Jun 102015
 

Today we complete our 12 reasons not to own gold, which also draws to a close this little pros and cons exercise.  Read on for further issues to consider in advance of any gold and precious metals purchases.

7. Supply/Substitution

Nearly all the gold ever mined is still in existence today – this has been part of its attraction (durability) as a form of money throughout history – and it also makes it somewhat unique.  Although there are some industrial uses for gold it is, as a result of its value, normally economic to recycle this (it’s typically not consumed in said industrial processes) and this therefore means it continues to remain in the total pool of available metal. In the global gold marketplace, there is no real distinction between ‘new’ (first supply after mining and refining) and ‘old’ (recycled) gold, and these differing sources compete directly for the same pool of demand. The issue this presents is, if gold demand drops substantially enough, the market can become significantly oversupplied as a result of the level of secondary metal available. This can even lead to net purchasers becoming net sellers, thereby both reducing demand and increasing supply. Compare this to oil, wheat etc. that are consumed when used and therefore, assuming no substitution becomes available, there will always be a demand for more.  In essence, the demand for gold has in the past and could again go ‘negative’ with secondary supply exceeding demand.

8. Size of Market

Although the gold market is a reasonable size and relatively liquid, it pales in comparison to the size and liquidity of the equities, bonds or derivatives markets.  Arguably this could actually be considered a positive as well as a negative, however it is clear that a smaller market is more prone to large movements in price, and hence increased volatility.  Furthermore, the ‘other’ precious metal markets are actually significantly smaller in size than gold and can experience liquidity issues – one only needs to view the spread on platinum and palladium spot prices to see the issue this presents.  There have even been historical precedents of precious metals markets being ‘cornered’.

9. Popularity Shift

If you look at the developed Western part of the world, there is mostly a level of ambivalence towards precious metals for anything other than ornamentation and jewellery – there are notable exceptions such as Germany, but even there the general populace’s view of gold is still primarily as a means of decoration. In one of the prior blogs we identified the rise and increasing per capita wealth of China and India, with their cultural affinity for gold, as potentially being very positive for gold prices mid to long term.  This could also easily be expanded to include most of Asia and the Middle East – pretty much as soon as you head south and east of the Mediterranean, gold appreciation begins to rise.  However, what if increasing prosperity at an individual level (the main reason given for support of demand and subsequently prices) actually changed the perception and therefore demand of gold and precious metals within the populace of these various places?  What if the ‘Love Trade’ was somewhat weakened?  It is certainly a potential eventuality worth considering.

10. Government Confiscation

As the old saying goes ‘History may not repeat itself but it does rhyme’.  Although the idea of government confiscation may to some appear outlandish, we must at least acknowledge that this has happened in the past, with the US Executive Order 6102 potentially being the most notable example. Perhaps in this case “confiscate” is too harsh a term as private holders of gold did actually get recompensed for the gold they handed in. Crucially, however, compensation was paid at USD20.67 per oz and then the gold was immediately revalued to USD35.00 per oz – i.e. private holders were, to put it inelegantly, royally stiffed.  Many jurisdictions actually have statutes on the books which can be leveraged to confiscate private gold holdings, usually in cases of emergency.  Clearly what constitutes an emergency would be at the discretion of the authorities enforcing said statutes…

11. Rise of the challengers

The digital age has not only provided us with the convenience of mobile banking (and the inconvenience of social media…), it has also spawned various crypto currencies, the most well-known of which is Bitcoin.  Although it is my humble opinion that these crypto currencies exhibit many of the potential negatives of holding gold (volatility, no yield, popularity shift etc.) and little of the positives, there is no question that we live in a digital age and following generations may have more of an affinity with a digital rather than historical form of money. Crypto currencies do have some advantages including anonymity, direct merchant acceptance and ease of international transacting, which physical gold doesn’t necessarily share.  Is it a direct competitor?  I’d say not. But as an additional alternative to fiat currency, it may attract some of the money flows which would otherwise go to gold and precious metals.

12. Barbarous Relic

Many a gold bug scoffs at this statement; however it has been uttered by some influential thinkers and investors – John Maynard Keynes and Warren Buffet to name two. Whether we agree with them or not, these two people have had a profound impact on the current thinking around both monetary policy (Keynesian economic policy is pretty much the playbook all developed economies have in the back pocket) and investment psychology.  When the Oracle of Omaha speaks, people listen.  And when central bankers speak, a (albeit slightly twisted) version of Keynes can be heard.  Arguably these two people alone may have had quite an impact (likely not positive) on people’s attitude to, and appreciation for, gold and other precious metals. Has this already been priced in though?

Conclusion

We’ve now completed both the pros and cons of owning gold (and precious metals in general) which we hope you’ve found useful. Upon reflection it’s apparent that the cons identified really indicate that you shouldn’t put all of your wealth into gold (or precious metals in general) however the pros emphasise the value of having a portion of your portfolio devoted to these hard assets.

The way I personally view ownership of gold is as a pure savings and wealth preservation vehicle, with a little insurance thrown in, as opposed to as an ‘investment’ (investment in this case being an allocation of capital which is put at risk in the attempt to significantly grow overall wealth).

So in summation, the path isn’t completely golden (yes, bad pun intended – I formally apologise) when owning precious metals, and it is important that any prospective purchaser understands that…however the merits of allocating at least a portion of your portfolio in the direction of precious metals are certainly there.