The market has been acting a bit strangely the past week or so. There's been a lot of speculation taking place, both to the upside and to the downside. Stocks are running way past their normal moves and falling much farther than would be expected. Are the Main Street stock speculators getting a bit itchy? Perhaps, but the trend of the market is still up, including the topicof this article: Gold.
If you have some time on your hands and you'd like to look back into the history of gold, you'd see some correlations with its long-term rise and fall. One that might stand out is the inverse correlation between its price and our government printing money. Since the printing of money has a direct correlation with the price of gold, let's start there.
The US dollar as we know it has been around for about 32 years. Yes, we were using the dollar long before that, but 32 years ago is when our government decided to take the dollar off the gold standard. That standardguaranteed that all dollars in circulation were backed by America'sbullion reserves at Fort Knox, Tennessee. But that's no longer the case, and you can thank President Nixon and the Vietnam War for the detachment.
You see, we (America) needed money to pay for the Vietnam War, and we couldn't get enough if our dollar remained on the gold standard. So Nixon unpegged the dollar from gold and turned on the printing presses (which led to inflation, but that's a story for another time).
Today the US dollar is "fiat" money. Fiat money is basically any currency printed by a government as legal tender that is not redeemable for gold or other commodities and lacks economic value except that which the printing government gives it. So basically, fiat money is worth what others are willing to pay for it. The problem with fiat money is that governments can print as much as they want, when they want, without asking anyone. This is not a good scenario for investors, but it can be mitigated if investors have gold as part of their portfolio.
Flashback to 1970: The US was in the middle of a very unpopular war on the other side of the world. It was in a small foreign land few people had heard of. The enemy was invisible. And our country didn't really have the money to pay for it. Fast forward 32 years: We are fighting a war on the other side of the world, in a foreign land few people had heard of, against people we can't see-and it's really expensive.
What happens when our government needs money to pay for what it can't afford? Does it have to dig up the money? No. Does it have to stop spending? No. All our government has to do is turn on a printing press, which is certainly less costly than spending $270 to mine an ounce of gold. All they have to do is move a decimal point on a computer in some building; they don't even have to print more money, though they indeed do that as well.
Printing money is such a big part of how our government works that at the end of 2002 (October), Ben S. Bernanke, a member of the Board of Governors of the Federal Reserve System, made a statement in response to a question about deflation. The question was about what the Fed was going to do to counter deflation, if and when it starts (I believe it has started already, but that too is another article). Bernanke's comment was, "We have an invention called the printing press, and if need be, we'll turn it on." In other words, the money sitting in your money market account is going to be worth a whole lot less after the US gets through printing a whole lot more dollars. Bernanke's comment set off a pretty big chain of events. In a very short time, gold shot up $65 an ounce and the US dollar index lost 7%.
Printing money whenever the Fed decides it needs to brings up a question: "How much has the value of the dollar fallen over time?" I'm glad you asked. A dollar in 1900 was worth a dollar. That same dollar today is worth 7 cents (Department of Labor Statistics). And do you know why the dollar is worth 14 times less today? Because the US government hasn't taken any lessons from the diamond industry; instead, it just kept increasing the money supply, so much so, that in 1900 there was $34 of cash in circulation per capita, compared with $2,075 of cash in circulation per capita today, an increase of 61 times. That should make you fall off your chair. The government cranked out 60 times more dollars over 100 years; and yet, the dollar has only fallen 14 times during that century. Not bad. Still, that should make you sit up and ask, "How can I preserve my hard-earned money?" Now we're talking.
How about putting part of your money in gold?In 1900, it cost $19 an ounce. Today (April 2003), an ounce costs $360. The price from 1900 has increased by a factor of 18. As I said before, during the same period, the value of the dollar dropped by a factor of 14. Are you following me? The value of gold increasedby a factor of 18, while the value of the dollar decreasedby a factor of 14.
Which one of these holds its true value? Gold. Obviously. In 1900, an ouncebought a man a nice suit, and in 2003 an ounce can still buy a man a nice suit. Gold holds its value, especially when we go to war and print money to pay for it. It holds its value because the US Fed (or any other government) can't "print" more of it. Plus, gold is not someone else's liability. You are not buying someone else's government debt, which means that governments can't mismanage it. It cannot be inflated away. God did a good job with gold. If there were no other reason to buy, that would be enough, but there's more.
Gold coins leave no paper trail. Gold can easily travel over borders, it can be stored easily, and it has the same value in downtown San Francisco as it does in downtown Istanbul. It is the world's only inflation-proof currency, and everyone accepts it. The only other inflation-proof commodity I know of is diamonds.
Let's take a look at the two easiest ways to buy gold:
1 - Gold mining stocks
2 - Gold mutual funds
Gold mining stocks are a great place to start. I suggest you look at the bluest of the blue chips of gold mining stocks. If you own zero gold, this is where to begin. It should be a company that doesn't hedge itsmining production ("hedge" means it doesn't sell future mined gold for a set price, it sells it for whatever the market says it's worth at the time of production). Any company that does not hedge itsproduction will experience a rising stock price when gold itself rises. If you don't want to buy an individual stock, you can go to an independent mutual fund ranking company and investigate gold sector mutual funds.
Lessons:
1 - Gold holds its value when compared to the US dollar. Compare its valueover the last 100 years to the US dollar, and you can see whyit is essential to your portfolio.
2 - Wars and the printing of money have a tendency to increase the value of gold over the short term. Right now we are in both.
3 - Buy gold now so that when the world wakes up to it you can feel like the person who bought technology stocks in 1995 and sold them in 2000.
4 - The US dollar is flooding into the market, which will drive up the price of gold.
To being prudent and smart.
(This article was originally written in April 2003)
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