Gold is valuable insurance
[1/29/01 2:30 PM EST] There’s always been a magical relationship
between people and gold. In childhood fairy tales, the mere mention of
the shiny yellow metal prompts thoughts of vast wealth and power.
It seems an unlikely relationship; after all, gold is very limited in its uses.
You can’t eat it and it’s not very good for building tools or shelter. Yet
even when early humans were struggling to meet their basic needs,
gold held a place of high esteem. Perhaps it was gold’s color and shine,
or maybe its resistance to corrosion, that attracted early people, but
that’s all ancient history, better left for the academics. The more
important question today is, what place should it have in the portfolios of
investors?
I am closer to being a “gold bug” than anyone else at RedChip™, but I
am hardly advocating that everyone put all their money into gold, guns
and canned goods and move into a bomb shelter. I do own a little bit of
gold for investment purposes, but it’s probably my hobby of coin
collecting that got me labeled a gold bug by my fellow analysts.
However, my hobby and my investment ideas are two entirely different
things.
My thoughts on gold are best summarized in the words of President
Herbert Hoover, who said, “We have gold because we cannot trust
governments.”
Gold’s role in the world’s monetary system essentially ended with
Hoover’s presidency. The newly elected President Franklin Roosevelt
issued an executive order outlawing the ownership of gold by the
American people, and the free convertibility of U.S. dollars into gold
abruptly ended. Gold’s last official role ended when President Nixon
closed the gold window in 1971, meaning that foreign governments
could no longer convert dollars into gold at $35 an ounce. Nixon’s
actions came to the cheers of economists everywhere. Most felt that gold
was an archaic relic of a bygone era. Of course, the arguments from
economists come as no surprise to me, because as a group they tend to
have more faith in government than the masses have in religion.
Economists argue that tying a currency to gold or any other commodity
places too many restrictions on the government in managing the
domestic economy. They point to numerous recessions and depressions
under the gold standard, which occurred because the government was
forced to raise interest rates to abnormally high levels to protect the gold
reserve. Of course, a freely floating currency backed by the “full faith and
credit of the United States government” (which basically means that only
the government can print Federal Reserve notes) hasn’t done a whole
lot better; you only need to look back at the inflation and high interest
rates of the late 1970s and early 1980s to see that.
The gold standard is just another method of account for money. If the
U.S. were to go back on the old gold standard at $20.67 per ounce, we
would find that prices really haven’t changed all that much over the last
half-century. One gold dollar would be equal to about $15 in current
money (given gold prices near $300 an ounce), so the price of an
average car would be about $2,000 while the average house would cost
about $10,000. Of course, the minimum wage would be about $0.40 an
hour, and annual family income today of $45,000 would become $3,000
in gold.
Now to the more important issue for investors: What should be the role of
gold in investors’ portfolios? I don’t believe that gold should be at the
center of a portfolio, but I do think it should be held as an insurance
policy in a forgotten corner. Gold is different than almost any other
investment in that it doesn’t pay cash dividends, nor does it have
earnings or an anticipated annual return. But the very things that make it
different also make it desirable within a diversified portfolio.
Gold tends to move opposite the stock market or other financial
investments, making it a useful insurance policy against adverse market
conditions. Many people argue that gold is a poor investment given its
performance over the last decade, but that view misses the point. Gold is
most valuable when everything else has gone to hell in a handbasket.
Just look at gold in 1980: Even as the stock market was still under water
from the bear market of 1973–74, gold peaked at $800 an ounce. The
fact that gold has performed so poorly in the 1990s tells me that it’s
doing just what it should—the opposite of the financial markets that have
performed so well. Holding between 2% and 10% of one’s portfolio in
gold should not drag down its performance during periods like the last
decade, but it may make all the difference in the world if we encounter
another period like 1980. Many people disagree with my views on gold,
even though I try to be much more realistic than many hard-core gold
bugs. Economists will likely tell me that gold is archaic and without value
in the modern economy. If gold really is worthless, then I welcome the
people who think so to give me their gold.
Better yet, perhaps they should give it to their special someone on
Valentine’s Day in a few weeks. After all, gold jewelry has won more
hearts than paper money or T-bills ever will.
Jeff Tryka, RedChip™ senior analyst |
