Foster Publishing, Coin & Stamp

The first thing people usually consider when buying gold is its price, but unfortunately, they are grabbing the wrong end of the stick. Price is of secondary importance. To explain why, one has to examine the reasons for buying and holding gold.

The motivation to buy gold is usually driven by the pursuit of some defensive financial strategy. For example, gold is a proven and time-tested inflation hedge, so people acquire gold if they believe inflation is likely to worsen. This defensive strategy aims to protect your purchasing power because with gold you hold sound money instead of some inflating national currency.

Another defensive motivation to acquire gold is its unique attribute of being money with no counterparty risk. This significance of this risk was highlighted by the bank-run at Northern Rock in the UK last year and more recently, Bear Stearns in the US. People withdrew their money from those banks because they recognized that their ‘money’ was only as good as the financial capability of those banks to make good on their promise. In contrast, gold is not dependent upon a promise because it is the only money that is a tangible asset, and not an I.O.U. of some financial institution.

Another reason people focus on the price of gold is because they consider it to be an investment, but it’s not. Investments generate rates of return because you put money at risk, for example, by lending it or buying equity in a company. If the investment is successful, you will generate a return, increasing your wealth. But gold doesn’t do this. Gold preserves wealth; it doesn’t increase it.

For example, one ounce of gold purchases approximately the same amount of crude oil today as it has at anytime over the past 60 years. Who would want an investment like that? Gold hasn’t generated any rate of return. It hasn’t given its holders the opportunity to buy more crude oil. But because you can still buy essentially the same amount of crude oil, an ounce of gold has done exceptionally well at protecting wealth by preserving purchasing power, which is what money is supposed to do.

Money is a temporary store of value where we place a portion of our wealth while we decide whether to spend, invest or save (hoard) it. So when we hoard gold, we are in fact saving money until that moment in time when we decide to spend or invest it, which brings me back to my basic point.....

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As a follow up to the Fed's recent announcement to pump more liquidity into the money markets, James Turk explains why liquidity won't help and how it will make market conditions worse. I thought this passage was of interest:

 

The economic boom-to-bust cycle caused by bank lending and their subsequent credit contraction is not rocket science, nor a startling revelation. The last banking bust occurred in the late 1980s and early 1990s. Before that, a much deeper bust occurred in 1973-1974, and it more closely mirrors the severity of the way the present bust is developing. Here’s how Ludwig von Mises described the process nearly one-hundred years ago, making clear the inevitable destruction of fiat currency from inflation.

"The course of a progressing inflation is this: At the beginning the inflow of additional money makes the prices of some commodities and services rise; other prices rise later. The price rise affects the various commodities and services … at different dates and to a different extent. This first stage of the inflationary process may last for many years. While it lasts, the prices of many goods and services are not yet adjusted to the altered money relation. There are still people … who have not yet become aware of the fact that they are confronted with a price revolution which will finally result in a considerable rise of all prices. These people still believe that prices one day will drop. Waiting for this day, they restrict their purchases and … increase their cash holdings.

But then finally the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. The crack-up boom appears. Everybody is anxious to swap his money against "real" goods, no matter whether he needs them or not, no matter how much money he has to pay for them. Within a very short time … the things which were used as money are no longer used as media of exchange. They become scrap paper.”

And scrap bank accounts. While paper was the predominant form of currency in Mises time, today bank deposits moved around by check, plastic cards and wire transfer are a much more significant form of currency than paper.

This video does a good job of explaining how much value the dollar has lost against hard assest, like wheat, oil, gold and copper. In the case of the nickel and penny, the value of the metals have exceed the face value of the coin. In December 2006 the US Mint banned the melting of both coins and put tight limits on the amount that can be exported out of the county. At that time a nickel's metal content was worth 7 cents, and a penny's was worth 1.12 cents.

In 2006 alone, the U.S. dollar shed about 10% of its value against the euro. But the dollar's value is tumbling even more rapidly against tangible real-world assets like wheat and gold and crude oil, nickel, copper and all other real commodities.

Today, for example, one U.S. dollar buys 44% less wheat, 55% less gold, 67% less crude oil and 83% less nickel than it could buy at the beginning of 2001. In fact, the value of the U.S. currency has dropped so precipitously against nickel and copper, that the metallic content of a U.S. nickel is worth much more than the nickel.



Also....

On this weekend's Financial Sense Newshour broadcast, James Turk analyzes the fine print of the silver ETF (SLV), talks about the dollar reaching all time lows this year, and forecasts the metals market in the months ahead. By year end, he sees gold reaching $850 and silver going above $20.

"But keep in mind... it's really not so much that gold is going up, it's that the dollar basically is going down. (An ounce of ) Gold still buys the same amount of crude oil it did 60 years ago. So, it's really that everything looks like it's going up, but the reality is that the dollar is going down."

Click here for Turk's interview which begins at 59:45