In our opinion, the main reason that gold is in an ultra-long-term upward trend in REAL terms is that the overall cost of monetary inflation (creating money out of nothing) is much greater than the reduction in the purchasing power of money. Monetary inflation can make things look better in the short-term, but it leads to the long-term destruction of wealth. The faster the rate of monetary inflation, the greater the amount of wealth that eventually gets destroyed by misdirected investment.

After the ability of the banking system (the central bank and the commercial banks) to create money out of nothing became unconstrained by gold, the average rate of monetary inflation increased. A long-term effect was slower economic progress (slower rate of improvement in living standards) and heightened desire for more savings in terms of a monetary asset that can't be depreciated at the will of banks and governments.

The other misguided assertion is that owning gold is pointless because gold is a sterile, non-productive asset. This assertion emanates from value investors such as Warren Buffett, who like to compare the total market value of the world's gold with the combined market values of a group of large companies (Wal-Mart, Exxon, Intel, etc.) and pose a question along the lines of: What would you rather own -- a big chunk of metal that does nothing except sit in a vault or all of these phenomenal businesses? The question is meaningless, because nobody is ever faced with the choice of owning the world's gold or owning the 30 best companies in the world. 

Most people have a range of investments plus some cash savings. In a world where there was no uncertainty there would be no need to maintain any cash savings, but in the real world there is always uncertainty about the future and therefore the desire -- on the part of most people -- to hold some cash in reserve. Although gold can be a very good investment at times due to the large swings in its pp discussed above, it is the portion of an investor's portfolio dedicated to cash that gold bullion is 'tailor made' to occupy. This means that gold isn't in competition with great companies such as Wal-Mart and Apple, it is in competition with the US$ and the euro and the Yen and the other national currencies.

So, the question that some value investors have asked in their efforts to disparage gold ownership should be re-phrased as:

In which form would you prefer to hold your monetary savings -- in the form of money that banks can create in unlimited amounts out of nothing, or in the form of a metal that has been used as money for thousands of years and whose supply never increases by more than 2% from one year to the next?

The answer to the above question isn't necessarily straightforward. A lot depends on the policies being implemented at the time by central banks and governments. Over the past several years the obvious answer from our perspective has been "the metal", because central banks and governments have been rapidly inflating the supplies of national currencies and generally getting in the way of real economic progress. As things stand today the obvious answer -- again, from our perspective -- is still "the metal", because the Fed is dominated by bozos who truly believe that the economy can be strengthened by counterfeiting money and because the other major central banks are no better.

    *Our method of adjusting for inflation was outlined in an article in December of 2010. We make the assumption that over the long term the percentage decrease in the dollar's purchasing power will be approximated by the percentage increase in its supply minus the percentage increase in the combination of population and productivity.

-- Posted Tuesday, 7 February 2012 | Digg This Article