Gold is a subject of much contention in the financial world.  There are the 'gold bugs' who worship the stuff; there are haters, who think it's nearly worthless; there are those who view it as just another commodity; and, of course, there are those who think we should go back to a 'gold standard' for the US Dollar.  How should a rational person view gold?

First, contrary to much of what one hears as common wisdom, gold is not a good inflation hedge.  Yes, it can act as an inflation hedge at times, but it is extremely unreliable in this regard.  Real estate is a much better hedge against broad-based, moderate inflation.

What gold is best for, and the reason why it is soaring at this time, is as a potential alternative currency.  With the Fed trashing the US Dollar on an ongoing basis, and with the market assuming that they will continue to do so in an ever-increasing fashion, one must look for a different store of value for one's savings.  While large-scale dollar devaluation is wonderful for eliminating old debts, it destroys the value of all capital that is denominated in US Dollars.  Hence, producers and savers must look for a way to retain the value of their holdings.

There are many potential assets into which one can convert his increasingly-worthless dollars, but there are issues with most of them:  illiquidity (real estate), spoilage (food), valuation difficulties (diamonds), potential devaluation (other fiat currencies), etc.  What is needed is an alternative currency, something which can maintain its value and is at the same time easily tradable.  Gold and other precious metals work very well in this regard.

To see why gold, as opposed to other assets, can be a successful currency, let's examine the characteristics of a currency.  A currency must be:

• Durable -- it must not degrade over time.
• Non-consumable -- even if used for other purposes, it must be recoverable
• Relatively rare -- it can't be something so common as to be worthless
• Relatively common -- there must be enough of it to circulate
• Difficult to produce -- it can't be something everyone can get or make in quantity
• Easy to verify -- counterfeiting must be avoided
• Easy to value -- it must be completely consistent and measurable
• Agreed upon -- most people must be willing to accept it as a means of trade

Gold passes all these tests.  So does silver.  One doesn't hear about 'silver bugs' simply because silver is more common than gold, but it would make an excellent smaller-denomination currency.

If one looks at the history of gold pricing (especially the period since restrictions on valuation and private ownership were lifted in the 1970s), gold has risen when the value of the US Dollar was in doubt.  When people had faith in the US Dollar as a store of value, gold drifted lower towards its base industrial and jewelry value.  Today, gold is soaring as the value of the US Dollar (and other fiat currencies) is being questioned more strongly than ever.

What should today's saver / investor do about gold?  That largely depends on how one believes the Fed will act.  If one believes the Fed will continue to destroy the value of the dollar, one should buy gold and other good alternative stores of value.  If one believes the the Fed will get its act together and stop the current insanity, it would be a terrible time to buy gold.

I believe that one should always have some gold, for the simple reason that a central bank (or treasury -- whatever government function controls the currency) can always decide to devalue a fiat currency.  However, I also believe in diversification.  To the extent one can afford them and/or has space to store them, one's 'portfolio' should include real estate, silver, hand tools, a generator, food, fuel, a high-quality water filter, whiskey, etc.  Essentially, one should have things that hold value, are tradable, and/or are used to produce trade and survival goods.

Best of luck to all in these uncertain times.

Posted by: Hermit Dave at 09:25 AM | Comments (2) | Add Comment
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