Chapter 2

Going for the Gold

IN THIS CHAPTER

check Understanding the consequences of gold’s history

check Investigating inflation and gold

check Finding data, info, and resources on the gold market

“Going for the gold” and “good as gold” and many other familiar phrases mentioning gold have been around for what seems like forever but for good reason. Few things conjure up thoughts of wealth and affluence the way gold does. No pirate in a B-movie shouts “Aargh! There’s aluminum buried on that island, mateys!” On the other hand — gold … now we’re talking. Few things have had the endurance of gold both as a metal and as a store of value. It is then the first precious metal to consider for wealth-builders today. It has through the ages become the quintessential precious metal.

Gold is an element that is found on the standard periodic table of the chemical elements. Gold is listed there with the symbol AU and the atomic number 79 (don’t worry, the quiz has been cancelled). The most malleable and ductile of the metals, you could actually take a single ounce of gold and essentially stretch it out into 300 square feet (no one knows why you would do it but it sounds impressive). Gold is a good conductor of heat and electricity (and probably thieves as well). Because it is generally resistant to rust and corrosion, gold quickly became an ideal material to fashion into jewelry, coins, and therefore … money! The desirability of gold now became ensured.

However, every major society is inflating its currency at record rates. All the major currencies are subsequently losing their value slowly but surely. Because paper currencies are easily inflated, each unit of currency (dollar, euro, yen, and so on) loses value — not so for gold. As a tangible investment, use this chapter to find out how gold stacks up amidst all the investment choices available today.

Gold: The Ancient Metal of Kings

Since the early days of civilization, gold achieved its status as a symbol of wealth, a unit of exchange, and the essence of money. As an object of desire, it had the qualities virtually everyone deemed as necessary to be called “money”: It was a rare element that was easily carried and exchanged, and was also a universal form of money that crossed nationalities and cultures. When nations traded goods and services, gold could have easily had the slogan “Don’t leave home without it.” For centuries gold had a place of honour in society — even after paper currencies came on the scene.

Paper currencies (also called fiat currencies) started coming into usage in the days of Mesopotamia when the drachma was used. Paper currencies didn’t have any intrinsic value like gold; it was more or less a claim to intrinsic value. In other words, a paper currency had value because it had a claim of value from another asset such as grain or precious metals. So, paper currency was really an IOU. Paper currency gained popularity because it was easier to carry and transact with versus carrying bags of coins.

Many ancient societies used paper currencies as an IOU, attaching precious metals held at a bank or secure storage facility as the backing asset. So, the paper currency had value as long as you could redeem the currency in precious metals such as gold. During the course of history, paper currency soon decoupled from gold and became a competitor instead. First kings and then governments saw that paper currencies were a better alternative to gold … or so they thought.

They discovered that paper currencies issued by the government had certain advantages over gold — the main advantage was that paper currencies could be printed at will while gold was not easily produced. The supply of gold throughout history only grew at about 2 per cent per year. On the other hand, paper currencies could be produced very easily and very quickly. Although this may have been the advantage of currency, this was also currency’s fatal flaw.

Remember During the past 3,000 years, there have been literally thousands of different paper currencies that came into existence and ultimately ended up vanquished. When governments can create money by printing up endless supplies of paper currencies, then the temptation to inflate becomes too great. If you can create money at will, why not? This would fill up the government’s treasury early on, but as more money is created, its value diminishes and it becomes worth less and less until it’s … well, worthless. Paper currencies end up with the intrinsic value of nothing, but in the long run, gold is still gold. Gold endures. Aargh, mateys!

As the Great Depression unfolded during the 1930s, most of the major industrialized nations abandoned the gold standard in an attempt to stabilize their economies. This unfortunately opened up a long-term problem as inflating their currencies became a way of life. The subsequent result is something that everyone is paying now … much higher prices.

Reviewing Recent Trends in Gold

Gold has a track record dating back thousands of years, but fast-forward to recent times. In the late 1970s, gold experienced a 20-year bear market, and then the bull market started in the 21st century. The late ’70s was a time of inflation, energy problems, international conflict, and economic hardship. Hmmm … does that sound familiar? The conditions in the ’70s definitely have a lot in common with the first decade of the 21st century. From 2000 to mid-2007, though, gold began a bullish, upward slope. Examining gold’s history and trends impacts how you decide to invest, so take a close look at the sections that follow to get an idea of gold’s history as well as its promising future.

Explaining all the bull

So after a 20-year bear market, gold awakened at the start of the millennium. Gold (along with other natural resources) was in the early stages of a bull market in the early part of the 2000s. Several reasons explain gold’s historic bull market:

  • China and India: These two countries alone will have an economic impact that will reverberate across the globe. Virtually every major economy and financial market will be affected, directly or indirectly. As they modernize their economies and as their collective 2.5 billion occupants increase their consumer spending, this will require much in the way of natural resources.

    More specifically to the topic of gold, both of these countries have a long history of being very gold friendly. India is a huge consumer market for gold. China is loosening its formerly strict regulations and allowing its ample citizenry the ability to own gold and build wealth in a freer economy. All of this adds up to great news for gold aficionados. Whew … 2 billion people with money who like gold! Can you say “soaring demand”?

  • The Middle East: In spite of all the conflict and turmoil, this area has great potential. Although these countries wield economic and political clout that offers great challenges, this area is yet another gold-friendly region. Many in the region are using their oil profits to buy precious metals. This means more demand.
  • Inflation everywhere: Perhaps the most compelling bullish reason is that every major country in the world is growing its money supply at historically high levels; most of them are growing their money supply at double-digit rates making this an unprecedented inflationary environment. This means more dollars chasing fewer goods.

Telling the tale of the tape: Gold versus other investments

Gold has retained its value through good times and bad, but make no mistake about it: It has an edge over other investments during difficult or uncertain economic times. In the 1930s, gold was resilient during the Great Depression; stock prices plummeted yet gold was strong. Gold did drop in price during the 1930s but not because of market supply-and-demand factors; the U.S. government banned private ownership of gold so people were essentially forced to sell it.

So you’re better off comparing gold with other investments starting with the 1970s and moving onward. As of December 1974, gold ownership became legal for private citizens in the United States. Just in time! Table 2-1 is a snapshot of gold compared to other investments and inflation in the first decade of the millennium, when it started its upward swing. Note: Prices are in U.S. dollars.

TABLE 2-1 Comparing Gold to Other Investments and Inflation

Asset

Time Frame

Quote 1/2/00

Quote 6/3/07

Initial Investment Amount

Ending Investment Amount

Annualized Rate

Total Return for 6½ Times

Did It Beat Inflation?

Gold

6½ years

282.05

650.50

$10,000

$23,063

12.90%

131.00%

Yes

Inflation*

6½ years

See rates

n/a

$14,755 (amount you need to retain purchasing power from initial investment)

6.00% + (using the real rate of inflation)

45.00%

n/a

Bonds

6½ years

n/a

n/a

$10,000

$13,250

5.00%

38.00%

No

Stocks (based on Dow Jones Industrial Average)

6½ years

n/a

n/a

$10,000

$11,806

2.78%

18.00%

No

Passbook account

6½ years

n/a

n/a

$10,000

$11,023

1.50%

9.75%

No

* Inflation isn’t an asset, of course, but it’s important to compare.

Remember Gold shines brightest during periods of inflation (especially hyper-inflation). In a period of stagflation, such as in the 1970s, hard assets (precious metals, real estate, natural resources, and so on) tend to do better than paper assets (such as stocks and bonds).

Table 2-1 is very telling. Certainly, a year here and a month there show that gold performed poorly. But then, you’re not investing; you’re trading or speculating. The table clearly shows that during the specific period analyzed, some common paper investments just couldn’t keep pace with inflation. Notice the column for inflation illustrates that you would need to have at least $14,755 in 2007 just to match the same purchasing power of $10,000 in 2000. Gold resoundingly beat inflation while paper investments fell short.

Technical stuff By the way, Table 2-1 might make you ask about gold-mining stocks and how they fared during this period. A good barometer of the gold mining industry would be an index called the NYSE Arca Gold BUGS Index (HUI). BUGS stands for “Basket of Unhedged Gold Stocks.” The HUI is an index representing a batch of stocks that are gold-mining stocks that do little or no hedging. Basically, hedging is the practice of selling next year’s production at this year’s prices to lock in a profit. This practice is fine if gold’s price is flat or declining. But if gold is rising, then the company foregoes the potential profit. Done too excessively in the wrong market conditions could spell bankruptcy for the company. Hedging isn’t a good practice in a rising gold bull market.

Anyway, back to the HUI. How did it perform during the time frame as compared to the other investments in the table? At the beginning of the decade, the HUI started at 73.77 (1/3/00), and it ended the day of trading on June 30, 2007, at 329.35 for a total percentage gain of 346 per cent. In other words, a $10,000 investment in a representative portfolio of gold-mining stocks that made up the HUI index at the beginning of the decade would have been worth $44,645. Sweet! Yes … gold mining stocks are “paper” investments, but fortunately they derive their value from a desirable underlying asset … gold.

Assuring gold’s success

Remember Gold is a tangible investment that has its own intrinsic value. It sounds weird, but this concept is important when you compare it to “paper” investments. All paper investments are basically “derivatives,” meaning they derive their value from another entity or from a promise from another party. Think about paper investments, and you see that they’re essentially a promise that needs to be fulfilled. Paper investments have major risk associated with them: the risk of default by the other party. This is also referred to as counterparty risk. Look at the panorama of paper investments:

  • The dollar and other currencies: When you hold a dollar in your hand, what are you holding? The dollar is a piece of paper with official printing on it. It has no intrinsic value; it is a promise of value backed up by the full faith and credit of the government. However, if the government (any government for that matter) prints up lots and lots of dollars (monetary inflation), the risk is that each dollar becomes diminished in value.
  • Stock: Stock, common or otherwise, represents a piece of ownership in a public company. If the company is in business and doing well, the stock for that company will have value. But what happens if the company goes bankrupt? In that case, what will be the value of that stock beyond just being a printed piece of paper? Therefore, stock also has the risk of default. (Flip to Book 2 for more about stocks.)
  • Bonds: A bond is a form of debt (as you find out in Chapter 5 of Book 3). If you have a bond investment, it is a piece of paper that states that another party will pay you interest and ultimately pay you back the sum of money (the principal) that was loaned. In the bond investment, you are the lender and the person obligated to pay you back is the borrower. What happens if the borrower can’t (or won’t) pay you back? You could lose some or all of your money in a bond. Because bonds are a paper investment, they have the risk of default.
  • Mortgages and loans: In this century, markets across the globe have been in turmoil because of problems with sub-prime mortgages. A sub-prime mortgage is where money was loaned for the purpose of buying real estate (typically a home) to individuals who have below-average credit. The point is that mortgages and loans, like bonds, are paper investments that have … you guessed it … the risk of default. All situations of extending credit — whether it is a bond from a corporation, a government agency, or some cash you loaned to your Uncle Stanley — run the risk of default.

Securing a Safe Haven from the Coming Storm

Understanding the value of gold is like understanding an umbrella without discussing rain. People quickly see the value of an umbrella when it rains. They also understand the value of buying an umbrella on a sunny day, especially when rain is forecast for the next day. To understand gold (as the umbrella), you should understand its role in bad economic conditions (the rain).

Comparing monetary and price inflation

As more and more people wise up to inflation, ultimately they will do something about it. Although inflation has been high in recent years and has the potential to go higher, much of the public hasn’t caught on. You can’t blame them; the responsibility for informing the public rests squarely on the shoulders of the government and the financial media. The reporting of inflation is in fact dreadful. You should understand inflation not only because of how it helps gold go up, but you should also understand it because it is a pernicious and pervasive problem. The following sections should help you sort through and gain an understanding of inflation.

There are two types of inflation. One is a “problem” while the other is a “symptom.” The “problem” is monetary inflation. That is just a fancy phrase for the government’s central bank practice of printing money (actually, printing currency). The more a government prints, the more the supply of money could grow. After the money is created, it’s circulated through member banks. This money makes its way into the economy through actually printed currency (such as the dollar), electronic transfer, or through loans (credit). This is the problem.

The end result of the problem of monetary inflation is the next phenomenon, price inflation. Price inflation is the one everyone talks about. That’s when your uncle goes to the store and says to the sales clerk, “You’re charging how much for this?!” Price inflation can be a problem for everyone, but in the big picture, price inflation actually is the “symptom.”

Tip You can find out more about inflation in Canada via the Bank of Canada (www.bankofcanada.ca/core-functions/monetary-policy/inflation/) and Statistics Canada (www.statcan.gc.ca/eng/subjects-start/prices_and_price_indexes/consumer_price_indexes).

Watching the dollar

The dollar is the “other side of the coin” so to speak. When people refer to “rising inflation,” they’re really referring to the falling value of the dollar (or other currency). If, for example, you look at the long-term chart of gold versus the U.S. dollar, you will see the dollar zig-zagging downward and gold zig-zagging upward. It stands to reason that the more and more dollars you add to the system, the less each unit is worth.

Tip To monitor the price of trading currencies, you can go to major financial websites, such as BNN Bloomberg (www.bnnbloomberg.ca/). Futures markets-related websites also track currencies, so you can check out places such as FXStreet (https://www.fxstreet.com/) and Yahoo! Finance (https://ca.finance.yahoo.com/).

Buying and owning gold

So maybe you have thrown in the towel screaming, “Okay, okay! Stop it, you win! I see the light! I’ll buy some gold (and aspirin)! How do I do it?” Thanks for asking.

The following list shows you the many ways that you can get involved with gold:

  • You can buy physical gold:
    • Bullion coins: Gold as coins
    • Bars and ingots: Another form of physical gold
    • Numismatic coins: Gold through collectible coins
    • Jewelry and other forms (such as collectibles): Make sure that your spouse doesn’t see this. Where’s that aspirin?
  • You can buy paper gold:
    • Gold certificates
    • Gold exchange-traded funds
    • Gold mutual funds
    • Gold-mining stocks
    • Gold futures
    • Gold futures options
    • Gold indexes
    • Gold managed accounts

Checking Out the Gold Market

Gold is a worldwide market and the long-term supply-and-demand fundamentals are very bullish. The following sections give you some insights into the gold market.

Gold market data and information

The more you know about what is happening in the gold market, the better prepared you will be to profit. The following organizations provide extensive research and data on the yellow metal:

  • GFMS (formally Gold Fields Mineral Services): GFMS does specialized research on the world’s precious metals market, specifically gold, silver, platinum, and palladium. Find out more about GFMS at www.refinitiv.com/en/products/eikon-trading-software/gfms-precious-metals.
  • CPM Group: CPM is another leading consulting firm that specializes in commodities and precious metals research. They provide extensive research on the precious metals markets and publish their work in several annual yearbooks: The Gold Yearbook, The Silver Yearbook, and The Platinum Group Metals Yearbook. The CPM Group was founded in 1986 by Jeffrey Christian, a metals analyst and the author of the book Commodities Rising. Its website is www.cpmgroup.com.
  • Gold Anti-Trust Action Committee (GATA): The Gold Anti-Trust Action Committee was formed in January 1999 by well-known gold analyst Bill Murphy. GATA advocates and undertakes litigation against illegal collusion between financial institutions (such as central banks and large brokerage firms) that intervene in the gold market. GATA’s aim is to foster a freer market for gold since the central banks and brokerage firms have on an ongoing basis managed to control the price and supply of gold and related financial securities. GATA’s website is www.gata.org.
  • World Gold Council (WGC): The World Gold Council was created by gold mining companies and refiners in 1987. Its mission is the promotion of investment and usage of gold by consumers, investors, industry, and central banks. The WGC’s website is www.gold.org.
  • Mining Association of Canada (MAC): The MAC is the national voice of the Canadian mining industry in Ottawa. Visit its website at https://mining.ca/.
  • National Mining Association (NMA): The NMA is the voice of the American mining industry in Washington, D.C. and the only national trade organization that represents the interests of mining before Congress, the administration, federal agencies, the judiciary, and the media (www.nma.org).

Industrial supply and demand

The major determinants for gold’s performance (its price going up or down) boil down to inflation and supply-and-demand factors.

Total demand and supply

Time for the big picture first. In 2010, total annual worldwide demand was about 4,200 tons (according to www.gold.org/goldhub/data/gold-supply-and-demand-statistics), and the total annual worldwide supply was a little over 4,300 tons. In 2019, total annual worldwide demand was between 4,300 and 4,400 tons, and the total annual worldwide supply was about 4,820 tons.

No matter which way you slice it, the big picture in the long term is that supply-and-demand factors for gold are bullish.

Demand

Demand for gold comes from two places: investment and industry. Gold has unique properties which mean more applications of it in technology, healthcare, and other vital industries. Gold is extremely resistant to corrosion and it has high thermal and electrical conductivity. Therefore, it is an excellent component in electrical devices. Gold is also used in medical equipment because it is resistant to bacteria. New uses for gold have been found in pollution control equipment and fuel cells. In addition, gold has promising application in the new area of nanotechnology. The practical uses for gold keep growing.

Tip For current news on the many new ways gold is being used in industry and medicine, check out gold’s growing uses at www.gold.org/goldhub/research/relevance-of-gold-as-a-strategic-asset-2020.

Supply

Gold is mined on all the major continents. Specifically, it has been most plentiful in places such as South Africa, Canada, the United States, Russia, and Australia. (There is no mining in Antarctica but then again, why would you want to?)

For thousands of years, gold was (and is) considered money. It has outlived thousands of currencies, and in due course, it will outlive more currencies. Part of the reason for its durability as a desirable form of money is directly tied to its rarity. You can create lots of paper currencies almost instantly, but you can only increase gold by a mere 2 per cent per year. It is easy to inflate man-made currencies and history tells you this has happened very, very often. It is happening today! But … it’s not easy to inflate gold.

Although new mines do come on board every year, it doesn’t have a significant impact on total worldwide supply since old mines do close down after no more gold is found. In addition, it often takes mines 5 to 10 years (sometimes longer) to go from discovery to production. Although increased market prices for gold are indeed an incentive for more gold exploration, it doesn’t happen quickly. It does take years to translate higher market prices into new gold mine discovery and production.

When the price of gold does go up significantly, gold “scrap” does find its way into the marketplace. Scrap is basically recycled gold. As the price of gold goes up, it becomes more economical to recover scrap to refine it and reuse it.

Investment demand

Since the beginning of the new millennium and obviously due to gold’s bull market, investment demand has grown tremendously. Actually, according to market studies by the CPM Group, a very unusual situation rose during 2006–07. In that time, private investors (as a collective group) owned more gold than the group of central bankers. The first time in world history!

Much of the new investment demand comes from two sources: the popularity of precious metals-related exchange-traded funds (ETFs) and from international investors such as from China, India, and the Middle East. More and more investors are seeing the big picture, and they understand that gold has unique advantages and is a good part of a well-balanced portfolio.

Central banks

Central banks play a pivotal role in the gold market and sometimes that role can be a controversial one. It stems from the “love/hate relationship” that central banks have with gold (maybe they need therapy). On the one hand, central banks are the single largest holders of gold in the world. Most governments have gold as an asset in their official reserves. Yet, on the other hand, gold is a “competitor” to the currency that is issued by the central bank on behalf of its government.

You’ll notice that whenever gold is rallying, one or more of the central banks will either announce a large sale of gold or actually sell a large amount of it. And they have a considerable amount of the yellow metal; it is estimated that central banks along with other governmental institutions (such as the International Monetary Fund) held roughly 17 per cent of the world’s above-ground stock of gold at the end of 2019 (see www.gold.org/about-gold/gold-supply/gold-mining/how-much-gold). This stockpile is nearly 34,000 tons (that’s tons, not ounces) of gold.

Keep in mind that not all central banks work in unison. Some are buying gold while others are selling. Although the central banks have much autonomy about how to manage their individual gold reserves, most of the major central banks have agreed to do their buying and selling according to guidelines stipulated in agreements such as the 2014 Central Bank Gold Agreement (CBGA; see www.gold.org/what-we-do/official-institutions/central-bank-gold-agreements). Some interesting developments have occurred in recent years.

Central banks in “the West” such as the U.S. Federal Reserve and central banks in Western European governments (such as the United Kingdom, France, Spain, and others) have been net sellers of gold. Meanwhile, central banks in the East (both middle and far) have been net buyers of gold. This tends to generally reflect attitudes about gold in both spheres. Folks in Asia and peripheral regions as groups embrace gold far more than those in North America and Europe. As a total group, it has been a net seller which was a contributing factor to some of those steep corrections that have been experienced by precious metals investors in recent years.

Central banks don’t have to just buy and sell their gold to influence the market. They are also involved in activities such as gold derivatives and in leasing gold. For a discussion, see https://www.gold.org/goldhub/research/gold-investor/central-banks-return-to-gold.

Tip Central banks report their gold position and activities to the International Monetary Fund (IMF) and you can view some of this information at the website at www.imf.org.

Meeting a Few Gold Bugs

The term “gold bugs” has sometimes been used as a pejorative but many veteran gold analysts and well-known commentators have come to wear the name like a badge of honour. The following is really like a “hall of fame” for the world of gold since some of these stalwarts (actually most of them) were successful and active back in the late 1970s.

What these folks have in common goes beyond an affinity for gold investing. Through the years they have offered research and insights that benefited the gold-investing community for decades. Some of their forecasts became legendary. Yes, they have had their misses, but in the investment world, when you have far more hits than misses and keep doing it for years and even decades, this is something you can’t ignore.

To me (coauthor Paul), another reason for checking them out is that I like to know that you just don’t talk the talk; you need to also walk the walk. If I know that the person involved made a lot of money on his or her own advice, that goes much further than people who tell you to invest in X and then you find out that they made most of their money by selling reports and newsletters about “How to invest in X.” In other words, these folks are primarily self-made in their financial independence due to the adherence and application of their own knowledge.

Tip Drum roll please! Here is a pantheon of gold bugs worthy of the name:

Digging into Other Gold Investing Resources

The gold market can be a fascinating one and if your money is riding on it then it better be a well-researched one as well. Here are some solid websites for gold investors:

Staying informed about the gold price and getting the latest news: