Principles of Wealth #25*

“Hard money” advocates and precious metals dealers contend that gold is not only the safest way to store wealth but also a very good way to grow wealth. The truth is, gold is a valid way to protect wealth from certain unlikely economic situations – but for the ordinary wealth builder, owning lots of gold is both risky and unwise.

There is a school of economic theory that puts gold above all other asset classes.

Here’s the argument:

* Stocks can go up but they can also go down. The same can be said for real estate, commodities, and bonds. But over the long haul, gold will preserve an investor’s wealth because of its intrinsic value.

* President Nixon made a huge mistake in 1971 when he took the dollar off the gold standard. When the dollar was tied to US gold reserves, the government could not print more dollars than there was gold to back them up. Now, the government had the freedom to print as many dollars as it wanted, backing them up with Treasury bonds (promises to repay the debt sometime in the future).

* When nothing can stop the printing of dollars, politicians will print them in an effort to speed up economic growth. But as the number of US dollars in circulation increases, the value of the individual dollar goes down. This causes inflation spikes that make virtually every asset other than gold – stocks, real estate, commodities, and bonds – worth less.

* In 1970, before Nixon’s decree, an ounce of gold could be bought for about $35. In 2019, that same ounce of gold would cost about $1,290. Meanwhile, as US debt has skyrocketed, the risk of a massive economic collapse has become more and more likely. Any day now, we could see banks freezing assets, the stock market crashing, bondholders losing everything, and “blood in the streets.” Gold will then be the only currency that anyone will accept. And here’s the silver (gold) lining: When that happens, the value of an ounce of gold will soar to $5,000 and even $10,000. Investors that own gold will become the new rich.

So… is that likely? That’s the million-dollar question.   READ MORE

Gold as an Investment

If you look at the price of gold since 1971, you can see that it has been a pretty good hedge against inflation. In the 100-year period from 1918 to 2018, the price of an ounce went from about $300 to about $1,300 – an increase of 433%.

But how does that compare to the stock market?

In 1918, one could buy the stock market (a share of every stock in the DJIA) for $1,370 in inflation-adjusted dollars. In 2018, that investment would have been worth $24,300, a 17-fold increase. More than 4 times what gold brought during the same period.

The difference is that the stock market represents businesses that produce products and make profits, some of which are then reinvested for growth. And as Warren Buffett has pointed out many times, gold does none of those things. It just sits there as a hard currency, maintaining its value so long as enough people believe in it.

So if gold is not a good investment, what can be said for it? How can it be helpful to the prudent wealth builder?

Gold as Insurance

The answer is that gold is a kind of insurance. An insurance against the sort of unlikely but possible economic catastrophe that hard money theorists have been warning about for years.

A smart businessperson, when apprised of a risk to his company, does not ignore it because he thinks it is unlikely. He insures against it. If the potential damage is great and the likelihood of it happening is probable, he will pay a significant premium to be insured against it. If the potential damage is great but the likelihood of it happening is small, he will pay a small premium or go without the insurance.

Buying gold as insurance against economic Armageddon falls into the latter category. If it does happen, the damage could be great. But the likelihood of a situation where gold is the only currency… that seems very small.

Of course, we don’t know. And as Mark Twain famously said, “It ain’t what you don’t know that gets you into trouble, it’s what you know for sure that just ain’t so.”

And that is one reason why the prudent investor will have some portion of his wealth in gold.

But there are other reasons to own gold, other ways that it can protect you. For example:

* Regulators can confiscate your stocks and bonds — even your cash — for all sorts of political, commercial, or bureaucratic reasons.

* Banks can seize your real estate if you can’t meet your mortgage payments.

* Brokerages can collapse, wiping out your retirement accounts.

* A lawyer can sue you, win a judgment, and then put a lien on your property and/or salary.

And in addition to its value as insurance, gold offers the following practical benefits:

Tangibility.Your stocks and bonds exist on an electronic spreadsheet. This spreadsheet is the property of some huge financial institution. What if it disappeared? It’s not likely, but it’s still a possibility. When it comes to protecting what you have, your risk tolerance should be zero.

Portability.Real estate is a tangible asset but it is not portable. If, for some reason, you want to get out of the country, you can’t take your property with you. And since real estate is non-portable, you can’t protect it from confiscation either.

Privacy.Another problem with real estate (and many other forms of tangible wealth) is that it is public. Clerks record and preserve every real estate transaction for anyone to see. With a working knowledge of the internet, your neighbors can find out what you own and what you paid for it.

You won’t have to worry about any of this with gold. So having some portion of your wealth in gold makes financial sense.

You can buy it, hold it, or sell it without anyone knowing what you are doing. Because it is expensive, you can transport a good sum of wealth discreetly. You can, for example, carry $20,000 worth of gold in the pocket of your jeans — and $1 million worth in a carry-on bag. Plus, you can ship gold coins on a plane or a boat or by parcel post.

The Factors to Consider When Buying (or Contemplating Buying) Gold

Gold is a reasonably good hedge against inflation and a good insurance policy against theft and confiscation and even economic collapse. But since it is not a good investment, you don’t want to own more than what you really need.

The purchase will depend on:

  1. Your own assessment of the potential catastrophic event.

History shows us that blood-in-the-streets financial disasters are rare, and this is especially so in the USA. Debt – both government and private – is unquestionably out of control. But there are several things that can come into play to offset or minimize a debt-driven economic collapse. For one thing, the government can raise taxes. For another, it can allow a modest level of inflation to eat away at the debt (by making the dollars owed worth less). And finally and most powerfully, debt can be erased by economic expansion.

Still, if you believe that such an event could seriously damage your ability to survive financially, you should definitely have some gold in your SOA (Start Over Again) fund.

  1. Your own assessment of the likelihood of that event happening.

The more likely you think it is for the catastrophic event to happen, the more urgently you’ll feel the need to buy and store gold. But keep in mind that the prudent investor buys only as much as he feels he needs to insure against the possibility. The rest of his money is better put into quality stocks, real estate, and bonds, which will give him a better return in the long run.

  1. What it costs to buy insurance against said event.

About 5% to 10% of your net worth (but no more than two years’ worth of living expenses) should be adequate. How much you should buy at any given point in time, however, depends on the price. Because if you are buying gold as a hedge and/or as insurance, the price you pay for it (the premium) matters. Since there is no way of knowing for sure whether gold prices are headed up or down, the prudent wealth builder will take advantage of dollar-cost-averaging and acquire it slowly over time.

* In this series of essays, I’m trying to make a book about wealth building that is based on the discoveries and observations I’ve made over the years: What wealth is, what it’s not, how it can be acquired, and how it is usually lost.