From The Vault: The Special Case For Gold

October 24, 2008

An HAI classic seems more timely than ever given today's market.

  • Not A store of value; THE store of value
  • A pathway to security
  • The only market hedge against turn meltdowns

 

 

[Editor's Note: From The Vault is a new HAI feature that periodically highlights some of the best and most timeless content on our site. In light of recent market turmoil, Tom Vulcan's gold piece seemed appropriate.] 

 

"Water is best, but, shining like fire blazing in the night, gold stands out supreme of lordly wealth."

                            Pindar - First Olympian Ode

 

Since the Greek poet Pindar described gold in these glowing terms in 476 BCE, its identification with wealth has changed very little over the ages.

Indeed, priced as it is now and viewed against both the increasingly ragged backdrop of the U.S. economy and current credit crunch, its association with wealth, secure (or "lordly") wealth, is particularly strong.

Why Buy Gold?

Three of the most fundamental reasons for buying gold are the following:

  • For economic security
  • For physical security
  • Against contingencies

 

For Economic Security

Gold is an excellent long-term hedge against inflation.

In the very long term, and despite sometimes quite significant short-term price fluctuations, gold has been shown to maintain its store of value in terms of real purchasing power.1 In other words, as the value, i.e., purchasing power, of the dollar falls (and inflation goes up), so the price of gold rises.

Unlike any of the world's currencies, each of which represents debt incurred by the relevant issuing government, gold is not a liability. And since it is not a liability, it can neither be repudiated, nor its value undermined by inflation. This stands in stark contrast to the world's paper currencies that, printed as they are, by "fiat," always lose value in the long term (this can, and does, also happen in the short term.)

In addition, gold has been shown not only to provide a strong hedge against a declining dollar2 (when gold is traded throughout the world it is always bought and sold in U.S. dollars, i.e., it is nominally priced in U.S. dollars), but also to be a better hedge against the dollar than other commodities.3

For Physical Security

Gold is a secure asset.

In the past, when there was a gold standard, governments banned individuals from holding gold - preventing those individuals, in effect, from holding (and preserving) their wealth beyond the control of government. As the young Alan Greenspan put it in 1966: "In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold." Now, however, it can be freely held.

Held as an asset, not only is gold liquid, but it is also subject neither to the freezes nor to the imposition of exchange controls that can, at times, threaten other asset classes and currencies. As, once again, Mr. Greenspan put it back in 1966: "It [gold] stands as a protector of property rights."4 It has a physical security not associated with any number of other assets.

 

Against Contingencies

Gold is an excellent "crisis" hedge.

Undisputed worldwide as a store of value, gold can be a form of "insurance" both in times of crisis and when there are extreme untoward movements in other asset classes. For example, during the period of hyperinflation in Germany from 1918-24, gold maintained its purchasing power while the value of bonds and stocks were catastrophically diminished.

Set apart as it is from other commodities because of its acceptability, portability, homogeneity and indestructibility, the market in gold is both universal and highly liquid. You can buy and sell gold around the globe. Even James Bond in "From Russia with Love," traveled with some 50 British gold sovereigns hidden in his briefcase - just in case!

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