Way back in 2009, I remember fielding all manner of questions from people wanting to invest in gold, having seen it spike from its turn-of-the-millennium slump, and worried about the state of the wider financial economy.
A whole swathe of those were from people wanting to invest in exchange traded funds (ETFs). I always and without exception slammed the notion of a gold ETF as being outstandingly awful, and solely for investors who didn’t really understand the modern case for gold — those who believed that gold was a “commodity” with the potential to “do well” in the coming years. People who wanted to push dollars in, and get more dollars out some years later.
2009 was the year when gold ETFs really broke into the mass consciousness:
Yet by 2011 the market had collapsed: people were buying much, much larger quantities of physical bullion and coins, but the popularity of ETFs had greatly slumped.
This is even clearer when the ETF market is expressed as a percentage of the physical market. While in 2009 ETFs looked poised to overtake the market in physical bullion and coins, by 2011 they constituted merely a tenth of the physical market:
So what does this say about gold?
I think it is shouting and screaming one thing: the people are slowly and subtly waking up to gold’s true role.
Gold is not just a store of value; it is not just a unit of account; and it is not just a medium of exchange. It is all of those things, but so are dollars, yen and renminbei.
Physical precious metals (but especially gold) are the only liquid assets with negligible counter-party risk.
What is counter-party risk?
As I wrote in December:
Counter-party risk is the external risk investments face. The counter-party risk to fiat currency is that the counter-party — in this case the government — will fail to deliver a system where that fiat money will be acceptable as payment for goods and services. The counter-party risk to a bond or a derivative or a swap is that the counter-party will default on their obligations.
Gold — at least the physical form — has negligible counter-party risk. It’s been recognised as valuable for thousands of years.
Counter-party risk is a symptom of dependency. And the global financial system is a paradigm of interdependency: inter-connected leverage, soaring gross derivatives exposure, abstract securitisations.
When everyone in the system owes shedloads of money to everyone else the failure of one can often snowball into the failure of the many.
Or as Zhang Jianhua of the People’s Bank of China put it:
No asset is safe now. The only choice to hedge risks is to hold hard currency — gold.
So the key difference between physical metal and an ETF product is that an ETF product has counter-party risk. Its custodian could pull a Corzine and run off with your assets. They could be swallowed up by another shadow banking or derivatives collapse. And some ETFs are not even holding any gold at all; they may just be taking your money and buying futures. Unless you read all of the small-print, and then have the ability to comprehensively audit the custodian, you just don’t know.
With gold in your vault or your basement you know what you’re getting. There are other risks, of course — the largest being robbery, alongside the small danger of being sold fake (tungsten-lined) bullion. But the hyper-fragility of the modern banking system, the debt overhang, and the speculative and arbitrage bubbles don’t threaten to wipe you out.
Paper was only ever as good as the person making the promise. But increasingly in this hyper-connected world, paper is only ever as good as the people who owe money to the person making the promise. As we saw in 2008, the innovations of shadow banking and the derivatives system intermesh the balance sheets of companies to a never-before-seen extent. This often means that one failure (like that of Lehman brothers) can trigger a cascade that threatens the entire system. If you’re lucky you’ll get a government bailout, or a payout from a bankruptcy court, but there’s no guarantee of that.
Physical gold sits undaunted, solid as a rock, retaining its purchasing power, immune to counter-party risk.
I think more and more investors — as well as central banks, particularly the People’s Bank of China — are comprehending that reality and demanding the real deal.
“I think more and more investors are comprehending that reality and demanding the real deal.”
And more importantly: Central Banks are comprehending that. Primarily the PBOC.
Thanks Doug. Will amend this before I submit to ZH/Daily Crux, etc.
and then there is this:
Notice the shape a big birdy to fiat!
That spot is about 100km from home. I went to the site with a detector and found this
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It’s not just gold’s value today. Gold’s independence (as well as rarity and tradition) has been the main factor in its 6,000 year monetary history.
when the dust settles those that hold phyzz will be… ok.
just hope gov(s) dont confiscate it all for our protection ey
It’s happened before. It will happen again. But it’s very, very, very hard to enforce.
The video commentary is just stunning. “Gimme the gold.” Pretty much covers the situation. Now it is somewhat unfair to compare the notional value of open obligations to the actual physical on hand, but it’s not 40x unfair, if you get my gist.
Actually I don’t really think it’s at all unfair, so long as people keep their minds unclouded and realise that you’re always going to get some kind of multiplication effect via securitisation/derivatives. The ratio you get will give you a very clear idea of the relative liquidity of both the futures and physical markets…
Aziz – just a comment I read your blog from work and when i checked your site yesterday or the day before and that serviced article was up (along with the lovely picture you added for emphasis) I nearly had a heart atack – if anyone had seen that flash up they would have thought i was looking at one of those “bad” sites!!
in fact, i’m not even putting this comment in that article in case my history is reviewed haha.
Yeah, to some degree I am engaging in lowest-common-denominator tabloid journalism… I suppose it is something I should be careful about, as I do not want my site to be branded NSFW…
i still don’t get it. why gold? why not silver, bronze, copper, tungsten, or mercury? or paper? or promises? gold is not productive and offers no means of production. why put it on a pedastal because 6,000 years ago people worshipped it?
Well paper and promises come with counter-party risk, which is the entire point of the article. If you want to minimise your systemic counter-party risk exposure (a good idea in today’s hyper-connected leverage-oriented economy) you want to reduce your exposure to paper and promises.
As for the other options, well they’re not very liquid, because they don’t have the 6,000 year history, although they are certainly just as much a store of value. Keynes’ point on the barbarous relic is very interesting and gives, I think, a degree of insight into the neurosis of modernity, a mindset in which tradition is seen almost as a bad thing instead of being seen as an indicator of robustness , which is actually an extremely useful indicator.
but gold isn’t liquid at all!
at least nowhere near as much as paper money. and if you want real liquidity, how about using water?!
i just don’t get why anyone places any value in gold, at least over and above other metals or natural resources. the european fiasco today is a repeat of countries using the gold standard in the 1930s. rampant inflation in the 1500s and 1600s was a direct result of the spanish “finding” gold in the americas. it makes no sense to put your faith in gold. what happens if there is a huge gold fine in say ecuador tomorrow? why should that result of more gold sloshing round the economy drive inflation? i just don’t get gold bugs.
It is liquid compared to other low counter-party-risk assets, e.g. industrial (“productive”) metals whose purchasing power is tied to the business cycle. For 100% of the history of human civilisation, if you had gold and needed to convert it into consumption of energy, food, capital goods, there have been buyers. Perhaps this is an irrational delusion, but it is an irrational delusion that has held for the entirety of the history of civilisation, which is a very strong signal that it is uber-robust.
i also don’t get your counter party risk argument. albeit i do if you are hoarding assets and not spending your money (or gold). i would think most people spend the money they earn on the things they need to live on a regular basis. to some extent this eliminates the counter party risk because you use your wages to buy food, pay rent etc etc. inflation erodes your spending abilities, particularly with time. so, this could be a problem if you are a saver with no regular income. however, using gold as a currency (or to link your paper currency to gold) is a recipe for economic disaster as per the 1930s and the eurozone now.
The risk of a new Gold find is a good point Ian. I see why using Fiat Currency has a upside in that the Government controls the issue of currency (but can be abused if they lend to friends at ZIRP). If there was a worldwide gold currency and I found gold using my home made rocket ship (Pun intended) I could cause massive inflation overnight.
Buddy: as history has gone on the potential for gold-denominated inflation due to increases in the supply of gold has greatly fallen, because deposits have added less and less (proportionally) to the gold supply.
Yes things like deposit insurance and public faith in fiat currency decrease the counter-party risk of using a “promise to pay” note as a medium of exchange/store of value. But in the last twenty five years there have been some devastating developments in terms of systemic counter-party risk.
The more shadow banking and derivatives instruments are created, and the more they are traded the bigger the systemic counter-party risk and the dangers of a default cascade become. This is, by the way, exactly what happened in 2008. These kinds of instruments spread risk around the system; they are systemically poisonous, and the fact that the Fed now swapped out a load of junk MBS for newly-printed 0101010110011 (thus offering a kind of “deposit insurance” for shadow banking) hasn’t made the system any safer.
And if your paper assets are dependent on cashflow from institutions with these kinds of “assets” on their books, your paper assets have massive counter-party risk.
Yes, the Fed can bail out the system again. There seems to have been a conscious effort (IOER) to convince primary dealers to hold excess reserves so that the Fed can monetise debt and bail out shadow banking without inflating the money supply (M1, M2) very much. But how long can that really hold? The more Asian nations start decreasing their hold of treasuries (China and Russia are doing it), the more the Fed has to monetise to keep rates low and the Treasury’s interest burden low. Will there be a breaking point? I don’t know when or how it will come, but I expect it, not least because primary dealers may get greedy and start biting the hand that feeds them.
I’m pretty sure the earliest currencies (metal-based ones) were mostly silver in nature. Gold wasn’t money, it was something you gave to an oracle, or a temple as a gift. Then it happened that the temples had accumulated so much gold that they lobbied and influenced the cities/countries around them to make it money (thereby making them the richest entities at the time). So yes they worshiped gold, but gold only became money because it was a means to an end to accumulate influence and power for the temples.
As per my other post, I think gold served the same purpose all the way until 1913. I highly doubt the european/Us based populace had more gold than those in power at the time – those in power had more gold than your ancestors, so it remained money. Gold has always been a simple means to an end.
What end could it serve in the next 500 years?
Is that you Ben Bernanke? Just kidding welcome aboard. Fair points though. I think Gold stores a lot of value in your pocket, can’t be duplicated and is accepted in more places world wide than American Express.
According to statistics of the London Bullion Market Assocation
“The average daily volume of gold and silver cleared at the London Bullion Market Association (LBMA) in November 2008 was 18.3 million ounces (worth $13.9 billion) and 107.6 million ounces (worth $1.1 billion) respectively. This means that an amount equal to the annual gold mine production was cleared at the LBMA every 4.4 days, and to the annual silver production every 6.2 days”
This means, 5 Trillion dollar worth of gold is traded in through the city of London every year! This is a spectacular volume of gold, which means the gold market is bigger than oil, copper, iron ore, ect.
As to the article – I have to admit I am a little hesitant about any type of gold. I am assuming here that those in power A> have great control over politics and the world financial markets (I am not talking goldman Sach, I am tlaking those who OWN goldman sach) and B> Can see the direction thing are going and are poised to take advantage of any currency crisis that may happen if that happens (IE Rothchild and the battle of waterloo). If this is true, then the only way gold could appreciate is if and only IF those in power have a vested interest in gold.
Do they? My wife often asks me “what do those in power want?” it’s not money – they control and create that at their will. It’s got to be power and physical assets – Ie income producing assets such as countries and corporations. do they really have a need for gold?
Gold is an sset that served them well in the past – I don’t see it as the ultimate end for those in power, and i’m not even sure if i would see it as a means to an end for them as well. The fed and fiat money was the means they used to consolidate their power. Can gold be of any use for them for the next 500 years?
What if they are taking advantage of the price run-up (and the one that will no doubt come I am sure) in gold to offload their hoard?
just some thoughts.
Don’t worry about the dollar-denominated value of gold.
Worry about the gold-denominated value of living (oil, property, energy, goods, etc), in comparison to the dollar-denominated value of living. Gold is extremely robust; the same thing cannot be said of dollars. Gold’s value in terms of purchasing a standard of living does not depend on the actions of a central bank, etc. It depends of its scarcity, and 6,000 years of history.
In terms of the power money and gold, well, they tend to start buying at the bottom of a long-term cycle. The peak of the last cycle of gold seems to have ended around 1980, and the market bottomed-out around the turn of the millennium. We are nowhere near the end of the cycle, which is recently correlated very strongly with the government debt expansion:
Gold also remains relatively cheap priced in equities. Historically, we have looked at gold peaking at DJIA:AU 1:1. We’re still floating around 10:1.
According to Adam Smith, Golds price realitive to silver in the 16th century was about 10-14 to 1 depending on the country. Gold and Silver production from the Americas had a major influence on price. Smith says the only stable commodity relative to the price of labour was corn. I guess the Agricultural revolution caused corn to depreciate since then, but if you think they never used fossil fuels back then, and fossil fuels will become more expensive in the future then food commodities will be more valuable in the future. Wheat stores very well.
“The Hard Grains
The Hard Grains all store well because of their hard outer shell which is nature’s near perfect container. Remove that container and the contents rapidly deteriorate. Wheat, probably nature’s longest storing seed, has been known to be edible after scores of years when stored in a cool dry place. As a general rule for hard grains, hermetically sealed in the absence of oxygen, plan on a storage life of 10-12 years at a stable temperature of 70 degrees F. They should keep proportionately longer if stored at cooler temperatures”
and yet to believe that a large gold find is not possible would be a strange position for this blog to take, given the frequent black swan references. which makes it equally odd for me to understand the faith placed in gold.
I don’t believe it’s not possible. But I know a thing or two about gold geology: when the Earth formed, most of the heavier elements were sucked to the centre by centrifugal force. So the gold in the Earth’s crust is mostly from asteroid impacts, so quantities are somewhat limited. If we found a way to dig down to the core and extract gold from there, we would find much higher quantities, but it seems unfeasible. It’s the same principle as those who say that nanoengineering or particle accelerators might some day be able to create huge amounts of gold. If we lived at that level of technology, I don’t think any currency would be necessary at all. Currency is only necessary in a world of scarce resources and production. So we are limited to two real sources: crust-based deposits, and asteroid mining.
Further, I believe that because of the size of the current gold supply (much larger than 100 years ago) it would be much harder to find a large enough deposit to really dent the value. The biggest danger is asteroid mining, which is many years (and presumably financial crises) away from real feasibility. I’m not really placing “faith” in gold, so much as I am saying that it is the least bad liquid asset to hold out there. There are risks. Eventually gold may become worthless. But I am almost certain that the present U.S. dollar will be long dead before that.
I’m no particular gold-standard advocate but I do find some people’s choice of attacks against it odd… for me one of the ‘least negative’ of gold’s negatives is the concern of a new discovery of gold causing inflation, not least because of it’s consistant rareity (for geological reasons that you outline aziz). The inflation caused by the discovery of the new world and it’s gold is pretty much a one-time-ever event, and anyway surely the expansion of the money supply by the discovery of previously unknown gold was matched by an expansion of the size of the total world economy by discovery of previously unknown people and resources whose value the total world gold supply would now have to measure?
and anyway when compared to paper money, which can hardly be described as consistant in it’s supply, surely such an argument is essentially moot. People say gold has no value as a commodity because it has no function (other than jewellry), but perhaps you could say that in the same way that copper is well suited to conducting electricity, gold is well suited to being money.. therefore that is it’s function, and hence from where it’s enduring value is derived. As long as people have needed use of ‘money’, there has been demand for gold and silver to perform their function – it is hard to think of any other element/commodity more suited to the role…
I’m not really an advocate of the gold standard either, because I don’t think that it achieves the thing that it is supposed to achieve — namely, scaling the money supply to the economy’s inherent productivity. There are much, much better ways to limit excessive credit creation.
But gold is still a form of money, and a useful one for market participants, even if the popular consensus has been to re-designate it as a commodity.
A discussion about gold’s “intrinsic” value is very much the same as a talk about the bible being the word of god. Some will be for, some will be against. gold is a commodity just like any other (proven by Aziz’s charts comparing oil/gold and anything/gold). It just so happens to be an easy commodity to carry around. Oil wouldn’t be handy and wheat rotts. I don’t think there is a reason why gold is better than copper or tin. It’s not really. There is a demand for copper, and a demand for tin, and a demand for gold. they are all commodities. I would be interested in seeing a chart of gold versus other metals for the last XX years to see how they stack against one another.
Money is a commodity. Its significance is that it is so commonly exchanged and accepted that it takes on the characteristic as a medium of exchange. Thus becoming money. So instead of X for Y, you get X for M which can then be later converted to M for Y. But it too is a commodity. Gold has been used before as money, but currently it is not money. However, that doesn’t mean it won’t become money again or hasn’t been taking on some characteristics of money among some individuals and central banks.
The word intrinsic value is thrown around way too much yet it does very little to define value. What does intrinsic mean? Does it mean it can be consumed? Or a value based upon its utility? Everything has a value as everything can be exchanged for another good. Everything of utility has a value, even if minuscule. If it had no utility, no one would want it and thus no one would pay for it (even cow poop has value, just not yours). There is even utility in money. Try going to the grocery store to barter for a can of beans. Gold however is not easily debauched as paper money so its “value” is relatively stable compared to paper.
When you look at the dollar chart of gold, oil, copper, or tin, you are looking at a chart comparing dollars to gold, oil, copper, or tin. Miracle right? So does that mean dollars are a commodity as well? YES. So because it is a commodity means it is useless? Maybe in the future, but I surely could use some of that sent my way.
Hence my Pun about the rocket ship above. I tend to agree with you Ian. I don’t know how to link, but John Aziz has a Blog on Mining the Stars. This will be the same issue as the Spanish bringing Gold from the America’s. Adam Smith noted the terrible inflation in Spain because of this. Printed Money. Gold finds. The same thing. The only constant is the price of labour. “I don’t get out of bed for less than $10,000”- Linda Evangelista
In the mid 70’s I bought 5 Kruggerands for $141.00 each. I still have them. I have been buying for years, but not after gold went above about $350.00 toward its high at $850.00. It has been a bumpy, but profitable ride, but I still will not sell.
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The GLD scam exposed (Part 1): http://preciousmetalspete.blogspot.co.uk/
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I find it curious how folks mix up the words currency and money. Those are NOT the same things, not interchangable. Like price and value. Gold is the ultimate form of money b/c it can act as currency all over the world, IF you have it and need to use it as such. Paper currency definitely does not satisfy that basic requirement, it isn’t a store of value. Nuff said!
Ah. Excellent point.
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US wages priced in Gold. Also links to other commodity gold ratios
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Physical form of gold is good to invest in and most preferred by investors these days and so is the returns you get in your investment if you’ve a good knowledge of gold market trends.
I accede with you on this though it has been changed significantly as now gold don’t seem to be stable enough to invest in and expect good returns.
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