In the Orient, gold has always been a revered investment, but why is it coming back into fashion over here? Should you be investing in gold?
Let’s take a look and see what all the fuss is about…
What exactly is gold for anyway?
Gold has some industrial uses, but these are pretty irrelevant. Demand for gold comes mostly from investors. But from an investment point of view, there’s something missing. And it’s an important something – that is income.
As Warren Buffett says about gold, “It gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”
Normally, an investment is valued with reference to its dividends, or the interest it pays. Because gold doesn’t pay any income, it makes it practically impossible to value.
Other commodities at least have a use – foodstuffs, oil, or other metals. The usefulness of the commodity generates demand, which, together with the supply gives us its value.
As an investment, all you can really say is that it’s speculative. You are gambling that its value will go up. Why else hold it?
To explain the income conundrum, it may be better to consider gold not as an investment, but as a currency….
Gold as a currency
As a currency, it doesn’t matter that it doesn’t pay a dividend, and it doesn’t matter that there’s no real use for it.
With currency, you’re looking for a store of value (for saving) and a means of exchange (for spending). Think about it. Paper money doesn’t have any use other than for saving and spending either.
The beauty of gold over paper currency is that it can’t default. It can’t be made worthless by politicians and central banks in the same way that paper based currencies can.
As central banks have created more money through quantitative easing, gold has gone up in value. If you view gold as a currency, you shouldn’t see this as gold having risen, but look at it as paper currencies having fallen against gold.
But there’s a problem with the currency idea. For years since the early ‘80s until the late ‘90s the gold price fell. Yet, this was at a time when paper money was being printed willy-nilly across the globe.
The amount of gold in circulation grew modestly, while the amount of paper money boomed. So the value of the paper currency should have crashed versus gold. In fact, the opposite happened!
There must be more going on than meets the eye.
Gold isn’t a pure investment and its price doesn’t act like a currency would. So what explains the run up in the gold price over the last few years?
Well, there’s another theory. And it says that gold is really an insurance policy…
Gold as insurance
If gold is an insurance policy, then what’s it insuring against? And most importantly, is it insurance that’s useful to you?
Would a widower with no dependants take out life assurance? No – why would he bother? He’s got no reason to shell out on insurance premiums when there’s nothing to gain from the payout.
As with any insurance, we need to know what we’re insuring against and if the payout is worth the premium.
Put bluntly, gold insures against a collapse in paper based currency.
The policy says that the value of gold will stand up as paper currencies collapse. [see the current rise in gold as the Greek crisis unfolds].
It supposes that a new money regime will, in some way involve gold. Or in the absence of a new money regime, gold will be acceptable tender.
So, should you take out this ‘gold insurance’? Well, as with life assurance, it depends on your situation.
If you have hard assets –houses, land, antiques and cars then they all have an inherent value. Whatever happens to a currency, hard assets can be sold, or rented – their value will adjust to a ‘new money’ regime.
If you have skills, then you have inherent value. You’ll be able to earn income whatever the new currency is.
However, if you are dependent on cash savings and bonds and you have few physical assets you are willing to part with, then you are exposed to currency.
So, is gold worth a punt?
I suspect that UK politicians, whatever the colour, will have problems stemming the public debt situation we’re now in. I suspect they’ll continue down the path of endangering the currency, rather than making the tough decisions needed to rescue us from debt.
So long as governments and central banks edge closer to default, then the premium on protecting against such an event keeps rising. That means gold goes up.
Remember, this is an insurance policy. I’m not saying that all paper currencies are imminently doomed. I’m saying there’s a chance of default and right now, the chances of a default are increasing. If you have cash and bond savings and depend on these for income, then you have the most to lose in a currency crisis.
These are troubling times and the subject of gold investment raises unpleasant scenarios. But then, you don’t insure against pleasant outcomes do you?
Good investing...
Bengt Saelensminde
For The Right Side
P.S. There’s good reason to suspect that the UK is in a more precarious position than most. As many Icelanders have discovered, it can be worth having some currency insurance in place!
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