Wealth Building Lessons

Most people think that since Gold was in a bear market for nearly 2 decades (between 1981 and 2000), its a poor investment. They also claim that its speculative, you can’t leverage it, and its highly illiquid. But none of these are really true.

In January 2000, Gold was trading at less than $300/oz. Today its at nearly $700/oz! Its been in a stealth bull market and not a lot of people have been talking about it.

Gold is a store of value. Over the long term, it holds its value against inflation and especially a devaluing currency. You can go to any country in the world and easily find someone to exchange your gold at a global exchange rate. (of course, depending on where you are, you may experience significant slippage. Slippage is the commission you are charged to buy or sell an asset).

In places experiencing hyper-inflation, gold is especially valuable. Check out this graph of gold prices between 1833 and 1999.

Until the dollar moved away from the gold standard, its value was almost constant for over a century. This is because the amount of Gold above the ground is very stable. As a percentage, very little is increased every year through mining. Countries can’t just print more Gold, and so there is very little inflation in any currency that is linked to Gold.

On the other hand, when a country indiscriminately starts printing more and more paper currency, it starts to devalue. Assume I’m selling a rock-concert ticket to my friends. None of them have more than $10. Guess what the highest bid will be? Now assume I give each of them $100. Guess what the highest bid will be now? Okay, thats a little too simplistic, but by increasing the amount of money circulation, the government effectively drives up the price of goods. Zimbabwe has seen over 1000% inflation in a year thanks to reckless printing of trillions of Zimbabwe Dollars. Under these sort of conditions, the price of Gold does extremely well in relation to the currency being devalued.

Right now, the world is flush with liquidity and credit.

According to Richard Russell of the Dow Letters,

The net result of the removal of gold behind paper money has been a virtual explosion in credit creation and liquidity. The sheer amount of liquidity that is floating around the globe is incalculable. Fifty trillion, one hundred trillion? Nobody knows. The only thing we do know is that the total amount of unbacked paper is utterly enormous. The result is that it’s floated up the price of everything from stocks to bonds to real estate to commodities.

In the face of this enormous inflation of paper money and credit, the Fed pretends that it’s holding back inflation. The Fed does it with phony inflation statistics. The current reasonably accurate inflation number is 7 percent. The current estimation of the M-3 money supply is 9 percent. The only thing holding back massive price inflation today is the massive over-supply of goods.

And according to Wells Capital Management strategist, James Paulsen says

The world is awash with U.S. dollars. Ultimately this prolonged period of excess liquidity will result in higher inflation and a lower value of the U.S. dollar

Guess what, the dollar is being devalued and we are experiencing inflation.

Right now the Dow Jones Industrial Average Index is hitting a new high every day. But instead of pricing it in US Dollars, if you measure it in Euros you get a different picture. Its rising, but its still not up to the level it was in 2002!

And if you measure it in the price of Gold, it looks even worse.

April 2007’s Core CPI numbers came in at an annualized rate of 2.4%. However, unless you live in a cave and don’t use any utilies, don’t drive anywhere, grow your own food, and don’t pay for college or health care, the Core CPI numbers aren’t really relevant. The actual inflation numbers are closer to 5% for the year.

According to Jon Nader from Kitco.com,Gold reduces the risk of portfolio without reducing the gain. He recommends 5-10% of your assets in Gold.

Some investors have told me that the highest price ever for Gold has been around $800. At nearly $700, most of the gains have been made and it will never exceed the previous $800 high.

Actually, during the previous cycle of Gold, it went from a low of $35 to a high of $850, or a 2,400% increase. Assuming it only makes 1/3 of the move it made last time, we’re still looking at an 800% increase. From a 2000 low of $275/oz we’re looking at the potential for Gold to hit $2,200/oz. (even if you adjust $850 for inflation, it comes to $2,200 so its not an unreasonable assumption). At under $700, there’s still room for a 200% move.

If you do decide to buy Gold, don’t forget to sell it at the top of the cycle. How will you recognize the top? Well you can’t. The only way is to buy it now when its cheap and to sell it once panic buying ensues. If you lived through the stock market bubble of 1999-2000, you probably would have seen a similar frenzy. Living in California, I couldn’t enter an elevator or a barber shop without people discussing the money they had made buying stocks with no product and no revenue.

What are the different ways to buy Gold?
You can buy actual Gold and gold bullion coins. If you do, buy it from a low cost dealer like American Precious Metals Exchange. They’re amongst the cheapest dealers around, charging only 5% commission above the spot price of gold for bullion coins like American Eagles and South African Krugerrands. For some reason, Canadian Maple Leafs command a slightly higher premium. Some dealers will charge you a 30% commission. Avoid them.

You can also buy old coins like pre-1935 British Sovereigns, French Lucky Angels, Napolean 1st French Francs, and Danish Mermaids. You can get most of these for under $150 and they contain about 1/5th of an ounce of gold. I usually buy them from American Precious Metals Exchange, except for the Napoleon 1st 20 Francs, which are my favorites and pretty hard to find. They were minted around 1806 and they sure aren’t making any more 200 year old gold coins! I usually buy them off Ebay.com.

You can also buy older American Eagle coins. A lot of them are graded as “Mint State” and cost thousands of dollars. I’m not a big fan of buying over-priced gold. Although collectibles have historically done well during inflationary periods, its still a risk and I’m don’t like to buy something with the hopes someone else might be willing to pay more than I did (thats called the greater fool theory of investing). I did however buy the Perth Mint Lunar Series of 1 oz Gold coins for $20 over spot price (back when Gold was under $600/oz). They have infact become collectors items and most of them sell for $100-$250 over the spot price of Gold (although the Dragon coin sells for $500+ over the spot price).

If you do buy actual gold coins, make sure you buy one of decent quality. (What defines decent quality is beyond the scope of this article). If you buy a slabbed coin, pay a premium for PCGS or NGC grading. There other many unscrupulous coin Grading services that over-grade coins.

Thankfully, there are easier ways to invest in Gold. You can buy a gold ETF (GLD) which track the price of Gold. You can also buy gold mining shares. Some of the popular ones are Yumana Gold (AUY), Newmont (NEM), GoldCorp (GG). Or you can buy the ETF (GDX) that tracks the main mining companies. Another way is to buy mutual funds that invest in both mining companies and the actual commodity such as UNWPX.

There are also companies that will store your gold for you. I’m not a big fan of those. They charge you 1-2% a year in fees and there’s always a risk they’ll embezzle your Gold. Plus the FBI is currently investigating one of them for facilitating money laundering and will probably shut them down.

There are a lot of ways to get exposure to Gold. Do it now while its under $700/oz and not after it spikes up over $1000!

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