The faith-based metal
Nov 2, 2010
Below is an excerpt from a commentary originally posted at www.speculative-investor.com on 31st October, 2010.
The following note about gold was included towards the end of Jeremy Grantham's Q3-2010 Letter:
"Everyone asks about gold. This is the irony: just as Jim Grant tells us (correctly) that we all have faith-based paper currencies backed by nothing, it is equally fair to say that gold is a faith-based metal. It pays no dividend, cannot be eaten, and is mostly used for nothing more useful than jewelry. I would say that anything of which 75% sits idly and expensively in bank vaults is, as a measure of value, only one step up from the Polynesian islands that attached value to certain well-known large rocks that were traded. But only one step up. I own some personally, but really more for amusement and speculation than for serious investing. It may well work and it may not. In the longer run, I believe that resources in the ground, forestry, agriculture, common stocks, and even real estate are more certain to resist any inflation or paper currency crisis than is gold."
We agree that gold is a faith-based metal, although we don't like the term "faith-based". It is more appropriate to say that gold's value is not primarily determined by how much of it gets consumed in industrial, commercial or digestive processes. Gold is not "mostly used for nothing more useful than jewelry", as Grantham claims. It is mostly used as a store of purchasing power. And at a time when there are good reasons to believe that the official money will be subject to increasingly rapid inflation, a reliable store of purchasing power is extremely useful.
While it is true that commodities other than gold can be reasonable stores of purchasing power, gold is best suited to the role. One reason is that so much of it "sits idly" in vaults. The fact that industrial/commercial uses account for only a tiny fraction of its total demand makes gold the only commodity that can be accumulated in large amounts by investors without adversely affecting the economy.
Of course, the reason there is so much gold sitting idly in vaults is that gold has proven itself in the past to be extremely useful as a store of purchasing power. This usefulness relates to its physical properties. For example, it is much easier and cheaper to transport and store $10M worth of gold than to transport and store the same dollar amount of oil or base metals. For another example, diamonds offer the advantage of being cheap and easy to transport and store, but for many people diamonds are disqualified as convenient depositories of purchasing power by their lack of homogeneity (every diamond is different and it takes an expert to assess the monetary significance of the differences) and divisibility. The precious metals (gold, silver and the platinum group metals) are really the only commodities that have near-ideal physical characteristics to be stores of purchasing power, but the platinum group metals must be immediately eliminated from consideration by the fact that all of their supply goes to satisfy industrial/commercial demand.
Land, especially land that generates an income from the production of crops, livestock or timber, could turn out to be an excellent store of purchasing power over the next 10 years, but land has the disadvantage of being illiquid and immobile. You couldn't, for example, move your land in order to sidestep an adverse change in the political environment, and you might not be able to sell it in a hurry.
Common stocks can be good investments if bought at reasonable prices, but they aren't reliable stores of purchasing power. One reason is that the real return provided by the shares of a company will largely depend on the decisions made by the company's management. One wrong decision by management could wipe out a lot of purchasing power.
In summary, Grantham is correct when he says that gold is a "faith-based" metal. Like paper currencies, gold has no "intrinsic" value. Grantham's mistake is assuming that gold's lack of use in industrial/commercial applications makes gold useless. The reality is that a reliable, convenient and widely-accepted store of purchasing power will be very useful at all times, and will deserve a hefty premium at times when a policy of currency depreciation is being aggressively pursued by the stewards of the official money.
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