ago.

This time is different, asserts my friend. He wonders why I can’t see all of the crazy and unprecedented things the government and the Fed are doing with our fiat currency. Yes, I can see it. He wonders if I haven’t studied history and found that gold has replaced every fiat currency in the past 3,000 years. That’s a handy statistic tossed about in certain circles, but what they imply by it is a gross distortion of fact.

To be sure, fiat currencies have their problems, not the least of which is centralized government control. But before jumping into other kinds of currencies, it would be wise to understand their pitfalls. Gold is not the panacea that its promoters make it out to be.

By buying actual gold, my friend has exchanged some of his fiat currency assets for a commodity currency. This is different than having currency based on a gold (or any other commodity) standard, which is a representative currency.

(Those that favor a gold standard representative currency seem conveniently ignorant of the widespread dissatisfaction with it throughout many areas of the U.S. during the last half of the 19th Century and first part of the 20th Century — even being a major issue in presidential campaigns. All types of currencies have their advantages and disadvantages.)

When I opined to my friend that selling mutual fund shares at a low point in favor of buying gold at near historic high prices was probably an unwise strategy, he would have none of it. “I’m not doing this for investment value. I’m doing this for survival.” At that point I suggested that making financial decisions based on fear is rarely a successful model. He replied that he is quite certain that he will end up far more secure.

SmartMoney’s Jack Hough explains in this article why gold has been used as money and why he thinks it is a bad way to go, even if you do believe that Armageddon is only months away. Gold has been used as money because it doesn’t decay, isn’t consumable or useful in very many applications, and is “exceedingly rare,” “divisible,” “easily shapeable,” and “easy to test for purity.”

Those are fine qualities. But gold, says Hough, “doesn’t work to make itself more valuable. It just sits.” The price of gold rises and falls with demand, of course. But over time, gold’s value is relatively stagnant. One “dollar invested in gold in 1802” would be worth about $2.80 today. That same dollar invested in stocks would be worth about $420,000. Even investing it in U.S. Dollars would have returned over $250.

Fair enough, my friend would say, but he’s not in gold for its investment value; only for its barter value. He also isn’t going to be around for 207 years. Besides, he is confident that the $420,000 in stocks and $250 USD mentioned above will be worth $0 within five years, so gold is where it’s at, even if its value doesn’t change.

My friend could be right. Despite the government’s shenanigans, however, it is much more probable that gold will plummet within five years, much as it did after its 1980 high point. Not everyone buying gold today is a survivalist. When stock prices rise and gold prices drop, many gold owners will sell their gold and buy stocks.

Most people are emotional investors that buy high and sell low, doing the exact opposite of what generates wealth. Non-emotional investors know that volatility can be their friend, not their foe. When it comes to creating and maintaining wealth, volatility does not necessarily mean insecurity.

If you’re a millenarian, you believe that there will eventually come a doomsday and that many awful things will happen in the run up to that event. But will that happen within the next five years? That’s a much harder question. Such has been the forecast from certain folks every time there has been an economic downturn or a disaster. We always seem to bounce back. (Yeah, I know. That’s like what people said to Noah before the flood.)

It would be hubris to say that it is impossible for our monetary system to collapse. The most likely course of events, however, will be that human ingenuity will kick in and we will work our way through the current economic downturn. Policies will be tweaked and tempered. There will be ups and downs. As normalcy sets in, some that prepared for doomsday will feel that their preparations were in vain.

Even if you do think doomsday is just around the corner, Hough suggests being “cautious about stashing too much wealth in something so fickle [as gold], especially when it’s popular.” He advises that a better instrument would be “ordinary commodities,” or better yet, “the means of producing them.” People will always need such things and will find ways to pay for them, even in a collapsed economy.

One survivalist friend of mine has a huge stash of toilet paper. As long as it’s kept dry it doesn’t deteriorate very fast. He is positive that people will be willing to pay top price for TP in the dystopian future’s barter system.

One final word on buying gold. It has been my experience that buying anything that everyone else in a given group is buying eventually yields undesirable results. Engaging in the time honored tradition of chasing fads will produce the same kind of outcome that always results from such faddish pursuits. Somehow that makes me think of a large dusty stash of vinyl LP disco albums a friend still had lying around in 1993.


Jesse Harris said...

If your friend is truly convinced that the end was near, he wouldn't be buying gold; he'd be stocking up on non-perishable food. If everything collapses, that's the one thing that will maintain true value.

Scott Hinrichs said...

My friend is serious. He is also stocking up on non-perishables and is even now in the process of constructing an in-ground well armed shelter where he will be able to fend off those that would steal such goods.

Frank Staheli said...

I've thought about using a little bit of my monthly earnings to start small--to buy and have on hand some silver that, should hyperinflation hit, I could still buy a few loaves of bread and gallons of milk at the store for essentially the price they were when I bought my silver. But that's assuming that anyone would care to barter for my silver at that point.

I'm only thinking along these lines because we already do have a large non-perishable food supply.

I think your friend would be better off (spiritually, anyway) in the long run if he stocked up on foodstuffs with the intent to share them with his neighbors in need. That's my plan. We'll (maybe) see how it works.


staraman said...

The value of gold would be far great than $2.80... do you you how many dollars a 1913 dollar would buy now? Your math is completely wrong.

Scott Hinrichs said...

On the math thing, it's your word against that of the guy at SmartMoney. The guy is a financial journalist. That doesn't necessarily make him an authoritative source.

I've done a lot of looking around to try to validate his numbers. There is a lot of 'data' out there, much of it contradictory and much of it put out by gold sellers or people that stand to gain from others buying gold right now. It is difficult to find anything both authoritative and unbiased.

This Wikipedia article on using gold as an investment seems somewhat level headed. It notes, "Investors generally buy gold as a hedge or safe haven against any economic, political, social, or currency-based crises." It also has a fairly good discussion about various investment strategies.

Quesi said...

We are definitely going down the path of inflation. Whether that becomes hyper-inflation or not we shall see. I believe it to be in the realm of possibilities for sure, so why not be prepared to the degree that one thinks it possible? You don't even have to be in an end-of-the-world mentality to think that our monetary system could collapse. There is nothing sacred about the US economy that protects it from unbridled spending, excessive debt, and excessive waste. The housing bubble wasted trillions of dollars at the same time we were engaged in two foreign wars. It seems that we have a pretty good recipe for disaster. I do agree that ingenuity will take us out of this, but I also think that the dollar's value will diminish substantially if not exponentially. I think it would be wise to diversify investments beyond dollar-based investments.

I don't view gold as a good investment myself, especially at its current price. I think that there are many things that have value when a currency loses its value. I am inclined to invest in dirt (property), homesteading skills, my community, non-perishable foods, and other personal and family skills. A person's skills in conjunction with the collective local community working together will bring people closer together and through a crisis. Shooting your neighbors will deprive you of your best assets.