Monday, April 11, 2016

Gold Finger

Investing in gold is screwing yourself.

The gold bugs are at it again.   People bought gold as high as $1800 an ounce, on the promise that it would hit $5000 "any day now" - only to see it languish at $1100 for years on end.   The myth of gold was exposed.  It is just another commodity, not a "safe haven" or an "investment".

So the gold bugs have upped the ante.  Today they are saying gold will hit $10,000 an ounce.   These predictions are starting to sound more and more like a story told by a small child.  Up next, gold will hit a gazillion trillion dinosaur-zillion dollars before my 5th birthday!

To recap what we have discussed before, there is nothing magical or inherently special about gold compared to other metals.  You may as well invest in silver, copper, zinc, or even lead.   All have market values, all are commodities.   The only difference is, there are actual uses (other than jewelry) for some lesser metals.

Can you make money in commodities?  Sure, if you get lucky or know what the hell you are doing.   It is a tricky business, as you have to understand how the supply works and what demand is based on.   For things like pork bellies or corn futures, this is not hard to quantify.  People have to eat, and you can figure out supply based on historical production, weather, and other data.

Gold is an interesting commodity in that the demand is based on perception alone.   In the last few years, demand shot up as people panicked and thought gold would be "safe".   But as it turned out, leaving your money in stocks was a better bet - they went up in value and paid dividends, the latter being something gold will never do.

And the supply of gold is not as finite as people would have you think.   Mines crank out an ounce of gold for about $500 or so, leaving them a huge profit in a market where price seems to have stabilized at $1100 or so.   Other folks, seeing money to be made, have opened up old mines, even in places like the Carolinas.   Meanwhile, impoverished people along the Amazon are raping the rainforest to get gold - the separation of which is accomplished using toxic mercury.

And burglars across America are breaking in and stealing your gold jewelry and melting it down to sell for drug money.   Turns out the supply isn't as finite as we thought.

So what was the allure of gold?  Why was it used as currency for so many years?  Why did the Aztecs make enormous amounts of gold jewelry for their leaders and high priests?

Well gold does have some interesting properties.  For starters, it is an excellent conductor, which makes it desirable for electronics.   However, with prices going through the roof, manufacturers are turning to lesser metals, such as copper, aluminum, or silver.   For jewelry it is particularly desirable because it never tarnishes, unlike silver and copper and aluminum, which rapidly oxidize and require constant polishing.

Gold as currency was popular in more primitive times because it was relatively rare (and thus hard to counterfeit) but not so rare as to make it unobtainable.   It was also relatively easy to mine and refine - gold nuggets and dust can be found in a stream or picked up on the ground.   Platinum or aluminum - in ancient times - were very rare and hard to refine.  Today, we throw away aluminum.   Not more than 100 years ago, it was more valuable than platinum.  Napoleon dined on polished aluminum flatware, while his lesser cohorts had to make do with mere platinum or gold.   The tip of the Washington monument is made of what was the world's most precious metal at the time - aluminum.

If you could go back in time and take a six-pack of soda with you, the value of the empty cans would be enough to buy you a mansion.  Such is the fate of metals - and the laws of supply and demand.

So gold was a good choice for currency.  Rare, but not so rare or hard to refine as to be a pain-in-the-ass to obtain.   But not so common that people could counterfeit your currency and thus dilute your money supply.   Controlling your currency (big M as we call it here in the States) is key to controlling your economy.   As the Europeans are finding out, when one country can basically print money (through poor lending practices) it can take the whole economy down.  The Brits are patting themselves on the back for sticking with the pound (which of course originally was based on the value of a pound of silver).

The penalty for counterfeiting in olden times was death.  That illustrates how important monarchs viewed their currency.   If people could spoof the coinage, a king could be toppled.

So gold came in handy as a currency.  It was rare enough without being too rare.  It didn't corrode, so your wealth would not rust away.   Oh, and it was very, very malleable, so it was easy to press into coins using the primitive dies of the time.   And detecting counterfeit coins wasn't hard to do.  You weight them so insure they were the correct weight, and they you could immerse them in a glass of water and determine their volume - and thus compute density.  If someone tried to pass off a lesser metal as a gold coin you could catch them pretty easily.

Skimming metal from gold coins was another practice that was punished severely.  Primitive coins often had flanges on the edge or had flat edges.   A person could "shave" a little off each coin that passed through their hands and end up with a nice pile of gold.   Get caught, however, and you'd end up in jail or dead.   So as technology progressed and coin dies got more sophisticated, edges of coins were milled with ridges, which would make "shaving" readily apparent.

Thus, gold emerged as a currency of choice - not because, as some gold-bugs say, that it has some inherent value as a currency or inherent value of its own, but because it met all the criteria for an ideal currency in pre-industrial times.   It was scarce enough to make counterfeiting hard without being too scarce to be impractical, it was easy to press into coins because it was malleable, it didn't corrode into dust like other metals, and it was easy for people with primitive tools (scales, graduated cylinder) to measure its density (and authenticate).

Gold bugs hold otherwise.  And again, their pronouncements often sound like that of a small child.  Gold is valuable "just 'cuz it is" and nothing more.   For example, this "expert" uses circular logic to explain the allure of gold:

Jim Grant, a "respected Wall Street Publisher" (interesting credential) noted that  the argument for gold begins with its role as the original money.  From NPR:

"People recognize it as such. You don't need a Ph.D. in economics to have it explained to you. Gold is sort of the Muhammad Ali of monetary substances; the world over, you look at it, you know what it is," Grant says. 
Pegging the dollar to gold would limit inflation, he says, and force greater fiscal constraints on governments because they couldn't simply print money to pay their debts or bail out bankers. 
And, he says, it would bring the kind of stability to the monetary system that it had a hundred years ago.
Read that last sentence again, and when after you fall out of your chair from laughing, you may understand why Ron Paul followers are total losers.
Gold is great because it is, is basically what he is saying.  And that seems to be the Alpha and Omega of gold bugs.   People have sought out gold in the past because it was perceived to be valuable.   Our history is flush with "gold rushes" and gold strikes.   Europeans came to America in search of gold, committed genocide in the name of gold, and then stole all the gold they could and brought it back to Europe in an effort to prop up bankrupt monarchies.

But of course, that never quite worked out the way they thought it would.  When the Galleons returned to Spain loaded with gold, the supply of gold increased - increasing Spain's effective money supply.  As a result, gold dropped in value, and Spain's money problems really weren't solved by raping the new world.  Gold did not create real wealth for anyone, just the appearance of it.   The wealth of an economy is measured by its productivity, not on how much of a commodity it manages to hoard over time.

You could go out and hoard a pile of zinc.   It would not make you any wealthier, just some jackass with a mountain of zinc in his back yard.   And a mountain of gold is no different.  If you sold everything you owned and bought bars and bars of gold, well, you'd be no richer or poorer than before - but now your wealth would be dictated by the commodity price of gold, which you would have to hope goes up.

Bars of gold are one of those high-index Pavlovian response things, like the suitcase full of hundred dollar bills trope.  In "caper" movies like Goldfinger or Kelly's Heros the villains (or good guys) conspire to steal huge hoards of gold.  Of course, the practical matter of moving gold, which is heavy, is one of the logistical problems of such capers.   Movie makers know that audiences will respond to stacks of bars of fake movie gold, just as we respond to the suitcase of hundred dollar bills.  But the reality is, of course, that if you stole gold, you'd have to sell it to get money to buy things you could actually use.  It really isn't an end in and of itself.   It, like any currency, is just a placeholder of the value of things.  It is the idea of money not real wealth in and of itself.   So long as other people perceive it to be valuable, you are set.   And that is true with all currencies.

And yes, you can trade paper currencies - or even electronic ones.   Remember BitCoin?   People are still raging true believers about that and other "virtual" currencies.    Some folks made a lot of money early on in BitCoin, which is sort of like a pyramid scheme, if you think about it.  Since BitCoins are "minted"by having your computer solve increasingly difficult meaningless problems, the people who got in early in BitCoin made a pile.   Since then, the value of the currency has gone up and down so dramatically that people have made and lost fortunes overnight.

Speculating in currency is no different than speculating in gold, and that basically amounts to gambling, not investing.

What is the difference between gambling and investing?  Simple.  Investing is taking money and putting it into something that will make more money.   It could be a loan to someone who will pay you back, with interest.  It could be an investment in a company that makes things that are sold at a profit.   Investing involves putting money into things that (you hope) will make more money through some rational mechanism.   And yes, there is risk in investing.  Borrowers may default, factories may fail to make good products, or the public may decide not to buy.   There is risk.  But overall, investments tend to increase in value over time, as they create more wealth, even if some fail.   For ever dollar invested on average, more than a dollar is made in the long haul.
Gambling is merely betting on the price of an item - whether it will go up or down.   When you gamble on a commodity, you are betting on the direction the price will go.   The commodity has no mechanism to make money in and of itself.  It cannot pay interest or manufacture goods.   It never pays dividends.  And this goes for stocks as well - stocks for companies that are losing money and pay no dividends.  These are just speculative gambles, not "investments" per se.  There is risk in gambling - all risk.   And for each person who makes a dollar gambling, someone else loses a dollar - or more.

And not surprisingly, the money to be made gambling is not nearly as lucrative as investing.   You might double your money, at best, with a lucky bet.  But if you gamble long enough, you eventually lose as much as you win.   It literally is a zero-sum game (as a reader correctly pointed out).  For every winner there is a corresponding loser.  With investing, everyone wins, on the whole (other than those who bought and sold at unfortunate times, or invested in losing stocks, or thought they were investing, but were merely gambling).  And the gains can be spectacular - as illustrated by how the stock market has outperformed even the meteoric rise in gold prices.

Gold at $10,000 an ounce?   People say this because they want to sell you gold.   It is like taking debt advice from a Bank - it is self-serving advice.   To reach this theoretical price, the demand for gold worldwide would have to increase by a factor of ten and production would have to grind to a halt in every mine in the world.   Neither factor seems likely, short of the Apocalypse.  And if the Apocalypse comes, you'll wish you "invested" in ammunition.   But pining for the end times is a shitty investment strategy as well.  Gambling on Armageddon is a sucker's bet - the odds are incredibly long, and as it turns out, guns and ammunition are just commodities as well - and the market is saturated with both, worldwide.

It just amazes me that after the gold debacle of the last decade, that the gold bugs are still pushing this.  But for every disillusioned "investor" in this metal who quits the game (after losing his shirt) is some new bright-eyed Trump supporter willing to get in - and listen to utter nonsense about gold.