Posts Tagged ‘money’

What should be your real reason for buying gold?

Monday, November 20th, 2006

Speculators are always in the market. Where speculators congregate, there will be herd behaviour, mob rule and rumours. Late last year, gold pierced the psychological US$500 market, which heralded in a ‘gold rush,’ culminating in a short-term price bubble of around US$730 in May this year (see our article, The story of gold). After the bubble burst, the gold price, till today, remained trapped in volatile range.

The aim of these gold speculators was to make as much money as possible in the shortest possible time. When they saw the price of gold moving up with great momentum, they joined in the party, resulting in a dangerous price bubble. Since they did not care about understanding the underlying value of gold that they were punting their money on (for hedge funds, it is usually other people’s money), the only reason for them buying is because the price was going up. As investors, we prefer to invest, not bet. When we look at gold, we perceive it differently from the gold speculators.

At this point in time, the gold price is still in a long-term uptrend. There is a good reason for it?its underlying trend is a big hint to us that something amiss is going on in the global currency system. Thus, as we said before, the root reason for investing in gold lies in your confidence (or rather, the lack of) in the fiat currency system which the world is using right now. And we would like to repeat this point again: the ?money? that we commonly use everyday is the fiat paper currency, which has no intrinsic value because it is not backed by anything physical (e.g. gold). Such ?money? can be conjured up at will by the central bank?s printing press. Thus, its value merely lies in everyone?s confidence in it (see our previous article, Gold & Oil, hand-in-hand).

Thus, your real reason for investing in gold is not to ?make money??you do so as a hedge to preserve your wealth.

Is gold a commodity?

Tuesday, October 17th, 2006

One of the interesting fallacies that we had noticed is that gold is currently being classified as a ?commodity? by the market. Thus, this has produced very interesting results that can be exploited by a shrewd long-term investor.

First, what is the definition of a ?commodity? in the financial world? In the Wikipedia, a commodity is described as

things of value, of uniform quality, that were produced in large quantities by many different producers; the items from each different producer are considered equivalent.

As such, the word ?commodity? has a wide range of meaning. There are agricultural commodities like wheat, corn, sugar and orange juice and industrial commodities like oil, gas, coal, copper, iron, zinc and nickel. For the purpose of this article, we will stick with the industrial metal commodities.

Now, let?s go back to the original question. Is gold an industrial metal commodity in the same league as zinc, copper, iron and nickel? Up till now, the financial market seems to think so. Gold more or less move in the same direction as the other metals. Whenever there is a sell-off in the industrial metal commodities, chances are, gold will be sold off as well. But do we think gold is an industrial metal commodity?

No, we don?t.

Let?s us look at the fundamentals. When we look at the non-gold industrial metal commodities, we see a common denominator among them?they are all mainly for industrial use. For example, copper is used for electrical wiring and iron is used for making steel and so on. That is, they are the raw materials that are used to make other things.

Gold, on the other hand, is different. Since the beginning of human history, gold had always functioned either as money or as a store of wealth. Today, despite the breakage of its relationship with the US dollar back in 1971, there is limited industrial use for it. Therefore, the common denominator among the non-gold metals does not apply to gold.

What is the implication of this?

This means that the dynamics behind the demand for gold and the demand for the other non-gold metals are completely different. Therefore, the market is fundamentally wrong to treat gold as if it is an industrial metal commodity. In the short term, this can result in good buying opportunities for gold when it follows the prices of the other metals downward. In the long term, gold will eventually separate itself from the rest of the metals.

We do not know when it will happen, but we are pretty confident it will be within our lifetime, perhaps in the near future. Meanwhile, if you are to buy gold today, please make sure you know the right reason for doing so and buy from a position of financial strength. As Keynes said, ?The market can remain irrational longer than you remain solvent.?

Gold & Oil, hand-in-hand

Friday, October 6th, 2006

We love to observe the market. One of the observations we made is that oil and gold seems to rise and fall together, with oil leading the way. What is the unsound thinking of the market that results in this kind of behaviour?

This is how the market thinks: inflation is good for gold price. Rising oil prices result in inflation. Therefore rising oil prices is good for gold price.

In the short term, this unsound thinking will be a self-fulfilling prophecy. But in the long run, it will be exposed as no more than a passing fade. Regretfully, we shouldn?t even call it ?thinking? in the first place- the market?s ?thinking? is often pseudo-thinking that frequently change drastically along with the tide of unreliable human emotions. Today, the market finds it fashionable to ?think? this way. Tomorrow, it will be fashionable to ?think? another way.

So, what is the real deal with gold anyway?

Now, let?s go to the fundamentals. For much of human history, gold was often used as a store of value. That is, gold was money. Initially, with the introduction of paper currency, gold was still used as a backing for paper currency. Therefore, a gold-backed currency instills as much confidence (in its use as a store of value) as gold itself.

In 1971, something happened that shook the foundations of the financial world. The relationship between the US dollar and gold was severed. That is, the US dollar was no longer a gold-backed currency. Since the US dollar is the world?s reserve currency, the money that most of us hold today is no longer backed by gold.

Therefore, fundamentally, the value of gold relative to a currency is an expression of confidence of that currency in its utility as a store of value. This fundamental reason is based on the assumption that gold is trusted as a store of value. Based on the fact that gold had always served this function for most of human history (except from 1971 to today), we doubt its use will significantly change for the rest of human history.

What will result in a loss of confidence of a currency that is not backed by gold? In truth, an un-backed currency is nothing more than a piece of paper (or in this age, digital information). Therefore, monetary inflation (printing of money) will result in a currency losing its value. The effect of monetary inflation will be general price inflation, which is the general trend towards higher prices across all goods and services.

As we said before (see The story of gold), gold was rising quietly (though not so quiet for the past 12 months) for the past several years. What does this tell us?