The Gold Investor’s Manifesto or Why Gold Is Not Just a Metal

«Paper money eventually returns to its intrinsic value — ZERO», Voltaire, 1729

The discussions that arise among usually calm and reasonable economists and financiers regarding the average life expectancy of a fiat (paper) money trigger a surge of emotions uncharacteristic for this category of people. Some claim that the average life span of a fiat currency is 27 years. Others argue that this is complete nonsense, though accepting the fact that paper money does have underlying fundamental problems. The only thing they manage to agree on is that in the entire history of paper money, for one reason or another, 599 paper currencies out of 775 episodes did not survive[1]. Not all paper money died a bad death. The introduction of the euro instead of national currencies might serve as an example. But the chances of a bad ending for paper money are also high.

There are certainly paper currencies of advanced age. For example, the British pound has been in circulation for more than 300 years. But there is an interesting nuance here. At the time of its birth, one pound could buy 12 ounces of silver. Today’s value of one pound is just 0.5% of its original value. This means that even the most successful paper currency — the pound sterling — has lost more than 99% of its value in the entire history of its circulation.

The purchasing power of the US dollar, another successful paper currency, has fallen 90% since 1950 and 96% since 1913. Furthermore, this trend has intensified since the abolition of the “gold standard”, that is, the system that linked the value of the dollar and other currencies to gold, in 1971. Between 1971 and 2020, the dollar lost 85% of its purchasing power [2].

The value of gold in dollar terms has increased 90-fold since 1920. Has gold fulfilled its function as a safe asset and a means of preserving savings? Given that the price index of goods and services in the United States — the world’s largest economy in the twentieth century — has increased only 26 times over the last more than a hundred years, the answer is unequivocally yes.

Was gold the best financial investment over the last hundred years? The data shows that 5 ounces of gold would have been enough to buy a basket of stocks that made up the Dow Jones Industrial index in 1920, while about 16 ounces would have been required in 2020. Thus, it can be stated that in the past century, many other financial assets have indeed turned out to be a more profitable investment than gold. But this analysis lacks one thing: all modern financial assets that compete with gold — stocks, bonds, unit trusts, investment funds, derivatives, cryptocurrencies, and so on and so forth — have yet to pass the test of time.

Behind gold and its younger sibling silver is more than 3 000 years of history as a real means of preserving savings, which indicates that[3]:

• in 1979: the average price of an ounce of gold was 306.68 US dollars. That was enough to buy a large bed in America.

· 42 years later: the price of an ounce of gold is about 1,850 US dollars (1,530 euros). This is still enough to buy a large bed.

• in 1963: a gallon of gasoline in America cost 31 cents. This meant that three silver 10-cent coins could buy a gallon of gasoline. The total weight of silver in these three silver coins was 0.217 ounces.

· 58 years later: 0.217 ounces of silver (5.85 US dollars or 4.85 euros) can buy two gallons of gasoline. Even if the price of oil doubles or the price of silver halves, one still will be able to buy a gallon of gasoline.

• in 600 AD: in the Middle East during the time of the Prophet Muhammad, a family could buy a chicken for one silver dirham (3 grams).

· 1400 years later: a family in the Middle East can still buy a chicken for 3 grams of silver (2.60 US dollars or 2.15 euros).

• in 1 AD: a citizen could purchase a toga (i.e., a suit), a leather belt, and a pair of sandals for one ounce of gold.

· 2000 years later: an ounce of gold (1,850 US dollars or 1,530 euros) still buys a suit, a leather belt, and a pair of shoes.

• in 400 BC: at the time of King Nebuchadnezzar of Babylon, 350 loaves of bread could be purchased for an ounce of gold.

· 2400 years later: you can still buy 350 loaves of bread for an ounce of gold (1,850 US dollars or 1,530 euros / 350 = 5.29 US dollars or 4.37 euros per loaf).

• in 1000 BC: historical sources indicate that King Solomon purchased horses in Egypt for his army. They also show that he paid 150 shekels of silver for one horse. 150 shekels was equal to 55 troy ounces of silver.

· 3000 years later: you can still buy a horse for 55 troy ounces of silver (1,485 US dollars or 1,227 euros).

Gold has stood the test of time:

• its value is universal across all cultures and civilizations.
• it is anonymous and has no maturity, unlike government debt securities. Gold can be sold and no one will know who its previous owner was. While paper money is a government-issued security where the rules of circulation are determined by the government itself.
• its supply cannot be increased by pressing a button on the central bank’s computer keyboard.
• it does not depend on the subjective will of controlling shareholders, issuers and regulators.
• it does not burn like buildings and does not depend on the benevolence of insurance companies and court decisions.

The role of gold is particularly increasing in times of political, economic and social turmoil:

• if the authorities rush to save the financial system from collapse by printing paper money and are successful in their efforts, this will lead to the monetization of the banking sector’s obligations, to hyperinflation and an increase in the value of gold in monetary terms.
• if the authorities’ efforts to save the financial system are not successful, it will lead to the collapse of banks, the introduction of restrictions on the movement of capital, the freezing and subsequent write-off of depositors’ funds. In these circumstances, gold will remain the main, time-tested means of payment, thus regaining its status of real money.

Have we experienced an undervaluation of precious metals over the last hundred years, thus assuming the historical opportunity of a profitable investment in gold? It is entirely possible.

Financial journalists back in 2013[4] estimated that the amount of money supply in the United States reached 10.5 trillion dollars (M2 monetary aggregate), while the size of the US gold reserves was 260 million ounces. This implied that the potential value of a troy ounce of gold might exceed 40,000 dollars, while the market price of one ounce was about 1,200 dollars. By January 2021, the amount of money in the United States had already reached 19.5 trillion dollars[5], while the size of the gold reserves remained virtually unchanged, reaching 262 million ounces[6]. This implies the value of a troy ounce of about 74,000 dollars. It is hard to believe. On the other hand, one might reasonably assume that the real value of the precious metal significantly exceeds 1,850 USD. Having been presented with all the facts, one could not help recalling the old and proven universal truths that money is power, and gold is money.

References:

[1] John Paul Koning, Moneyness, 2019.

[2] Calculations based on the consumer price index data published by the US Bureau of Labor Statistics.

[3] Jeff Clarke, Big Gold, Casey Research, 2009 and the author’s estimates as of January 2021.

[4] Todd Ganos, Forbes, 2013.

[5] US Federal Reserve, January 2021.

[6] US Treasury Department, December 2020.