Friday, March 21, 2008

There is another reason to own gold

Everybody knows that gold is an inflation hedge. That’s why most people buy it. They know from experience that the purchasing power of all national currencies is being constantly eroded by inflation. But they also know that their purchasing power is preserved by owning gold.

For example, the price of crude oil has been rising for decades when viewed in terms of dollars or any national currency. But when the cost of a barrel of crude oil is viewed in terms of ounces or grams of gold, its price is essentially unchanged. In other words, the dollar price of crude oil and the dollar price of gold are both rising more or less lockstep. By owning gold instead of US dollars, you can today purchase basically the same amount of crude oil as at any other time in history.

In other words, gold is an inflation hedge. But that is only one of gold’s advantages. There is also another valuable reason to own gold, and significantly, this other reason is becoming increasingly important.

Gold is also a catastrophe hedge. Gold enables us to protect our wealth from a financial meltdown because it does not have counterparty risk.

The monetary and financial system is rapidly spinning out of control. We are witnessing the unwinding of decades of reckless credit expansion. Borrowers--corporations, hedge funds, homeowners, etc.--who no longer have the financial capacity to repay their debts are defaulting on their obligations in increasing numbers. In that environment, the safety of one’s wealth becomes paramount, to protect against the catastrophe of default in all types of financial assets.

In short, promises are being broken, so in an environment in which financial assets are becoming increasingly doubted, one needs to own tangible assets. Own things instead of promises, and there is only one money that is not dependent upon someone’s promise and that’s gold. So buy gold; it is the best catastrophe hedge. But also buy gold because it remains the best inflation hedge.

For example, gold was $670 per Toz in August of 2007, and crude oil was $71.50 per barrel. In other words, the ratio was 9.37 Toz of gold per barrel.

Gold today is $992 per Toz, and crude oil is $109 per barrel. So both prices have risen considerably in dollar terms (i.e., inflation), but the price of crude oil today is 9.10 Toz of gold per barrel, less than last August, but essentially unchanged. Gold performed as expected, being a nearly perfect hedge against inflation.

So when considering all of its advantages, gold provides what everyone wants: peace of mind knowing that the portion of your wealth placed in gold is safe.


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