Friday, November 19, 2010

Talking about Gold and Silver - Part 2

I did receive a few reactions to my article on gold a couple of weeks back.

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 Some of the main objections:


1)      Gold has no use for it, in the same sense that other commodities do – people don't need it to perform any useful function.  Its value depends on what people are willing to pay for it.

2)      A return of 6 to 7 percent in dollar terms and 11 to 12 percent in rupee terms is not really high


There are other objections usually advanced as well. That Gold is a dead investment, it's just a piece of metal with no productive use, prices are already high and where will it go from here…  Strangely, no one talks of silver much – it doesn't seem to evoke so much interest as gold.


Which is why in the history of the world more people have died fighting for gold than for any other cause – except religion of course!


Talking of gold not being of much use – is that not a desirable thing for something that is used as a store of value and a medium of exchange? Of what intrinsic use is the rupee coin you have? Historically, people across cultures have experimented with various forms of currency and the attributes that are required are:

                The sovereign cannot just print more of it whenever he wants (this is critical – we'll touch upon this again)

                It should not be affected by the elements

                It should be rare – else more and more of it will just reduce the value of other peoples' holdings

                It should preferably not have other uses since you do not want your currency to be consumed – only used to buy things that can be consumed


Gold and Silver have been most used in currencies over the years. It has invariably happened that the value of the underlying metal increases over time while the currency does not hold its value – obviously the coins are then melted for their intrinsic worth!


Governments across the world are just printing money as they wish.  They need this power to print money since it is the means of wealth distribution. Printing more money implies that (a) the value of the money you hold drops, and (b) the money that is printed newly can be deployed anywhere in the economy by the government, i.e., those in power.  They have just used their power of patronage to dispense largesse at the expense of all of us, and we do not even realize it! That's why governments hate to peg their currencies to any external value index.


Read the stories of hyperinflation across the world – Germany and Austria after the war, Argentina, and more recently, Zimbabwe, to see what can happen – and it's not an extreme doomsday scenario.  Well, it is extreme, and it is doomsday, but the way governements across the world are behaving now, it is not very improbable.


A return of 11 to 12 percent over the long term is not small. It is certainly a little higher than inflation. There is a lot of variability in y-o-y return, but we are only considering long term returns here.  Both stocks as well as real estate offer similar or greater returns over the long term. 


Between the two, silver is more volatile than gold. Silver has many industrial uses and a lot of it is consumed. Newer uses are being found for it in nanotech and other cutting-edge advances. Silver prices tend to go down more when economic activity is down, and increase more than gold when economic activity picks up, in line with other commodities.


For the long term I am bullish on gold, and more bullish on silver. Gold and silver should form part of every investor's portfolio – not the whole part of it, not a majority part of it, but certainly a substantial part of it.


How do we go about investing in Gold and Silver?  We shall see that in the next part of this series.


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