This is part 1 of Milly's "Precious Metals for Beginners" series. For other parts see:
Part 2: Silver vs. Gold
Part 3: Coins? Bars? ETFs? What form of Precious Metals are right fo...
Part 4: Where to buy Precious Metals
Gold and Silver should be a part of anyone’s savings and investing. My personal goal is to have it represent 10% of my retirement portfolio and up to a quarter of my emergency savings.
I didn’t start out believing in gold. It gets a lot of hype in sensational language, which always makes me skeptical.
My biggest obstacle to adding precious metals to my portfolio was is it is hard for me to imagine going back to using gold and silver as currency. It is just too out of place in today’s modern society and impractical in the digital world. If there were a dollar crisis, my tools would probably be worth more than useless metals and I can use them now.
I knew their are some inherent physical properties to the metals that make them valuable in industrial and medical applications, but I still don’t think it would cost nearly as much if those were the only competitors for the metals. Only 10-12% of the gold out there is used industrially. It is mostly people just liking precious metals and speculating in the metals that keeps the prices so high. I didn’t want to invest in other people’s fancies.
Let me Change your Mind
Now I see gold and silver in a new light. A lot of the people who don’t like precious metals point to the S&P 500 and show that gold isn’t going anywhere, but the stock market is. Well, it may be true that US stocks have matched or out performed gold, but not by nearly as much as we are led to believe.
Gold as an Investment
From 1971 (when the US abandoned the international gold standard) through 2016, gold has actually tied the return of the MSCI US (large and mid cap US market) at a return of 10.6% annualized. That wasn’t all in the huge gold jump that happened at the beginning either. The last 10 years has returned an average of 7.7%, lagging the US stock market by only 0.5% (source with pretty pictures).
I did my own math and graphing with an exponential trenline (to avoid cherry picking dates) and came up with both the S&P 500 and the Perth Mint gold prices returning 7.3% annually.
That is not a lot of missed gains compared to the risk of a major market correction any day. You might pay the 0.5% in fees to your brokerage anyways. If you agree with Lewitinn in Yahoo Finance that 93% of the stock growth since November 2008 is resultant of Federal Reserve moves, then that is a lot of risk. You could see 93% of those gains come crashing down any day, especially if the Federal Reserve isn't able to do the tightening and normalization they planned (rate hikes and unloading the balance sheet).
Precious Metals as Protection
Even with all of those investment benefits, I still see precious metals as the way to preserve wealth, not to invest. I suspect much of the gold rise is actually dollar weakening. No matter what any politicians or leaders do to the US dollar (and you know what they are going to do), precious metals will hold value. Jim Rickards once asked someone how their family preserved their wealth for 800 years. The response was a third in land, a third in art, and a third in gold. These are the things that last.
As the value of the US dollar and future dollar (treasury bonds) continues to drop, I believe one (or both) of the following two things will happen in the near future, possibly even before the 2018 mid-term elections, probably before the 2022 mid-term elections. I'm not sure how to present these without sounding like I'm using a scare tactic. If you think these are too extreme, just move on and remember all of the other great reasons to invest in precious metals.
1. QE4, or rather the fourth round of "Quantitative Easing", a disguised term for explosive money creation (eventually leading to inflation). At the end of 2008, 2010, and 2012 the Federal Reserve bought up massive amounts of mortgage-backed securities and Treasury securities through a program called Quantitative Easing or "QE". Those three rounds of easing brought the Federal Reserve balance sheet (assets purchased with money created out of thin air) from $700-800 billion to $4,500 billion, effectively adding those trillions of dollars to the money pool. One glance at this M1 money supply graph (ready to spend money) can show you how dramatic the effects were. By the time they were done at the end of 2014, the Feds had bought nearly 3 times more in assets than there was M1 money when they started QE1!
Why is this bad? Each round takes more and more money "printing" and lessens the share of each dollar on the dollar market. This lessening of dollar share hasn't led to price increases yet because the crisis also lead to a greater demand of dollars. Dollars were crucial to all of the liquidation and exchanging going on in the crisis. The problem is we are short changing all of the countries holding treasury securities who thought they were buying a larger share of future dollars. I think QE4 will cause countries to throw in the towel when it comes to buying securities. The treasury auctions are already falling and we are beginning a trade war with China. Why on earth would they keep buying our debt?!
I know I've kind of left the primary topic. I will probably move this section to a future post once it is ready, but the bottom line is this: Buy precious metals because the US Dollar and treasury securities are going down and the plummet will only increase in speed as the problems unravel.
2. Jim Rickards’ “Ice-9” prediction (Road to Ruin) will be realized. There could come a day when the government will be forced to freeze all digital money except for a small amount for gas and groceries, much the same way as they have done in Greece. Even if the money never is seen again, or inflation happens to an extent that it isn’t worth anything when we get it back. Precious metals are individually and physically owned. They are a safety net when financial weapons are deployed. Precious metals will preserve.
One question you might be asking: If you believe that much in gold and silver, why only 10%? One answer is I’ve seen a compelling prediction of a $10.000/oz price of gold. That's in today's dollars, so if there is major inflation, the number will be higher. This isn't some fudged Wall Street chart pattern prediction either. This is a mathematical analysis done by a world expert on currency wars and is based on the required non-deflationary price of gold. If we reach $10,000, your 10% would become about 100% and even if you loose everything else, you’re insured.
Why not more than 10%? Right now we are in a very difficult time for investing. According to John Keynes, we are in a depression which is highly deflationary. Companies are laying off workers (who in turn find part-time jobs, "creating" jobs on federal reports), individuals are deep in debt, and savings are at a record low. In times like this, short term opportunities are the way to go.
At the same time, countries around the globe are cheapening their currencies with monetary easing. The US government simply cannot afford the real value of their dollar denominated debt to increase. Eventually, they will have to change course and switch back to monetary easing "money printing". Inflation will win at some point.
In his book, The Big Drop, and in this article, Jim Rickards explains the thoughts and methods behind a "barbell" strategy that is loaded up on the ends as a protection against inflation AND deflation, with cash in the middle ready to pivot positions as needed. So if you put 35% of your investments in hedge funds, private ventures, angel funds, and the like for your deflation hedge, and leave 30% cash (and treasury bills) in the middle, you only have 35% to diversify into a inflation hedge. As stated earlier, those should include precious metals, undeveloped land, and fine art (try 10%, 20%, 5%). If you want to tweak those numbers you are always welcome to.
I know that was a lot of external thoughts and analysis in a beginner's precious metals post. The bottom line is you don't want to put it all into gold.
In any case, Jim Rickards recommends 10% and most precious metal companies recommend 10%. If people who do more research than me and are an even bigger believers in precious metals than me recommend 10% in gold, I should say the same.
What about confiscation?
When looking into gold as an investment, fingers are often pointed to Executive Order 6102 signed by President Roosevelt in 1933, which required gold to be traded in to the Federal Reserve for the official gold price of $20.67 per troy oz. The criminalization of “hording gold” in the US lasted all the way until 1974, after we left the gold standard. Other gold controls have occurred in Australia and much more recently in India. I’m not going to let fear of confiscation prevent me from buying for 5 reasons:
1. There was a good reason for gold confiscation at the time. It is one thing for the government to confiscate items that cause destruction such as illegal weapons and drugs, but the confiscation of gold comes down to one thing: they needed it, so they took it. As terrible as it is to have the “land of the free” to secure themselves a discount on your savings, it was this confiscation that allowed us to keep on the gold standard for about 40 more years. Without this questionable move, we would have had a run on the gold reserves and it is impossible to say what that would have done to the American future we live in today. Was it the right thing to do? I doubt it, but I may be reaping the rewards today. (or maybe it just means it is going to be that more painful when the ungrounded financial system fails)
2. Gold owners were compensated. It is against the constitution for gold to be sized without just compensation. Sure, the government might do something sneaky like dump a bunch of gold supplies into the market to suppress the price just before they close the market so that they can buy at discounted prices. Even if they don't, you’ll still miss out on some massive gold hikes in the event of a gold crisis. Either way, you’ll probably still be better off buying gold today and selling it to the government in a few years than just holding onto dollars. The shakier things get, the more gold will go up.
3. Not all gold was confiscated. There were exceptions for industrial uses and some personal exceptions as well. Rare coins were exempt and individuals were even permitted the equivalent of 5 troy ounces of coins.
4. Owning gold is the patriotic thing to do. If there is going to be a future gold confiscation, wouldn’t it be much better for the United States to get a bunch of gold from it’s citizens than to have that gold sitting in India, China, and Russia? I don’t want to give away real money for fiat currency, especially when it is in a crisis, but at least it is going to someone who wants the United States to be strong. We want as much of the world’s supply of gold in our own borders. Owning gold is the patriotic thing to do.
5. The risk of confiscation is smaller today. In 1933, the dollar was backed by gold (what it is backed by today). They had to stop a run on the gold reserves when the gold peg was strained.
Today, we live in the world of floating exchange rates.
If the US really gets into a bind, instead of confiscating gold, they can just print whatever money they want to cover their debts. Yes, creditors will be upset about taking a "haircut" when paid in a debased currency, but they took an inflation risk when they bought the government securities.
-MillyThis is part 1 of Milly's "Precious Metals for Beginners" series
For Part 2, click here: Should I buy Silver or Gold?
Disclaimer: I am not a licensed or certified financial coach, planner or adviser, just an enthusiast. Anything I recommend should be personally analyzed and discussed with your financial adviser.