Tuesday, September 12, 2006

8 Things Everyone Should Know About Gold

Gold is one of the world’s most misunderstood assets. There are many reasons for this unfortunate situation, but one stands out. Gold exists in an environment in which there are many powerful forces fiercely hostile to it. Most notable among these are governments and the myriad of vested interests that feed from the public purse or rely upon some government-issued license or privilege. Governments have confiscated gold, taxed it, propagandized against it and even outlawed it.

Gold does not have any powerful sponsor championing its cause. In fact, the opposite prevails. Apologists for central banks as well as government toadies clamoring for continued state control of money have worked hard to discredit gold where possible, for example, by blaming it for things it was not responsible – like the Great Depression – and by denigrating gold as a fondling of speculators or a superstition better suited for primitive economies.

In short, conventional economic wisdom and monetary thinking has one aim; it is to justify and perpetuate today’s monetary system. It does not undertake a critical review of the system nor take an unbiased, unprejudiced look at alternatives such as gold.

Yet despite this hostile environment, gold continues to be valued throughout the world. Stripping away the misinformation and half-truths about gold, it is clear that gold continues to serve an important role. Why is that?

It is because gold is useful, and as a consequence, it therefore has value. And how does gold’s usefulness arise?

Here is a basic primer highlighting eight essential features of gold that everyone should know. By evaluating them, it is possible to determine whether gold’s usefulness could be of value to you, just as it already is of value to countless millions of people around the world.

1) Gold is a special, unique commodity

Gold is a special, unique commodity because it is the only commodity produced for accumulation; all other commodities are produced to be consumed. Essentially all of the gold mined throughout history still exists in aboveground stocks. Nevertheless, gold is rare.

The entire aboveground gold stock is only about 155,000 tonnes. If all this gold were put into one lump, its size would be 8,000 cubic meters, the volume of which is equal to the bottom one-fifth of the Washington Monument or 3¼ Olympic size swimming pools. It is also astonishing to note that in one day twenty-times more steel is poured than the total weight of gold mined throughout history.

2) Gold’s supply is its aboveground stock

Because it is accumulated and not consumed, gold’s supply is its aboveground stock. This fact changes everything in terms of how to analyze gold.

Gold’s price is still a function of supply and demand, but the supply that matters is not the relatively little amount mined each year, which history shows only increases the aboveground stock year after year by a relatively consistent 1.7% per annum. Rather, gold’s supply is the total weight accumulated in its aboveground stock for the simple reason that a gram of gold mined today is no different from a gram of gold mined by the Romans two-thousand years ago. In other words, gold in the aboveground stock is perfectly substitutable for newly mined gold.

In the short-term gold’s supply is relatively unchanged because new mine production cannot be meaningfully increased quickly. As a consequence, gold’s price is principally a function of demand.

While it is common to hear that gold’s price is determined by jewelry demand, that belief is misguided. Just like wet streets do not cause rain, the price of gold does not depend upon jewelry demand. The important point is not the form gold takes when it is fabricated, but rather, the use to which it is put. Most jewelry is high-karat gold acquired because of gold’s monetary characteristics, not for reasons of adornment.

Therefore, the price of gold – or more precisely because it is money – gold’s rate of exchange to national currencies depends upon monetary demand, or what some people mistakenly call its investment demand. It cannot possibly be otherwise, given that gold’s supply is its aboveground stock and that some 80% of this amount is held for monetary reasons, and not for fashion, adornment or other factors.

3) Gold is money

This observation about monetary demand means that gold is money. In other words, gold is hoarded because its greatest usefulness arises from those attributes that make it money.

Gold’s advantages as money are numerous. Perhaps most important in our present age marked by the perennial inflation of national currencies, gold is money that cannot be debased by creating it ‘out of thin air’ by government fiat.

Another important factor in gold’s favor is the mountain of debt and financial derivatives that overhang the world economy. Gold is the only money that is not contingent upon anyone’s promise, an attribute that explains why gold is called “sound money”.

4) Gold is an alternative to the US dollar

The US dollar is in trouble because it is being debased – it is being inflated by newly created dollars that are used to fund the growing federal government budget deficits and other public and private debt. This insidious inflation erodes the purchasing power of the dollar month after month. Consequently, more and more people are turning to gold as their preferred money.

It used to be that the dollar was “as good as gold”. The dollar achieved that distinction because it was formally defined as a weight of gold under the rule-based system known as the gold standard. Under that system, which ended in August 1971, gold and dollars were interchangeable and essentially the same. But no more, to the detriment of those who hold dollars. By some estimates, the dollar has lost more than 90% of its purchasing power since then.

Despite this dreadful deterioration the dollar has suffered, it continues to circulate as currency. Those same inexorable forces that create a hostile environment for gold are at the same time promoting and propagandizing the dollar to talk-up its demand. The Federal Reserve’s pro-dollar, anti-gold propaganda is aimed to maintain the illusion that the dollar is reliable money. Consequently, in contrast to their interdependent and complimentary role under the gold standard, gold and the dollar have become competitors. In fact, gold is the dollar’s only serious competitor. They compete for holders, and it is their relative demand that determines their rate of exchange, or what we call the ‘price’ of gold.

The relative demand for gold and dollars also explains the importance of dollar interest rates, which need to be raised from time to time to entice people to accept the risk of holding dollars instead of gold. But remember, only real (i.e., inflation adjusted) interest rates matter. Nominal interest rates are not important. For example, if dollar interest rates are 10% and the inflation rate is 10%, real interest rates are zero, and low or negative real interest rates are bullish for gold.

5) Gold preserves purchasing power

Gold preserves purchasing power, but there’s another way to describe this essential feature of gold. Don’t view gold’s price to be rising. Rather, recognize instead that the purchasing power of the dollar is falling. This conclusion can be made clear by looking at the price of goods and services in terms of dollars as well as gold.

For example, the above chart presents a base-100 analysis of the price of crude oil in dollars and goldgrams from December 1945. Since then crude oil prices have experienced a 64-fold price increase in dollar terms. A different picture emerges though when crude oil prices are viewed in grams of gold. A barrel of crude oil today costs about the same amount of goldgrams as it has at any other time shown on the above chart. So even though the dollar is no longer defined as a weight of gold as it was under the gold standard, this chart clearly illustrates that gold remains the most useful standard by which to measure the price of goods and services.

6) Gold’s value is determined by the market

Gold’s value comes from its usefulness, not from central banks. It is important to understand that the market gives gold its value, though central banks would have you believe otherwise. Central banks tell you what they want you to hear. They would like you to think that they control gold’s price, as that perception makes it easier for them to bolster the demand for the dollar. But the reality is quite different. The market determines gold’s price, just like it determines the price of a Picasso or a loaf of bread.

Central banks intervene in the gold market – just like they intervene in many other markets. The reason for their attempts to manage the gold price is simple. By keeping the gold price low, central banks make the dollar look better. With their interventions central banks are trying to make the dollar look worthy of being the world’s reserve currency when in fact it is not.

The gold price is a barometer that measures whether a national currency is being managed well (i.e., no inflation). So by trying to keep the gold price low, central banks artificially make the demand for dollars higher than it would otherwise be. Intervention is also consistent with the statist philosophy of many governments these days, namely, that they will usurp whatever power is needed to try maintaining the status quo that preserves the privileged position politicians enjoy at the expense of taxpayers.

Though central banks do not control the gold market, they can influence gold’s price. Importantly, their influence is diminishing. Central banks have been dishoarding much of the gold in their vaults, so they now hold a relatively small part of the aboveground gold stock. After the Second World War, about 68% of the aboveground gold stock was in the vaults of central banks. It’s now about 10%.

Less gold within their control means that central banks have less influence on its price, which is one of the reasons central banks are no longer the factor they once were. To learn more about central bank involvement in the gold market, you need to know what GATA knows. The Gold Anti-Trust Action Committee has published the combined research of many analysts, including several articles by me, and it is all available for free at www.gata.org

7) Gold is in a bull market

Gold has been rising since 2001, and the many problems national currencies are suffering mean gold is headed higher still. How much higher?

No one of course knows because there is never any certainty when it comes to markets. But in my October 2003 interview in Barron’s I identified $8,000 as my 10-12 year target. I reaffirmed that target price and remaining 7-9 year time frame in a subsequent interview in Barron’s in May 2006. Now before you say that target is outrageous, consider the following.

It takes about $10 today to purchase what $1 purchased in the 1970s, which saw gold rise that decade from $35 to more than $800 in 1980. I expect history to repeat, achieving the same mathematical ratio in gold’s gain, but with the dollar result being 10-times greater to account for its loss of purchasing power. Thus, I expect gold will climb from $350 in 2003 to over $8000 within a decade’s time.

It is not unreasonable to expect that gold will once again command the purchasing power it once did, particularly given the ongoing inflation and debasement of the dollar. One should never underestimate the capacity of central banks to destroy the purchasing power of a currency. In other words, gold is not rising – as the above chart shows, it still purchases the same amount of crude oil it did 60 years ago. Rather, the dollar is collapsing.

8) Buy physical gold, not paper ‘gold’

It is prudent to buy gold because of the alarming problems facing the dollar and other national currencies. Gold offers a simple means to diversify and therefore hedge the risks inherent in national currencies, but make sure you buy physical metal, not paper. There is a big difference between owning metal and just a promise to pay metal to you. Sometimes the promise is not worth the paper it’s written on.

Examples of physical metal that you can own are coins, bars, high-karat jewelry and the gold offered by my company, GoldMoney, which stores the gold you own in a specialized and insured bullion vault near London, England. Examples of paper ‘gold’ are gold certificates issued by banks and mints, pool accounts, futures accounts and the NYSE listed exchange-traded fund. With these products you own a piece of paper rather than gold itself. These paper products give you exposure to the gold price, but they come with the risk of default, namely, that you won’t be able to get your metal when you need it.

Gold should be viewed as the bedrock asset in your portfolio, so do not take any risks with it. As a consequence, own physical metal instead of just someone’s paper promise.


One objective of this short essay is to present the rationale for buying and owning physical gold, but another aim is paramount. It is to present facts that enable one to use reason, and not emotion, in analyzing gold’s essential nature and therefore its usefulness. In our world, some things are not what they seem at first blush, a maxim that is particularly true for gold, which in recent decades has become one of the world’s most misunderstood assets.

Gold may not be for everyone, but a fresh look at the facts never hurts. The 8 facts presented here should be carefully considered to better understand gold, which is the first step in determining whether gold may be useful to you.

Copyright © 2006 by James Turk. All rights reserved.
James Turk is the Founder & Chairman of GoldMoney.com. He is the co-author of The Coming Collapse of the Dollar.