I must admit that something has been bothering me lately. By all accounts, the amount of gold being purchased by consumers like you and me has gone through the roof. Quoting from the American Precious Metals Exchange (APMEX) in their blog entry about the Financial Crash of 2009:
Many Americans (average working people, not just the super-rich) are extremely concerned about the very apparent devaluation of the US dollar. To combat this concern and protect whatever wealth they may have, these citizens are seeking to possess physical gold and silver in volumes not seen in modern history.
In fact, at APMEX, the numbers of orders increased 262% for Gold from 2007 to 2008. Silver orders increased 358% from 2007 to 2008. So far, 2009 appears to be making those increases look paltry by comparison.
The thing that has been bothering me is that the price of gold has not been going way, way up like you would expect it to when demand is super high. Why not? I finally stumbled upon the answer today in this article on MoneyMorning.com. Basically, gold is good to own as a hedge against inflation, not against recession.
As institutions and trade funds are forced to liquidate, many are doing so with their gold. Let me try to explain on a basic level using a simple example. Many funds have rules or guidelines for how the money is invested. For example, a fund may decide to have no more than 15% of its assets invested in gold. So, let’s pretend that a particular fund had $1000 in assets (before the stock market crash) and 15% of that was in gold and the rest in various stocks. They had $150 worth of gold and $850 worth of stock. And then the stock market collapsed and the stock lost 40% of its value and is now only worth $510 (instead of $850), but the gold did not lose any of its value (still $150). The fund now has $660 worth of assets, but now the gold comprises almost 23% of their portfolio. In order to follow their own guidelines, they need to sell enough gold to bring their holdings of gold back down to 15%. This increases the supply of gold in the market and helps keep the price down.
This is what has been happening in the real world. The price of gold isn’t shooting through the roof because it makes sense for investors to sell now in order to liquidate some of their assets, thus keeping the supply of gold in line with demand so the prices are not as affected. This also makes a lot of sense because everyone is afraid that we are entering a deep recession (which we are) and they expect prices to fall, including the price of gold, so sell now while the price is seemingly high. However, things will not happen like they did in the Great Depression. This time we will have an inflationary depression because of the glorious antics of the President and fellow Democrats to print money out the ying yang. Ginormous inflation is all but assured at this point.
Now is the time to get some gold if you can because many experts are predicting the price of gold to reach $1500/oz by the end of the year (it’s around $900/oz now).
The only person to come out of this OK is going to be Mr. T. Do you think he still has all those gold necklaces?
ReplyDeleteAnyone who says they know what the price of gold is going to be next year is a fool or a liar. Gold is a commodity which can be highly volatile. Very few financial institutions actually invest in gold. If you want a safe investment then Treasuries are the safest they get.
ReplyDeleteI am surprised that the author of the article overlooked a very critical factor of gold prices. Gold and commodities in general, are goods that hold a value across borders or currencies.
For example, since the financial crisis hit the dollar has APRECIATED greatly in relation to all major foreign currencies. Now a dollar is worth more in terms of Euros, pounds, yen, or whatever. That means you can buy more things with a dollar than you could before. This also follows the deflation we have seen in our economy. When this happens, the price of a commodity goes DOWN in terms of dollars. It may stay the same in terms of Euros.
Here is an illustrative example. If you went to England with $100 and the exchange rate was $1 for .5 pounds, then you would be able to get 50 pounds. Hypothetically, the price of gold per ounce is 50 pounds and you buy an ounce of gold. The price of gold is $100 or 50 pounds per ounce.
Now let’s say 1 month later the exchange rates change to $1 for 1 pound and the actual demand and supply for gold has not changed; You can still go to England and buy an ounce of gold for 50 pounds. But now you go with $100 and you exchange it for 100 pounds and now you are able to buy 2 ounces of gold. But because people know they can go to England and buy gold for $50 per ounce instead of $100, this will cause the price of gold in dollars to decrease to $50 per ounce. This though experiment demonstrates that the price of a commodity may differ in different currencies but it holds the same intrinsic VALUE.
So while the supply and demand for gold have changed, this article overlooked the effect of exchange rates on the price of gold. The appreciation of the dollar has decreased the price of gold in terms of dollars.
This whole dynamic is why investing in commodities is a risky business because it opens you up to the risk of supply/demand changes AND exchange rate fluctuations (which are VERY hard to predict and highly speculative).
While your thought experiment is nice, it is not reflective of reality. You say, "You can still go to England and buy an ounce of gold for 50 pounds." Not true. Who in their right mind would sell you an ounce of gold for 50 pounds in England when he could sell to a buyer in the US for $100? The reality is that the price of gold in England would rise to 100 pounds while remaining $100/oz in the USA. You would still only be able to buy 1 ounce of gold regardless of where you buy it.
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