Gold is in the financial news at the moment, having risen to a high above $1,500 in 2019. Are you wondering whether you need to own any precious metals in your investment portfolio? In this article, we’ll examine gold and silver as investments.
As a disclaimer, nothing in this article constitutes investment advice. The purpose of this article is to give the reader a clear understanding of how these hard assets can act as stores of wealth, protecting the value of your money over time.
What Is Investing?
If you’re new to investing, then ask yourself if you understand what the term means. Investing is putting your money to work for you rather than you working for your money. Investing involves growing your capital base through the allocation of funds to various asset classes.
Typical investors will go top-heavy in investments like stocks and currencies. They also like passive instruments like hedge funds and mutual funds, as well. Some investors still believe in precious metals, and they choose to allocate a percentage of their portfolios to this hard asset as well.
Investment strategies provide the investor with annual returns, measuring the “Alpha” obtained through the management of the portfolio. The best hedge funds in the world get a return of around 90-percent for their clients. However, the rest of the pack slides in between 4 to 10-percent returns for investors.
By consistently growing their capital base, investors increase their wealth, without having to go to a job to make more money.
What Is Money?
Do you know how to define money? Money is principally a unit of exchange. Other characteristics of money include the need for it to be portable, durable, and divisible. Money also needs to act as a store of value over time, as well.
Since the early civilizations in recorded history, society relied on the use of precious metal coins in gold and silver to drive their economy. The Chinese, the Greeks, and the Romans all used gold and silver as the foundation of their monetary systems.
It was only in recent decades that the dollar became a solely paper-backed currency with no gold value attached to the note. Throughout history, people have always relied on gold and silver for completing transactions, and gold still retains its value today.
The Gold Standard Explained
If you’ve ever heard about the gold standard, but don’t know what it was, then this section is for you. Up until 1933, gold and silver coins were considered currency through the developed world. People would go into stores and purchase goods with gold and silver coins.
However, after the end of the First World War, President Franklin Roosevelt confiscated the private supply of gold in America to boost the coming war effort against the Nazis in Europe. He used the Federal Reserve to launch a paper dollar that represented an amount of gold owed to the bearer of the note.
This monetary system went on, with numerous alterations to the dollar amount of gold represented by the note. Eventually, in October of 1971, President Richard Nixon suspended the gold standard indefinitely. By severing the ties between gold and the dollar, Richard Nixon ushered in a “Fiat” era, where currencies no longer required backing by physical instruments.
The Modern Fiat Money System
With the end of the gold standard, and the launch of the Fiat dollar, Richard Nixon and the Federal Reserve began the great credit expansion of United States monetary policy. The US started issuing government debt at record rates, and consumer spending went through the roof, before ending in financial calamity.
The economic downturn of the late seventies and eighties gave way to a new boom in credit and growth in the nineties. This cycle once again led to a boom and bust in 1997, with the failure of Long-Term Capital Management in Thailand. Shortly after that, in 1999, the Dotcom bubble popped on the NASDAQ stock exchange.
However, it wasn’t until the Great Financial Crisis of 2008, that the fiat dollar system experienced its first real to the test. The collapse of Lehman Brothers led to a credit crunch that nearly collapsed the entire world financial system.
It was only through massive money printing programs that the US government, the IMF, and the Federal Reserve managed to lout the banks and the world from financial disaster. In the decade that followed, we have seen the biggest bull-run in history in US equities, with markets reaching all-time highs.
The Dangers of Global Debt
If history teaches us anything, it’s that markets move in cycles. At the moment, we are at the peak of an extended bull-run like no other before it in history. Continuing growth at this pace is impossible, and sooner or later, equity markets will experience a violent collapse.
When collapse does arrive, it could spread systemically throughout the entire financial system. Credit markets will freeze, banks will shut down, and the population will lose most of what they own in savings and investments.
Today, money is not even paper – its digits on a computer screen. Did you know that less than 4-percent of the world’s money supply exists in physical cash? The rest of it is accounting entries on a ledge held by a bank.
When bankers want to create more money, they do so at will, and then lend it to each other at practically no cost. One cannot deny that the last 20-years have seen a remarkable expansion in human innovation due to credit expansion. However, there is still a real threat attached to the progress.
If the financial system were to collapse, and society had to move onto another financial system, what would they use for trade? In times where the entire financial system freezes up, you can assume that money flows around the world dry up. As a result, companies don’t get paid. Utilities will end up dying, and the power grid will shut down.
In such a scenario, cryptocurrencies like Bitcoin would be useless for trade, because there is no more electricity. Not only would there be chaos in the streets, but you would have nothing to buy food. In this situation, it’s possible that gold and silver could emerge again as a means to provide trade during uncertain times.
Eventually, when the world establishes a new financial system, you can trade some of your precious metals for the current currency. At this point, you can bet that your gold will be worth a fortune in terms of the value of whatever currency comes next.
For example, after the hyperinflation that destroyed the monetary system of the Weimer Republic in Germany, you could pick up and entire city block for the cost of 28-gold coins.
Are Gold and Silver Still Money?
Gold and silver bullion coins still have recognition as legal tender in countries around the world. The oldest form of money may be nothing more than a “pet rock” in the eyes of some economists, but gold demand proves otherwise.
The US Mint frequently experiences shortages of silver to meet rising demand, and gold is a similar story. Gold and silver coins will always retain their value over time, making them the best store of value in any asset class.
Gold and silver coins still trade today, and you can pick them up from any bullion coin dealer in thousands of locations across the United States. These dealers buy and sell gold and silver coins, making a profit from the spread in the transaction.
The key takeaway is that gold and silver coins are still redeemable for cash, and they hold value over long periods. However, they do come with some level of risk. Just like cash, gold, and silver are exposed to the risk of misplacement, seizure, or theft.
If you own gold and silver coins, you’ll need to keep them in safe storage. You can apply for safety deposit boxes at banks and other private gold dealers, such as Brinks. These organizations keep your gold and silver in segregated storage facilities, ensuring that you have certificates for your deposits, and everything matches up to audits.
Gold and Silver as a Hedge Against Uncertainty
The primary reason why investors use gold and silver in their portfolios is as a hedge against economic uncertainty. Gold and silver are what are known as “safe-haven assets.” During periods of market volatility or economic downturns, investors liquidate risky assets like stocks. They take the profits and convert them into gold until the volatility passes.
When the investor is ready to retake a risk, they convert the gold to equities and bonds and make more money than they would be holding gold and silver. However, gold and silver are not only an effective hedge against market volatility.
Gold and silver also act as a hedge against inflation. Since the creation of the Federal Reserve in 1913, the US dollar has lost over 95-percent of its purchasing power. Over time, inflation eats up the value of paper money because there is nothing to back the currency.
As the government adds more money supply to the global financial system, it causes inflation in the prices of goods and services. However, America got away with printing trillions of dollars, and still experienced very little inflation.
The reason why the American economy does not experience runaway hyperinflation is that they export their inflation on the currency markets. While America sees a strong dollar, the rest of the world sees their currencies erode into nothing.
Take the Canadian dollar as an example. Americas third-biggest trading partner experienced more than a 365-percent decline in the Canadian dollar since the expansion of the Federal Reserve’s balance sheet in 2008.
This scenario means Canadians pay more for goods and services and for exchanging dollars, and it’s a similar situation everywhere else in the world. However, the pain in emerging markets is where the real cost of America’s abnormal monetary policy shows its ugly head.
Currencies like the Bolivar, South African Rand, Argentine Peso, and Turkish Lira all experienced rapid declines in the value of their currencies over the last decade. By allocating your savings to gold, you benefit from a hedge against currency inflation.
The world prices gold in dollars, and if you live outside of the US, then gold can provide you as a way to match both consumer inflation and currency depreciation against the dollar.
Bullion Vs. ETFs
It’s a prudent strategy to allocate 5 to 10-percent of your portfolio to gold and silver bullion. However, you can buy gold through two primary means; bullion and ETFs. Bullion is gold and silver bars and coins. ETFs are paper instruments traded on the stock market, and they have no direct representation of physical gold.
If you own $20,000 of gold ETFs, it doesn’t mean that you own $20,000 of physical gold bullion. All this instrument means is that you have the right to buy gold contracts at a specific price on a specific date.
Many investors get confused and think this is the same as owning physical gold. However, they are mistaken. If the stock market collapses, and your gold ETF goes to zero, you lose all your money and have no gold to show for your efforts.
In Closing – Stay Away from Numismatics
When you decide to add gold and silver to your portfolio, we recommend you do so with bullion coins and bars. Some unethical dealers may try to sway you away from your bullion purchase, in favor of collectible numismatic coins instead.
It’s vital that you don’t listen to the advice of the consultant. They are only interested in selling you an over-priced coin and making a commission.
Numismatics are collectibles, like Persian carpets. As a result, they have a value higher than the bullion content of the coin. However, when push comes to shove, and you want to trade the coin for cash, you’ll find the market is illiquid, and no-one wants your coin.
You can also expect to take a substantial loss on the spread between buying and selling. Avoid numismatics and ETFs, and only allocate physical bullion coins to your gold and silver portfolio.