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Understanding the Objective Value of Gold

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I am currently looking to take a full position in gold and silver (physical), as a protection against loss during the hard times that may be ahead of us. Before I do so, though, I am seeking to better understand the reasons behind their inherent, objective value. The sources I've consulted thus far are Michael Maloney of goldsilver.com (precious metals advisor to Robert Kiyosaki, the "Rich Dad" guy) and Greenspan's 1966 article "Gold and Economic Freedom" in C:TUI. Here is what I have gleaned from Greenspan's article:

A metal is generally chosen [as a medium of exchange] because it is homogeneous and divisible.

...

The commodity chosen as a medium must be a luxury...the term "luxury good" implies scarcity and high unit value

...

In the early stages of a developing money economy, several media of exchange might be used, since a wide variety of commodities would fulfill the foregoing conditions. However, one of the commodities will gradually displace all others, by being more widely acceptable. Preferences on what to hold as a store of value, will shift to the most widely acceptable commodity, which, in turn, will make it still more acceptable. The shift is progressive until that commodity becomes the sole medium of exchange. The use of a single medium is highly advantageous for the same reasons that a money economy is superior to a barter economy: it makes exchanges possible on an incalculably wider scale.

Whether the single medium is gold, silver, seashells, cattle, or tobacco is optional, depending on the context and development of a given economy. In fact, all have been employed, at various times, as media of exchange. Even in the present century, two major commodities, gold and silver, have been used as international media of exchange, with gold becoming the predominant one. Gold, having both artistic and functional uses and being relatively scarce, has always been considered a luxury good. It is durable, portable, homogeneous, divisible, and, therefore, has significant advantages overall other media of exchange. Since the beginning of World War I, it has been virtually the sole international standard of exchange.

(CTUI, p.97.)

For the most part, that seems like a decent explanation of gold's value. As a supplement to that, Maloney's book "Guide to Investing in Gold and Silver" gives brief historical accounts of the ascendancy of gold in tandem with the decline of various empires after they sink into enormous debt and start pumping out fiat currency (e.g. Athens, Rome, U.S. following WWI.) Clearly, then, governments and populations place high value on gold as a medium of exchange. What I still want to know, though, is:

1) How did this get started (e.g. back in ancient Greece, did one merchant say to another "I'll trade you these nice, shiny, rare, malleable bars for your cattle," or did one government say to another "I'll trade you these nice, shiny, rare, malleable bars for your grain stores," or was the evolution of gold as money more subtle and complicated than that)

2) How can I teach myself, through books and experience, to keep a well-trained eye on the value goverments and markets place on gold, silver, and on other commodities or media that might compete with these precious metals for the position of "sole" or most popular medium of exchange.

In other words (concerning #2): although people have always placed high value on precious metals, how will can I feel secure that things will continue this way? Or, if another medium is threatening to replace these, how can I understand the forces behind the new trend? I'm not expecting a pat answer to this, of course; rather, I'm embarking on a journey of long-term education, and I was wondering where might be a good place to continue from here, having read the Maloney book and the Greenspan article.

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Wow, thats a pretty tough one. Straight off I will say that "The God of the Machine" by Isabel Paterson really helped me with some of the theoretical issues you've raised. It covers a lot more, but it did help me with similar questions about why we use gold and not some other substance.

1. Regarding how it all got started, that might be lost information. People have been using gold in trade for a long time. Its just a hypothesis, but I suspect gold simply represents a "perfect storm" of the qualities you mentioned. Meaning its scarce but not so rare that it can't be adequately distributed for the purpose (platinum), and not so abundant that that prohibitive amounts would be required (silver). In addition to hitting the scarcity "sweet spot" it holds up better over time than silver. Maybe that led to its use as a luxury metal when civilization evolved enough to support such things. Why wear a single platinum ring when the same value can be represented in a significantly more ostentatious display of gold, and platinum can sometimes be mistaken for silver to boot? Eventually it just becomes embedded deeply into man's culture, I suspect.

Aside from the above reasons, there is the empirical data as well. Gold as a value standard and commodity has survived some extensive upheavals with civilizations over the course of human history, and its still used as a tool for those tasks. That implies, to me, that gold usage is not a transient fad. At least as long as there isn't a cataclysm that reduces civilization below the level that we know gold was previously used.

2. I have no idea other than the book suggestion above. Kitco.com has some good tracking tools for precious metals for data.

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Unfortunately, while McKeever is great on most issues, he's wrong on fractional reserve banking.

http://www.dianahsieh.com/blog/2006/06/fraud-or-not.html

Thanks for pointing out issues on the fractional banking system part of the link. I haven't wrapped my head around the entire issue yet, but there are definitely some strong arguments out there on the topic.

Tim

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  • 1 month later...
1) How did this get started (e.g. back in ancient Greece, did one merchant say to another "I'll trade you these nice, shiny, rare, malleable bars for your cattle," or did one government say to another "I'll trade you these nice, shiny, rare, malleable bars for your grain stores," or was the evolution of gold as money more subtle and complicated than that)

Much more subtle and complex, but really quite obvious... once one understands the purpose of money.

Over the course of human history, as life expectancy extended and division of physical and cognitive labor became more complex, and leisure became more accessible, a demand for a safe store of value gradually evolved. The longer the life expectancy, and as human beings were enabled to plan further and further into the future, the more durable currencies needed to be. Keep in mind that even as recently as the mid 19th century life expectancies were in the mid 20's. So... rewinding, currencies competed with one another, and since no government existed to enforce a standard... many currencies existed. This was bartering. Each commodity was its own currency, with its own exchange rate interconnected between hundreds of other commodity-currencies. Gold, precious metals, stones, etc... win out in the currency competion because of their durability, their value, and because we are unable to simply produce them out of nothing... whether highly coveted jewelry or something used as components in computer systems... they are valuable, unlike a piece of paper which can arbitrarily have a number inscribed on it to dictate its "value." For a paper dollar, it takes virtually no more ink to print a 100$ than it does to print a 1$.

There is some value in the commodity itself other than its use as money, this does not diminish the value of other more perishable commodities, but makes them less ideal to use as money. Sometimes its more convenient to use non-monetary commodities as money, like when trading cars or baseball cards. That a commodity can be considered "money" doesn't make it more valuable or bestow it any special significance, the same exchange rate would exist between gold and say, bushels of corn no matter if you regarded gold as money or not... no matter if you referred to the value of gold in terms of dollars or bushels of corn. The important distinction to make is between Value, and which units of measurement one chooses to use in describing that value. Currency simply enables us to objectively (if allowed the requisite calculations free of market distortions) assign an objective quantitative value to a given spread of goods and services. Its too difficult, given our enormous range of options now, to describe each good or service in terms of a different currency or commodity. For example consider price comparisons. You look at burgers across food chains, McDonalds sells a burger for 1$, Wendy's sells one for 2$, Steak'n'Shake sells one for 5$ dollars. We can see a range of value because of the common unit of measurement. If we described the value of a McDonalds burger in terms of chicken eggs, a burger at Wendy's in terms of silver shavings, and a Steak'n'shake burger in terms of Shoe Laces... decision making in the market becomes impossible.

On the reverse end, with our current system of Fiat paper monopoly money, an individual is disabled from making rational market decisions because of distortions in the value of the dollar. The value of a dollar today is higher than it will be tomorrow, so how is one to project and take into account the actions and influences on the dollar to adequately save for retirement... or even for something as short ranged as next years vacation?

2) How can I teach myself, through books and experience, to keep a well-trained eye on the value goverments and markets place on gold, silver, and on other commodities or media that might compete with these precious metals for the position of "sole" or most popular medium of exchange.

Considering none of those metals or commodities are the "most popular medium of exchange" its impossible for anything to replace them except other forms of fraudulent monopoly money.

In other words (concerning #2): although people have always placed high value on precious metals, how will can I feel secure that things will continue this way?

Because those metals are valuable for other reasons than just being (at one time) considered money, and they are scarce resources.

Or, if another medium is threatening to replace these, how can I understand the forces behind the new trend?

Its not about which commodity money will replace which commodity anymore. It will be many years before Fiat fails and we return to commodity money, if you're looking to play around with exchange rates for currencies watch the exchange rates between the currencies, their relationships to commodities, and metrics like the CPI and the GDP (although these "official" metrics are riddled with accounting tricks that fudge the numbers of operate on presuppositions which are false, its better than being blind).

As for where to begin,

Begin with understanding economic philosophy as this will serve to provide the framework in which to integrate all you will learn when studying all of the historical market trends, economic theories, like the ones from Keynes vs Mises vs Rothbard. If you begin anywhere else you will end up having to undo damage caused by misintegrated understanding of simple concepts like "money"

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Thanks for the responses, everyone. Earlier this week I (finally) got around to buying gold and silver at $1132/oz and $18.23/oz, respectively, through Goldmoney.com. I'm only putting 40% of my assets into this account (as a partial hedge against my own naivete), and of that I'm going 20% gold and 80% silver.

Let's see where this goes...

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Thanks for the responses, everyone. Earlier this week I (finally) got around to buying gold and silver at $1132/oz and $18.23/oz, respectively, through Goldmoney.com. I'm only putting 40% of my assets into this account (as a partial hedge against my own naivete), and of that I'm going 20% gold and 80% silver.
If you're willing to share, what time-horizon are you looking at; and, I'd be interested in the range of outcomes --- over your time-horizon -- that you think are very likely, fairly likely and surprising.

As illustration, you bought gold at $1132. So, an example of the type of information that would interest me are:

- not sure about the next year or two, but am thinking in the 2+ year range

- in that time horizon...

... ... very likely that gold is between $1,200 and $1,300

... ... fairy likely that it is between $1,100 and $1,500

... ... surprising if it is either below $1,100 or above $1,500

(Just an illustration of type; ignore actual prices used.)

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snerd--

I'm looking to buy and hold the metals until their prices skyrocket during the big market crash of 2016.

Seriously, though: I want to hold for a while, and fluctuations during the next two years--even gold going to $1500--probably won't make me flinch. Will I sell at $2000/oz? $5000? $10000? It will all depend on the state of the country, the state of the world, and the vicissitudes of my own life at that time.

As far as likelihoods over the next two years, please keep in mind that my opinions and decisions are those of an eager new student just beginning a journey of developing practical wisdom. My sources come primarily from the gloom and doom newsreel of GoldSilver.com (they frequently interview this Dr. Doom guy named Marc Faber), so if you want to see some discussion of average-to-worst-case scenarios you can go there.

I do have to be honest about my motivations, though: this is, for me, more than just protection against a weakening dollar. I'm in it mainly for the thrill of taking control of my own destiny. Last year I lost 40% of everything I had in a mutual fund, then took another huge loss in a get-rich-quick merger that my optimistic, financially-savvy friend *thought* he had analyzed thoroughly. After that, I vowed never again to invest in something that I did not understand or follow closely.

Over the past year I've held cash, as 18-month CDs yielding a quarter percent hardly seemed worth it. Now I'm moving into gold and silver, and I'm keeping my eye on them. Could I take losses? Of course, but the losses would be *mine*--not my fund manager's, not my friend's--and by sinking or swimming on my own judgment I'll be forced to learn and grow.

After the metals run their cycle (say, over the next 5-10 years), where will I turn next for investment? Maybe other commodities (if I like learning about them), maybe another kind of investment that captures my interest. I do have a dream of buying a big house, living in the top floor and renting out the rest of the space (thereby producing cashflow as well as providing me with a place to live and an asset I can love and attend to regularly), and I also have ideas for businesses I can start related to things I love.

This is starting to digress, so I'll re-state that the main point tying these examples together is to have control over one's wealth, rather than leaving it to the mercy of a money manager, a stock one does not understand, or a government that will ruthlessly inflate away the buying power of your cash by diluting the money supply.

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through Goldmoney.com. I'm only putting 40% of my assets into this account (as a partial hedge against my own naivete), and of that I'm going 20% gold and 80% silver.

Thanks for the update on your decisions.

Are you having them store it for you or are you storing it personally?

And what reasons led you to goldmoney.com?

Thanks!

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Are you having them store it for you or are you storing it personally?

And what reasons led you to goldmoney.com?

I'm having them store the metal. There is a small fee associated with that, of course, but it's not much more expensive than renting a safe deposit box at the bank, and it's fully insured against theft, fire, etc. Also, if you change your mind and want them to ship you physical metal, you can do so by paying a "fabrication cost" that's as low as 2.5%.

I initially looked into local dealers, but their bid-ask spreads were too high: around 4% for gold and 6.7% for silver. (These spreads are the differences between the price at which you can buy from the dealer and the subsequent price at which you can sell back to him.) The spreads at goldmoney.com, on the other hand, are only about 0.5% for gold and 0.8% for silver. I initially checked out kitco and bullionvault (per recommendations on this forum, actually), but their spreads seemed to be much higher.

It's very possible that I didn't find a good local dealer or that I misread the information on the kitco and bullionvault sites. If anyone has any evidence to the contrary (i.e. low spreads for local dealers or for any online companies) I'd love to hear it.

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I liked the explanation of how something becomes money, in the novel :

"The Great Idea", 1951 (titled "Time Will Run Back" in Britain, revised and rereleased with this title in 1966)

http://www.mises.org/books/time.pdf

by Henry Hazlitt

It's an entertaining read,

Highly recommendable.

"This is written as a novel, set in the future, in a completely com-

munized world, from which every trace of the former capitalist civili-

zation has been removed; but in trying to solve their problems the

people of this world rediscover democracy and the free enterprise

system. I used this story-and-dialogue form because it seemed to me

not only the most effective way to dramatize the contrast between

communism and socialism on the one hand and capitalism or a free

market economy on the other, but the most effective way to explain

some of the fundamental and even abstruse problems involved in the

choice.

The theme of the book might also be stated in the form: If capital-

ism did not exist, it would be necessary to invent it—and its discovery

would be rightly regarded as one of the great triumphs of the human

mind."

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I would not buy gold (or any form of gold paper) and let someone else hold it. It is too easy for them to sell the same gold more than once.

The small premium to get the real thing is easily worth it.

I like gold mining stocks, because I feel confident that the companies aren't selling more shares of their stock than they admit.

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Why? Is it legal to tell someone you are holding their gold and sell it at the same time?
No, it would be illegal for someone to do that. The question is whether one would trust the other party to act legally. Personally, I would only trust a few of the really large institutions -- like GLD. Here too, if I were preparing for a really widespread collapse of institutions, I would want to have the gold in my possession.

OTOH, if I were not getting ready for such a collapse but merely speculating on the price of gold, trading some options or futures may be the way to go. I would check whether trading options or futures could be a cheaper way when compared to the difference between the buy and sell price of physical gold. As I say, this is not something I would do if I was someone who thought some world-wide (or even US-wide) institutional collapse was coming.

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With options and futures, you are controlling a *lot* more gold or silver or platinum. If you want it for delivery you cannot beat the spread, but of course you'd be paying for gold in (say) December at whatever price it is in October. Not a bad deal if it's going up, and you aren't impatient. But you have to buy 100 oz at a time (1000 for silver, 50 for platinum). Then when it's time to cash it in, you are going to have to do it all at once, since you probably got a single big bar as your delivery. (Which is not so bad unless it's a hyperinflationary scenario...on the sale, you'll be left with more money than you can spend right away, and it's dwindling in value rapidly--so you end up buying smaller coins and bars to keep it safe, and *then* you end up paying the premium you were so smug about avoiding. All in all, though not a bad way to go if you do NOT expect hyperinflation.)

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Why? Is it legal to tell someone you are holding their gold and sell it at the same time?

Isn't this just the same thing as the leveraging that banks do - loaning the same thing (dollar or gold) out to multiple people, hoping that they won't all ask for it back at the same time?

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Isn't this just the same thing as the leveraging that banks do - loaning the same thing (dollar or gold) out to multiple people, hoping that they won't all ask for it back at the same time?

Banks loan the same thing to multiple people? That sounds not just legally, but even physically impossible. But even if it were, Scott is talking about selling, not loaning, so it couldn't be the same thing.

FRB can be a legitimate practice, unless done with government backing.

Also, to Scott: with storing gold in your home (or anywhere else), why would you put more trust in the Police preventing criminals from stealing your gold, than in a major firm (and of course the authorities as well) keeping it safe? In both scenarios the only thing you can depend on is the Law.

Edited by Jake_Ellison
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Also, to Scott: with storing gold in your home (or anywhere else), why would you put more trust in the Police preventing criminals from stealing your gold, than in a major firm (and of course the authorities as well) keeping it safe? In both scenarios the only thing you can depend on is the Law.

I'll run with that.

Is it always the police "protecting" one's property? I would state that I am the first line of defense for my property. Police are more there to pick up the pieces and act as the government's arm of force IF they could arrive in time. Yes, they could investigate.

My thoughts have been around access. If things did hit the fan, how would one gain access, let alone contact the firm depending upon the level of some kind of breakdown, to get one's silver/gold? There might be some thoughts to keeping it in a local safe deposit box. Why not put it in a secret location in a fire proof safe in one's house? Insured even.

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I'll run with that.

Is it always the police "protecting" one's property? I would state that I am the first line of defense for my property.

Sure, you are the first line of defense, if you're at home and armed. But are you the main defense? I don't think so. Without government protection, you would be easy prey to criminal gangs. Without you protecting yourself, you would still be pretty safe, because of government protection. So, the main factor in that equation is the Law, not your sidearm.

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Sure, you are the first line of defense, if you're at home and armed. But are you the main defense? I don't think so. Without government protection, you would be easy prey to criminal gangs. Without you protecting yourself, you would still be pretty safe, because of government protection. So, the main factor in that equation is the Law, not your sidearm.

All of those things apply to a safe deposit box and a company that would charge for storage. None of us (myself, the bank, or the gold company) have a monopoly on force. Banks in my area seldom have anyone inside after hours, and they don't have armed guards even. I don't have a vault. So, that cuts both ways. A vault is a known location, so if one had knowledge of something in the vault, that would be the place to go. Maybe even by government regulation... I don't know specifics on how the US government leveraged gold out of private hands in the 30's...

Back to personal ownership, easy prey to criminal gangs would still require knowledge of a specific location in one's house.

Personally, I don't have a substantial amount of gold/silver, but there is an attractiveness to it that I'm exploring. Seems reasonable to keep it home for easy access with multiple secure locations in the house, etc. Follows that confusion of the location would be protection.

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Silver and Gold - How do you measure its worth!

Some older figures here. In 2004 the population was estimated to be 6.4 billion people. With 153000 tonnes estimated mined in history and 32150.75 oz/tonne yields 4,919,064,750 troy oz or a smidgeon over 0.75 troy/person.

Compare that to 80 trillion Federal Reserve Notes divided amoungst the US population yeilding 269,896.06 FRN's/person, we can see that they just do not make dollars like they used to!

Again, to try and extrapolate this world wide would be ~48,076.92/person.

In addition to being homogeneous and divisible, another desirable quality would be rarity.

This would only be part of the equation. Austrian economics lays some good groundwork in understanding the 'subjective' side, if you will.

As a sidenote:

In the USA, ~1% of the population controls ~38% of the wealth.

If the US still has ~1.25 billion tr. oz., ~3 million people would control just under 164 tr. oz.

In the world, to extrapolate, 64 million people would control just over 29 tr. oz. (~1%/~38%)

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To the OP:

Be cautious in financial speculation, regardless of the commodity. Also, I would urge you to consider carefully the objective value of gold as money vs. the objective value of gold as an investment. Its value as the former: fungiblity, high store of value, scarcity are not necessarily the qualities one seeks in sound investment. I would highly recommend a book by Benjamin Graham called The Intelligent Investor. Warren Buffett has also written a bit on the value of gold as an investment.

Keep in mind you can learn just as easily from a $500 mistake as you can from a $50,000 mistake.

Edited by Mixon
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To the OP:

Be cautious in financial speculation, regardless of the commodity.

Thanks. Here are two of my premises, which I lay out for checking:

1) The only alternative I've set up for myself is cash

2) Gold and silver are going to do better than cash in the long run, and even in the moderately-short run. (Why wouldn't they? dot dot dot) Thus even if we're in a bubble and, say, yesterday's sharp decline continues, I can just wait until their perceived value relative to the USD bounces back.

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