Thinking about Gold Investment

Michael Kendall February 9, 2020 2 Comments

Let’s say that in 1971 you understood what the end of Bretton Woods and the ushering in of the global fiat system meant. You understood that the severing of BW’s gold link and the absence of any monetary standard of reference would result in dollar devaluation that would reflect in a rising price of gold (POG). You realized there would be many ups and downs in the value of the dollar and hence the POG, but the long-term trend would be a continuous dollar devaluation.  That is the uninterrupted history of fiat. What is the best way in 1971 to invest and profit from that knowledge?  (Investment in any hard asset, whether real estate, art, or any collectible would achieve the same result.  I will concentrate on gold, because historically it has the most stability of value of any asset.)

Depending on the resources one has available to invest, I think for the average investor, the best way would be to get a home safe and buy as much physical gold as you can afford. By knowing that the inherent course of fiat is continuous devaluation, you could hold that gold, understanding that it will only appreciate in value relative to the dollar for as long as the Fed maintains its fiat system. We are now at almost half a century since the severance of the gold link, and there’s no end in sight to dollar devaluation. When a fiat currency finally implodes, the end comes quickly, ala Weimar, Zimbabwe, the Russian ruble, etc. Holding gold in your home in 1971 removes the storage costs of a depository institution, which would be significant over 49 years. 

By understanding what drives the POG—the Fed’s maintenance of the value of the dollar and not gold supply and demand—you could hold your physical gold for the long term. Through all the price ups and downs, one could hold with the same investment confidence that Buffett holds See’s Candy or any of his other core investments. It is essentially a worry-free investment. The worst that could happen is we go back on a gold standard, and you sell your gold at the new, highly appreciated linked value.

Investing in gold today is much different. The severing of the BW gold link at $35/oz was the base bottom in the POG never to be revisited. To invest with the same philosophy now requires discovering a new interim bottom. This is not as hard as it seems, because the optimum POG represents a new interim bottom. (There have been deflations in 1980-1982 and 1997-2001 where the POG fell below the optimum POG. Any new deflationary event represents the best opportunity to buy gold.) 

The intersection of the POG with its optimum price was the insight I understood in July 2015.  I predicted that gold’s continuous decline in price from its high of $1900 in 2011 would not fall below the optimum POG, which was at $1100 in July 2015. I then defined by a rule that the POG would track the rise in the optimum POG. This is what happened until Dec 2018 when the Fed abandoned its normalization attempt and initiated the next round of QE devaluation. The POG is now around $200 above the optimum POG.

There were no gold ETF’s in 1971. Today, the ETF GLD is basically a proxy investment vehicle for holding physical gold in your home safe—if you believe GLD holds the physical gold that backs the ETF. In theory with GLD, you can achieve the same investment ideal that owning physical gold provided in 1971 without the risk of home storage or institutional depository costs.

Investing in a gold miner in 1971 to hold for the long-term would be very difficult if not impossible. Are any gold miners from 1971 still in existence? Miners come and go based on gold price volatility, management competence and business decisions, mergers and acquisitions, geographical political considerations, and the inherent finiteness of a gold mine’s limited reserves. Miners can be far more profitable, due to expansions of multiples, in interludes when the POG falls at or below a new optimum POG with new dollar devaluation on the horizon. This is the situation that started in July 2015 and remains today. Absent a unique bottoming in the POG like that which occurred in July 2015 where you could throw a dart at any miner and profit, investing in miners requires understanding how the Fed works to gauge the direction of the POG, how the gold industry works, and constant due diligence.

This is not to say that one needs to tick the bottom of a gold market to invest, as indicated by the optimum POG, any more than one needs to tick the bottom of the S&P to invest in equities.  It does mean that having an understanding of the optimum POG, the Fed, and the gold industry assists in achieving peace of mind with a gold investment—in the same way that Buffett achieves peace of mind with his value investments.