Gold?!

If you have been reading this blog for any length of time, or if you are new to it, and you haven’t commented well then you are missing out on an opportunity.  I am willing to address specific questions.  How often do you get to query a retired and very successful investment manager about topics near and dear to your heart, for free?  Pause and ponder that for a moment.

No such bashfulness exists for my loyal reader N.G. who, encouraged by my addressing her question about innovation, has now submitted the following:

“Is gold a safe haven in times of economic turbulence and, if so, why? After all, gold has no intrinsic worth. Another thing:  Gold has been on a secular uptrend. Is this likely to continue or is it another speculative bubble?”

Let me take these questions in turn…

I don’t think of gold as a truly safe haven in times of economic turbulence.  Yes, it performs well when there are big concerns that the First World’s economies are in trouble and consequently that their currencies are weak and considered dangerous.  But the primary benefit of investing in gold at these times is that there seems to be a belief that gold is a safe-haven.  In other words, investing in gold for this reason is a recursive argument.  We invest in gold because we think that the currencies have no intrinsic value and we are nervous that those currencies are overvalued.  But the exact same case can be made for gold.  Which brings us to N.G.’s second point…

Gold has no intrinsic worth.  I disagree with this statement.  People covet gold because of its color and quality – that is its intrinsic value.  You may disagree, but many people choose to live in climates because of the aesthetics of the weather or the beautiful sunsets.  Most people would not disagree that there is some intrinsic value to living near an ocean, or in the mountains, or in a warm climate.  Therefore, it can also be valued that gold has some intrinsic value, too.  So the real question, just like the question about whether or not real estate prices in California, Florida, the Riviera, Valencia, or other tropical places makes sense is: is gold worth what it is trading for right now?

My answer is “no.”  But then again, I have been saying that since gold was trading at $1,100 per ounce (sorry Carolyn Tyler) almost three years ago.  Gold has basically continued to rise in value.  However, I have to say that investing in gold right now is a dangerous proposition.  Anytime you are buying into something that is trading at its all-time high, whether that is a stock, a house, or gold, you have to have a compelling fundamental case in mind that supports the idea that you will not just make more money in that investment, but more than you could in some other investment.  That is: If I am going to surrender my very liquid and coveted cash, then my investment needs to be the best return:risk combination I am aware of.  Is there a fundamental case for gold?

I don’t think so.  One would argue that the fundamental case is that the supply of gold is fixed and therefore any incremental increase in demand should lead to a higher price.  But demand exceeding supply is the same fundamental case made for any asset in a bubble.  These conditions being present don’t make a choice to buy an investment case.  An investment is a commitment to illiquidity in hopes of earning a higher return.  The only real way to make money in gold, in my mind, is to speculate.  That is, to guess which direction prices are going to go.  This is not a commitment to illiquidity.  This is a commitment to gamble.  Some do very well at this sort of thing, and if you do, then by all means purchase interests that are gold-related.  Quite frankly, my mind and sense of ethics just doesn’t work this way.

Now the really important question that N.G. asked was if gold is a speculative bubble, how much longer will it last?  I think that you could make a case that gold will continue to stay at elevated levels and that it might never get back to the low levels it traded at in the early years of the millennium.  Why?  I said above that gold does have an intrinsic value.  The number of people who believe that continues to increase as more Indians and more Chinese attain higher standards of living and many of whom then, in turn, want to own gold objects.  Barring any major gold finds in the world’s mines, you would have to believe that the price of gold is going to be permanently higher.  How much higher could it rise?

I would guess that a good proxy for future price increases in gold would be: the percentage change in gross domestic product per capita for the middle to upper-classes of the world’s largest economies.  That is, between 3-10%.  Remember my point above, though.  Are there competing investments that can earn you better returns-to-risk than 3-10%.  If yes, then I would avoid gold.  If no, and you feel that you understand gold, then invest in gold.  But it’s not for me.

Jason