In light of the carnage in the Italian bond market, it is a good time to ask “why is gold a good investment?”
Contrary to popular opinion, gold has not risen due to inflation expectations. In other words, investors are not hedging against inflation turning into hyperinflation. After all, the 10 year bond yield in the United States is only 2%. Certainly, there are no signs of hyperinflation at the current time.
Rather, the rise in gold has to do with risks in the financial system. Italy is raising questions of whether or not many financial firms are solvent. That is why is gold a good investment right now.
Italy is the fourth largest bond market in the world. With yields rising over 7%, the bond market is saying that Italian debt needs to be restructured. No big deal right? After all Irish debt was restructured and it did not dent the financial system.
However, the size of the Italian bond market can cause systemic problems. Do Italian bonds need a 10% haircut or a 50% haircut is rather immaterial right now. There are over $2 trillion euros of Italian bonds outstanding. The ripple effect of even a 10% would mean that most banks and insurance companies would have to raise capital or risk insolvency. Yes, the issue is that serious.
The markets can digest the default of an Argentina or a Greece. However, the default of a country the size of Italy would make Lehman Brothers look like a parking ticket.
Why is gold a good investment? Gold gives one an opportunity to own an asset outside of the financial system. Gold bullion should be at the core of every portfolio. A ten percent allocation to physical gold and silver should be the bedrock of any porfolio looking for an asset that does not care whether banks or insurance companies choke on Italian bonds.
Why is gold a good investment? Have you seen the performance of the U.S. Dollar over the last decade. It has been pitiful and consumers have lost at least 35% of their purchasing power over the last decade. After all, do you remember when gas cost $1/gallon? I remember when you could buy groceries and fill up the gas tank for under $50 and that was in the year 2000. If one examines the rising cost of food, gas and insurance premiums it is clear that the dollar has lost a lot of value over the last ten years.
Why is gold a good investment…
Here are some reader questions that I’ve recently fielded.
Why is gold a good investment in an environment of low interest rates?
The issue is not the fact that interest rates are low. The issue is that interest rates are negative. The inflation rate is most likely between 3-5% and the yield on a ten year bond is less than 2%. Thus, there is little reason for investors to hold their money in bonds or cash because they are guaranteed to lose a minimum of 1-3% at current inflation levels. When interest rates are negative investors opt to put their “money under the mattress.” Gold is the equivalent of putting your money under the mattress.
Why is gold a good investment when it has “no use?”
It is true that gold does not have industrial applications like silver, palladium or platinum. Gold, due to it’s price is not widely used outside of the jewelry industry. However, the “use” of gold is money. Gold has risen over the last decade due to investment demand, not do to industrial demand.
It should be remembered that gold has been money for thousands of years. Paper money on the other hand is a relatively new phenomena. Most people probably wouldn’t even know that the U.S. was on the gold standard up until 1971. In other words, the experiment with paper money in the United States is only 40 years.
People often confuse the industrial use of gold with it’s monetary use. Certainly money is needed by any society. A store of value and a medium of exchange is a requirement for capitalism to flourish. Thus, no one would suggest that “money” has no use. In fact, it’s the lifeblood of society. Since gold is money or has been money for thousands of years, clearly it is useful.
Why is gold a good investment if it’s gone up for ten years in a row?
Many people are hesitant to invest in gold because it has been in a bull market for a decade. Subsequently, most people think that the end of the bull market in gold is closer than the beginning of the bull market in gold. Nobody wants to be the fool that bought gold at the top. Everybody wants to be the bargain hunter who scooped up gold coins for $300. However, the last decade of out performance is not really the issue. The question is whether the fiscal and monetary system of the U.S and other Western nations is on the road to recovery or are things getting worse? I think that we’re still moving backwards and that is why is gold a good investment after all these years.
Remember, a decade ago you could have bought Treasury bonds and made 7%. Nowadays, after the debt has doubled making the U.S. less credit worthy you will receive less than 4% on a 30 year bond.At the beginning of the gold bull market there were legitimate options for your capital. Now there are few options due to negative interest rates.
