Last Updated on October 11, 2024
[Disclaimer: I own physical gold and gold stocks. This is not investment advice and is provided for information only. This considers the economic case for gold and is not a recommendation to buy. Do your own research and consult a financial advisor.]
The key arguments in favour of buying gold are:
- Gold is money
- Gold is financial insurance against fiat
- Gold is financial insurance against Bitcoin
- Gold performs well during inflation and deflation
- Gold is a store of value
- Gold allows you to remove wealth from the banking system
- Gold has no counterparty risk
- Gold is liquid
- Gold is easy to store and maintain
- Central banks will continue their easy money policies
- Central banks are buying gold
- Fiat money systems don’t last, gold does
- As the monetary system deteriorates more people will look for a safe haven
Gold is not talked about much by governments, central bankers, economists or the media.
But gold is money and of current forms of money it is the one with the longest history.
While it’s got plenty of popularity in pockets of online media, it’s quite rare that the role of gold in the monetary system will entire the mainstream discussion.
Ron Paul’s presidential campaigns in 2008 and 2012 are the only events in recent memory that even offered a hint of gold filtering through to public consciousness.
This invisibility suits central bankers and governments just fine. While most central banks around the world quietly hold or even accumulate gold, they would rather keep this out of the public eye.
That’s because our monetary system is a fiat system. That means currency you hold, either physically or in your bank account, has no hard asset backing. Therefore new units of currency can be easily created and added to the money supply.
Such a system relies entirely on the confidence of the public in central banks and governments. Therefore to them, gold, as the alternative to this system, is best left unspoken about.
Yet the fact that central banks hold gold is a tacit acknowledgement of its status as money, no matter how disparaging the rhetoric towards gold might be.
And that is one of the most important arguments in favour of owning gold.
Gold has been money for thousands of years, it continues to play a monetary role today and it will almost certainly play a monetary role in the future.
13 Reasons To Buy Gold
1. Gold Is Money
Technically, gold should not even been seen as an investment. Viewed with a proper lens it should be viewed as money.
However, our fiat currency system has no formal tie to gold and therefore gold trades at market prices. So even thought it actually is money, it kind of makes sense to treat it like an investment.
Critics of gold like Warren Buffett make a fair point when they say that gold isn’t an investment because it has no earnings and no yield. If you buy one ounce of gold now and hold it for eternity, you will still only have one ounce at the end.
But as Jim Rickards says in response, the fact that gold has no yield shouldn’t be a criticism but is actually one of the strongest arguments in favour of it. Money is not supposed to have a yield because true money is not a risk asset. Yield only comes with risk.
“Gold has no yield or return because it is not supposed to. Gold is money, and money has no yield because it has no risk. Money can be a medium of exchange, a store of value, and a unit of account, but true money is not a risk asset.”
Gold isn’t good for creating wealth, gold is good for preserving wealth.
Stocks are a much better vehicle for growing your wealth. With stocks you are investing in real businesses that produce goods and services and have earnings. Holding stocks, you would expect to not only earn dividends but to see the value of the company and thus the stock price rise over time.
Buying gold in many ways is no different to buying foreign currency. As an earner and holder of New Zealand Dollars, I could keep my cash position in NZD or I could convert it to AUD, USD, GBP or gold.
I still invest in stocks, in fact my stock market portfolio is far bigger than my positions in gold. Even most ardent gold bugs would never normally recommend more than 10% of a portfolio to be positioned in gold. I don’t see gold as an alternative to stocks, rather, I see it as an alternative to dollars.
However, if you look at the Dow/Gold ratio then it becomes clear that, even if you were to pit gold and stocks against each other, there are long periods of time where one performs better than the other. Most of the time, stocks do better, but there are certain times where gold will outperform.
For example between 1968 and 1980 gold exploded from $35 to $850, an average gain of 30% per year for 12 years.
As Peter Bernstein notes:
“Even the greatest bull markets in stock market history pale by comparison.”
But then, followed a brutal bear market between 1980 and 1999, in the same period when the Dow climbed from 850 to 10,000.
So the choice is not gold or stocks but gold and stocks, each having a different weighting depending on where the Dow/Gold ratio is.
If you are able to time it well to move from a stock bull market to a gold bull market and back to a stock bull market in a cyclical fashion then you will do very well over your investing lifetime.
Although, that is far easier said than done.
2. Gold is Financial Insurance Against Fiat
The global economy and financial markets are complex systems with a lot of inherent risk.
Gold is the ultimate insurance against any kind of risk, volatility or change in the financial system. Whether it is inflation, deflation, a stock market crash, a monetary system reset or even a geopolitical shock.
In all of these circumstances gold will either perform well or will lose you less than most other assets, which is still a win.
During inflation, gold’s price will rise to preserve its purchasing power, as it did in the 1970s.
In a deflationary environment, even as gold goes down, other prices will go down further and faster, so gold will retain and possibly improve its purchasing power.
In a stock market crash, gold often falls initially as people sell everything. But it falls less, recovers faster and then rises as it acts as a flight to safety.
Similarly, in a geopolitical shock markets often sell off and there is a flight to safety. Gold benefits in these circumstances.
In a monetary system reset, as has happened many times over millennia and several times in the 20th century, gold will always persevere. Authorities have not yet figured out a way to remove gold from the monetary system completely. As much as they don’t want to admit it, they need gold, as it is universal global money.
3. Gold Is Financial Insurance Against Bitcoin
Bitcoin is superior to gold. It is more portable and divisible and is a superior store of value.
As Bitcoin monetises, gold should demonetise, in much the same way silver did during the classical gold standard.
Until Bitcoin came along gold was the superior choice to hedge against fiat debasement. So now that we have Bitcoin, why would you ever need to by gold if its an inferior alternative?
Many Bitcoiners would say you shouldn’t buy gold, you should only buy Bitcoin.
However, my position is that gold is insurance against Bitcoin’s failure.
To be clear, I don’t expect Bitcoin to fail. And by buying gold I expect that insurance policy to never be needed. And of course there is an opportunity cost in not buying more Bitcoin.
But gold has thousands of years of history, while Bitcoin has a decade and a half.
You insure to protect against the unexpected and catastrophic, which is what it would be for those who go all in on Bitcoin should it fail.
4. Gold Performs Well During Inflation and Deflation
Most people can intuitively understand why gold would perform well during inflation.
But Jim Rickards argues that gold also performs well during periods of deflation. The nominal price may fall, but it will fall less than other assets which means its real value will rise.
This could be because of supply and demand as investors will move into gold. However, Rickards also argues it will be because in a deflationary period the government will likely revalue gold much higher in order to increase the price of other goods in an attempt to break the deflationary cycle.
You and I can’t predict the future. And whether we will face significant inflation or deflation or one followed by the other, it makes sense to hold an asset that should perform well in either environment.
5. Gold is a Store of Value
[Disclaimer: The argument that gold is a store of value applies to the long term. In the short term gold can experience volatility and steep price declines and you can lose money.]
The price of gold is quoted in fiat currencies, primarily the US Dollar, and its price rises and falls when measured this way. Yet you are under no obligation to view gold as a commodity that is priced in USD.
Once you see gold as money there is another way of looking at this. When the price of gold rises, you could see it as the dollar falling against gold. When the price of gold declines, you could see it as the dollar strengthening against gold.
Dollars, or any other fiat currency, are not a stable store of value. Their value falls over time. So it doesn’t actually make a lot of sense to use them as a constant to measure gold against. While it may make some sense to use fiat currencies as a measure of gold in the short term, it makes very little sense in the long term.
Over the long term, the rising price of gold is more accurately seen as the falling value of fiat currencies. Those currencies are losing value because you require more of them to purchase the same weight of gold as you did before.
Over time you also require more fiat currency to buy a basket of goods. This is consumer price inflation. Gold should preserve your purchasing power against the same basket of goods.
While the nominal price of gold may rise, over a long period of time 1 ounce of gold today should buy more or less the same basket of goods in the future, regardless of the gold price quoted fiat currency.
One of the main arguments for holding gold as money is that it protects your purchasing power. You don’t buy gold expecting to make enormous returns. You buy it because you expect it to preserve your wealth and preserve your purchasing power.
The theory is, what an ounce of gold can buy today, it should also be able to buy in 5 years, 10 years and 100 years. You are looking for preservation, not growth of capital. There is a big difference.
History shows that gold is very good at protecting your purchasing power over a long period of time.
Today we live in a financial system where central bankers have a policy target of 2% inflation. In other words, the system is designed for you to lose 2% of your purchasing power every year. The reality is of course much worse with inflation well beyond 2% and at the highest rates since the 1970s.
Even at 2%, that may not sound like much, but it quickly adds up. While your wages and salary also increase in a wage-price spiral, they increase slower than inflation. This means your earnings are actually going backwards. If you have savings and your returns are lower than the rate of inflation, then you are also going backwards.
It is in this environment where gold is incredibly useful.
In the short term you can lose money due to the fluctuation in the short term trading range of gold, nevertheless the principle of holding gold for the long term is sound.
This truism is often explained with the idea that, from Roman times to the present day, an ounce of gold could always buy a high quality men’s suit. This is affectionately known as the gold/suit ratio.
Seen this way, gold may experience some short term price fluctuations but over the long term it is a stable store of value that will preserve your purchasing power.
This is why gold is often held by old money families who seek to preserve their wealth over multiple generations.
6. Gold Allows You to Remove Wealth From the Banking System
Most of our financial lives are digital.
Yet there are some significant advantages that come with the fact that gold is physical and not digital.
You can hold it in your hand or store it in your home safe.
Unlike a bank account it cannot be hacked, you cannot be locked out of your account and you are not at risk of identity theft.
You cannot be subject to a bank bail in, like Cypriots were in 2013, nor will you be vulnerable to a bank freezing your account.
Even if there was some problem with the internet or electricity at some point in the future, your gold would still be accessible.
As Jim Rickards explains:
“Gold is simple, an element, atomic number 79; it is the opposite of complex. It is robust in the face of international monetary collapse and financial market complexity. Owning gold is insurance against the current economic climate and unstable monetary system. Gold is the anticomplex asset, and therefore one asset that an investor should own in a complex world.”
7. Gold has no Counterparty Risk
Were you aware that when you make a bank deposit you are actually providing an unsecured loan to the bank?
What that means is that “your money” becomes a bank’s liability. In other words, it exists on their balance sheet as a figure that they owe you and is no longer your property.
This is important because it means that it isn’t “your money” which they are holding in custody on your behalf, despite the fact that is what it looks and feels like to you.
As long as the bank is solvent, this isn’t a problem. You can recall your loan at anytime and withdraw “your money.”
But if the bank were to fail, there is a chance you may lose some or all of your deposit.
This is what is meant by “counterparty risk.” There is some other entity that you require to remain solvent in order for your asset to retain its value.
Bank deposits, physical cash, bonds and stocks all have counterparty risk.
Gold does not.
8. Gold is Liquid
Gold is considered a highly liquid asset. This means it is easy to convert into cash.
This is due to the fact that the gold market has a large number of participants – both buyers and sellers – who recognise the spot price of gold.
The spot price is determined by futures trading activity on commodity exchanges in the world’s major financial centers.
By comparison other asset classes that people use to protect against inflation and preserve purchasing power, like real estate or collectibles, are not very liquid at all.
These things can only be sold for whatever a market participant is willing to pay. Since there are far fewer market participants and they have a subjective value of the price, it is more difficult to sell. A sale in an illiquid market may take a long time, or if you are desperate you may have to sell for a lower price than you want.
With gold, you can buy and sell to almost any bullion dealer in the world quickly and easily at the spot price, plus or minus the dealer’s premium.
9. Gold is Easy to Store and Maintain
On one hand physical gold is less easy to store than money in the bank or shares in a brokerage account.
But again when comparing to real estate or collectibles, the other assets in the same purchasing power preservation class, gold is in fact very easy to store.
It packs a lot of value into a very small space, which is why gold coins have been money for so many centuries.
You can use a home safe, arrange a safety deposit box or allow an online bullion dealer to store it in their vault, possibly offshore, and pay a small custody fee.
Maintenance is easy with gold. You can just store it and forget it, with one annual payment for storage and insurance.
Compare that to the hassle and ongoing costs when dealing with real estate which may include dealing with tenants, taxes and local regulations.
That’s not to say that real estate is not a great investment. It is. It just comes with a lot more hassles.
10. Central Banks Continue Easy Money Policies
If central banks were better stewards of fiat currencies, the case for gold would not be as compelling. Any actions that they take to improve the soundness of their currencies would be bearish for gold.
Unfortunately, central bank actions since the 2008 financial crisis, have primarily led to a loss of confidence in the long term health of fiat currencies.
The central banks have been devaluing their currencies and undertaking quantitative easing in an effort to generate inflation and prop up asset prices.
In these circumstances the case for holding some gold is strong.
11. Central Banks Are Buying Gold
While the largest holders like the USA and Germany haven’t been adding to their gold holdings recently, other nations have.
The last decade in particular has seen Russia and China buying up significant amounts of gold, while Japan, India, Turkey, Thailand, Poland and Brazil have been adding notable amounts to their holdings over the last few years.
Not only does this mean that large purchasers are bidding up the price, but it is a signal that central banks see gold playing a monetary role in the future.
If they want to hold it, then that is a good case for you, a private individual, to hold some.
Some economists and commentators have put forward very plausible arguments to suggest that there may be some return to the gold standard in the future.
Even if this doesn’t happen, I’m still happy to own gold for the reasons above and look for gradual price appreciation. But, if a new gold standard does eventuate and gold is repriced significantly higher, then I do not want to be on the side-lines. I want to have a sizable position.
It may seem preposterous to think about a return to the gold standard. And if you are only looking back to 2008 or even 1999 then that would be reasonable.
This generation has only ever known a world with one dominant military, economic and financial superpower. A world with no metallic peg, floating exchange rates, massive central bank stimulus and, most importantly, high confidence in governments and the central bank system.
But if you look back a little further things start to look a little different.
Nobel Prize winning economist Robert Mundell wrote an excellent piece in 1997 where he journeys through monetary history from the end of the Napoleonic Wars in 1815 to the end of the 20th century.
He notes how unusual it is in history for countries to have their currencies neither anchored to precious metals or to another dominant currency.
Yet this has become the new normal for us.
The result of the abandonment of the dollar standard, Mundell argues, has been a free lunch for America as their currency has become the dominant global currency, but with no tie to gold they are free to print as much as they like. The stability of the global monetary system thus depends on the discipline of the Federal Reserve.
Having reflected on the past he makes some predictions for the future and argues that gold will have a role in the future monetary system, although more likely at a market price than a fixed price.
He also makes an eerie prediction (remember this was 1997) where he says that central bankers will try to keep the price of gold from rising because this will be a warning sign of inflation. He implies that gold’s rise would prompt the public to lose their faith in the dollar, which since 1971 is backed by nothing but confidence.
Jim Rickards also makes a good case for a potential return to a gold standard and he argues that is in fact already happening. He calls this the “shadow gold standard” where the world is moving towards a gold standard but without anyone actually saying so.
Rickards argues that if confidence in paper money is lost then the next step would be to turn to the IMF. They have their own fiat currency called a Special Drawing Right (SDR). When that fails, the final recourse will be to gold.
He notes that the IMF is the third largest holder of gold in the world and that Russia and China have been acquiring significant amounts of gold in recent times.
The argument is that these countries are attempting to increase their gold to GDP ratio so that they will have a good seat at the table the next time there is a monetary reset.
He even postulates that the gold price may rise to $10,000 per ounce if the USA, the Eurozone and China were to agree on a gold standard using the M1 money supply with 40% backing.
I think these scenarios are plausible but there is no way to know how long we might be waiting for this new gold standard. Nevertheless, I want to be positioned accordingly in case.
This doesn’t mean I’ll be selling all my stocks and going 100% into gold but I sure won’t be neglecting the yellow metal.
12. Fiat Money Systems Don’t Last, Gold Does
Peter Bernstein succinctly explains the problem with fiat currency:
“All the countries in the world now function with monetary systems convertible into nothing except from one nation’s money into another nation’s money, all of which is costlessly procured with the touch of a computer’s keyboard.”
Our financial system is a fiat system. The dollars we hold are not backed by any tangible wealth.
The only tenuous link to gold is the fact that central banks still hold gold in their vaults.
Until the early 20th century, most major powers had their currencies backed by gold in what was known as the classical gold standard. This meant that the amount of paper currency that could be issued was limited by the amount of gold in a central bank’s vault.
Most major European economies came off the gold standard during World War One. Some returned to a gold standard after the war only to then abandon it again during the Great Depression.
After 1933 the gold standard was no longer a “true” gold standard. This is because the FDR decreed that only governments and not citizens were able to convert their dollars into gold.
Following World War Two, however, countries abandoned their gold standard and pegged their currencies to the US dollar, which was itself tied to gold. Thus during the Bretton Woods conference the “Dollar Standard” was established.
The USA maintained their gold standard until Nixon finally abolished the last aspects of it in 1971. Thereafter the central bank currency was backed only by public confidence in the institutions that issue it rather than gold.
For this to work the public must be prepared to accept, use and store this fiat money.
For the most part, this has worked well in the sense that people have had confidence in the monetary system and, despite its flaws, it has been retained.
But there is a risk inherent in this system. That risk is public losing faith in government and central banks. Then the confidence we have in the currency evaporates and the system will fail.
If confidence evaporates then an alternative money will be needed.
History suggests people will turn to gold.
Bitcoin is now an alternative proposition and the only serious challenger. I expect that Bitcoin will outperform gold and will become the superior hedge against fiat debasement.
But gold has two things going for it in the medium term – history and the fact that it was, and still is, a critical part of the global monetary system.
This confidence in central banks will erode if reckless government spending, reckless money printing and unwise manipulation of interest rates continue to a point where people refuse to hold dollars.
Right now, the number of people who don’t have confidence in fiat currency is quite small. Therefore, the confidence remains and the system continues.
However, I would argue that since the 2008 crisis and now the Covid-19 crisis, more people are becoming aware of the financial and social problems caused by fiat currency, extremely low interests and enormous government debt.
It’s still a very small number but it is growing.
13. As The Monetary System Deteriorates More People Will Look For A Safe Haven
Could there be a crisis of confidence in the future? Quite possibly, although how far we are away from that is anyone’s guess.
When it does happen, it is going to be very bullish for gold.
Jim Rickards argues that the US monetary system has actually collapsed three times in the 20th century. First in 1914, second in 1939 and third in 1971 when Nixon ended the convertibility of dollars into gold.
By collapse he doesn’t mean chaos and anarchy. Rather, that bankers and government officials have had to sit around a table and create a new monetary paradigm with new sets of rules. Each time this represents a death or collapse of the previous system and the birth of a new one.
All of this is bad for the holders of fiat currency. Not only do you have inflation eating away at your purchasing power, but you are holding a currency with a reasonable amount of systemic risk.
That systematic risk may not appear for a very long time. But when it does, it can happen rapidly and can destroy your wealth, if it is held in fiat currency.
Buffett argues that those who preach doom because of budget deficits and national debt would have made a mistake by going into gold to protect themselves compared to the returns they could have made it stocks.
History shows him to be correct so far, but does that mean that we are immune to problems in the future? I would argue not. Just because growing government debts have not yet caused a major systemic issue doesn’t mean that deficit and debts can carry on forever. The bill will have to be repaid eventually.
Yet even Warren Buffett, who wastes no opportunity to beat up on gold, acknowledges that investors are right to be fearful of paper money. His alternative is stocks but in fact the alternative to fiat money is gold.
You don’t have to wait until governments and central banks put us back onto the gold standard. You just reduce your exposure to fiat currency by moving a portion of your wealth from cash to gold. It will preserve your purchasing power against inflation and survive any systemic risk to our current monetary paradigm.
Even the former Governor of the Bank of England Mervyn King acknowledges:
“It’s still early days to conclude that around the world, governments have found the solution to maintaining price stability with a managed paper currency. We made real progress in the 1990s and early 2000s and a lot of countries went down that road and followed us. But hyper-inflation has clearly not disappeared – the second biggest hyper-inflation in history was in Zimbabwe in this century – so I can understand why holding gold would seem to be a sensible part of a national portfolio. Because there is clearly a need to take some precautions against an unknowable future.”
Conclusion
Gold has a long history as money.
Despite the fiat nature of our system since 1971, gold still has a shadow role in the monetary system as a reserve asset of central banks.
Given the risks inherent in the system it may make sense for you as a private individual to hold some gold as well, if you are willing to accept the short term price volatility.
Holding gold for the long term should serve you well whether we face inflation, deflation, a monetary system reset or a financial or geopolitical shock.
For an explanation of how to buy gold, click here.
Sources:
Ammous, Saifedean. The Bitcoin Standard : The Decentralized Alternative to Central Banking Hoboken, New Jersey: John Wiley & Sons, Inc, 2018.
Bernstein, Peter L. The Power of Gold : The History of an Obsession. Hoboken, N.J.: Wiley ; Chichester, 2012.
Rickards, James. The New Case for Gold. London: Penguin Business, 2019.
Image Credits:
Pile of Gold Bullion Coins by Zlataky on Unsplash
Dow to Gold Ratio by Long Term Trends
Bank of Cyprus is licensed under CC-BY-SA 3.0
Jerome Powell is in the public domain
Genoa Conference is in the public domain
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