As Good As Gold

Gold has been on an absolute tear this year. Closing slightly lower Friday, the yellow metal is up 61.65% since the beginning of the year. Since August 19, gold is up over 28%. And just this week, it rose a healthy 5.6%.

These are huge moves for what is generally a fairly stable asset and store of value. So who is doing all the buying, and why?

At the dawn of the 20th century, famed banker JP Morgan asked a young apprentice, "Is it demand that creates rising prices? Or is it rising prices that creates demand?"

As an asset moves through its cycle of being cheap, to fairly priced, to overpriced, the answer to both of Morgan's questions is yes.

Early in the cycle, fear of buying is high. What if it goes lower? What if it doesn't move and I sit on dead money? Per Warren Buffett, this is probably the time you should buy. Or as Buffett stated, "Be greedy when others are fearful." During this period, the only thing that makes the price rise is demand. If enough demand exists to keep the supply limited, the price of the asset will increase, and demand will have caused rising prices.

As word gets out that the price of the asset is increasing, a shift in the reason for buying picks up steam. Momentum players enter the game because the price is rising. Their motto, "The trend is your friend."

At the end of a cycle, there is a "blow off" top, where everyone is buying and calling for the price to hit the moon. The price is rising so fast, people are afraid to miss out on the gain. Only buyers exist.

Is gold in a blow off top here? Is what we see panic buying?

As it turns out, it is not Costco shoppers (Costco now sells 1oz gold bars - 1 oz Gold Bar PAMP Suisse Lady Fortuna Veriscan (New In Assay) | Costco), and nor is it your panicky neighbors stocking up on gold. Those sources of demand do not make up for the amount of buying we see.

Instead, it is record gold buying on the part of central banks around the world, and central banks don't "panic" (Central Banks Accelerate Gold Buying Amid Global Uncertainty).

Now I do find it ironic that central banks tell you and I not to buy gold, declaring it a worthless relic of the past, while at the same time they are accumulating and hoarding the metal like never before.

There is only one reason central banks buy gold, and that is to ensure their currency can be backed by something real should the currency suddenly weaken.

The one currency everyone is most concerned about weakening...... The U.S. Dollar!

With $37 TRILLION of government debt, there are legitimate concerns that the deficit, inclusive of interest on the debt, will continue growing exponentially. That deficit is funded with loans printed from thin air by the Federal Reserve. And if they continue to print that much money, a weaker dollar and the resulting inflation is a sure thing.

If the dollar is losing value, do you want to be hanging on to dollars, and U.S. Treasury bonds, saving them? Or do you want to be in gold, retaining value? I think we all know the answer to this, and this is what we see the central banks doing. They are anticipating a deterioration in the value of the U.S. Dollar, selling their Treasury bonds and instead buying gold.

Causes for the dollar deterioration vary from geopolitical uncertainty, to trade deficits, to markets that appear "richly valued". In fact, all of the above may be a factor. Regardless of the cause, central banks around the world are collectively calling into question the value of the U.S. Dollar.

So where do I see gold going from here? The truth is gold hasn't changed in value at all. The only thing that has changed is its price in dollars. If the dollar falls in value, it takes more of them to buy the same thing, meaning the dollar price of that item increases. But that doesn't mean the item is worth more, when compared to all other things besides dollars.

Over the coming years, I definitely see gold's dollar price continuing to increase, and at a gradually increasing pace. If history is any guide, the U.S. Dollar will ultimately fail. Throughout the history of 30,000 fiat currencies (those not backed by gold), the average lifespan was only 30 years. The U.S. Dollar is now in its 54th year of being a fiat currency. Prior to August 15, 1971, the dollar was backed by gold.

In the short run, I speculate we are nearing a top, but it could still have one more blow off frenzy higher. At some point, a rush of sellers is going to come out of the woodwork looking to capitalize on the increased price and lock in those gains. Market "corrections" as they are called take the extreme excesses out of the market before it begins a new uptrend.

While I do own gold, it does not make up a significant portion of my net worth. Holding 5% or even 10% of one's assets in gold is reasonable. Currencies can and sometimes do collapse, and when that happens, gold and silver typically become money. While there is an increased risk of a dollar collapse, violent declines are highly unlikely, while a continued slow deterioration is a nearly certain thing.

When we think about it, gold produces nothing, pays no dividend, and does not really increase in value relative to other things. It is a "store of value", but not a wealth builder.

Instead of gold, I would rather own shares in a company producing a product for a profit. With a solid company, the shares will increase in value like gold when the dollar drops, and at the same time the company throws off a dividend. Better yet if the dividend is increasing yearly and the company is growing.

But I have to admit it is fun holding several bars of gold in your own hands, especially if it's yours!

One of the best videos about gold and money I think ever produced is the "Hidden Secrets of Money" series by Mike Maloney. Mike does an excellent job in teaching his listeners about money, what it really is, and what is happening in our economic system today. Each video of the 10-video series is packed with useful information presented in layman's terms, and you will never see money the same again after listening to him. Watch them in order, but videos 4 through 7 are important. Here is a link to the first video of the series: Money vs Currency - Hidden Secrets Of Money Episode 1 - Mike Maloney