Why buy gold?

[stahleyp]

I don't know why gold is so popular.

 

Over the past decade or so, gold has gone up something like 25% annually, from what I understand. I would think there would be a reversion to the mean.

 

Gold doesn't have an IRR. It doesn't produce anything. It just sits there and you can make stuff out of it. To be far one of the reason people are so so bullish is the best that emerging markets will consume more of it.

 

If we go through a deflationary period, gold's ability will be a drawback and the price could drop drastically.

 

If we go through an inflationary period, the economy probably (hopefully) isn't that bad off, and the price of gold could also drop.

 

The only reasons I could see to be bullish are the following:

 

As I stated above emerging markets will want to purchase more gold.

 

or if we go through some type of stagflation environment where we have negative growth and rising prices, like the 70s, of which case it might be "cheap" on an inflation adjusted basis.

 

Is the market pricing gold so high because of the last two things then?

 

 

 

 

[watsa_is_a_randian_hero]

I am short gold.

 

Gold is just as much of a fiat currency as the US Dollar or any other currency.  Nothing backs gold, it pays no interest, pays no dividends, produces nothing, and selling it at a higher price is dependent up a "greater fool."

 

If you want inflation protection, a much better bet is leveraged hard assets.  Oil tanker companies, crane equipment companies, mining equipment companies.  Another great bet for inflation is shorting futures on the 30 year swap.  If you have access to an account with futures the ticker is I3. 

[oec2000]

The argument being made by the "gold bugs" is not so much inflation but that it might become the default reserve currency if people lose confidence in the USD. You can't create gold out of thin air like you can fiat money which perhaps explains why gold has risen in value against the USD over the long run. I don't know what gold has returned in real terms or how its performance compares with T-bills with income reinvested. (It's not exactly true that gold does not provide any income - you can get some income by lending it out as many central banks used to do.)

 

We've seen how central banks offloaded their gold holdings when gold was in the doldrums in the 1990s. It would not be surprising to see some central banks jump on the gold bandwagon because of its rise in value (some central bankers look through the rearview mirrors too).

 

I have a tough time buying gold because I can't figure out its intrinsic value (if anybody can at all!). But, there are some smart people (Soros, Einhorn, Klarman (maybe?)) who have taken positions in gold - as insurance, I suppose. That should give us some food for thought.

 

Maybe those of you who are economists can explain whether there is an argument for the value of the total stock of gold to have some kind of relationship with global GDP or money supply (for as long as gold is accepted as a reserve currency).

 

It does feel like gold is in a bubble yet it seems still far from the euphoric last stages when every man and his dog is clamoring to buy the stuff. It might be a good idea to short it then but for now Keynes' advice about markets staying irrational for longer than we can stay solvent should be heeded. Or, if you are like Soros, you may want to buy into the developing bubble to profit from when the bubble becomes fully developed. Of course, none of these has anything to do with value investing! :)

[bargainman]

Gold is just as much of a fiat currency as the US Dollar or any other currency.  Nothing backs gold, it pays no interest, pays no dividends, produces nothing, and selling it at a higher price is dependent up a "greater fool."

 

I agree with the rest of what you said.. but..  Gold is not as much of a fiat currency.  There is currently a limited supply of gold in the world.  Pretty much all the gold that's ever been mined in the history of humanity is around, and according to wikipedia:

 

"A total of 165,000 tonnes of gold have been mined in human history, as of 2009.[1] This is roughly equivalent to 5.3 billion troy ounces or, in terms of volume, about 8,500 cubic meters, or a 20.4m cube."

 

So we're talking a 20.4 m cube vs all the printing presses in the world :-)

 

 

[stahleyp]

 

 

I have a tough time buying gold because I can't figure out its intrinsic value (if anybody can at all!). But, there are some smart people (Soros, Einhorn, Klarman (maybe?)) who have taken positions in gold - as insurance, I suppose. That should give us some food for thought.

 

 

Einhorn and Soro are betting on it. In the WSJ article is accurate, Klarman is not bullish on gold.

 

"All the obvious hedges”—commodities and foreign currencies, for example—”are already extremely expensive,” he warned.

 

Especially gold. “Near its all-time high, it’s a very hard moment to recommend gold,” said Mr. Klarman."

 

http://online.wsj.com/article/NA_WSJ_PUB:SB10001424052748704167704575258442772338282.html

 

[oec2000]

 

 

I have a tough time buying gold because I can't figure out its intrinsic value (if anybody can at all!). But, there are some smart people (Soros, Einhorn, Klarman (maybe?)) who have taken positions in gold - as insurance, I suppose. That should give us some food for thought.

 

 

Einhorn and Soro are betting on it. In the WSJ article is accurate, Klarman is not bullish on gold.

 

"All the obvious hedges”—commodities and foreign currencies, for example—”are already extremely expensive,” he warned.

 

Especially gold. “Near its all-time high, it’s a very hard moment to recommend gold,” said Mr. Klarman."

 

http://online.wsj.com/article/NA_WSJ_PUB:SB10001424052748704167704575258442772338282.html

 

 

Thanks for clarifying. I thought I may have read somewhere about him buying gold as insurance but could not find the article - hence the "?" in my earlier post. Maybe I was thinking of John Paulson - not sure I would put him in the same league as Klarman though.

[SmallCap]

Gold doesn't have an IRR. It doesn't produce anything.

I have a tough time buying gold because I can't figure out its intrinsic value

 

These has always been my two arguments about why I have never even been interested in investing in gold. I see all the supposed benifits of gold being also available in other basic metals but they have more to offer in my opinion. I also much prefer the idea of investing in real estate (they're not making any more of it these days) over gold (they are always finding more of it) and RE has the advantage of producing something and an income stream while you wait.

 

I have been amazed at how home values around me are so good that they cash flow positively so easily. I really like the idea of investing more in RE.

[stahleyp]

 

 

I have a tough time buying gold because I can't figure out its intrinsic value (if anybody can at all!). But, there are some smart people (Soros, Einhorn, Klarman (maybe?)) who have taken positions in gold - as insurance, I suppose. That should give us some food for thought.

 

 

Einhorn and Soro are betting on it. In the WSJ article is accurate, Klarman is not bullish on gold.

 

"All the obvious hedges”—commodities and foreign currencies, for example—”are already extremely expensive,” he warned.

 

Especially gold. “Near its all-time high, it’s a very hard moment to recommend gold,” said Mr. Klarman."

 

http://online.wsj.com/article/NA_WSJ_PUB:SB10001424052748704167704575258442772338282.html

 

 

Thanks for clarifying. I thought I may have read somewhere about him buying gold as insurance but could not find the article - hence the "?" in my earlier post. Maybe I was thinking of John Paulson - not sure I would put him in the same league as Klarman though.

 

No problem. Paulson and Klarman are both great managers, but I wouldn't say Paulson is on Klarman's level. From the research I've done on Paulson, it seems like his fund did okay, but not great, before 2007. He made his fortune betting against the housing market. Klarman has been doing very, very well since around 1982, I believe. Although, to be fair, his fund did trail the S&P for several years during the 1990s.

 

[SmallCap]

"All the obvious hedges”—commodities and foreign currencies, for example—”are already extremely expensive,” he warned.

 

Would real estate qualify as a hedge in the same way that these other areas would qualify and if not why?

 

 

[stahleyp]

"All the obvious hedges”—commodities and foreign currencies, for example—”are already extremely expensive,” he warned.

 

Would real estate qualify as a hedge in the same way that these other areas would qualify and if not why?

 

 

 

 

I know Klarman was talking about in some speech or interview that he was investing in some commercial real estate.

 

http://www.reuters.com/article/idUSN1815559420100518

[Zorrofan]

You need to stop thinking about gold as an investment - its not. Gold is simply a hedge against economic collapse. If you think the Euro will self-destruct or the US government will default, you buy gold. Sanj's good buddy Eric Sprott thinks that the global economy is headed for the mother of all downturns, so he holds gold.

 

My $0.02

 

cheers

Zorro

[rick_v]

I am going to give you all my thoughts on Gold and hopefully this can spark another good debate for the weekend.

 

First let me start by quoting James Grant:

 

What is a dollar?

 

It's a testament to the world's abiding faith in the United States currency. We know what the dollar used to be: It was a legally defined weight of gold. And we know that that is not what it is today. The fact is that, today, the dollar is undefined and, like every other currency, uncollateralized. It is whatever Mr. Market says it is. That this piece of paper, or electronic impulse, of no intrinsic value is accepted the world over as a means of payment and a store of value must stand as one of the greatest and most improbable, monetary achievements of all time.

 

What is the Gold Standard?

 

The essence of the gold standard is the idea that in monetary affairs, too, the rule of law should apply. Money should be lawfully defined. The government that issues it should protect and defend that statutory value. A gold-standard country should balance its external accounts. No nation, however powerful, should be permitted to consume much more than it produces for years, or even decades, on end, as the United States has been privileged to do under the post 1971 non gold standard.

 

Now Here are my thoughts about Gold.

 

Gold is the ULTIMATE Store of value it backs itself. Why? Because we as human beings have been using it as a means of exchange for thousands of years. Why did we humans did decide to do that? Because Gold is one of the rarest natural resources in the world yet is also one of the heaviest and is mallable.

 

Lets discuss the fundamentals of gold as a natural resource (precious metal).

 

90% of the above ground gold has been mined since 1900

Annual Gold Demand has been steady at 3,500 tons a year yet supply from mines is only 2,500 tons a year which means that about 1,000 tons each year come from central bank sales and scrap recycling (sell your gold to me.com's).

A mine which is considered "rich" will yield one ounce of gold from two truckloads of ore. *again this is a rich ore body.

Since 1998, as price of gold has quadrupled, annual expenditures of public companies for new mine discoveries has gone up from $800m each year to $3.8B last year. Yet the amount of gold discovered (annual mine discoveries in ounces) has decreased by 74%!!! In 1998 public companies discovered 70m ounces of gold and in 2009 about 15m had been delineated.

Cash costs for producing gold have been going up and up and up.

In the last 2 years the largest buyers of gold in  he world have been China and India as their central banks look to build up their relatively tiny stocks of gold reserve.

If you take all the gold in the world that has ever been mined (24K .999 gold) it would fit into a cube which would stretch 18 meters across and 18 meters high. Such cube would easily fit underneath the Eiffel Tower.

Annual Gold production at 2,500 tons would fit in a living room of a normal sized house.

There are many more facts which you can read up online.

 

So the fundamentals of Gold are VERY bullish. They are more bullish than anything else I can think of in the world today. The question is how to profit from this trend and how to do it using principles of value investing.

 

I personally feel that buying bullion or Gold ETF's is not the way to go and have not deployed my capital that way. I also dislike Gold futures as they require the investor to anticipate the precise timing as to when gold will rise.

 

That being said there are ways to gain leverage to the price of gold while also demanding a margin of safety.

 

Without describing how I do it, I will just say that accounting laws are VERY favorable for investors in this industry. If a mining company spends $25m delineating an ore body that ore body will be carried on its books at $25M. There is no revaluation mechanism unless that ore body is producing and even then it will not reflect total reserves. Savvy investors can look for dislocations in valuations. Many exist!!!

 

I have bought gold companies at $25 per ounce in the ground only to see them rise to $300-700 per ounce. Today the average non-producing company trades at roughly $150 per ounce still providing sufficient leverage to the price of gold, even when including cost of production.

 

This industry is a totally different one from reading vanilla balance sheets and income statements. A whole new set of skills is required. But I can promise you Gold as a commodity/currency/natural resource has fantastic long-term fundamentals. And so the trick is to buy an ounce of gold today at a discount to its intrinsic value in the future.

 

Personally, I believe that Central Banks globally have become irresponsible and that the only true currency left is Gold. Gaining exposure to companies that own significant resources will be the trade of this century. I have no doubt in my mind!

 

 

 

T

 

 

 

 

 

[Guest broxburnboy]

I am short gold.

 

Gold is just as much of a fiat currency as the US Dollar or any other currency.  Nothing backs gold, it pays no interest, pays no dividends, produces nothing, and selling it at a higher price is dependent up a "greater fool."

 

 

We've had several iterations of this same discussion over the last couple of years but it boils down to this:

 

Gold is money, fiat currencies are not. Either you get it or you don't.

 

Gold alone amongst all the different means of exchange that have been used throughout history maintains its role as a store of value not dependant on someone els'es promise. What you see is what you get... an ounce if gold has its own intrinsic value. If it was next to worthless, it would be used in plumbing, electronics, jewellry, as an industrial catalyst, as a superior roofing material etc. etc. etc.... paper, whether fiat currencies, stock certificates, or any other iou, contract etc.. is all counterparty risk and has a miniscule intrinsic value

 

With this in mind you can say that the US dollar is devaluing in terms of gold, not that gold is getting more expensive, the observation then becomes, that the "greater fool" will now sell their gold for depreciating piece of paper with a little more ink on it.

 

If you beleive that Gold and Silver are intrinsically worthless, please explain why the dollar value of silver coins withdrawn from circulation in the 70's have increased in fiat price by a factor of about 10.... according to your theory they should have dropped and should now be virtually worthless.

Also please explain why the IMF, the Federal Reserve and most central banks hoard their gold as assets to back their currency. They should have dumped their gold ages ago since it is worthless and creates no real return.

 

[rick_v]

Good points, what many people don't know is that the US has the largest gold hoard out of all the other nations. That is if its all really there :)

[Myth465]

 

We've had several iterations of this same discussion over the last couple of years but it boils down to this:

 

Gold is money, fiat currencies are not. Either you get it or you don't.

 

Lol

 

This should say either you  agree or you dont. I dont. Gold has a value just like corn, wheat, or labor but its not money to the vast majority of people walking around today.

 

Im agnostic towards it from an investment perspective, but I would venture to say you are the minority in this argument.

[SmallCap]

please explain why the dollar value of silver coins withdrawn from circulation in the 70's have increased in fiat price by a factor of about 10.... according to your theory they should have dropped and should now be virtually worthless.

 

you are talking about something that is valued by collectors not metal recyclers. Those coins were removed from circulation quicker and more aggressively because of their metal content and so those coins became rarer and therefor worth more.

[SmallCap]

90% of the above ground gold has been mined since 1900

Annual Gold Demand has been steady at 3,500 tons a year yet supply from mines is only 2,500 tons a year which means that about 1,000 tons each year come from central bank sales and scrap recycling (sell your gold to me.com's).

A mine which is considered "rich" will yield one ounce of gold from two truckloads of ore. *again this is a rich ore body.

Since 1998, as price of gold has quadrupled, annual expenditures of public companies for new mine discoveries has gone up from $800m each year to $3.8B last year. Yet the amount of gold discovered (annual mine discoveries in ounces) has decreased by 74%!!! In 1998 public companies discovered 70m ounces of gold and in 2009 about 15m had been delineated.

Cash costs for producing gold have been going up and up and up.

 

I don't have the comparable numbers for other metals like platinum but if you remove the historical aspect of Gold

 

Gold is the ULTIMATE Store of value it backs itself. Why? Because we as human beings have been using it as a means of exchange for thousands of years.

 

then wouldn't there be the same type of arguments behind platinum? Take away the historical aspect of gold and what is so different about it in comparison to any other rare metal?

[bargainman]

 

We've had several iterations of this same discussion over the last couple of years but it boils down to this:

 

Gold is money, fiat currencies are not. Either you get it or you don't.

 

Lol

 

This should say either you  agree or you dont. I dont. Gold has a value just like corn, wheat, or labor but its not money to the vast majority of people walking around today.

 

Im agnostic towards it from an investment perspective, but I would venture to say you are the minority in this argument.

 

I think the 2 most convincing arguments I've heard regarding gold are

1. it's a store of value because there are thousands of years of human history saying gold is valuable.  Plus, if you ask any Joe, Jane on the street anywhere in the world, if gold is valuable, they will say "yes" pretty much unequivocally.  It's basically human behavior, ingrained, and it would take a lot to change it.  Changing behavior and beliefs on a large scale like that is next to impossible.  I mean it's the whole idea of having a brand!  A brand means something, just like gold has a brand which means 'money'.  Only 'elitist' investors (  ;D ) argue about whether it's actually valuable or not.  The vast majority of the world just takes it as a given, and that's not going to change.

2. There is a very limited supply and it's not growing very fast not will it grow very fast.

 

That said, I personally won't invest in it because I agree with Myth and Watsa_radian that it doesn't produce any cashflow or do anything productive other than just be.  But the 2 points above do convince me that it's valuable in and of itself.

[stahleyp]

I think gold is good for diversification purpose in a portfolio, a small amount, of course, as an inflation hedge, and for jewelry. I don't think it's a good time to be buying a lot of gold, though.

 

Gold is getting a ton of hype now. Gold commercials, gold stores, gold vending machines! Anyone remember a few months before the oil market burst, they were selling prepaid gas cards? lock in all the gas you want for only $4 a gallon! everyone knew that gas was never coming back down. peak oil! emerging markets using more oil!  dollar devaluing against oil! on and on.

 

Gold may continue it's torrid pace. People much smarter and richer than any of us (i'm assuming!) are betting on it. i just think history is against those that buy gold, and there are plenty of indicators that the market is getting a bit frothy.

 

Something else I wanted to throw out there. a lot of people say that gold has a way to go because it's still so much below the inflation adjusted prices of the 70s. Well, that might be true. I would make the argument that it may not get that high again, because the market learned from it's mistakes last time. when you buy gold at outlandish prices, be prepared for terrible gains. Is it an outlandish price right now? i don't know, but it's certainly not cheap.

 

 

[biaggio]

for what it is worth, it is hard to buy gold as a value investor. "We" normally like to buy the present value of $1 for $0.50. It is hard to buy without knowing what the IV or present value is. It is especially hard buying something that probably does not have a lot of personal utility value. Most of us are cheap skates + only after we get enough pressure from our wives that we breakdown + maybe buy some jewelery (I can t even spell it).

[Guest broxburnboy]

 

you are talking about something that is valued by collectors not metal recyclers. Those coins were removed from circulation quicker and more aggressively because of their metal content and so those coins became rarer and therefore worth more.

 

Wrong... I'm talking about the current melt value of silver and other metal coins. Check this out :  http://www.coinflation.com/

for the current melt value of metal coins.

You may notice that even the humble copper penny of the 1980's is now worth over 2 cents current money. This has been the  trend since the unpegging  from the Gold standard in the early 70's and the very definition of debasement of currency.

 

All the monetary metals have increased in terms of the US dollar since then... gold by the most because its new supply is severely limited.

Again you are free to believe that the US dollar is the ultimate store of wealth and by extension that government and central banks have discovered the source of all wealth - the printing press ....good luck with that.

[biaggio]

Slightly off topic though, I found it interesting that Andrew Carnegie one of histories great capital allocators, according to the biography I read several months ago sold his empire for Gold-backed security yielding 5%(he was fearful of governments printing currency). Now I would interested in that. I don t suppose that these exist today.

[ERICOPOLY]

5.3 billion troy ounces -- global supply of gold

6,700,000,000 -- global human population

 

There is 8/10 of an ounce of gold per person.

 

$9,117 -- global GDP per capita 2008  (don't have more recent figure)

 

So, on a gold standard, each person in the world has a maximum cash supply of $960 (if all gold were equally distributed as coin).

 

I'm not an economist of course.  But would global GDP fall if the global money supply were roughly 1/10 of global GDP? 

 

Once I get my $960 and allocate 100% of it to the family budget, how do I have room to purchase more things next year if somebody invents a new widget?  Is there room for a new widget?  If no money available for new widgets, does this deter innovation? 

 

Final question -- has fiat currency changed the pace of innovation?  I really don't know -- but it's something I wonder about.

 

 

 

 

 

 

 

 

[rick_v]

SmallCap

 

Platinum is a precious metal as well and its fundamentals too are favorable. The issue with platinum is that its not as ubiquitous as gold and its even more scarce so the distribution of the metal is not as robust as that of gold.

 

I see Silver/Platinum/Gold/Copper as all in the same boat. Over time they cannot be manipulated by central banks and they are in constant demand or must be consumed (in the case of copper) by humans. Thus they are really the only true currency.

 

 

But again I don't advocate buying the ETF's or straight bullion on any of these that is not how I generate alpha.

 

There are better ways to gain long-term exposure!

[Guest broxburnboy]

5.3 billion troy ounces -- global supply of gold

6,700,000,000 -- global human population

 

There is 8/10 of an ounce of gold per person.

 

$9,117 -- global GDP per capita 2008  (don't have more recent figure)

 

So, on a gold standard, each person in the world has a maximum cash supply of $960 (if all gold were equally distributed as coin).

 

I'm not an economist of course.  But would global GDP fall if the global money supply were roughly 1/10 of global GDP? 

 

Once I get my $960 and allocate 100% of it to the family budget, how do I have room to purchase more things next year if somebody invents a new widget?  Is there room for a new widget?  If no money available for new widgets, does this deter innovation? 

 

Final question -- has fiat currency changed the pace of innovation?  I really don't know -- but it's something I wonder about.

 

 

If gold were cash and allocated equallly to each of the world's inhabitants, the US buck would have zero value and all your measures of GDP would be in goldgrams or ounces- the yardstick would have changed. Because the total wealth of the world can be measured in US dollars now, there is no need to actually have that many dollars in existence.

There is no claim that the gold is the only store of wealth, there are others - barrels of oil,  bushels of wheat, acres of farmland, but gold alone amongst all the commodities has been used as money, because of its high intrinsic value, its finite supply (cannot be inflated), its indestructability and its portability. It is used as the ultimate store of wealth and indeed is used as a partial backing of all major currencies. It has the same convertible value in India, Peru, Timbuktu and Wall Street. Either you get it or you don't.