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Fundamental reasons to own gold from a published report circa 2003. At that time nobody wanted to touch gold...
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Warren Edward Pollock October 6, 2009
The value of gold pertains and relates directly to the metal having acceptance as currency. Gold finds its optimum value when it can be used as a currency to store wealth, guarantee paper, or effect transfer in goods and services.
Perceived or functional demand for anything creates value. Societal culture and structure will dictate what has importance be it a baseball card, oil, an automobile, a house, or labor hours. Value can be transitory or it can endure as gold has throughout civilized history.
Currency translates through uniform quantification the relationship in societal value between the desirable commodities, services, and outcomes. Both complex and all but the most basic societies need currency to effect the transfer of wealth. Gold provides a physical foundation point in currency throughout history, between nations, and across culture.
Integrated and global societies have highly complex currency systems largely predicated on common values. Law, stability, and property rights allow people to enjoy the benefits of a fast moving multiplied economy with a high velocity of money. Liberty may be an additional component or its presence may be reflected in the rights to protection of property. The three basic precepts, of law stability and property rights, combined with currency provide the very basis for productivity and most importantly these conditions foster investment and innovation with the objective of societal returns.
In the United States, unlike many other nations, value may be found in things tangible or intangible and in property either physical or intellectual. Investment and re-‐investment in productive enterprises result in economic success. The four pillars of economic success are law, stability, property rights, and currency. These supports are critical components of advanced economies.
However, Law property rights and stability, are inherently more fragile than perceived. Politics, culture, war, natural resource depletion, population pressure, mismanagement, malfeasance, events, and even collective rather than objective opinion can drastically detract from the core requirements for societal success.
The comfort of highly functional economies provides false shelter and harbors erroneous perception in security. Therefore as the foundation currency, gold, has a role, in all types of economies from the most basic to the most integrated.
By political objective, the correlation between gold and currency has become temporarily more distant since the 1970's. Just thirty years later some banks and societies are moving back towards the fundamental of gold today. A short-‐lived politically biased counter-‐trend does not represent a speck of time in relation to the history of gold.
Worldwide political objectives, as well as cultural experience, are not congruent or unified to common interests defined primarily by western thought and influence. It can be definitively said that interests are currently trending apart. Gold will become more valuable as currency in a predictable long-‐term enduring countertrend. History speaks to this and it will outlast us all.
Today specific economic, political, regional, and international circumstances have the propensity to drive a stronger correlation between gold and its role as currency.
Both mainstream and outlying contingencies can and will drive gold to become more attractive as currency. Therefore a portfolio that has a percentage weight in gold proportional to the probability of specific circumstances will be well served.
Finding that proportional level of gold to probability of circumstance presents some challenge. However, and in general, the level of gold holdings per capita needs to be much higher to adequately reflect the probabilities in which its application would be useful.
Inflation, in a paper money system or fiat money system, has to be considered part of the normal range of economic activity. If the economy were trending to inflation gold would rise inversely to unsecured paper. The value of gold stays constant while the currency devalues as it loses purchasing power.
Central banks have spent much of their efforts curtailing inflation. The pariah of inflation has been the watchword of every central bank simply because inflation inherently exists in unsecured paper money systems.
War also provides potential accelerants to inflation. I make this statement with the caveat that for structural reasons this may not apply in total to the present circumstance in the Untied States.
Gold provides a natural hedge against this normal and mainstream economic contingency of inflation yet few people hold even 1% of their portfolio in gold to offset the high probability of inflation over time. Most people are totally unprepared for the mainstream, recurring, and relativity frequent contingency of inflation.
Presently I believe the globe may be in a period of "stagnation-‐deflation". "Stagnation-‐deflation" implies that a mix of deflation and inflation are present in a slowing economy. Both an economic boom and "stagnation-‐deflation" represent outlying economic events one deviation outside the norm. ""Stagnation-‐deflation"" provides opposite traction to the dislocation of a boom.
In "stagnation-‐deflation" returns that can be derived on investments trend lower therefore gold appreciates because the opportunity cost for holding gold decreases. Simply put, more people want to hold gold to offset uncertainty and holding gold does not cost much because alternate investments do not provide meaningful returns. Perhaps after adjustment the United States will correct to the normal economic range. However, political interests are reticent to allow an adjustment to occur to take the energy out of a corrective force so in the near term therefore the US could shift to a more severe outcome as the potential energy of chronic and structural imbalance compound rather than release.
Unless the currency, stock, and debt markets shift to sustainable levels and valuations, and in the process wipe out wealth, the probability of the "worst case" scenario increases. In politics the "art of the possible" in pleasing a constituency has much to do with short term perception rather than need or circumstance. Gold has absolute neutrality to politics and it has an incredibly long time horizon.
I qualify these "worst case" events as two standard deviations away but that does not mean that they are not probable. War and structural imbalances such as deficits can drive a bad situation to a worse outcome.
Where do we go from here? We can go into a recovery, which would bring us into a normal economic range. Inflation is one of the possibilities because the economy would bounce off a higher money supply, as the velocity of money would increase through accelerated economic activity. Gold speaks directly to the inflation potential of this outcome. Or we move to outlying contingency two standard deviations from the mean.
The two extreme potentialities are hyperinflation and/or a liquidity trap.
A liquidity trap, depression, zero-‐bound, call it what you want circumstances become so unpleasant that Gold might be the least-‐worst option. Gold becomes a Hobson's choice, "no choice at all." Gold as currency thrives in inflation therefore hyperinflation would also drive gold towards the role of currency.
In either worst case the risk of confiscation of gold, government intervention, or command of the economy increases because of social considerations. A question to ask would be whether or not government tends to reward the individuals who are making the best personal economic choices?
What is the likelihood of these probabilities? Would these contingencies warrant one percent of one's investments to be in gold? What measures can be effective in diversification both to gold and in relation to gold holdings?
Presently the United States stands engaged in a war. Gold also finds its value as currency because war represents a major uncertainty and it can cause rapid dislocation.
Whether or not people in the United States believe that Gold has value today many cultures, central banks, and individuals are quite convinced that gold provides utility as currency. Unfortunately the common call to any asset class usually means that the best time to enter has been exhausted. With objective consideration gold deserves to be present at appropriate levels as part of any portfolios.