Gold and other precious metals have been a point of fascination since the dawn of civilization. It could be argued that the extraction and exchange of precious metals went hand in hand with, and played an integral part in enabling the early development of civilization itself. Specialization and trade made possible through even the most rudimentary monetary systems frees up time and creates exceptional societal value and well-being. Before the advent of money and coinage, or in its absence, people seeking to trade or make any form of exchange were forced to endure the barter system.
The History Of Gold
In the barter system, you have no choice but to exchange one good for another, or for an assortment of goods. This gets quite tricky when the goods you have to trade are relatively valuable, but are not the goods the other side wants or is looking for. For example, say you are a dairy farmer and can offer milk or butter in exchange for the candles you need from the candle maker. He has no need for milk or butter, perhaps he is lactose intolerant, but knows he could trade the butter later for something he wants. However, the key problem with this is of course perishability. How long will this butter last before it is worthless? And what exactly is a fair-value ratio of butter-to-candles? As you can see, with even simple exchanges such as this, things can get quite complicated. The introduction of money and coinage revolutionized the exchange system. Throughout history many items have been used as money, such as unique sea shells, or even rocks with holes in them; but the most resilient and ubiquitous form of money was the precious-metal coin.
This formed the basis as to what made the gold coin or bar so successful across time. As a noble element resistant to oxidation, gold retains its qualities across time without tarnishing or corroding. This is representative of the value-store that it posed for any traders that would utilize such coinage. The candle-maker would could confidently sell the above candles for a set amount of precious-metal money (whether this be a gold, silver, copper, or some other metal coinage), and know that the coin itself will not deteriorate and lose value the way bartering for milk or butter would. He can then use this money at will to purchase any other goods without having to consider the unique needs of the other trader. He could also store his savings for an indefinite period of time to accumulate savings for the future or a large purchase.
Kingdoms, empires, and principalities alike would mint and standardize their own coinage all across the world, typically based on the type of precious metal used and the coin’s weight. This made transactions easier as local coins would be well known and largely interchangeable, and known foreign coins from abroad could be used outright (as their type and weight was well-known), or traded for local currency from “money-changers”. In fact, for much of civilization, even any notes or paper money has been based off some form of gold standard, meaning that money in circulation was backed by a fixed amount of gold or precious metal. The advent of concepts like fractional reserve banking, fiat currency, the petro-dollar, central bank monetary policy, interest rate movements, and now cryptocurrency have all moved society and economies away from the simple days of precious-metal based transactions; but the value inherent in gold and its cousins still remains.
This store of value across time is and has always been the fundamental characteristic of gold which has kept it a desirable and exchangeable good. A simple internet search for price history charts reveals that speculation in gold prices can be a volatile and potentially profitable, or loss-creating, endeavor. Zooming out on price history graphs reveals that at the very least gold tends to hold its value relative to the purchasing power of the global hard currencies. That is to say, gold prices tend to go up on average in line with inflation. And this should come as no surprise, as gold continues to play its role as simply a store of value.
The Limitations Of Gold
However, there is a flip side to all this. While storing value is quite useful; it is not the same as creating value. Sure, a commodity speculator can get lucky and buy-low-and-sell-high; but at the end of the day, a lump of gold will always be a just lump of gold. Of course it has some physical properties for use in machinery and electronics, or can be forged into jewelry to be sold at a higher price than the raw materials; but these increases in value are largely derived from the added value of the skilled labor to turn the gold into something else. The gold itself will never create anything. This is both its strength and its weakness.
So is gold a good investment? Some would argue that gold is not even an investment at all. The following thought experiment was recently posed in Warren Buffet’s annual letter to the shareholders in his company, Berkshire Hathaway: When considering gold as an investment, as with any investment it should be considered against what else could be bought with the same money. Take for example all the known gold in the world (sometimes the biggest numbers have unique way of simplifying things). If you were to assemble all the gold in the world, it would form a cube roughly the size of a baseball diamond. At 2012 prices (when Buffet made this analogy, and it is worth mentioning the price of gold has gone down since then), this would hypothetically be worth around 9.6 Trillion USD. So what else could you buy with 9.6 Trillion USD? For starters, you could buy the entirety of the United States farm land, 16 copies of Exxon Mobile, Apple computers, and still have roughly 200 Billion USD left over to buy other companies or investments. So which choice then is a better investment; the cube of gold or the basket of assets?
Fast forward 20 years. Behind door number 2 you will have enjoyed 20 years of crop yields from the farmland, and all the value that has created. You have enjoyed the profits of extracting and selling 20 years of oil from your 16 hypothetical copies of Exxon Mobile, as well as 20 years of profits and innovation from whatever Apple will have invented and sold over the course of the next two decades. This, in addition to whatever yield from the leftover 200 Billion that you were still able to go investment shopping with. In addition to the 20 years of crop yields and profits produced, you still also retain all the wealth of whatever the market value of those assets will have grown to be over time; which could be a considerable amount, or at the very least increased with inflation.
Now let’s check in on the giant cube of gold sitting in the vacant baseball field. It’s still sitting there and is as shiny as ever, and probably has gone up in market value with inflation, but it has produced nothing new in 20 years.
So which would you choose?
As with any investment decision, there is of course no one perfect solution. This is not to say gold or other precious metals do not have their place as forming one aspect of well balanced portfolio, which they do. Gold has a way of weathering economic storms exceptionally well, as when fear and doubt fills the hearts of the market, investors flock to the safety and security of hard assets. In this regard, a small portion of gold can help to prop up other parts of a portfolio during a down year, or be used to section off a portion of your assets with the aim of simply keeping pace with inflation over a medium term. In the end, real investment reward comes with risk, which comes through placing hope in the future,; in a company and the people within it, and what they are able to produce, innovate and create.
[ Sources ]
– The Role of Monetary Policy – Milton Friedman, The American Economic Review, Vol 58 No 1
– Exchange-Rate Regimes and International Trade: Evidence from the Classical Gold Standard Era – J. Ernesto López-Córdova, The American Economic Review, Vol. 93 No. 1
– A History of Ancient Coinage – Percy Gardner, Journal of Hellenic Studies, Vol 38 No 196