Week 21 - Gold

These days, i get a lot of questions about gold. There are those who wonder why it's doing so well and others who don't care and just want to know how to own it. We are reading more in the news and hearing more on the radio that gold is hitting new all-time highs each week. Normally, these types of conditions would lead me to believe that we are in a 'gold bubble' and that gold is overvalued at these levels. However there are still those that think gold can go higher.

In my opinion, the value of gold is affected by many factors, so I will try to explain a few of them as well as I can.

Supply & Demand

Economics 101, as they say. This is the simple theory that the price of something can increase if more people want to buy it, or if less of it is available for sale. It is difficult to predict supply (we have no idea how much gold is still in the ground) but most believe that because of the rapid economic growth in China and India, there are many more people wanting to buy gold than there used to be. Should this increased level of demand cause gold to increase from $200/oz to $1350/oz today? Again, difficult to say. That is some increase, though. There's an expression that might relate to this massive level of demand; that the Stone Age didn't end because we ran out of stones - things come along that might be viewed as better than gold or at least an effective replacement. This might not be likely with gold though because of its historical significance as the precious metal.

Gold as a currency

Many moons ago, gold was used as the standard for valuing one country's currency. That country might hold a level of gold in their reserves, which would serve to give their dollar (or pound, franc, etc) some value. The United States did this until the '70s I believe, but then declared that they were no longer going to relate the value of their currency to their gold reserves, which would allow the price of gold to appreciate or depreciate in U.S. dollar terms. Today, the U.S. dollar itself is known mostly as the world's 'reserve currency'; a country would value its currency vs. the U.S. dollar. Gold is also valued in U.S. dollars but with the tremendous fiscal deficits south of the border, many are wondering if gold itself is the only safe 'currency' to hold. Ironically, people have been saying this for years but in 2008 during the global economic meltdown, gold dropped in value significantly as investors rushed to convert their holdings into U.S. treasury bills (short term bonds); a telling sign as to where people still believe their money will be the safest. Still, many believe this story is far from over as nothing seems to be getting done about economic health south of the border. If things get bad enough in the States that their dollar depreciates rapidly, then many believe gold will still be looked upon as the 'new' safe haven.

Gold as a store of value - a safe haven?

That's where things get tricky. Right now many believe that governments around the world are struggling to keep the value of their currency low versus the U.S. dollar. America wants their dollar value down as much as possible because of how many foreign governments are holding U.S. dollar denominated debt. Why not just turn the money-printing presses on at home to make it easier to pay those governments off? That's pretty much what the U.S. has been doing and is also what China has been doing for years, to keep them in a competitive advantage as an exporting nation. In this case, one would think that gold, being priced in U.S. dollars, would stand to benefit.

I believe that like any currency, gold has to have a level of trust behind it. I don't want to hold my wealth in some measurement that has the potential to decline significantly in terms of my purchasing power. If it's going to cost me 400 oz of gold to buy a nice house today (about $520,000 CAN), then I don't want to risk the value of gold depreciating because people don't think it's worth that much. With paper currency, the health of the government and the level of inflation is really what helps maintain a reasonably consistent level of value. In Canada, we have a very healthy economy and therefore a strong dollar, relatively speaking.

Conclusion

I have a difficult time valuing gold for these reasons. Gold isn't a company. It can't win new contracts or increase productivity in the plant to help its stock price climb. The value of gold is based only on external factors that in my mind are extremely difficult to predict; currency movements, future supply and demand, U.S. economic health to name a few.

I have always kept my clients out of gold when they ask for my advice. So far, it has been an opportunity lost. But I'd rather look at it as a risk that I am not taking. There are other ways to store value that I view as safer today, in my opinion.