Thursday, December 9, 2010

Why Buy Gold?

Gold is clearly all the rage these days - and not just for investors. Denizens of the suburbs are having frequent “gold parties” the way past generations had Tupperware parties. By way of personal experience, I stopped at a farming town for lunch recently (I was passing through on my way to another destination) and ate at a local diner. The decor was more or less what you’d expect for a rural diner except for the ubiquitous “We Buy Gold!” signs posted on nearly every wall and both sides of the front door. It seems the proprietor of this fine dining establishment was also in the gold biz.

Gold has long been considered an excellent hedge against inflation. It tends to zig when stocks zag, and it does increase in value when paper currency declines as we have seen over the past few years. Much of the increase in the price of gold has also been attributed to the fear of a large degree of inflation down the road due to the reckless sending in Washington D.C. since the economic crisis began in 2008.

All of this makes sense, but why buy gold bullion or coins instead of a gold ETF?

You could buy a gold ETF or stock in gold (or precious metals) mining companies and receive the same benefit from rising price and protection against inflation as owning physical gold. In fact, I would argue that it will be easier to sell so called paper assets than hard assets when the price of gold starts falling. I’d wager that the diner proudly advertising “we buy gold” will take down those signs when the price trend of gold reverses, but a mining company will still have an underlying business with assets and value.

It seems to me that there are two general categories of gold buyers:

  1. The investor who is looking to diversify or capture some of the gains in the rise of commodities in general or gold in particular.
  2. The post-Armageddonist who sees a future in which the economic system we’ve grown accustomed to over the last few hundred years is going to collapse in on itself, leaving a world where paper money is worthless in its wake.

Ammo is the currency of the future.
In the post-apocalypse of the 2nd type of buyer, "things" once again become important as the world resorts to a bartering system and who doesn’t love the shinny metal that’s captivated humanity for millennia?

My problem with that group is that often times the future they fear is more likely to feature ammunition as its currency than a metal that’s nice to look at but has few practical applications.

Propagating this survivalist, dystopian view of the future in this current environment of fear and economic uncertainty helps sell gold coins and gold bullion, but would you really be any better off than owning an ETF?

Is it more likely that if the world economies are going to collapse it will be just enough that gold is still important and not so much that basic survival becomes the imperative? Or is it more likely we will see double digit inflation and a weak dollar?

I’m speaking of likely doom-and-gloom outcomes here, it’s also entirely possible we’ll see a moderately weak dollar, and inflation somewhat higher than average but well below that of weimar Germany in the 1930’s. all scenarios are possible, but the one in which gold becomes the primary currency of choice and stocks are worthless seems less than likely.

All the same, I'm off to stock up on ammo for my glock. ;-)