New to the Gold Market?

“Are you looking to buy gold? Have you thought about why? What’s in it for you?”

IF YOU’RE LOOKING to buy gold today, please let me stop you and advise a cold bath.

I mean, have you thought about why? It’s just a lump of metal. Why would anyone ever want to buy gold at today’s prices?

After all, gold doesn’t pay you an income. So it can compete only with cash in the bank (provided its safe) or government bonds (provided they pay) when inflation rises faster than interest rates. That’s what happened when gold rose eightfold for U.S. citizens in the late 1970s. It doubled in price when this happened again — and inflation beat interest rates — in 2003-2006.

Nor can gold compete with stock market shares when the economy is growing and real revenues rise. It remains the most unproductive of assets, an inert metal with few industrial uses.

That means gold has no future profits to promise you. But for the very same reason, it also means gold doesn’t rely on consumer spending, new business investment or clever balance sheet gimmicks for its value. Gold is simply a rare precious metal that people all over the world have used to store wealth for more than 5,000 years.

And right now, that simplicity is gold’s unique appeal.

Buying gold is as far as you can get from today’s complex and exotic debt markets. They’re making headlines for all the worst reasons today, as banking stocks plunge, mortgage bonds slip into default, and losses pile up at hedge funds.

Gold, on the other hand, is recording near three-decade highs, and it still doesn’t owe anything to anyone. In our current financial marketplace, that makes gold rarer still.

Gold’s lack of “default risk” also sets it apart from the mountain of debt built up by Western consumers and their governments. The big picture?

  • The average British household now owes nearly £9,000 (almost $18,000) even before you account for its record mortgage debt
  • The U.S. government has run up $9 trillion in debt, much of it owed to fast-growing Asian economies like China and all of it waiting for U.S. taxpayers to make the repayments
  • Even in Europe, the single currency Eurozone now faces a housing-debt slump in Ireland and Spain. Italy may have to pull out of the euro. Greece’s high-spending government should have pulled out five years ago.

Compared with this epidemic of debt, very few people own gold. Fewer still own it outright, in their name alone. However, the global derivatives market of financial promises has doubled in three years, to stand above $415 trillion. That’s more than eight times the value of the entire world economy!

Last month, it was mortgage-backed bonds and the complex contracts they’ve spawned that froze the interbank lending markets completely. Much of the betting has turned out to be worthless, and the fear remains that the worst losses have yet to show up. Of course, gold might also lose value. But unlike a mortgage-backed bond, it can never go to zero, not according to 5,000 years of world history. And so far in this global credit crunch, the gold market’s response shows that its “safe haven” status has only grown stronger.

In a nutshell, that’s why the gold price has now shot to a 27-year high. But is today, right at the top of the chart, the right time for you to buy gold?

Six weeks ago would have been better; gold has risen 10% since then against the dollar, pound sterling, and euro. Buying gold six years ago would have been better still. Early gold buyers spotted trouble ahead, and they have been rewarded for taking a risk on this no-income asset.

Since 2001, gold has very nearly doubled against the world’s five major currencies. For Japanese gold buyers, it’s risen threefold in terms of the yen. But very few early investors appear to be selling just yet, and many respected analysts agree with their logic — that the real trouble in world finance has barely begun.

Think of the current “credit crunch” as a major sporting event, says Jon Markman for MSN Money. After speaking to Satyajit Das — “one of the world’s leading experts on credit derivatives…author of a 4,200-page reference work on the subject…[and a] developer and marketer of the exotic instruments himself over the past 30 years” — he now believes we’re just hearing the national anthem played before the game really begins.

“It won’t end well for the global economy,” says Das, actually laughing! Buying gold now could prove a wise decision if this crisis gets worse before the world’s debt problem is cured.

Buying gold does not come without risks, however. The gold market remains highly volatile over short-term periods of time, twice as volatile as U.S. stock markets, in fact. And even if the bull market starting in early 2000 runs for another seven years from here, you must expect sharp and severe pullbacks in the meantime.

“Gold rose 600% in the 1970s,” as Jim Rogers, world-famous commodities trader and best-selling author of Adventure Capitalist, put it recently. “Then gold went down nearly every month for two years. Most people gave up.”

You can’t blame investors who quit the gold market between 1975-1977 for putting their money elsewhere. The gold price fell very nearly in half!

But that’s simply “what happens in bull markets,” as Jim Rogers says, and between 1977-1980, “gold went up another 850%.”

Fast-forward to gold’s current bull market, and it enjoyed another huge surge before May 2006, rising by $230 per ounce in only six months. That spring, and for the first time in more than two decades, gold began making headlines at last — and the price promptly slumped by one-fifth.

There’s no reason to think a sharp pullback won’t happen again. There’s every reason to wish that you’d bought back at $575 per ounce in October last year, rather than $730 today. Ask your financial adviser, and he (or perhaps she, but it’s distinctly “men only” work here in London) should warn you that after six years, gold’s bull market could soon burn itself out.

Your adviser should then point to the 1980s and ’90s and show you how gold just kept sinking, year upon year upon year. Any U.S. investor or saver who bought gold in January 1980 suffered a 70% loss over the next 20 years. They still won’t be even today!

So don’t think it can’t happen. Be sure to accept responsibility for your decision if you do choose to buy gold. That way, you’ll sleep better at night — which is the No.1 reason people ever buy gold in the first place.

To buy peace of mind, a defense against the bad things that happen when credit and money start to crumble.

Adrian Ash

September 25, 2007

The Daily Reckoning