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Numerous commentaries in the media, both on
television and in print, would have us believe that gold is a bad investment.
Headlines warning investors to avoid the yellow metal are commonplace.
Examples such as “Five reasons not to own gold”, “Gold is
in a bubble”, “Gold as an investment - think again”,
“Gold is a bad hedge”, “Gold is a pointless
rock,” and “Why gold is a bad investment” can be found
with a simple Google search on gold and investment.
Each of the above points are addressed and debunked
in the BMG Special Report, 'Six Biggest Myths About Gold' which readers of
this article are strongly encouraged to read and which can be downloaded for
free at www.goldmyths.com
These articles miss the point, because they treat
gold as an investment. To fully understand gold's role in an investment
portfolio, we need to adopt a new mindset, a gold mindset.
Simply put, gold is not a bad investment, and gold
is not a good investment. Gold is not
an investment at all - gold is money.
While many people believe gold is an archaic relic
that has no role in today’s sophisticated, computerized, paper-based
monetary system, three facts contradict this popular misconception:
- Gold, silver and platinum are traded on
the currency desks of the major banks and brokerage houses, not the
commodity desks. Traders understand gold is money to be traded against
paper currencies.
- The world’s central banks hold
about 30,000 tonnes of gold in reserves. While
there has been a lot of media attention given to central bank sales in
the past, gold holdings have only declined by about 2,000 tonnes since 1980. Central banks have become net
buyers since 2009 and have been adding gold to their currency reserves.
Central bankers understand gold is money.
- The turnover rate between members of the
London Bullion Market Association is over US$20 billion per day, with
volume estimated at five to seven times that amount. Clearly, this has
nothing to do with jewelry sales and everything to do with the exchange
of money
The definition of “investment” is the
commitment of money or capital to purchase financial instruments or
other assets in order to gain profitable returns in the form of interest,
income or appreciation of the value of the investment. Through this
transfer of capital, in the expectation of a profit, an investor gives up
their capital and puts it at risk. The investor receives a return in
dividends or interest as compensation because their capital is at risk; they
may get back less than they invested, or they may get back nothing at all.
However, physical gold bullion or physical paper
currencies locked in a vault are not invested; they are simply being stored.
Since neither is invested, they don’t earn interest or dividends, but
they don’t have any counterparty risk. The major difference between gold and
currencies kept in a vault, however, is that gold’s purchasing power
increases while paper currencies lose purchasing power year after year.
Both gold and currencies can be taken out of the
vault with ease, and the proceeds invested by giving them to someone else in
return for dividends or interest. An interesting perspective can be gained by
calculating whether the proposed investment is likely to return more gold
ounces than were originally invested. For example, the 44 ounces of gold
required to purchase the Dow in 2000 has now dwindled to fewer than nine
ounces. Might as well have left the gold in the vault. Since gold maintains
and even increases in purchasing power, there is no need to put it at risk in
order to earn a minimal amount of interest or dividends.
Figure 1
illustrates how gold has not only preserved but also increased its purchasing
power from 1971, when the gold standard was abandoned, to 2011.
Figure 2
illustrates how all of the major currencies have declined over the last
decade when measured by gold ounces.
It is crucial to recognize that physical gold
bullion, held directly or on an allocated and insured basis in a vault, is
not an investment because it is not someone else's promise of performance or
someone else’s liability, and as a result has no counterparty risk. All
other forms of gold ownership are, in fact, investments. Paper gold
certificates, unallocated bullion accounts, ETFs, shares in gold mining
companies and futures contracts all have counterparty risk, and are either
someone else's promise of performance or liability. They may have their place
in a portfolio, but they are all investments. We hold physical gold in a vault, we hold physical currencies in a
bank, but we invest in financial
assets.
Nick Barisheff
Bullion
Management Group
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