Streetwise

Lauren Rudd

Sunday, April 21, 2013

Gold - An Overrated Under-Performing Asset

If you have been listening to my radio show you know that I have been berating gold, stating that it is an overrated under performing asset class whose price I said would drop to the $1,400 level. Well, I was wrong. The price of spot gold recently closed at $1,349 per ounce.

Will the price of gold recover? Probably it will, especially if you assume the usual strict adherence to the Greater Fool Theory. Even Federal Reserve Chairman Ben Bernanke was a bit befuddled over why a central bank would hold gold.

When asked if gold was money, Bernanke replied, "No, it's a precious metal." Pressed harder, Bernanke went on to say it is an asset. He likened gold to Treasury securities, stating that “I don't think that they are money either, but they are financial assets."

So why do central banks hold gold if it is not a form of money? Why do they hold diamonds? "Well, it is tradition," Bernanke said, "Long term tradition."

In his book Basic Economics, Thomas Sowell argued that over the long-term, gold's high volatility when compared to stocks and bonds means that gold does not hold value well.

For example, in real terms, meaning discounting inflation, a dollar invested in bonds in 1801 would be worth nearly a thousand dollars by 1998, a dollar invested in stocks that same year would be worth more than half a million dollars. Meanwhile, a dollar invested in gold in 1801 would be worth just 78 cents by 1998.

So what value does gold really have? Other than being pretty to look at, chemically inert, and the preferred metal of the electronics industry due to its low electrical resistance, what hidden value does gold really possess...distinct from mankind's desire to simply possess it?

Well, assume the doom and gloom soothsayers are right. Would you prefer to own gold coins or a fully stocked pantry? Gold really only holds value to those who give it value. And some of those people have the prerogative to change its "value" with a few clicks of a mouse.

Unlike real estate, equities, bonds or other dividend/interest/rent paying investments, gold does not produce income. If you were to lock away gold in a safety deposit box for 20 years, you would be forced to rely on the value of gold 20 years from now to be higher than at the time of purchase.

To make matters worse you cannot spend gold. Don’t believe me; ask the checkout clerk at your local grocery store if you can pay with a gold coin that is worth $1000 instead of a credit card. Well maybe we should go back to a gold standard as some political platforms advocate. Sorry, but such a conversion would be impossible due to the amount required physically. Realistically, the only thing you can do with the stuff is to lock it away and hope nobody steals it.

Having talked with countless gold owners, I have reached the conclusion people buy gold to preserve their wealth in the event of hyperinflation/devaluation of the dollar, or in the event society breaks down.

Although I give no credence to either, let’s consider both options. Those who buy gold talk about preserving their wealth because they believe that the dollar will depreciate in value. Wait, how is preserving your wealth a good investment? The goal of investing is to expand wealth.

If massive inflation is your concern, has gold not already priced this in. Furthermore, to prepare for such a scenario would it not be logical to look for an undervalued asset class, such as undervalued equities, or land. Gold is a highly speculative metal and not a vehicle for preserving, much less generating wealth.

Now if society breaks down, to which I give the same probability as winning the lottery, factions will form up and likely dictate what happens to you and your gold. Even if you have 20 pounds of gold, 10 years of rations and a room full of firearms, you cannot stand up against groups of hardened self-appointed ministers of righteousness.