September 24, 2008

The real reason to own gold

There seems to be a good deal of confusion these days about the reasons why individuals should own gold.

Who owns gold?

While there's the "momentum crowd" - those who will buy anything that is going up or sell short anything that is going down - these folks are more traders than owners and don't really factor into the "ownership" discussion.

This leaves basically two groups of gold owners - those who fear a financial catastrophe and those who fear the debasement of paper money.

However you look at it, there's a lot of fear associated with owning gold.

It's the End of the World as We Know It and I Own Gold

The financial doomsayers seem to believe that the metal is some sort of insurance against the wheels falling off of the global financial system (or, perhaps, the outbreak of another major war ... or both), in which case, all your other investments are likely to go down the tube.

They often say, "Be careful what you wish for", making the incorrect assumption that everyone invests as they are told by Money Magazine with an 80 percent allocation for stocks (which, lately, seem to want to go down without any help from catastrophes).

The thinking goes that a ten or fifteen percent investment allocation for gold bullion might be of assistance in some way if things go horribly wrong - as it was immediately after World War II when no one trusted any country's paper money - and that, before providing this much-needed assistance, the whole thought of having it there at-the-ready might make you sleep better at night.

While this may be true, it's also true that, if you buy gold for this reason, you should probably load up on shotgun shells and 45 caliber rounds as well, since, under these extreme conditions, they might fetch an equal value in barter with the added benefit of being eminently more useful in protecting your other valuables.

As for the collapse of the financial system, some would argue that over the last ten days the global financial system is already collapsing around us, yet the yellow metal is worth only a little more than it was before the collapse began - hardly enough to make any difference in any post-collapse existence, though that could surely change very quickly.

While anything is possible, it's hard to imagine this kind of extreme scenario playing out anytime in the near future, but, if it does, you will surely be better off owning gold coins than U.S. Treasury bills.

"Muddle-through & Monetization"

The other type of gold owner sees the outlook for the world as being a little less dire with fewer banks, businesses, and governments failing and with much less loss of life.

If the doomsayers are once again disappointed and the world continues to revolve around its axis which becomes no more or less tilted, there is another very powerful argument to own gold - the debasement of paper money that will, for a while at least, forestall the financial apocalypse.

If we're lucky, we'll avoid the financial apocalypse all together.

Last week's report by the Citigroup Mining and Metals Group was a good example of this line of thinking and more investors who currently do not count precious metals as an important part of their holdings should really take a cue from their work (here's the report(.pdf)).

They argue that owning gold can also be viewed as insurance against the government printing too much money in their herculean effort to somehow keep the wheels from falling off and the earth rotating about its axis.

Of all the possible outcomes from this point forward in the ongoing credit crisis, muddling through and monetizing debt would have to be the preferred outcome over Citigroup's other scenario - "Gloom & Doom" (see "It's the End of the World as We Know It" above).

Some might say that we're already well into the "Muddle-through & Monetization" scenario, having avoided the "Gloom & Doom" for years now, after the stock market bubble burst at the turn of the century.

Evidence of such is provided by the fact that, from 2002 to 2007, the gold price increased an average of 20.5 percent a year. Project this forward to the end of 2013 and you get a "Gloom & Doom" gold price of over $2,500 an ounce and nobody has to die.

Either way, gold owners come out ahead

Six or seven years into a gold bull market where prices have gone up for each and every one of those years (is there any other asset that can make that claim?), most people still don't understand why they should own gold. It's not because it's insurance against everything else tumbling down around you and, despite what traders think, it's not because the price has been going up.

The real reason to own gold is that governments are in the process of debasing their currencies in order to alleviate the pain of souring economies that were built on a fundamentally flawed principal - that more easy money can solve the problems created by prior easy money.

It won't.

In the long run, the only thing that easy money really does is make hard money more valuable when said hard money is measured using the easy money.

Gold doesn't have to go "parabolic" to reach $2,500 an ounce - a number often cited in the "Gloom & Doom" scenarios.

All gold has to do to reach $2,500 an ounce is to do in the next six years what it has done over the last six years.

The real reason to own gold is because the U.S. government and other governments around the world have been and will continue to try to remedy all known and perceived economic and financial market ills with their printing presses.

My guess is that somehow they'll be successful - at least for a while.

And just in case they're not, stocking up on bullets isn't a bad idea.