Feb 14th 2012, 16:18 by A.C.S | NEW YORK
I CAN think of only two good reasons gold is valuable: it's shiny and scarce. I reckon its popularity is a relic of the gold standard. If you think about it, other than shininess and scarcity, nothing makes gold intrinsically more valuable than dollars.
My colleague recently pointed us to Warren Buffet's take on gold. He favours stocks or real estate because, unlike land or a business, gold doesn't have much productive value.
Today the world's gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce -- gold's price as I write this -- its value would be about $9.6 trillion. Call this cube pile A.
Let's now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world's most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?
Beyond the staggering valuation given the existing stock of gold, current prices make today's annual production of gold command about $160 billion. Buyers -- whether jewelry and industrial users, frightened individuals, or speculators -- must continually absorb this additional supply to merely maintain an equilibrium at present prices.
A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops -- and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil (XOM) will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.
But because gold is in finite supply and there's a history of using it as currency, it's often cited as a good inflation hedge. Even if its intrinsic value is questionable, perhaps our fixation with gold as a safe haven is worth something. The thinking goes that if a central bank prints too much money, unleashing rampant inflation, gold will retain its value. Or imagine the mother of all tail events: if civilisation collapses we can still barter with gold. I don't have any evidence concerning whether or not gold will hold up in the latter scenario. But when it comes to the former claim, London Business School authors Elroy Dimson, Paul Marsh and Mike Staunton, in collaboration with the Credit Suisse Research Institute, recently published a report which shows that gold was not such a great hedge over the last 111 years.
If it were gold's value would be fairly stable over time and realised inflation. The figure below demonstrates that's not the case.
Its price may be correlated with expected inflation, but if you're looking for a hedge, gold's relationship with realised inflation is what's important. Gold's real value usually does not decrease during bouts of inflation. But what strikes me, other than by historical standards how overpriced gold looks, is how volatile it is. In finance volatile assets are considered risky; it's baffling that gold is considered a safe haven for anything. If an investor is looking to speculate in the commodities market, investing in gold may be a fine idea. But if you're looking for safety, inflation-linked bonds, or even equity, is probably a better way to go.
I suppose it is shiny and scarce, but so are diamonds, platinum, or even copper. By that logic it's time to start stockpiling pennies.
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Laugh if you like, I stockpile pennies. Buy only the ones the US minted prior to 1982. Since then they've all been zinc. Nickels too. The only US coin currently minted that still has an intrinsic value equal to or greater than its face value. Diamonds are only scarce because the cartels keep rein on the supply. Otherwise they're no more "precious" than semi-precious gems. If the suppy were allowed to flow freely we could buy them in the jewelry department of Walmart. of course, maybe since most people aren't aware of this they'll still find value in there somewhere I suppose. I suspect that for the most part that gold and silver are easier to assay and determine it's authenticity as well. Investing in land is definitely more productive than gold. But if the SHTF, try carving up a piece of sod and take it down to the cobbler to buy your new shoes. Maybe you could argue that you'll trade bushels of wheat instead, but think about how many bushels you'd have to tote around. Gold and silver are compact stores of currency. Fiat money is too, especially in electronic form, but remember that the scenario is economic collapse. Your Pound notes and Federal Reserve Notes will be unacceptable forms of trade in that event. I have to ask; why pick that 111 year time frame for your analysis. That seems rather arbitrary to me. Or is it perhaps if you extended for a longer historical period, say 150 or 200 years perhaps, that you might discover the curve more smooth and less likely to support your argument? Bet if you used most of recorded world history, let's say since the onset of the Egyptian dynasties, that chart would look even smoother.
I love it when gold bugs always cite the "if civilization collapses..." thesis. If that happens then what the hell do I need gold for? I'll take guns, food, and bullets.
For most of human history civilizations have come and gone, chaos and feudal governments have reined. More time has been spent in less civilized times than there has been in "civilized" time. What makes you think that it will always be as it is today? Has human nature really changed? Do you really believe that our oh-so-wise elected scoundrels will actually be able to stave off a failing economic system that is looking more and more likely to implode each passing year? Seems rather unlikely.
Also, fun fact: pile A wouldn't fit all that comfortably in a baseball infield. At 170,000 metric tons, it would most likely crush it.
Hopefully Buffett's comments will be taken to heart for awhile, providing a buying opportunity for those of us who admire gold's "psychological" value.
Very good article explaining hedge funds sticking arround gold. Since gold has cultural value in Indian Sub continent and Middle East Asian Countries (Exchange in Weddings, etc) gold will always appreciate with time. With China getting strongly into this trade is more positive for gold value.
Probably one of the most bias articles I've read in a while! So what are central banks doing for the first time in 40years?? Yea, stock piling the stuff!! Golds enemy isn't land, equity's or bonds it's simply just the devaluation of the dollar nothing else...look at what china, India, Russia think about the dollar judge them by their action....buying the shiny worthless piece of metal.
Gold hasn't needed a bailout while the stock market continues to be propped up
"If you think about it, other than shininess and scarcity, nothing makes gold intrinsically more valuable than dollars."
I am not a goldbug, but I do think that people are too easily dismissive of the metal's subjective value. There are several attractive properties of gold that have already been mentioned in this thread:
"¢ it can be melted and recast (unlike diamonds) "¢ it does not oxidize easily "¢ it does not combine easily with other substances to form useful alloys "¢ it is relatively scarce
The most important property of gold, however, is simply that people value it. It is not that "its popularity is a relic of the gold standard". Instead, the properties that made it attractive as a money standard are the same properties that people find attractive today.
Those properties do not mean that gold is a great choice for "buy and hold" investors like Mr Buffett. I also do not advocate for a return to a commodity-money standard. But I do take issue with the assertion that gold is sterile (not productive). To the degree that any money serves as a medium of exchange, gold is productive because it facilitates transactions (and thus economic growth).
I don't get why it's so difficult for mainstream economists to understand gold. It's really very simple. I suppose they just don't want to get it.
Gold is not an investment in the sense that it produces anything of value as does land, for example. Gold is valuable primarily because it is scarce and hard to counterfeit. That's it! There is nothing else to look for when wondering why gold is valuable.
Anything else that is as scarce as gold will be valuable, too. Diamonds are scarce because DeBeers makes them scarce. Antiques are valuable because they are rare. Scarcity and rarity create value because of the subjective theory of value. Nothing has intrinsic value, only subjective value. Therefore we value rare and scarce things more than we value abundant things.
Gold has value because of its scarcity. But it also has value for its durability, divisibility, ease of transport and storage, and liquid market. Oil is a good hedge against inflation but it's hard to carry around quarts of it. Because small amounts of gold hold great value it's easier to store and transport than is oil.
Land is a good hedge against inflation because of its scarcity, but it's very hard to transport and carry around enough in your pocket to buy something with.
Many things that are in short supply are good inflation hedges. I have a brother-in-law who has done very well investing in rare guitars. Gold enjoys all of the virtues of other rare and scarce things while at the same time offering an intensity of value in a small amount that makes it easy to transport and store. And it doesn't rot. Those combination of qualities cause more people to want gold than want rare guitars or oil or land or antiques or rare paintings.
Platinum and rare paintings hold up to inflation as well as gold, but the market is too thin and that makes them less liquid. Gold is a very liquid asset.
"A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops"¦"
Who invests with a 100 year time horizon? No one! So what is the point of such an example? And within that 100 year horizon will be decades when farmers go broke because prices fall or the prices of inputs rise faster than output.
""¦gold was not such a great hedge over the last 111 years."
So? Again, no one on this planet invests with a 111 year time horizon. There have been many times when gold is not a good investment. The decade of the 1990's is the most recent example. Central banks did not print currencies like mad men and sold or rented gold reserves. The opposite has been true since 2000. That's why gold has risen in price since 2000.
And you can't judge gold as an inflation hedge by using consumer price indexes. A great deal of price inflation happens in asset markets and not in consumer goods. Gold protects against asset price inflation as well.
Hayek used to say that the acid test of a good economist was how well they understood Mill's law that the demand for goods isn't the demand for labor. Today I think that test is too difficult for mainstream economists. We need to lower the bar. The test today is how well they understand the role of gold.
I think you missed one: universality. If I go to, say, Somalia, they probably don't care about rare guitars or paintings. But I can still trade gold for anything they have there. Anywhere on the planet, I can find someone who will regard gold as equivalent to money.
"The thinking goes that if a central bank prints too much money, unleashing rampant inflation, gold will retain its value."
This is a whole lot of nonsense. If a central bank prints "too much money", the nominal price of all assets rise. Buffet is correct to note that other tangible assets like real-estate, equity, etc. are smarter investments: they have productive value AND increase in value with inflation (just like Gold, or anything else).
While I confess that I have a personal interest the comparetive worth of gold, land and equities, I find the Sage of Omaha's commentary to be so simplistic that it calls into question his mental acuity.
If one were to attempt the corners he describes the prices of gold, land and equities would increase exponentially due to the buying pressure. Additionally numerous regulatory agencies would intervene long before a significant position was established. In reality ll Mr. Buffet has done is to create a straw man to suit his agenda and then gleefully demolish it.
Rather than dispensing folksy bromides I would rather the Sage reveal the inner workings of the black boxes that are the reserves of his insurance companies, or perhaps extrapolte the next hundred years returns on his investments in The Washington Post and the Buffalo News
To expand a bit on what W.C. Varones said:
If gold wasn't working as an inflation hedge, you'd expect to see something like e^-kt, that is, an exponential decay. You don't see anything like that.
As for inflation-linked bonds: I read just today, in an article by some outfit called "The Economist", that Britain might change the definition of inflation in order to be able to inflate away debts, even though some of those debts are in the form of inflation-linked bonds.
I trust the earth not to create a bunch more gold. I don't trust the government (or the Fed) not to create a bunch of inflation in paper money. And I don't particularly trust the government to create an "inflation-linked" bond that really matches inflation.
Gold isn't perfect. There's lots of volatility. But long-term, it holds up pretty well against inflation and other government games.
Gold became a monetary instrument precisely because it had no other functional uses beyond ornamentation. It is the perfect metal to use as a medium of exchange, because its value has no correlation to the rest of the industrial or agricultural economy.
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