Gold

I addressed a recent conference on Asset Allocation organised by Terrapin.  I drew attention to the fact that over the last ten years gold has risen from $265 to $1,385 (as I write) and has been one of the best possible investments.  This spectacular rise has been achieved in spite of persistent adverse press comment from newspapers of the undoubted calibre of the Financial Times and respected weekly investment magazines like The Economist.

The most frequent criticism is that gold has no instrinsic value.  The dictionary definition of instrinsic is ‘belonging naturally’ or ‘essential’.  It is clear that gold is not essential but neither are many other very attractive investments.

I remember in the mid 1960s when I purchased 50 paintings by L S Lowry for £50,000 from his ex-chauffeur.  At times Lowry had been hard up for cash and had paid his chauffeur with his paintings.  About a month after the purchase I sold the 50 paintings to a leading gallery for £100,000.  I was very pleased with the deal – bear in mind that you would need to add another zero to both figures to convert them to today’s money.

I did not like Lowry paintings then and I do not like them today.  Since I sold the paintings they have appreciated in value about 100 times so it is very clear that many other people do admire his work and are prepared to pay handsomely for it.

Not everyone has to agree on the value of alternative investments provided that there is a growing band of supporters to make a market.  It is indisputable that during the last 50 years Lowry paintings have been an excellent investment and it is also indisputable that they are very far removed from being essential.

There are many other similar assets that have been fantastic investments and are also inessential.  Bronzes, sculptures, diamonds and other precious stones and memorabilia come to mind.

An important feature of gold is that it is not only what it is but what it is not.  Gold is not the depreciating US dollar and dangerous Greek debt and it is not cash in one of the many doubtful and depreciating currencies.  Gold is an alternative currency and is well suited for this purpose as it has seven key characteristics – divisibility, indestructibility, stability, homogeneity, cognizability, utility and portability.  (I remember these by the mnemonic DISH and CUP from the days when I was studying Economics!)

Gold is also in relatively short supply.  All of the gold ever mined would fit into two Olympic-sized swimming pools.  There are very few easy high-grade mines left to produce gold and it is staggering to think that a low-grade deposit might be viable with a grade as low as 0.6 grammes per tonne.  Bear in mind that a gramme is just over 1/28th of an ounce and that to bring a mine into production might require a capital cost of $500m.  This makes it clear why gold is such an expensive, rare and precious metal.

John Kaiser, the producer of the excellent Kaiser Bottom-Fish Report newsletter explained the special nature of gold in a recent interview on Mineweb.  He said: 

‘I regard gold as a special asset class, whose specialness is derived from the fact that gold is very rare, hard to bring above ground and generally useless due to its high cost, unlike silver, which is more abundant than cheap and gets fabricated into all sorts of industrial applications.  Gold would be a wonderful conductor for electronics, too, but it’s just too expensive.  We have just over five billion ounces scattered around the world in safes, vaults and jewellery boxes not doing much at all.

Because gold has limited utility, its price is irrelevant to ongoing economic activity.  As a comparison, if oil shoots to $500 a barrel that means that your paycheck would allow you to drive just one-fifth the distance it allows you to drive now.  Such a move in oil would have drastic implications for the global economy.  But if gold shoots to $5,000 an ounce, what happens?  Well, the gold stays in my teeth.  Jewellery demand goes down even more, but nobody makes any decisions to substitute out of gold because it really isn’t being used for much.  In other words, it really should not affect the economy.

People buy gold because it’s a very exchangeable asset class and one that can’t be forged, counterfeited or multiplied like paper of digital assets.  Gold is an asset you want to own because the world is changing in terms of its geopolitical and economic centre of gravity; it’s moving from West to East and that shift will be turbulent.  The East, to some degree, is still communist.  We really do not know how financial and other assets and currencies will play out over the next 20 years.’

In sharp contrast to the rarity of gold, the supply of the US dollars in which gold is priced is rising rapidly as more and more are printed by the Fed.  This week’s QE2 is quite likely to be followed by QE3 and QE4.

Gold has been a currency for over 2,500 years and has a unique place in the human psyche.  Gold is the hallmark of excellence with, for example, gold medals in the Olympics being the ultimate prize in world sport.

Some investors worry about how gold would act in a depression.  The point they are overlooking is that gold is at its best in times of fiscal uncertainty.  It is also helped by today’s very low interest rates which keep the carrying cost low.

There are many critics of the idea of investing in gold but to my mind they are outweighed by the very high calibre of gold’s supporters including, for example, John Paulsen, who was one of the very few investors to forsee the credit cruch and made a multi-billion dollar profit out of it.  Also the Chinese, who know a thing or two, are encouraging their population to buy gold and India has added to its gold reserves during the last twelve months.

It may surprise you to know that I do not own any gold myself and I am not a constant gold bug.  However, I believe that gold is in a strong upward trend and now is its time.  To take advantage of this powerful market move I prefer to invest in junior mining stocks, which satisfy my demanding criteria.  They have been performing well, but, in my view, they still have a long way to go.  As Richard Russell of Dow Theory Letters is fond of saying ‘there is no fever like gold fever!’

Jim Slater