Since I started The Rich Moose, I have been positive about gold. I've included gold miners in a simple model portfolio. I believe gold (and silver) are great protection assets because history tells us they are.
We are at a weird point in history in currency terms. Never before has the entire world been transacting primarily with fiat currencies—money not backed by any hard assets. But that doesn't mean fiat currencies are new, it has been tried and failed many times before.
Save for a few blips of excitement, gold and silver have been largely an afterthought since the 1970's. Precious metals as an investment have been heavily criticized in recent years, just as they were in the 1990s and early 2000s.
Why not buy bonds that pay interest, or safe stocks that actually rise in value? Isn't it safer to be in bank stocks that have paid dividends for over a hundred years than to invest in a gold miner? Even Warren Buffett has slagged on gold several times, emphasizing its uselessness.
Gold or Bonds
Bonds—the safe go-to asset du jour—are debt instruments: a loan with an attached promise. The only confidence in a bond is the ability of its issuer to pay it back in full with interest as specified. Issuers of commercially available bonds are governments (at all levels) and corporations.
Governments have historically been the safest bond issuers, but history tells us even governments don't pay their debts as they should. There have literally been hundreds of defaults, partial defaults, effective defaults, or forced debt restructurings by governments in the last 500 years. This includes the most trusted governments of their day, such as the United Kingdom, France, Germany, Spain, and yes... even the United States.
Corporations are even worse and it's reckless to hold long-term corporate bonds as a safe investment asset. It's almost laughable that Apple Inc., in the notoriously volatile tech sector, is issuing 30-year bonds at rates just 1% above government debt. Remember Eastman Kodak or Nokia's cash hoard? I don't either.
The dangerous part about bond investing today is that we are nearing a crisis point in government debt for the largest bond issuers. The U.S., the U.K., Japan, Italy, Ireland, and Spain have very high debt levels. Since bonds are denominated in fiat currency terms, not gold or hard assets, it's easier than ever for governments to crank open the printing presses, devalue the debt, and pay it back in full—technically speaking.
I would be surprised if major governments didn't try to "stimulate" the economy next down-cycle by going through a massive devaluation.
Even the U.S., the greatest country of the 20th century, effectively did this twice in the last hundred years: in 1933 and 1971. The government printed more money, devalued the currency relative to hard assets, and met their obligations. Of course a large bond holder in 1932-1934 or 1971-1974 would eagerly tell you they were cheated.
Naturally if the government devalues their currency undermining bond values, corporate bond issuers benefit the same way. They will raise the prices of their goods and services to match inflation, but you can bet they won't offer to pay more for their bonds when it's time to cash them in.
If you must hold bonds because it makes you feel better, focus on short-term government bonds, even if the interest rates are not as good. It's also smart to choose good issuers. A country like Switzerland, Singapore, Norway, Canada, or Australia with very low debt levels is far more likely to uphold their bond and currency values than highly indebted countries.
Gold is not a bond and it never will be. Critics correctly point out that gold doesn't pay interest and that's okay. Gold is just a representation of a store of value. It's something that's tangible, quite rare, and makes a great asset that can be used as a medium for exchange without losing it's value. For thousands of years man has recognized this use for gold and I don't think that's going to change.
Gold is a great hedge to a monetary crisis or other forms of similar government stupidity. It performed fantastically in the 1930s and 1970s and will likely do so again when currencies are intentionally devalued.
Gold has also done well in other periods where monetary supply was expanded through debt, such as the 2000s and 2009-2012.
Gold or Gold Miners
In my portfolios I use gold miners to represent gold. This isn't a must—a gold trust or real gold will do just as well. They might even do better if you believe there will be a full loss of confidence in government, currency systems, and financial markets in the next monetary crisis.
I'm personally a little more optimistic than that and I'm very optimistic about the prospects of gold mining companies. In 2008 when gold prices briefly collapsed with the Financial Crisis, gold miners were heavily indebted after years of aggressive expansion during the resource boom and teetered on a liquidity crisis. Gold miners were punished with the rest of the market although they recovered months earlier and much more aggressively than the wider market.
Now we are in very different circumstances. Thanks to the gold bear market since 2012, many gold miners have low debt levels, they've significantly trimmed their costs, and have been typically cautious in deployment of capital. Without debt and liquidity problems holding them back, they are likely to do very well if the price of gold increases.
Miners are quite levered to precious metal prices. If all-in sustaining costs for a miner are $900/oz and gold is selling for $1,200/oz, the miner makes $300/oz of gold mined and sold. If gold prices jump 25% to $1,500/oz, the miner's profits will increase 100% to $600/oz.
Miners like Goldcorp, Pan American, Agnico Eagle, Kinross, and First Majestic have very low debt levels. Franco Nevada, the big streamer, has no debt, while Wheaton has very little debt. These companies are not likely to fail and are nicely levered to precious metal prices.
Gold or Silver
In history gold or silver could often be used interchangeably as a store of value, for transaction purposes, and as a hedge against currency devaluations. Typically when gold does well, silver does well too. Silver also has industrial use as a great conductor of heat and electricity and as a anti-microbial material.
That said, there are differences in the value of gold and silver. Historically, the ratio of silver to gold has varied between 15:1 to 100:1. It's currently trading 75 grams of silver to 1 gram of gold, implying that silver is cheap relative to gold.
While gold might do well in the next bear market, silver could do even better.
Limitations on Precious Metals
All this said, there are clear limits to the use of gold or silver as an asset in your portfolio. If all your money is 100% invested in gold and silver bullion, you might always have a nice hedge to government stupidity, but that doesn't make you rich, it just makes you Chicken Little.
One ounce of gold isn't going to grow another ounce every 10 years, but we know that productive growth assets like stocks often double in value in a single decade.
You want to have the bulk of your assets invested in something that is productive and grows in value, like shares in a good business (stocks), productive farm land or timber land, or profitable rental real estate. Preferably a bit of each if your net worth allows for it. Reasonable diversification across assets is always a good choice.
I personally choose 10% of investment net worth as a nice round number for precious metal assets. It's enough to do what it does without having a significant downside on returns.
Need evidence? In the last 100+ years, a portfolio consisting of 90% stocks and 10% gold would have outperformed a portfolio of 90% stocks and 10% bonds by nearly 0.5% per year while having lower drawdowns. And that's in an environment where currency was pegged to gold for the first 70 years.
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