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The Common Economic Myth: Gold Will Always Hedge Against Inflation

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By Edited Nov 7, 2015 0 0

Buying gold used to be something that people laughed at, scorned at, scoffed at and even jeered at. People promoting gold were often seen in the same light as the salesmen, the politicians, the lawyers, the ambulence chasers. They were seen as "hoarders" and "scrooges". They may have been put in the "tin foil hat" group and been considered paranoid and seen as crazy idiots. Never more so then when gold prices were $200 an ounce or $300 an ounce.

Who can blame people for thinking that really? I mean people had seen gold prices come down from $800 an ounce when it was in public awareness that gold was a "viable investment option" and gold was heavily marketed by people saying that gold would one day be able to pay for your entire mortgage and pay off your house, all the way to $200 over the last 30 year period. Now different people continue to say "gold is a buy" for 30 years and who's going to listen to them?

Anyone who thought buying gold was a good idea was foolish in the public view. Not only does it not do much social good for society by directing resources towards the creation of something that will be hoarded, but the idea that it's a good investment when it is nothing but a shiny rock while there are other businesses that may revolutionize how the world works is rediculous. Warren Buffett, the world's greatest investor never invests in gold, and practically laughs at the notion of doing so.

Don't take my word for it. You can interpret this however you want to, but Buffett has this to say about the notion of buying gold:

"Gold gets dug out of the ground in Africa, or someplace," he said. "Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head."

Someone may complain saying "we use it in jewelry". The problem is, unlike most resources that have to be used for something towards a social purpose, gold will eventually be passed on replacing the need for future generations to need to buy gold, or sold and then it can be melted back down and recycled and remade into jewelry yet again. The majority of the gold held is just held for the sake of "maintaining value". Gold has some uses, such as a gold crown in your teeth. But when you die, your teeth may get knocked out and the gold crowns may be melted down yet again and reused. In other words, if something has to be consumed to really go up in value beyond just going up with inflation, gold doesn't really fit the bill. Additionally many of gold's uses can and are often be replaced by metals like copper and silver, as the prices go higher it makes less sense for gold to be used, and more sense for other metals. In terms of the amount of gold vs the amount of silver in the world, silver is now more scarce as it is actually being consumed more without being recycled.

The thing is, a shiny rock of 10 pounds is very small and could fit in the palm of your hand. Take a stack of 10 of those and all you have are 10 paperweights but that would be 100 pounds worth andthe total would currently put the combined price above $120,000. What is of more value to society. A world with all the gold in the world and no food, no water, no shelter, no houses, or a world with all of those things but not gold? Lets be realistic here, cutting back on food so you can buy more gold and pay for the storage of gold so you can hold it and protect it from everyone else is kind of like Sméagol aka Gollum of lord of the rings. You sit in a corner worried that people are going to take "your precious" gold ring. You become bitter and parnoid about society and your "precious" is the only thing that allows you to sleep at night, but you continue to worry that you don't have enough gold anyways. The only way you win is if the world falls apart. In truth the more people that buy and hoard gold, the more that the purchasing power of that gold would actually Decrease in value. Why? Think about it. If money flows into gold, it becomes more economical to mine for gold and to own it yourself, and it becomes less economical to do anything else. That means building roads, that means providing shelter, and even providing food. There would be less that society could produce because it would be wasting it's resources fighting over "the ring of gold". In a caveman society of 5000BC gold has absolute no use at all, not even as jewelry. Maybe you can use it like a rock to hit someone over the head and steal their club so you can use it to hunt down an animal, or you can throw it at someone who's collecting fruits and steal their fruits so you don't die. If everyone in society stopped buying everything but gold and maybe a little food, the only industries that would receive enough money to continue would be gold and farming. People still have to eat, even if they eat less, but farming would actually not receive the same funding as people eat less. Society would fall apart as more people become obsessed with "their preciouses" until they all became slimy little power seeking gollums running around all paranoid and starving mean obsessive scrooges willing to betray their friends just for a tiny little peice of gold.

Really? For shiny rocks?

The argument is that it's the only thing that can protect you from hyperinflation. The notion is just silly. First of all, the two major gold crisis of all time whether in germany or america had the governments of the world making it illegal to own and/or stealing it from the people in the name of "protection". So the times in which they are most needed and you can't benefit from the price increase.

Additionally whether or not you believe in a conspiracy or not, the federal reserve and governments and the "powers that be" of the world have a vested interest in keeping the price down so they can keep the "status quo". Some people think this is bullish for gold as they can't keep the price down forever. I don't really agree. If they can simply create more paper contracts of gold and those get traded instead of the actual gold, why do people need physical gold if the gold futures entitle them to physical delivery if they were to choose? Maybe there's not enough gold in the world to actually deliver if all those who owned futures wanted physical delivery and in case of a crisis where everyone wanted physical gold their may be a run on gold. However, if this took place there would also be a run on silver, which is significantly more scarce and underpriced historically to such "crisis points". The US took the country off of the gold standard in the early 70s and by the end of the decade gold was at $800 which is an inflation adjusted high of some number above $2000. Basically in 40 years since the peak of gold prices in terms of inflation if you bought during the peak, you would actually have lost half of your purchasing power. If you bought during the peak and then sold at the bottom, you would have lost about 90% if you adjust for inflation and that's if you held it for 30 years.

Maybe gold still will go to $5000 an ounce, maybe it will go to $10,000 an ounce, or maybe it will go down to $120 an ounce over 30 years, but I think it's much to late to speculate in gold for more than a quick traade that shouldn't last more than a year and a half at the most, and even then you hve to understand it's not as safe as the salesmen on TV selling gold would like you to think.

Remember these people were once laughed at, and history will likely repeat, as those being laughed at for buying risky stocks and other things that aren't in favor will eventually have their day in the sun as the wheel of fortune spins around.

I fear that so many people hopping on to gold and miners now are the same people that bought beanie babies and dot com stocks as investments in the late 90s. They gained more and as they gained more they bragged about their returns and they felt rich so they took out large loans to buy houses they couldn't afford thinking they would just sell the stocks at higher prices to make the payments. The house they would, just before real estate prices rose. Those that hung on, might have actually bought more houses and put everything into their homes thinking that it was safe as home prices had never gone down for decades. Then once they got money together they bought real estate and they felt rich so they went out and used their houses as an ATM with home equity loans and then as both bubbles collapsed they lost everything as well. Now they think they're being safe by buying gold when gold doesn't entitle them to anything more than someone else is willing to pay, just like a dollar bill, a stock, or any other commodity, the difference is, gold is at an all time high and currently in favor now, making it MORE risky as an inflationary hedge, not less so just as housing and dot com stocks were a risk at the higher prices more so than at lower prices.

Personally, I think if you must hedge yourself against inflation, you should do so through other metals and commodities like natural gas, silver, uranium, and other commodities that are still much away from their highs. Certainly if a crisis hits and things get worse, other than silver these things probably won't go up like gold will, but eventually gold will fall out of favor, people will rush in to sell their gold and will try to replace it with other things that they perceive as value, whether that be real estate, oil, silver, or stocks. Meanwhile these commodities have more utility and can actually benefit from society. How do you make society better by simply buying up oil? Eventually you will sell it back to society, but by doing so, more people take an interest in trying to get oil out of the ground or find creative ways to provide society with energy as it makes more sense. Additionally, it saves people more money to switch to fuel effecient vehicles and production of cars that use less fuel make more sense. You effectively are "bidding" on what society should use it's resources on. Since you are just holding it as an investment, once the plans are in place to get oil out of the ground more effeciently and produce more fuel effecient vehicles has begun the processes, you can sell it for higher prices, as society values that same amount of oil more so, society is better as a result, even as you have physically done very little, and you can move onto another investment. Because society is better off as a whole, your dollars can do more. If oil goes down because there is a free energy, zero point energy, or magnetic energy or revolutionary solution, even though you lose money in your investment, the money you get back still will be able to allow you to travel about the same or more miles in a new fuel effecient car, and you will be able to do more in life because of you (and others like you) and your investments. Whether you use that oil yourself and you are able to do more with it, or you sell it and replace your car and fuel with the more effecien prices, the investments make society as a whole better, making it a win/win that you do not get with gold.

I don't have a crystal ball and I certainly can't predict the future, but I can certainly look at history, see that it has a tendency to repeat itself and realize that you should not buy things at all time highs. Gold certainly may continue to soar higher and even approach it's inflation adjusted highs of above $2000 an ounce, or even higher so that even if you bought it at the peak in 1970 it actually may do better than inflation adjusted highs. This leaves room for upside if it does happen.

However, if history does repeat and dow/gold approaches a ratio of 1 so that the dow is the same price as one ounce of gold, but silver also approaches the ratio of 1/16th the price of gold as it did, the biggest upside would not be in gold, but in silver. Back then silver was more abundant then gold, now it's the other way around as silver has been consumed, so we actually could see silver go much higher.

If you must buy into this precious metals boom, I would suggest silver over gold. Keep in mind that Jim Soros did buy gold options while calling it "the ultimate bubble" and Warren Buffett once owned the largest silver cache in the world but never owned gold and says he will never do so as it really doesn't help out society much where as providing capital to businesses like Coca Cola will help spread more happiness around the world and find ways to produce more at cheaper prices. Or he'll own companies like Johnson&Johnson or Kraft or P&G which supplys plenty of products to the world, or companies like Conico Phillips which help provide the world with oil&gas to operate all of it's businesses.

Stocks have a better long term history as businesses will always find ways to make the world better and will continue to grow along with the population, the demand, and through their own investments. Perhaps buying an index fund like SPY which shares in the earnings growth of several companies is a good idea.

I also know that by buying certain non perishable foods in bulk you can actually buy them for something like 20% less. This is practically an automatic 20% return on your investment if you plan to buy that much in the future. Even if prices of food drop somewhat you still will benefit from buying in bulk. If prices go up like they continue to do, and we see food inflation at 15% per year, your investment grows by 15% per year. To me, this is a much wiser use of one's money as you are not only able to buy at a discount to market prices, which you cannot do with gold, but you can also hedge against food inflation and your wallet will enjoy the gains as it's a much lower expense for food in the future.

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