Three reasons for gold

May 25, 2016

Pat Heller

When people discuss the reasons for owning gold and silver, there can sometimes be miscommunication because people can have different ideas of what it means to do so.

For instance, do you consider owning gold and silver as a form of alternative money? Or do you own them because it serves as a form of wealth insurance because their prices often move contrary to those of stocks and bonds? Or is ownership strictly a matter of acquiring an asset with greater appreciation prospects that other investment options?

To some, this may seem like making a distinction without a difference. But bear with me while I clarify the importance of these distinctions.

Monetary systems are used as a means to facilitate commerce. Money enables people to exchange a good or service that they give up while receiving a medium of exchange that can then be used to trade with a different party to obtain other goods and services of higher subjective value than the goods or services originally surrendered. (Note that in a free market, people will not engage in an exchange unless they anticipate that the material and psychic benefits they eventually receive are expected to equal or exceed what they give up.) The concept of money is one of the greatest inventions in history because of all the generally beneficial trade that it encouraged that increased human prosperity.

However, as history has demonstrated, no two monetary systems have matching track records over the long term. Fiat (paper) currencies are those unbacked by physical assets for which holders can redeem them. Researchers who have studied the subject report that such paper money systems have an average lifespan of about 40 years. Therefore, there is some financial risk in holding any form of money, especially government-issued forms, for more than a short time.

It is economically beneficial to possess some money to facilitate future transactions. To offset the financial risk of doing so, some people may opt to hold more than one kind of money. Over history, physical gold and silver have a track record of never having failed. Going back 6,000 years, before coinage was invented, gold was used as a medium of exchange.  Therefore, it is reasonable to consider owning some physical gold and silver as money to offset the risk of holding fiat currencies dependent on “the full faith and credit” of a government that may or may not still exist in the future.

Therefore, the idea of owning gold and silver as money is that the owner can potentially spend it someday.

Distinct from that, although similar in concept, is the idea of owning physical gold and silver as a form of wealth insurance. A number of years ago, I read of a research study that determined that an investment portfolio that held a modest percentage of its assets in physical gold and silver generally had the same long-term results as other portfolios that did not have a precious metals component.  Just from that it may seem that owning gold and silver is not really important.  However, this same study also reported that the portfolios that held some gold and silver experienced a lower level of market volatility (fluctuation) than investment holdings without these metals. As of May 24, the prices of gold and silver, as measured in U.S. dollars, are up more than 15 percent so far in 2016, far outperforming most stock and bond indices. There are other times when the reverse has been true.

In my mind, owning physical gold and silver as a form of wealth insurance is something that is a lifelong commitment, similar to maintaining other long-term insurance coverage such as on a home, vehicle, life, health, and so forth. This is not a position to be traded because price may temporarily fluctuate. I advise my customers to think in terms of their heirs someday inheriting their gold and silver held as wealth insurance.

There are also times when the future appreciation prospects for gold or silver, relative to the outlook for other investment alternatives, look especially attractive. It is for the reason of possibly being able to liquidate gold and silver in the future at prices higher than they cost to purchase that these metals could be acquired as an investment.

As with any investment, the future outlook for gold and silver can and will change over time. Therefore, investment holdings of precious metals should be considered available for sale as future market conditions merit. (Note that while I urge you to do your own due diligence on investing in gold and silver, I personally judge current market conditions to be favorable for doing so and have done so for my own account.)

As you can see, owning physical gold and silver can be considered as assets available as needed for everyday transactions, or as lifelong financial protection, or as assets that are bought and sold as part of long-term investing activities. The reasons why any person might possess these metals can be different from one to the next.

I am sometimes asked which of these reasons to own gold and silver I consider most important. In my mind, if someone has the financial wherewithal, I first recommend acquiring an insurance position, the gold and silver that will never be liquidated except in the most extreme circumstances.

For this purpose, I consider allocating 5-10 percent of what one considers either their net worth or the size of their investment portfolio to be prudent in stable times. In more turbulent financial markets, such as exist today, I might bump the percentages up to 10-20 percent. When acquiring gold and silver for this reason, acquiring lower premium popular coins and ingots is more important than other attributes of such products.

Let me share a real world story to point out another potential use of gold and silver wealth insurance. In the early 1980s, a number of Southeast Asian refugees resettled in mid-Michigan near where my store is located. In conversations with a number of them, I learned that they escaped government oppression and often certain death in leaving their homelands.  However, in order to buy their way to relative freedom, they had to pay gold to those who helped them. The reason I met many of them is that they came to my store as soon as their finances permitted to re-establish their insurance holdings of gold and silver – just in case they someday had to flee America.

After the insurance reason, it might make sense to own some physical gold and silver as alternative money. Just because the U.S. dollar as a name has a track record for well over 200 years is not a guarantee that it will sustain its current purchasing power or even survive long into the future.

Since the Federal Reserve System was created in 1913, for example, the value of the U.S. dollar has depreciated by 98.3 percent against an ounce of gold.  Therefore, it can also be prudent to own physical gold and silver to pay for everyday transactions. Obviously, the forms to purchase would be those of smaller, divisible unit value that would be suitable for commerce. It would not make sense to fill a gas tank or buy a loaf of bread using a one-ounce gold coin or bar to pay, but U.S. 90 percent silver dimes or quarters, or one-ounce silver coins or private bars and rounds would work well.

When it comes to owning gold and silver as investments, which I consider the least important of these three reasons, you need to do your due diligence. If you anticipate that their prices will outperform other investments from today over your chosen future time frame, then it is time to purchase. I strongly urge that you do your own due diligence in making this decision, as you have a greater incentive to make the best decision for your own circumstances compared to an advisor or sales representative who only earns income from people who do business with them.

If you choose to invest in gold or silver, I again recommend looking for popular low premium coins and ingots.

You probably realize that it is possible to own gold and silver to serve more than one of these purposes. If you do this, however, I suggest that you commit in your own mind, and probably writing it down to force yourself to do so, just how much of these assets are being acquired for which reasons.

The foregoing discussion does not include any consideration of owning numismatic-valued gold or silver coins.  In many instances, buying numismatic coins can realize greater appreciation than owning bullion-priced items, but they also carry greater risk of loss. It would be possible to own some bullion-priced pieces in a collection that would be suitable for any of the above reasons, but coins with a high premium over metal value should be considered separate from these above purposes.

Let me leave you with one final consumer protection tip.  There are coin dealers and marketers that seek to maximize their own profits by upselling would-be purchasers of bullion-priced coins and ingots. These sellers include companies that advertise special offers of low-priced bullion products to get you to call them, but the sales representatives then use every angle they can to switch the buyers into acquiring higher profit margin numismatic items. If you ever find yourself unreasonably pressured to do this by any company you contact to acquire bullion-priced coins and ingots, you should almost certainly refuse to do business with them.