Every ten years or so gold makes it into the headlines. Usually the gold bugs have their brief time in the spotlight and then disappear again for an extended period. Believers that economic Armageddon is close at hand always tell us that “this time is different”, as they are telling us now. Gold has hit record highs over $1,300 in recent days and is once again a big topic of conversation. There is no question that gold does best in the most uncertain times and there are certainly lots of big problems to worry about: the deepest recession since the great depression of the 30’s, government debt levels spiraling out of control and talk of sovereign debt defaults in countries such as Greece, Ireland and Spain. Coupled with a frenzied media sector desperate to fill a lot of air in the now omnipresent 24/7 news cycle, the macroeconomic issues have created a fertile climate for the those who sniff the sulphurous fumes of the coming financial apocalypse.
Gold has been valued throughout human history for its beauty, scarcity and durability. It has been used as money for at least 5,000 years, and is still viewed as the most stable store of value by many people in the world. Almost 80% of world gold production goes to make jewelry, much of which is held as a substitute for paper money or bank deposits by those who simply do not trust governments or banks, frequently with good reason. Many of the jewelry hoarders are in Asia and it is estimated that there is more gold held in India and China than in the entire rest of the world, although there is no way to tell with any certainty. There is even occasional talk of a return to the gold standard, a policy which would force currency issues to “back up” paper money by making it convertible into gold on request. There are a number of good reasons why this will not happen.
The world produces about 94 million ounces of gold a year, worth about $125 billion at current value. In contrast, total annual world economic output is about $70 trillion dollars. In other words, gold makes up less than one-fifth of one percent of world output. All the gold ever mined in the history of the world is estimated to be about 5.8 billion ounces, worth about $7.5 trillion dollars. Assuming you could find it all, that’s less than one ounce for every person on earth. If all the gold ever produced was owned by the various governments in the world (and of course they hold a trivial amount of the total) and if all money was convertible into gold, gold would be valued at about $13,000 per ounce. But of course that is not going to happen. Governments are not about to go on a gold buying spree, nor are they going to make their currencies convertible. There is simply not enough gold to go around.
One way to think about this is to imagine paying everyone in the world in gold. The world labour force is about 3.2 billion workers. Since the world only produces 94 million ounces of gold, that is about 8 grams of gold per person for a year of work, about the same amount of gold that is contained in a wedding ring. The $125 billion worth of gold produced each year is a drop in the bucket.
The major conceptual problem with the gold standard, and the reason it was abandoned by all the major countries in the world in the early 20th century, is that it limits the growth of the money supply to the rate at which gold holdings increase. Since gold is currently accumulating at the rate of about 1.5% per year, this would be the effective growth limit for the world economy. If the governments printed money faster than that, then there would be a run on the gold supplies. Why the rate at which gold is produced in the world should act as a speed limit for economic growth is a question with no good answer. Most economists view the gold standard as a major factor in the depressions of 1873 and the 1930’s, because it limited the ability of Governments to create money to feed a growing economy.
Since no government will willing make its currency convertible into gold, why is gold valuable at all? It pays no interest as does a bond, it does not pay dividends like a stock. Its price is subject to wild volatility, and adjusted for inflation, has gone down for thirty years – the $800 per ounce price in 1979 would be equal to $2,300 in today’s dollars.
Gold believers will tell you that gold is the ultimate hedge against debasement of paper currencies, which they view as an inevitable consequence of the huge government debts and deficits we see around the world. As dollars or euros or yen are printed in great quantities they will become less valuable. Only things that are scarce, like gold, will hold their value. There may be some truth in this argument, although it has not worked very well in the past three decades. The problem is, there are other scarce and durable assets which are more productive than gold.
These would include real estate which produces rents, timber which lasts for decades and gets bigger all by itself every year, other metals with industrial uses such as copper and nickel, and sources of energy such as the oil sands and long life coal and uranium mines. All these assets produce an annual economic return, which gold does not and will never do.
Our investment stance on gold is a practical one. We own a very modest position in one of the world’s largest producers, Barrick Gold, which we view as a normal investment, not a strategic one. The company is profitable and pays a dividend, just like all the other companies we own. We certainly don’t plan to buy gold bullion, speculative junior miners or derivative proxies for these assets such as ETFs. If and when we believe that inflation is a threat we will allocate assets to those sectors which typically perform well during inflationary periods. Meanwhile we will continue to view gold as the marginally important part of the world economy that it is.
Disclosure: Author owns shares in Barrick