Financial Industry Rants & Sins, Vol 20

My kids like to go to the pool on Sundays during the summer. Like all other summer activities, the pool has its dangers. So my kids get a heavy dose of sunblock and reminders about pool safety. But also there are several life guards who enforce pool safety rules, and if G-d forbid there is some kind of dangerous situation, they are there to diffuse the possibility of calamity by having the local police, fire, and ambulance on speed dial.

As I was browsing the financial media on my smart phone a few days ago, I came across an article that said your portfolio should have its own life preservers, a financial PFD, if you will. I totally and whole heartedly agree with the concept. The author said cash and US Treasuries are the obvious safe havens, but he dismissed the idea of owning precious metals and specifically gold. I kindly disagree with his last point about gold.

His arguments against gold were 1) it’s an antiquated relic of prior generations and their outdated ideas, 2) there’s no more need for it aside from jewelry and dentistry, 3) it doesn’t pay dividends, and 4) you can’t buy anything with it because it isn’t money.

Nothing could be farther from the truth regarding the yellow metal. So let’s have a look at the fallacy of not considering gold a safe haven asset and necessary component of your portfolio.

The first argument was that gold is an antiquated relic. There are all kinds of theories about how money came into use, borne out through barter systems that used salt, seashells, tea leaves, and the like. Eventually gold became money because of several advantages, including 1) it’s divisible, 2) it’s portable, 3) it’s a medium of exchange, 4) it’s a unit of account, 5) it’s something called fungible, 6) it’s durable, and 7) it’s a store of value. It’s also pretty rare and extremely difficult to get it from the ground and into the coins, bracelets, and electronics we use it in.

The most important thing here is that it is a store of value. The cash in your pocket holds all of the first six properties, but it is not a store of value. Since the inception of the Federal Reserve (the central bank of the United States) the dollar has lost about 96% of its value. Remember hearing stories about prices from your grandparents? The story I always heard was “Howard I used to pay a nickel a gallon for gas, and if I bought 12 gallons the 13th was free.” Last week I paid $2.47 for the same gallon.

Over long periods of time, an ounce of gold always buys about the same amount of stuff. A good men’s suit? $1200 or about one ounce of gold. 200+ years ago when gold was $2 an ounce, a good men’s suit was about the same $2. The average single family home in America was always about 180–200 ounces, which is currently about $250,000. $250,000 is the price in dollars, the value of the house is the roof, windows, plumbing, security, etc. There are plenty more examples to demonstrate how gold stores value.

If it was really an antiquated relic, we wouldn’t see 8100+ tons being held in Fort Knox, West Point, the Federal Reserve Bank of NY, and selected other locations. The London Bullion Market Association (LBMA) would not have over 7000 tons in its vaults. The International Monetary Fund holds over 3100 tons, and European sovereign holdings total over 11,000 tons. Other nations like China, India, and Russia would not be adding to their national reserves, and individuals around the world would not be adding to their own holdings either. So even though the talking heads on the TV screen claim gold is history, the truth is that the only role it doesn’t play today is the anchor to currencies around the world.

The second argument against holding gold was that it serves no purpose aside from jewelry or dentistry. If you are reading this article on a smartphone or computer, there’s gold inside. Did you watch last week’s solar eclipse with NASA or recently view any of their photos of anything in the galaxy? They use pretty high tech equipment and guess what it contains? Gold. Do you know anyone who has had a life saving heart surgery or perhaps brain surgery? How about something more benign like a CAT scan or MRI? Also contains gold in the machinery. Gold is still very relevant to our lives, and more uses are found every day.

The third argument is that gold doesn’t pay dividends. That is true, it doesn’t pay dividends. That’s because only companies pay dividends. Don’t feel bad if you’ve made that mistake, because I have a friend with a Princeton PhD in economics, he’s a CPA, and he has the longest alphabet soup of certifications I’ve ever seen after anyone’s name on their business card. He made the same mistake.

The real problem I have with someone saying “gold doesn’t pay dividends” is 1) he is probably doing something called chasing returns (dangerous), and 2) he is probably chasing yield (also dangerous). When you hear someone making this claim, they are comparing the dividend of gold (0%) to the dividends paid by stocks (about 3% over time) and bonds (about 6% average on 10-year treasuries over time). They are also comparing the long term gains of stocks against gold.

So let’s look at the long term gains of both gold and stocks. Gold bottomed out around $255 an ounce in 2000. Since then it has risen to about $1300 today. That’s a growth rate of over 10% per year. In the same time period the NASDAQ Composite Index is up by about 1% per year and the S&P 500 is up about 3% per year. If that period of time is not long enough, gold still wins out over longer periods. Even during shorter periods when gold doesn’t win, there is no risk of gold losing all of its value like there is with individual stocks.

The last argument was that you can’t buy anything with gold because it isn’t money. If you doubt that gold is money, go back to the beginning of point one. In fact, it is currently the only money in the world, and it is the only currency that ever existed to maintain that status for the last 5000+ years. In your bank account or wallet is just cash.

If you hold a one-ounce gold American Eagle and go to the supermarket with it, the cashier likely won’t accept it. But if you speak to the owner, he likely will. In fact, there was a story just after the financial crisis in 2008–2009 that a certain New York real estate developer turned president had announced that he would accept gold bullion for rent payments instead of cash. There was a time in our history that everyone accepted gold coins as legal tender, and that time will come once again.

Don’t get me wrong, I’m not a gold bug. It’s just a completely misunderstood asset that deserves serious consideration. Next week I’ll have more on the risks and scams to look out for if you want to buy gold. And if you want to see a much more in depth look at the yellow metal, have a look at my seeking alpha post here.

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