Gold: What, How, Why?

Gold.

That yellow shiny stuff that has been coveted for millennia. 

Do you own any? 

Should you own any? 

How do you get some? 

What would you do with it? 

Before getting into all those questions, let’s look at a brief history of the metal.

Gold has some unique properties that have led to its high demand:

• Conducts electricity

• Does not tarnish

• Is malleable

• Has great color and luster

• Feels heavy to the touch (which makes it seem important)

Interestingly, when the Spanish first came to the Americas, both cultures held gold in high esteem. Despite being worlds apart they both found it useful and had elevated it to an object of desire. Jewelry was one of the primary original uses for the metal and today is still commonly used for this purpose. 

• 560 BC - Gold was first turned into coins and used as a medium of exchange 

• Because of its high value, durability, and portability, it makes an efficient means of storing value.

• 64 AD - Romans start reducing the percentage of silver in their denarius coin

• It started out as nearly 100% silver and over ~300 years was reduced to only 2% silver.

• 1913 - The Federal Reserve issues its first paper currency

• Gold coins become less popular for transacting.

• At this time, all federal reserve notes were backed 1:1 by gold and each note stated that it could be redeemed for its value with gold or “lawful money”.

• 1933 - During the height of the Great Depression, Franklin D. Roosevelt issued the Emergency Banking Act 

• This allowed the US Treasury to issue emergency currency to banks that could not meet their withdrawal requests (basically the government bailing out the bank)

• Late 1933 - Roosevelt signed Executive Order 6102 which criminalized the possession of monetary gold (not jewelry) by any individual or business 

• That’s right, it was illegal to possess any gold coins or bars

• It wasn’t until 1974 that this was officially repealed by President Gerald Ford

• 1971 - President Richard Nixon removed the convertibility of US dollars to gold

• Once no longer confined to a gold standard, the US was now free to create more dollars at will without having to back them up with equivalent amounts of gold 

• An unbacked fiat currency was born

There are a lot of charts that show large divergences in income, spending power, etc. from the point of going off the gold standard onward. In fact there is a whole website dedicated to it.

https://wtfhappenedin1971.com

Here is one example:

Who cares about gold?

So why does all this matter? As currencies have become more fractionalized (less actual backing of collateral), it has made it easier for the government and Fed to “create” more money. The actual process is more complicated, but in simple terms, the percentage of backed dollars has become less and less relative to the number of stated dollars in the system. This is essentially exactly what the Romans did by reducing the quantity of silver in their coins. They were able to make more coins with less silver but pretended they were worth the same. Which worked, until it didn’t.

Ultimately, the Fed “creating” more money is one of the primary drivers of inflation. The “value” of certain goods, milk, a bike, house, doesn’t really change much over time. They still do the same things, the intrinsic value is similar. There are some technological advancements, but production costs for older technologies also generally decrease over time, so for the sake of simplicity, we can say this is a wash.

Inflation by definition is an increase in the price of consumer goods, primarily driven by the reduction in purchasing power of a currency. Hard assets such as precious metals, commodities, tangible assets, and real estate, don’t change in intrinsic value much. Therefore their value is generally closely linked to inflation.

Because inflation is the silent killer of your purchasing power, and essentially your wealth, it is important to be aware of how it works and what you can do about it. Historically gold, and other precious metals, have increased in value in relation to inflation rates.

In eras of higher inflation, gold and precious metals can provide a respectable investment return. Surprising to many, gold has actually outperformed the S&P 500 from the beginning of 1971 until today (April 2023). 5085% (Gold) vs 4380% (S&P 500) or in dollar terms $10,000 ➔ $508,500 (Gold) versus $438,000 (S&P 500) or a difference of $70,500.

So why don’t traditional investment allocators recommend gold? That is a good question. I believe the main reason is that gold doesn’t have a yield (doesn’t pay interest or dividends like stocks or bonds) and in more recent times, the last 10 years, has significantly underperformed the S&P 500. 

But times are a’changin’. Inflation rates are higher, interest rates are rising, this is a different environment from what has been the norm for the last 30 years. The last time inflation hit this high of a value was in 1981, 42 years ago. The last time interest rates were this high was in 2006, 17 years ago. But never before have we had this much debt: the current debt-to-GDP ratio is around 120%. 

Which means that if the US took the value of every single good and service that it produced for an entire year and used that to pay its debts, it wouldn't have enough to clear it (basically imagine working a whole year for no income purely to get out of debt and still having debt leftover).

The other primary investment thesis for gold is the flight to safety. In turbulent times, investors look for safety and because of gold’s long history and relatively stable value, it makes a good place to park some cash when markets are uneasy. When investors all flock to the same thing, buying pressure causes the value to increase thus making positive returns for those that got in early in that process. 

So how do I get some?

There are two main types of gold investments, physical and paper. Physical gold is pretty straight forward, it is owning an actual piece of gold. 

There are two primary places to find gold for sale. The first are online dealers like JM Bullion and APMEX. The second are local precious metals/coin collectible dealers. Dealers usually charge a premium over the spot price which is essentially their commission. Comparing different dealers can help to determine if you are paying a reasonable amount over spot. As this rate changes based on current market demand, it is hard to say what is a reasonable value.

Obviously there are some challenges that come with owning physical gold.

The primary concern with owning physical gold is storage. The simplest method is to just store it in your house. The problem with this is it could get lost, stolen, damaged in a fire, etc. The problem compounds as you obtain more of it. 

There are things you can do to help remedy this situation. 

1. Buy insurance

• Most homeowners or renters insurance has a limit on things like precious metals or collectibles so it is important to know how much coverage you actually have. More than likely you will be over this limit, at which point you can buy supplemental insurance specifically to cover your gold.

2. Store it in a gold vault

• There are companies that provide specific gold storage services. There are a lot of things to pay attention to with this option to make sure that you can get your gold if needed, what happens if the company goes bankrupt, how secure they are, etc.

3. Store it in a bank safety deposit box

• Most banks offer the ability to rent a safety deposit box which is basically just a form of secure storage at a bank. You can put most types of valuables or rare items you want in the box and nobody needs to know about it.

4. Use a Gold IRA account with an IRS approved depositor

• Gold IRA accounts offer the ability to work with a special gold depositor that handles gold storage. This is similar to option 2, just inside of an IRA account.

Because of the challenges that can come from storage, paper gold can be another way to get exposure to the shiny metal in an easier fashion. Paper gold is a general term for other types of assets that have exposure to the price of gold, but ultimately you just have an IOU or piece of paper saying you own it. 

1. Gold stocks

2. Gold miner stocks

3. Gold ETFs and Mutual Funds

4. Futures and Options

This isn’t much different than a lot of other investments, but because gold is often referred to as a safe haven and a means of transacting in the case of a defaulting currency, gold bugs (extreme gold investors) tend to scoff at the prospect of holding paper gold. That being said, there are many instances where these types of investments can make sense.

Purchasing gold company stocks, ETFs, mutual funds, futures, and options can all be done through a traditional brokerage account. You can also purchase these in a retirement account, whether that is a 401k, IRA, etc.

Bringing it all together

Whether it is physical or paper, having some gold or other precious metal exposure in your portfolio can be a good way to both hedge against inflation and provide diversification from other assets. 

Make sure to do your homework though as there are a lot of things to consider when making an investment. Knowing why you want to hold gold as well as your time horizon for your investment are key to picking the right vehicle.

Not sure what to do next? Schedule a free discovery meeting and we can talk about how gold could fit into your portfolio.