An Eye for Gold

Real Things


The super wealthy pay way too much for some stuff, don't they? I mean, $490,000 for a used old card table? I can get a brand new card table for $40, but here's a much nicer one for $280.

I caught a few minutes of the Antiques Roadshow the other day. Mrs. FOFOA had it on and I was passing through the room, but somehow that show grabs you and you have to stay to find out what the item they're examining is worth. This one was an old, wooden card table, originally made in Pennsylvania, and long ago refinished. Some lady had brought it in to have it appraised on TV. It was pretty nice, mahogany wood, claw and ball feet, and it had a swing-out leg that supports a hinged extension of the table's surface. The appraiser told her it was worth $250,000 to $350,000, and if it hadn't unfortunately been refinished years ago, it could have been worth up to $500,000 today.

I tried to find that episode online while writing this, but I only found a similar one. It's another card table they appraised for $200,000 to $300,000 and, when it actually went to auction at Sotheby's, it sold for $490,000! You can see the original appraisal here and the actual auction here.


What makes a second-hand card table worth $490,000? It's certainly not the need for a surface on which to play cards. That need can be met for much less money. You know what it is? It's that the wealthy fill their lives with otherwise-common items that perpetually rise in value, while we do the same with similar items that lose half their value, never to be regained, the minute we take them out of the store.

Two tables. One is $280 and the other is $490,000. The difference between the two is that the price of the former comes from demand related only to the service it renders in its specific form, as a table, and the latter comes from demand related to two different services it renders, that of a table and also that of a store of value.

I have explored this concept in many posts. It's not a new concept in any way, shape or form. In fact, man was using real things as stores of value, often in preference over their other uses, long before any labels were applied to this specific utility or function.

Take the $490,000 card table for example. We could say that the buyer paid $280 for a table, a well-crafted and nice-looking flat surface with four legs, and another $489,720 for a store of value. When you look at it this way, it starts to make sense why the wealthy often buy such remarkable "real things" and then hide them away for decades, packed in unassuming wooden crates, in places like this—Über-warehouses for the ultra-rich—rather than "using" them in their homes.

Which would you say is a $490,000 table's primary function or utility? As a table, or as a store of value? Obviously it can function both ways, but if someone pays 1,750 times more for one function than for the other, I think it would be fair to say that is its primary function.

The high price of these items which function primarily as stores of value comes from the demand for that specific function. Such demand creates a market and, thereby, the high marketability of such items. This is the network effect. And the long history and past success of such markets engenders the confidence in those who possess (and seek) such unique items that, when needed, they will be able to find a buyer ready to pay the highest price which can possibly be attained. This is what I like to call the regression effect. And while past performance is certainly no guarantee of future performance, especially in unique, one-of-a-kind collectibles, our natural tendency to believe that what worked yesterday and still works today will work again tomorrow does create a very real effect with very real results.

I hear that Christie's is booming these days. Here are just a few of the auction-related articles I've collected over the past two months:

How many more $100 million 'pictures' can the art market absorb?
PBS

Digging Into Deep Pockets at Auction
The New York Times

The Man Who Sold the Art World
The New Yorker

Warhol paintings up for sale in New York could fetch $120 mn
France 24

Grisly Warhol Painting Fetches $104.5 Million, Auction High for Artist
The New York Times


On Equal Footing with Giants


Here are a few snips from the article in The Economist which I mentioned above, titled Über-warehouses for the ultra-rich:

"The world’s rich are increasingly investing in expensive stuff, and “freeports” such as Luxembourg’s are becoming their repositories of choice…

Because of the confidentiality, the value of goods stashed in freeports is unknowable…

Collectibles have outperformed stocks over the past decade…

The goods they stash in the freeports range from paintings, fine wine and precious metals to tapestries and even classic cars…

These giant treasure chests were pioneered by the Swiss, who have half a dozen freeports, among them sites in Chiasso, Geneva and Zurich…

The wealthy are increasingly using freeports as a place where they can rub shoulders and trade fine objects with each other. It is not uncommon for a painting to be swapped for, say, a sculpture and some cases of wine, with all the goods remaining in the freeport after the deal and merely being shifted between the storage rooms of the buyer’s and seller’s handling agents…

Gold storage is part of Singapore’s strategy to become the Switzerland of the East… To spur this growth, it has removed a 7% sales tax on precious metals…

Switzerland remains the world’s leading gold repository. Its imports of the yellow metal have exceeded exports by some 13,000 tonnes…

Did you notice anything about the stuff the "ultra-rich" are stashing at those freeports? For one thing, most of that stuff is out of reach for the average saver. Most individual items that make their way to these storage facilities cost more than the average person makes in a year, and some cost more than he'll make in a lifetime.

Gold is the only "real thing" used by the wealthy, for this specific store-of-value function, that is also available to anyone. What's more, the gold of the everyman is the exact same quality gold that is held by the Giants. The same cannot be said about the paintings, sculptures, tapestries, cases of wine, classic cars or even the card tables held, and used, by people of average means.

I have everything on that list, except a classic car (although my car is 12 years old now, so I'm getting close). The difference is, I hold each of those items for the service it renders in its specific form only. My wine is for drinking and my art livens up my home. I have bought and sold an entire home-worth of expensive furniture, and I can tell you that, no matter how much I paid for each wonderful piece, in order to sell it when I needed to, I had to cut the price considerably.

Storage and moving expenses can greatly increase your cost basis in items that are only depreciating over time. This was why I decided to sell everything the second time I moved cross-country. It was a good decision, but what I learned was that, for the common man, household items, no matter how nice they are, are generally poor stores of value at our level.

That's not to say you can't do well with certain types of items, especially if you take your time selling them. I had a Dr. Who pinball machine which I sold for quite a bit more than I paid for it. But I took my time selling that item, and if I add the maintenance and expense of moving it cross-country to my cost basis, it was probably a wash, although I did get hours of enjoyment out of it. Then again, I didn't buy it as a store of value.

I do know a few people who buy fine wine by the case, numismatic coins, expensive paintings, pottery and even sculptures with the idea that these items will render the dual services of practical use and store-of-value. In some cases, a portion of their high price does indeed come from demand for the store-of-value function, but in most cases, at our level, the majority of the price comes simply from the demand for an exclusive level of quality. Exclusive items are sometimes called Veblen goods.

There's nothing wrong with enjoying an exclusive level of quality if you can afford it, but I want you to think about how these exclusive-quality items that may be within our reach actually compare to the ones used by the uber-wealthy. The difference really comes down to the magnitude of the proportion of their high price which was derived specifically from demand for the store-of-value function, as opposed to the item's practical use as a high-quality exclusive showpiece.

This store-of-value demand is the demand which creates a deep and liquid second-hand market for these "overpriced" items. Did you buy your collectibles from a store, or at an auction? If you bought at auction, how many others in the room also bid on your item? Is the maker of your precious item still alive? If you decided to sell your showpiece, how would you sell it? To a store? On consignment? On Craigslist or eBay? Is there a good auction house in your city? Do you have any idea how much commission auction houses charge? How long do you think it would take for you to find a buyer who would pay the highest price which can possibly be attained at any time? If you had to sell in a hurry, do you have confidence that you could attain the highest price?

These are all unique items we're talking about, so there is no standard that applies across the board. But over long stretches of time, some unique items climb a certain "store-of-value pyramid" while others don't. I like to call this the focal point effect. Take Andy Warhol for example. With one of his paintings selling for more than $100M, he has risen to become a kind of focal point among the various pop art painters of the 60s.


Does this mean that Warhols are in a bubble and a Rauschenberg at $10M would be a better investment? Perhaps, but I don't think so. And I'm sure that this view misses the point I'm trying to make. Since we're talking about unique, one-of-a-kind items, one can certainly pay too much for any single item. But in a proper auction setting, there will either be many bidders, or else you won't be bid up higher than you planned on paying. It is the focal point effect which adds the depth and liquidity to the highest-of-high-end auctions that gives the owners and seekers of such items the confidence that, if and when it comes time so sell their particular item, they will be able to attain the highest possible price at that time.

That focal-point-marketability is precisely what makes the very best-of-the-best stores of value. It is what drives some things to many multiples of the "intrinsic value" of their component parts, i.e., frame, canvas, paint and an aesthetically-pleasing image, while leaving others in their dust. So, in this case, a Warhol might be a marginally better store of value than a Rauschenberg, although you could have paid more for the latter in the 60s. In fact, you can still buy 60s pop art originals on eBay today for a few hundred bucks. Note that it's not the death of the artist that drives the focal point effect. There are plenty of dead artists. It's just that it takes time for the focal point effect to emerge and mature to this top level, usually longer than the normal human life span.


Surprisingly, however, that's not always the case. You might think that the anonymous telephone bidder who paid $58.4M for "Balloon Dog (Orange)" last month paid way too much, especially considering that, not only are there four more balloon dogs just like it, in arguably better colors than orange, but more importantly, the artist is still alive. And he's only 58 and still producing! But considering that there was a competing bidder willing to pay $57.3M ($51M + commission), how can anyone say he paid too much?

The seller of "Orange Dog" was Peter Brant, the 500-millionaire who is married to supermodel Stephanie Seymour. "Blue Dog" is owned by billionaire Eli Broad and is currently on display at the Los Angeles County Museum of Art.


"Magenta Dog" is owned by French billionaire François Pinault (but that's the artist Jeff Koons, not Pinault, in the picture):


"Red Dog" is owned by Greek billionaire Dakis Joannou:


And "Yellow Dog" (my favorite, although I would have called it "Gold Dog") belongs to billionaire hedge fund manager Steven A. Cohen:


Call it "Focal Point-Balloon Dog"! It doesn't have to make sense to you, it just "is". But does that mean that all of those balloon dogs are worth $58.4M now? Of course not. With these kinds of items, we don't know their price until after they are sold at auction.

Here are some interesting statistics. According to Investopedia, experts estimate that only 0.5% of paintings bought are ever resold, and public auctions account for only a small portion of those resales, with private transactions accounting for the rest. At the high end, fine art auction houses are the best way to attain the highest possible price at any time, but they can cost you anywhere from 3% to 50% of the sale price in some cases. The commission on "Balloon Dog (Orange)" worked out to about 12.3%.

Tracking or indexing markets for unique, one-of-a-kind items, like art, is different from tracking stocks, bonds and commodities. It's more like residential real estate due to the infrequency of trades and the uniqueness of each item. To create a useful index comparable to stocks, bonds and commodities, you can't just track the average price of sales over a period of time, since each item sold is unique. Instead, you would want to create a database consisting only of repeat sales of the same exact objects.

Two New York University professors, Jianping Mei and Michael Moses, did just that. They created the Mei Moses Fine Art Index based on a database they built which now contains over 30,000 repeat sale pairs for approximately 20,000 individual works of art. They are constantly adding to the database using mainly the public results of auctions conducted by Sotheby's and Christie's from around the world.

What they found was that the compound annual return on fine art exceeded stock market returns on 5- and 10-year timelines, but that the stock market outperformed art over the last 25 years. However, for the last 50 years, the returns were very close, with fine art achieving a compound annual return of 9.23% compared with 9.73% for equities.

Now I should point out that the purpose of this index is to compare stores of value with investments to encourage investors to incorporate them into their investment portfolios. Such is the Western investor mindset. Like paper gold, there's even a kind of "paper art". According to Investopedia, fine art funds typically use leverage to buy art, have a minimum entry investment of $250,000, and for that you will receive a diversified portfolio of art, annual statements and appraisals for the artwork.

Everyone knows that western minds don't like or want gold, but if they think you like it they will trade it up in price for the sake of "sticking it to you." Enter the world of "paper gold." –Another

If you buy into one of these art funds, you won't actually have pieces of art. You will, instead, have a securitized fractional interest in a stash of real art, kind of like owning a fractional interest in a real Giant's store of value. Only it won't be managed like a Giant would manage his stash, buying focal point winners and selling the losers until all he has left are the winners. Instead, a fund manager will decide which pieces of art will be purchased and sold, and his only concern will be the short term gains made from selling the best pieces so that he can make his 2+20. Another called this "a western way," to "cut the winners and let the losers run."

The thing about this focal point effect I'm trying to explain is that the winners rise to the top and just keep on rising, well out of reach for all but the Giants. What makes something one of the "best-of-the-best" is not its superior quality or age, but simply the focal point effect, which essentially means that Giants have already voted for it in the only way that matters, with their pocketbooks.

True Giants are extremely strong hands when it comes to stores of value. They generally have no financial need to sell anything, so when they do, it is often because they are "trading up". In this way, the very best-of-the-best items tend to make their way into the strongest hands where they just "lie still" for generations. And, of course, we cannot know the price of such best-of-the-best items except on the very rare occasions when they are put up for auction.

If we could, somehow, hypothetically, come up with an objective way to identify the best-of-the-best as a class, and also track their progressive appreciation, I think we'd probably find a lower but much more dependable (less risky and more homogeneous or uniform, especially over the long run) rate of appreciation than the Mei Moses index would otherwise lead us to believe. Of course, this is impossible to know, because the best-of-the-best focal point winners I'm talking about are the ones that never go up for sale, kind of like the Mona Lisa, so we will never know their price. All we can do is guess.

Here's where it might get a little bit difficult to follow because you'll need to think like a Giant. While these "best-of-the-best" items are perpetually appreciating, hypothetically at a remarkably dependable rate, and while that seems very appealing to us shrimps, it has nothing to do with the reason the Giants buy these things. Giants buy these things simply because of the regression, network and focal point effects that engender the confidence that, when needed, they will be able to find a buyer ready to pay the highest price which can possibly be attained at that time, whenever it may be.

It is, quite simply, the inherently-strong hands of the Giants that instill such remarkable dependability in the "best-of-the-best" focal point stores of value. If Giants suddenly had weak hands, and all such items were to hit the market at once, this would obviously no longer be the case. But that clearly doesn't happen, precisely because such items are only within reach of true Giants, who, by definition, have inherently strong hands.

We know this is true by the simple fact that these items I'm calling "the best of the best" so rarely come to market. Once they make their way into the strongest hands, they just sit there, lying still for generations. And this is why, on the very rare occasion that one hits the market, we see other Giants falling all over themselves to get it, bidding that item up to well above all "rational" expectations and, without fail, setting a new record. It's quite literally something that's only available to Giants, and you almost have to be one to even understand it. And because these items I'm talking about always sell for more than can "rationally" be expected or explained, they will never end up in one of those art funds. Only a true Giant can understand the "rationale" behind "paying way too much" for something.

And then there's gold. But I'm not talking about today's (quote-unquote) "Gold". I'm talking about physical gold, the singular item in that Economist article above which is not only hoarded by Giants, but is also available to anyone and everyone. If you can wrap your head around the concepts—the effects—that instill such remarkable store-of-value functionality in the best-of-the-best real things as I have explained them, then I am here to tell you that physical gold is even better!

ANOTHER: The gold market is made up of a very broad spectrum of investors. At the very farthest ends of this spectrum lie the persons with the largest influence on the physical bullion. The super wealthy at one end and the "third world no ones" at the other. The middle is occupied, mostly, by the "investors with western thought". The far ends buy bullion. And they don't buy it as a gamble or a game! It is a way of life that has worked, through thick and thin, even before the West was "The West".

Now, on the other hand, this "modern day middle of the spectrum"! Well, they have read why we need gold, but they have never "Experienced" the need for gold! Until that day, when they gain "Experience", most of them will make "A Gamble That They Never Intended To Take". Yes, they do invest in all forms of paper and or leveraged gold and all the while, expounding from the roof tops the coming currency crashes and stock market declines. Even looking for bank closures and bank runs, as they cling dearly to comex options and gold stocks!

Anyone, from the outside looking in can clearly see that "westerners" do lack "experience".

There is a "flaw" in this modern market that many do not quite grasp. In time, they will! There have always been people and companies that make a living dealing in gold. It is an ages old business. Today, we see a phenomenon that is "as none before". It is mostly done by the investors at the middle of the spectrum. The "trading of gold" has grown to a level never seen in history! You read every day, that no one wants or needs gold! In a way those statements are very correct! No investor wants to hold gold, but everyone and his brother ( and sister ) wants to trade it! The volume of paper trading, worldwide, on and off market is beyond belief! It has created a type of "Parallel Paper Gold Universe", existing side by side with the physical. The major "flaw" in this system is found in the makeup of the "traders" of this "paper gold universe". Without fail, the majority is made up by those in the "middle of the spectrum", those without "loss of currency "Experience" ". Mostly, they are of "western thought".

I have tried to offer these thoughts as a way for many to understand why this modern gold market is not as before. Most of these letters apply to investors at the far two ends of the market ( see my last post ) . Many, from other places, do understand these "expressions" as given. For many here, I resist the replies to questions that offer results for "gold traders". The intents and reasons are for persons to "consider" and "see" this market in a true light for today. Not for paper trades that will lead to certain loss for the future. I now believe, that by way of other posters, these thoughts are "in grasp" by many traders of "western thought". One may not "accept" the conclusions, but they can, "mentally experience the outcome" of the future. For this end I will now offer real direction. That of Why, When and How Much! I do this for those of "Family and Country", and persons of Honor. Those that live to help, not take, in times of change! Some say this knowledge should not be in a "public way", but I say secrets are for fools.

We must grasp that all commerce is done, at least, in the US dollar concept of "valuations of real things". In this way, " the true value of the purchase of real money" is hidden from view! Persons will say in the future, "how could gold be $500 one day and $5,000 the next"? I tell you now, it is already past that level, as in "present reserve currency dealings" it is not seen! Consider, that in all that you do and think, your "western values" are of paper concepts. From your birth, real things are not used to cross value themselves! When the battle to keep gold from devaluing oil ( in direct gold for oil terms ) is lost, the dollar will find "no problem" with $30,000 gold, as it will be seen as a "benefit for all" and "why did noone see this sooner"?

Now when I say that physical gold is even better, I'm not talking about carrying it through the revaluation. I'm talking about after the revaluation. But to understand what I'm trying to say, I think you need to put your mind there, into the future, to "mentally experience the outcome" of the future, which is why I included that bit from Another. He lays it out quite clearly. Today's gold market consists of a "Parallel Paper Gold Universe" used by "investors with western thought," and real physical gold used by Giants and "third world no ones" for generations.

"Street Gold" and "Paper Gold" are going to part ways! –FOA

Physical gold is the one real thing that puts Giants and "third world no ones" on equal footing. Third world no ones certainly don't buy $100M paintings, $50M balloon dogs, or spend half a million on small tables with their surplus income. But they do buy gold as a tradable wealth asset, that singular real thing (focal point effect) in which its perceived value comes from a very long history (regression effect) of broad demand (network effect) for its store-of-value function above and beyond any other services it renders as a shiny and malleable metal.

But what about those "investors with western thought"? If "Street Gold" and "Paper Gold" are going to part ways, does that mean gold will play no future role in the West? Of course not. The fact of the matter is that a large slice of today's "investors with western thought" are not true investors at all. They are conservative savers, which means they are inherently more like the Giants and "third world no ones" in terms of how they prefer to deploy their surplus income. Investor money is called "hot money" because it's always on the move, looking for the next great yield, which requires a certain amount of expertise and focus on the specific activity of investing. Saver money, on the other hand, is "cold money" as it lies very still, which requires a focal point store of value. Gold is for savers:

"[Another's] message and proposition was never for a trader's mindset or time frame. Indeed, his direction was for simple savers, like you and me… As I hold my gold for the money it is, traders will work all these markets as they must… most "physical gold" savers will find themselves "many steps" ahead of the "Western trading community" as this plays out… gold money was/is but a representation of the real tradable wealth you saved over a lifetime of work… This "long term gold accumulation" proposition was given some time ago, to induce conservative people to begin saving gold "now"… You see, there is a world of difference between saving real money as a "wealth of ages" and trying to trade this world's "paper derivatives"… These years be right for ones who save gold." –FOA

FOA called this function or utility "wealth money", which denotes both the physicality of the item (wealth) such that it represents true settlement—an exit from the monetary plane—as well as the primary source of its demand, which is above and beyond any other physical services it renders (money). But gold doesn't quite fulfill this "equal footing" promise yet today, as anyone who first purchased gold in August or September of 2011 can attest. It will, but not until "Street Gold" and "Paper Gold" part ways.

Of course, the time preference of non-giant savers is higher (shorter) than it is for true Giants. So for gold to be on equal footing with the likes of "Balloon Dog (Orange)" and "Silver Car Crash (Double Disaster)", it will need to have a few differences that make it much more amenable to turnover on a shorter time frame. And it will. It already does!

For one thing, the transaction cost is, and will be, much smaller than the 12% to 25% commission that top auction houses charge for selling high-end items. For gold it's around 5% today, and will probably be much lower at a higher price. Low transaction costs are important because they must be overcome and recouped through appreciation within the minimum preferred time frame. Likewise, the cost of storage and security must be recouped through appreciation. It costs a lot more to securely store a 12 foot-tall balloon dog than it does to store 1,000 ounces of gold.

These costs, round-trip transaction cost plus secure storage, compared with gold's real appreciation (appreciation in real, not nominal, terms), will naturally match the time preference of savers for settling physical plane imbalances versus carrying a monetary plane balance. In other words, the cost of carrying a cash balance will be compared to the cost of buying "wealth money" over a short time frame.

How short of a time frame, you ask? I can only guess, but I can easily imagine a round-trip transaction cost of 2% and an annual insured storage cost of around 0.1%, with a real appreciation of 1%++ per year. So that would put the minimum time frame for settling a monetary plane surplus at about 2 years, which is a good time horizon for known and expected expenses for which you'd want to carry a cash balance.

It is remarkable that gold and the physical part of the market are already so well-suited for this role and function. Large volume gold dealers make millions today even with a margin as slim as 1% or less, and large volume insured storage can be attained for just a fraction of a percent per year, even with today's price of gold. At a higher gold price, those same margins will be profitable for smaller operations. But even more remarkable, when you think about it in the proper future context, is how gold is perfectly geared to appreciate at just the right rate. Let's call it the Goldilocks principle. Fast enough to give us "an enduring, tradable wealth asset that places our footing in life on equal ground with the giants around us,", but not too fast, so that it will never attract the "hot money" flow of the investors.


Perpetual Appreciation (The Focal Point Effect)


Back in 2009, in Gold: The Ultimate Un-Bubble, I wrote that the price of gold is arbitrary:

"Furthermore, the price of gold is arbitrary. This means that gold can go as high as the people of Earth want to take it without EVER exceeding objective valuations by common metrics like earnings, interest or the sum value of its component elements... One of the most common criticisms of gold's use as an investment is that it cannot be valued the way stocks, bonds and real estate can… But if we invert this argument then gold can never be OVERvalued either, whilst those other things can..."

I want to discuss this concept a little more, because my use of the word "arbitrary" confused certain people. In this context, "arbitrary" does not mean random or irrational, but rather more like seemingly random or seemingly irrational, kind of like the price of "Balloon Dog (Orange)". It refers to the price being more subjective than objective, determined by individual preference and demand rather than by "rational metrics" or comparison to the price of other things.

Arbitrary

1: depending on individual discretion (as of a judge) and not fixed by law

3a : based on or determined by individual preference or convenience rather than by necessity or the intrinsic nature of something

b : existing or coming about seemingly at random…

This is precisely what sets gold apart from the world of investments and puts it more in league with high-end collectibles as a store of value. All things other than gold (and other stores of value) have relative values which are tied to each other by common metrics which cannot be applied to gold. The price of gold is "arbitrary" relative to the common metrics which price everything else, therefore when gold's function changes in Freegold, its new price (priced in other goods and services) will shock and awe anyone who didn't understand the "arbitrary" nature of the price of gold.

The price of anything is actually its relative value compared to everything else. That's what price is. It is relative value. FOA wrote, "Money in its purest form is a mental association of values in trade… the value is in your association abilities." This is where gold is distinct, disconnected from everything else. Not today. Today gold trades as if it is a commodity like oil or other metals, with a price driven by that association. But this commodity association is only in the minds of Another's "modern day middle of the spectrum". When "Street Gold" and "Paper Gold" part ways, "the dollar will find "no problem" with $30,000 gold", and people will say "why did noone see this sooner"?

Well, you can see it sooner, and that's why I'm discussing the concept of "arbitrary" pricing, from a $490,000 card table to a $58,405,000 12-foot-tall metal balloon dog, to a $104,500,000 Andy Warhol painting. But what about after gold is revalued and functioning as a true store of value? Can we expect it to continue appreciating into perpetuity? Yes, of course we can!

Now, I need to briefly mention the concepts of marginal utility and substitution since I used the terms subjective and objective above. All prices (relative values) are essentially subjective in that they are derived from demand related to the primary utility of the item. Think buggy whips versus umbrellas. An umbrella still has a use, and therefore demand, while a buggy whip does not. But the prices of gold and other stores of value are more subjective than other things, and the prices of other things are more objective than stores of value. And this relative measure of "objectivity" (as I'm calling it) comes from the concepts of marginal utility and substitution.

Marginal utility means that, for things in which their primary utility is the service they render in their specific form, like a table, the value derived from demand for this utility declines at the margin. How many tables does one man need? At some point he will have enough tables, and at that point, his demand for another well-crafted and nice-looking flat surface with four legs will decline. In economics, this is called the law of diminishing marginal utility, and it applies nearly all utility functions except the store-of-value function. Shoes, in Imelda Marcos' case, might be an exception to the rule.

The substitution effect is the idea that as the price (relative value) of something rises, it will eventually be replaced by a less costly alternative that renders the same or similar service. These two concepts are essentially limiting factors in the relative values of everything other than the very best store-of-value collectibles.

I'm getting into some heavily-conceptual territory here, so please bear with me. I want you to think about the regression (historical effectiveness), network and focal point effects as they relate to the very best artworks in the world. Being one of the very "best of the best" is an emergent property, one that can only be identified in hindsight. In fact, picking unique individual pieces of art is indeed a bit of a gamble. Who's to say that "Balloon Dog (Orange)" (or any of the colors for that matter) will turn out to be a good store of value 40 years from now? Will it stand the test of time? I have no idea, but I wouldn't bet my own money on it!

What would it mean for "Balloon Dog (Orange)" to stand the test of time, or not? Is it about price appreciation? As I said above, you really have to think like a Giant to see that it is not about price appreciation. I realize this is a difficult concept for a Shrimp to even consider, but as I said, Giants seek and hold these kinds of items because of the confidence engendered by the regression, network and focal point effects that, when needed, they will be able to find a buyer ready to pay the highest price which can possibly be attained in the market at that time.

They don't hold it because it appreciates. It appreciates because they hold it. Cause and effect. Perpetual appreciation is the effect, not the cause. The cause can be traced to the regression, network and focal point effects.

Of course not every piece of artwork that sells for $10, $50 or $100 million will be able to be resold years later for a profit. Only the "best of the best" will, and we'll only know for sure which ones those are in hindsight, after the fact, after they go to auction. And yet, even though we can't know for sure, we can have a high degree of confidence about some of them. How much do you think the Mona Lisa is worth?

What do you think? Is low but steady perpetual appreciation in real terms even possible? Someone asked me recently: "FOFOA, I've heard many people say that interest is evil, and then they use the old "if you deposited $100 earning interest over the last 2000 years it would be enough money to buy the world. So to play devil's advocate if gold rises in purchasing power over time wouldn't it create a similar problem to compound interest. Theoretically 5000 years from now one ounce of gold could buy the whole world and whatnot?"

This is a good question, because for Westerners raised from birth to think of value in terms of nominal digits, compounding appreciation does seem to raise a red flag. But in digital terms, even theoretically, there's a difference between nominal interest and interest in real terms, or real interest. In order to "own the world" you'd have to earn a compounding interest rate in real terms, and what time has revealed is that such nominal appreciation is always offset by a depreciating denominator.

Imagine you had a 2% inflation rate and you also earned 2% in compounding interest giving you perfectly stable purchasing power. As your compounding interest turns exponential, so too does your denominator (the numéraire) lose purchasing power. You can try an exercise on a simple Excel spread sheet.

Start with $100 in two columns. In the first column, depreciate the base unit by 2% per year. So 100*0.98 and reiterate that for 100 years. That will show you the decline in purchasing power of the base unit. Then in the second column, give yourself 2% interest for 100 years. 100*1.02. This will show you the compounding principle. After 100 years, your base unit will only be worth 13.26% of what it was the first year, and your compound interest savings account will have $724.46 in it. You can run iterations to infinity if you want, but as your nominal balance approaches infinity, your base unit value will approach zero.

If you take away the depreciating denominator, then yes, your purchasing power will eventually approach infinity. This doesn't happen in the real world, but, amazingly, perpetual appreciation in real terms is still possible with a true focal point store of value.

The Mona Lisa is quite possibly the most valued painting in the world, even though it has never been on the market in the 500 years since it was painted, and probably never will be. (Notice I used the subjective word "valued" rather than the more objective word "valuable", because value is a subjective attribute, especially in items whose primary purpose is the retention of said subjective attribute over time. Which is kind of the whole point of this post, but I digress.) It is certainly the best known, most visited and most written about piece of art in the world, great focal point features. It is considered a national treasure in France, although in 1911 an Italian tried to steal it back for Italy. How much the Mona Lisa would fetch on the open market is impossible to know, but we can probably guess the bare minimum.

The most expensive painting ever sold was a Cézanne painted in 1893 which sold to the State of Qatar in 2011 for around $300 million. While the Mona Lisa has never been on the market, it did go on tour in 1962 at which time it was assessed for insurance purposes at $100 million. According to Wikipedia, $100M in 1962 would be $760M today, "making it, in practice, by far the most valued painting in the world."

In order to calculate its real rate of appreciation, compounded annually, we must guess at a starting value for the painting. As I have said, the focal point effect is an emergent property revealed over time. So while Leonardo da Vinci was very famous in his day, we shouldn't assume an overly-high initial valuation. The Mona Lisa is believed to have been a commissioned portrait which was never delivered, went unfinished for more than a decade, and remained in da Vinci's possession until his death in 1519.

If it had been worth millions (in today's dollars) on the art market of the time, you would think he might have sold it, or at least finished it earlier. An amount was supposedly paid for the painting by the King of France after da Vinci's death, but it is unclear what the modern equivalent of that payment would be. It might have been the equivalent of $100,000 or more. So let's err on the high side and say that the Mona Lisa might have sold for as much as $500,000 in modern terms had it been auctioned off upon completion. That's probably too high, but it will suffice for our purpose.

We can use a compound interest calculator to figure out the rate of appreciation for something that appreciated in value from $500,000 to $760,000,000 over 500 years, and that rate is 1.47% per year, compounded annually. That's real, not nominal, appreciation. And that's the low but steady perpetual appreciation in real terms that I'm talking about. It comes from the focal point effect. Obviously not everything can appreciate in that way, but the focal point can. (BTW, if we start the Mona Lisa at $50K and appreciate it up to $1B over 500 years, which is probably more realistic, that's still only 2% annual appreciation.)

Like I said, I'm deep in conceptual territory here, so, again, please bear with me. I want you to think about all of the gold in the world as a single unit or mass. And as God is to Leonardo da Vinci, so gold is to the Mona Lisa. Gold is God's "Mona Lisa". And as you'd expect, coming from God, gold has many features which make it almost infinitely better than the Mona Lisa.

To begin with, while the Mona Lisa has 500 years of emergent focal point effect under her belt, gold has at least 5,000 years. Gold is divisible without losing value. If we cut up the Mona Lisa into 760,000 pieces, do you think we could sell each piece for a thousand dollars? And even if we could, would they retain that value over the long run? Gold is much more durable than the Mona Lisa, and therefore much more economical to store and transport. The transaction cost of gold is also much more economical. If you could buy the Mona Lisa through Christie's today, their commission would be $91M, but you could buy $760M in gold for a transaction cost of less than $8M.

Get the point yet? Gold has better fundamentals for fulfilling demand related to the service it renders as a "real thing store of value" than anything else. Those fundamentals are the regression effect (a longer history than anything else), the network effect (more Giants and "third world no ones" than anything else) and the focal point effect (only real gold is "as good as gold"). That doesn't mean it should appreciate at a higher rate than the Mona Lisa, however, because remember that appreciation is an effect of these fundamentals, not the cause.

The cause is the confidence in those who possess (and seek) physical gold, confidence engendered by the fundamentals, that, when needed, they will be able to find a buyer ready to pay the highest price which can possibly be attained on the market at that time. That confidence is the cause, and perpetual appreciation is the effect. But I think you'll need to think like a Giant in order for that to really sink in.

Giants, who think this way, indeed, are the foundational base of gold's value. Like the very best-of-the-best works of art, Giants have every reason to accumulate more, keep what they already have, and no reason to ever sell. It is quite simply the divisibility of gold that will "place our footing in life on equal ground with the giants around us."

There are several simpler arguments for perpetual appreciation that I could have made much more easily, like FOA's quote at the top of this section: "The more we built and created, the greater the gold value must always be in the future." This is physical plane appreciation we're talking about. That's what "real" means: gold appreciating against other real things. I could have discussed the changes in gold mining that revaluation will induce, and how public sector gold actions, including mining, will essentially be monetary plane operations with minimal effect on physical plane appreciation.

I could have discussed growth rates, stock to flow ratio and how revaluation in real terms eliminates prior volatility in real terms because it increases relative "mass", and therefore inertia, in both currency and relative value terms. I could have discussed the wide variety of investment options that will keep "hot money" away from gold, delineating, once and for all, savers from investors, traders and speculators. But I wanted to tackle the most difficult argument I could think of—the "infinitely divisible God's Mona Lisa" concept. So how did I do? Does it work for you?

Even with all of the towel-throwing we've seen over the last two years since the bull run ended, it's important to remember that for every seller there must be a buyer. Every last piece of gold on this planet is equitably owned by someone, even if it feels like no one wants gold anymore.

"Do you think that value has been lost by holding physical gold all these years?

If the answer is yes, you are wrong! I tell you now, it's all in your perception of what is value and what is real. Gold has been increasing in value since the early 90s and doing it at a rate much higher than any other investment. Cannot see this? Hear me now, what the wealthy and powerful know: "real value does not have to always be stated or converted thruout time. It need only be priced once during the experience of life, that will be much more than enough!" –ANOTHER

Revaluation is a one-off event. The reason for seeking and holding gold after the revaluation will not be the anticipation of another revaluation. For the very strongest hands which form the foundation of gold's high value, the reason won't even be perpetual appreciation. The fundamental reason for seeking and holding gold after the revaluation will be the confidence that, when needed, anyone anywhere will be able to find a buyer ready to pay the highest price that can possibly be attained on the market at that time. Of course, some people, who are today holding gold only for a revaluation windfall, will immediately cash in that lottery ticket. One such person just wrote this in the comments under the last post:

"To wake up one morning and find that I’m freegold multi-millionaire would be like a kid waking up Christmas morning, I can’t wait."

But I wonder how many weak-handed Western shrimps with this mindset will actually be among the strong-handed Giants and "third world no ones" that constitute the vast majority of equitable owners when the time comes. I know a lot of people who have already thrown in the towel, so I suppose it depends on when it happens, at $1,000, at $800, or at $250. I suspect there could be a lot fewer than we might think.

What we see right now is the last bits of physical gold gradually working their way into stronger and stronger hands as the price declines, just like the best-of-the-best artworks which, once they reach the strongest hands, never hit the market again. Just something to think about as you hear more and more Western investors throwing in the towel on physical gold. Wow, what timing!


Revaluation

"Yet, through it all, the revaluation must come as gold will return as money to represent all of this wealth many times over. For truly, all modern wealth will be directly or indirectly denominated in gold as our dollar reserve fails. To this end, the physical gold holder will stand "one step in wealth" ahead of every worldly paper trader." –FOA

"The removal of the political "world dollar settlement" price of gold will revalue this asset in terms that noone of "western thinking" can understand." –ANOTHER

"A poster on Kitco (I think his handle was AllenUSA) once did a superb job of explaining the dynamics of oil pricing during a currency collapse and gold revaluation." –FOA

"Both gold and currencies are traded with perceived future value in mind. Especially gold that is known to be revalued later." –FOA

"Later, gold will be revalued upward..." –FOA

"I fully well expect my wealth holdings to not grow one bit over the next twenty years!!!!!! But, I do expect the world markets to evolve and revalue my assets, showing their true worth. No, not near gold, not almost gold, not poor man's gold, not gold in the ground or other paper gold,,,,,,,,,,,, just plain old gold in the hand. An asset that will out perform every other holding in the times to come.

--------- The wealth of ages; a lifetime of work kept in a savings from our past. --------" –FOA

"Yet few considered the true ramifications if countries suddenly revalue gold not as money, but as a world reserve asset! We approach this dynamic today as world dollar debt has reached its limit. Exciting times for those that "walk in the footsteps of giants", awful times for those that have invested in the gold industry. It's not too late to change course and sail with the wind. With the direction of someone that understands, I have done just that! With the wind...........we are on the road now!!!" –FOA

"From this stance we can understand why many have viewed gold as a riskless holding that will be revalued. If it was part of your mix, the transition would always make up for any return lost from not holding other assets. Indeed, it is the very ultimate in a super leveraged investment. No other currency today could expect a 1,000% to 10,000% rise in value against the dollar, none." –FOA

"The current "paper gold market" is not a physical gold trading arena, as many here have observed and discussed. Truly, in every sense, it is a "currency market" as contracts are settled in the prevailing "currency values" of gold. It is through this process, that gold is purchased "as a stated value in currency terms", not in physical terms. It is known, that a switch to trading of gold to "physical terms" of the same volume as today, would not only bring a huge revaluation in price, it would also destroy the market." –ANOTHER

"If all the gold held by earth were placed in the hands as money, it would be used to revalue every "real thing" at a fair price. A tiny fraction of gold would buy much production of goods and services, on a basis equal for all men, not as a debt for later settlement, as currencies are now!" –ANOTHER

"Once fully understood, I think most would then agree with its inevitable outcome. Indeed, a "free gold market", based only on physical holdings would impact the world economic system unlike anything seen before it. And Yes, it's impact on the relative value of gold will make that metal the monetary wealth investment for the next thousand years!" –FOA


An Eye for Gold

FOA (12/2/99; 18:06:06 #20082)
An eye for gold!

After all these days,,, did Another "time" the gold market correctly? No, not for traders he didn't! But, then again, his whole message and proposition was never for a trader's mindset or time frame. Indeed, his direction was for simple savers, like you and me. As a conservative group, our holdings represent the most long lasting, stable assets that presently exist. Such assets collected over a lifetime should not be lost to a world gone mad! Truly, Another's thoughts represent the values held in the old world. For many these are in competition for our hearts against the current façade of economic reality.

We now understand how short-lived the current misconception of money must be. Other fast paced modern investors have accepted that "money was never wealth" and paper currencies need not be real things to represent their savings. Lost on these "educated of the Western world" is the knowledge that "wealth in the form of real things" was the first thing humans traded. It was only later that someone labelled these things as money. As a people, we once knew the special value of gold and held it beside our other tradable property. We held this gold more dearly because it made the best form of "tradable" wealth. In this context, its demand will remain, as always, infinite. It mattered not if one had one ounce or one million ounces, as gold money was/is but a representation of the real tradable wealth you saved over a lifetime of work. How far must modern gold now climb as it is reintroduced to the world as a new "tradable money wealth"? As far as the unlimited efforts of humanity!

Truly, as gold is once more used as "wealth money", this action will again impart an unlimited value for gold in use. The more we built and created, the greater the gold value must always be in the future. Neither time or new ideas have changed human nature as it seeks to run from the modern uses and valuations of "IOU" wealth. A wealth that was never as great as the dollar said it was. As a system it could never represent a lasting "wealth of nations" as held in the account of "common man". Gold will come pouring in to fill this void.

This coming new level of value for gold is the "proposition" Another presents. A concept that is now being embraced as "something new" for a failing economic system now based upon an over leveraged world reserve currency! Truly, the old ways will not fail those that see through our modern money fog. Another once put it somewhat this way; Nothing has changed our need for real things as tradable items. And this earth is still round my friends. As I hold my gold for the money it is, traders will work all these markets as they must. With the speed of light they now circle the earth, only to find their future as but one step behind me!

Yes, Another once said that. Differently of course, but an incredible bit of insight it remains. I also accept that most "physical gold" savers will find themselves "many steps" ahead of the "Western trading community" as this plays out. This "long term gold accumulation" proposition was given some time ago, to induce conservative people to begin saving gold "now". At any dollar price, be it $600 or $10! Such direction was given in the face of unprecedented choices from where someone could make fortunes using our modern vehicles. Yet, through it all, the revaluation must come as gold will return as money to represent all of this wealth many times over. For truly, all modern wealth will be directly or indirectly denominated in gold as our dollar reserve fails. To this end, the physical gold holder will stand "one step in wealth" ahead of every worldly paper trader. Whether they trade paper gold stocks or dow stocks, real estate deeds or CDs, in the end their paper winnings will compete with the spoils of all others of "Western thought". These "non physical owners" will seek to buy what gold they can at a price many will refuse to understand. If one made a million by paper investing, he will buy no more than a million in gold. Still, for every new buyer that wishes to escape the old paper world there will be the lowly physical buyer from the past who will already possess two million in gold.

You see, there is a world of difference between saving real money as a "wealth of ages" and trying to trade this world's "paper derivatives". The lasting wealth of physical gold does not have to be "converted" into real things prior to a currencies destruction. It already represents the new holding everyone will want. The coming "Western" economic dislocation will devastate all forms of assets that are held in "contract ownership". Be they stocks (most gold stocks included), bonds, businesses or savings accounts, etc.; the loss of a major currency will consume most of the equity these paper items represent. It has happened with every currency ever created and will happen again with our dollars.

So, the next time you read that someone lost their "bet on gold", remember, they lost because they made the wrong bet. Only a "bet" of "buying physical" over time represents the FOA/A true position.

Another recently said:

"The time? These years be right for ones who save gold. One good ear knows meaning of wind in trees. The leaves come down as seasons change. Fools see falling price of gold as "death of tree", they chase its price as leaves on the ground. Know you all, it is the season that has died.

Time will prove all things. Ones of simple thought, such as I will save the wood, not the leaf as they buy the gold, not the price! Thank You Another

I will be posting and replying this weekend.

Thanks
FOA


Freegold

What is coming isn't merely a simple correction of imbalances that may, on the surface, appear to be the result of perceived monetary "sins" of the last hundred years, like the creation of the Fed in 1913, the 1922 Genoa Conference, FDR's 1933 gold confiscation and the 1971 Nixon shock. No, it's much deeper, much more mind-blowing, and totally inevitable.

Freegold is the emergence of a new monetary paradigm that has no precedent, certainly not in modernity, and probably not in all of recorded monetary history. It's a brand new idea, ironically with its roots in ancient history, whose time has simply come.

So, while it is true, as gold bugs would have it, that gold never really left the monetary realm, despite its official change in status, one needs to understand that physical gold's role going forward will, in effect, be the result of a shift in consciousness that, without engaging in hyperbole, might be likened to the evolution in understanding about what the universe consisted of that transpired after Einstein introduced the world to The Theory of Relativity. Money's functions will, like the atom, be split, and the world will not be the same afterwards. (Hat tip Edwardo ;)


Seasons Change, Leaves Die… and so do Systems

"These years be right for ones who save gold. One good ear knows meaning of wind in trees. The leaves come down as seasons change. Fools see falling price of gold as "death of tree", they chase its price as leaves on the ground. Know you all, it is the season that has died."


Merry Christmas!

Sincerely,
FOFOA