3 Things to Know Before You Buy Gold

Here is an article by a random individual, but it was posted recently on the Motley Fool so naturally I had to prove its invalidity. The commentary appears in italicized print. Here it goes…

By Rich Smith

Do you subscribe to a newspaper? Do you read it? If so, chances are you’ve seen the same ad I’ve seen, which pops up every so often and commands that you go out and buy some gold right now.

It sure sounds like a good idea. After all, gold has been on a tear lately, rising nearly 50% over the past two years. And the advertisement makes some pretty compelling arguments for why it remains a good investment — if only they were true. So consider this a public service announcement, folks. Because if you’ve seen the ad (from an outfit called “United States Gold Distribution Center. Not Affiliated With the U.S. Government”), and if you’re tempted to buy some of the shiny stuff, here’s the myth-debunking you need to read, in three easy parts.

Many fewer newspapers are now advocating gold the way they were in prior years. This is simply because the first major leg has pretty much ended and we are now in a consolidation stage. Many have seen the ad but that is just another marketing strategy just like an ad for a car. There is a simple assumption that must be made: If the costumer is not interested in buying a car an ad is not going to convince them. I tried convincing my parents for months to buy gold and silver, something, but they’re not interested. It’s not the sentiment of the time. Now onto the “Myths” of gold and where they truly come from…

Myth No. 1: Gold is predicted to go to $1,800 an ounce

Whenever you’re reading an investment advertisement, here’s your first clue that it’s a set-up: Unsourced predictions and unfounded assertions, stated as fact. Unsourced, because the advertisement never says who exactly is predicting that gold will go to $1,800. And unfounded because, like the identity of the prediction-maker himself (herself?), the ad never explains the rationale for why gold should “go to $1,800” — or when, precisely, it’s supposed to reach that lofty price.

Ads a side for a moment, every time I read an article on gold I ask for the source as well as a valid basis for their reasoning. The reasoning that seems most profound always comes out the same. “We are ignorant to the exact extent of the irrational methods traders and speculators will present in the future, but supply and demand factors tell us that we are no doubt in a commodities bull market that should last years.” Thus $1,800 gold, as $200 oil, is not a matter of if but a matter of when. How far it goes from there once again depends on the frenzy of the time.

Similarly, the ad’s assertion that “10% to 20% of your net worth should be in gold according to most money managers” — Google any combination of words from that statement you like, and I challenge you to come up with a single reputable money manager who recommends anything of the sort. I tried, and the closest thing I found was not a confirmation, but a refutation — a quote from Fortune magazine stating that “even bullish gold pros caution the average investor to put no more than 5% of a total portfolio into gold-related holdings … ” [Emphasis added.]

If this article didn’t convince to buy gold until now, it just did. What does this say about the sentiment. I’m sure that in 1980 money managers would tell you not to have any more than 10%, even 5% in stocks. And how much gold were they holding then? How about in 1930 after the stock market crash? There was such a run on gold that the President of the United States had its ownership banned worried that citizens would drain America’s gold supply.

Myth No. 2: Gold has gained 3,500% in value

This statement from the ad is better-based in fact. With gold now selling in the neighborhood of $650 an ounce, a $20 gold piece issued in 1926 has appreciated roughly 3,150%. Factual in nature, this statement is less a myth than a red herring. The authors of the gold ad hope to dazzle you with the big number “3,500%,” and hope you won’t do the math to figure out what it means.

This argument does contain some validity. Gold has not risen significantly over the past few years. But it would only work with a certain type of speculator. The one that buys after something goes up in value. I always thought the Motley Fool were a bunch of contrarians. Maybe its just this editor.

But what does it mean? Simply put, it means that over the past 80-some years, gold has appreciated in value at an annual rate of 4.5%. Doesn’t sound as impressive when you put it that way, does it? More like something you’d expect out of a government savings bond or perhaps a generous money market account. Moreover, common stocks outperformed gold over that same period by better than a full percentage point (which may not sound like much, but works out to a 7,500% increase in value, more than twice the return on gold — and that’s before you count the dividends).

What I don’t appreciate is when people make this argument which extends from right before stocks did significantly well extending to all-time highs after an almost 20 year bull market. Compare stocks from 1929-1980, or the approximate 80 year range from the 1929 peak to the end of this bear market, and see what averages you come out with.

That’s right. Regardless of what the gold bugs would have you believe, over the past 80 years, you’d have done more than twice as well investing in such staid old companies as Coca-Cola (NYSE: KO), GE (NYSE: GE), and Eastman Kodak (NYSE: EK) than in gold.

Yes, but once again only in the years that stocks did well. More in a moment…

Myth No. 3: Gold is forever

But the ad’s most disingenuous statement has to be its assertion that “gold will retain its intrinsic value unlike the paper that is in the … stock market.”

Au contraire, mon frere! The difference between gold and stocks is not, as these hawkers of Gold American Eagle coins would have you believe, that gold is eternal and stocks, ephemeral. The difference is that gold is constantly being dug out of the ground, increasing its supply and diminishing the value of existing gold — whereas stocks increase in supply and value over time. As University of Pennsylvania Professor Jeremy Siegel describes in his book Stocks for the Long Run, over the course of the last two centuries (from 1802 to 2001) the value of $1 invested in gold has declined 2% as its supply increased. Meanwhile, $1 invested in stocks 200 years ago has increased in value nearly 600,000 times.

The fact that gold is constantly dug out of the ground doesn’t change the fact that it has amazing durability throughout the ages. (Never read about kings owning stock portfolios but I’ve heard of treasuries of gold). Secondly, what parts of supply and demand do we lack in gold. If the investor and industrial demand for metals such as gold and silver has been running at a premium to the rate of supply then by the fundamentals of economics there must either be a spike in supply doesn’t seem likely, or a decrease in demand – which free-markets usually accomplish through higher prices.

Indeed, gold has significantly underperformed stocks over the long run and offers little if not any interest rate or dividend but as the saying goes “Thats the price you pay for tranquility”.

Why? Because gold is a dead metal. While it has “intrinsic value,” it cannot create more value. In contrast, stocks are more than just paper. A stock is evidence of ownership of a share in a living, growing business — a business that has not only an intrinsic value today, but an ability to grow that value over time. To illustrate, a lump of gold cannot create a company, but companies such as BarrickGold (NYSE: ABX), AngloGold Ashanti (NYSE: AU), and Newmont Mining (NYSE: NEM) can always “create” (dig up) more gold.

And another difference
There is one key difference between gold and stock, though. As elements go, gold is gold — one hunk of 18k is the same as any other. Stocks, though — while they outperform gold on average — differ very much from one another. To illustrate yet again, over the past two years, the price of “gold” per se has increased roughly 50%. Meanwhile, the price of Barrick stock has risen 31%, AngloAshanti is up 34%, and Newmont 7% — which shows that you can do better in stocks by finding better companies.

…and I wouldn’t be surprised to see each and every of the above mentioned stocks to outperform the general markets year after year for the next decade. As for gold “increasing”, it would be similar to an investor who is buying stock because the value of the dollar is going. The Dow has already lost about half its value relative to gold. What would take 40 ounces of gold to buy the Dow in 2000 would only cost you 20 oz. today. History has brought this level down to the single digits as it has the general P/E ratio of stocks which is currently at 25 for the Dow and 20 for the S&P.

Our reasoning for holdings in gold is two-fold.

An Historic Safe-Haven
1. We consider the market highly overvalued with both prices, as well as earning ready to take an extended consolidation that will last years. It is thus our intention to be able to buy stocks cheaper at a later time as well as retain our purchasing power which, as those familiar with the “Time Value” of money know, continues to diminish greatly over time and even more so since the dollar has been taken off the gold-standard by the US Government in 1971. With inflation rampant we need to be sure.

Elements of Supply and Demand
2. The supply and demand fundamentals play an ever important role today than ever. A 5% holding in gold has always been warranted as a hedge in the rare possibility of an spike in inflation as we saw in the 70s or a catastrophic event that may send the dollar to the pits. But today, with probability taking the lead over possibility, mines eager to sell gold for a profit and fear of a dollar-diversification in the cards a much higher allocation may be necessary.

Just as if one wanted to get information from a stock guru they would have to ask someone who has been around when “equities were dead” not just a hedge fund manager who’s been around since 1997, so too in commodities. Those who have been trading in commodities for decades, in the down-and-out-trough of just about every grain and metal tell us that the prices today are unsustainable and that the major gains to be made are ahead of us.

Jim Rogers just mentioned in an article on Bloomberg that these corrections are there to scare all the speculators out if the market. When they finish they offer outstanding gains, well above the single digits for those who hold on tight. Remember the primary traits of the wealthy – conviction and patience.

“Many people end up being right but don’t hold out long enough to see that they indeed were”.



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