Why buy Gold?

Easy to answer.

Notice the housing bubble going on around you? Have YOU lived through a housing bear market where house prices actually DROP? In South Africa it's starting, round about now - the end of 2006. I sold my house 12 months ago and could buy it back today for what I paid for it. Which means someone is making a loss somewhere given transfer duties (sorry, state thievery), property taxes (more thievery) and interest paid to banks on the loan on the house (no comment here!).

Take gold as an investment though. Gold pays no interest. All that you have is capital appreciation. That's it. Nothing more, nothing less. At least a bank account pays interest, right? Surely something that pays interest is better than something that pays absolutely no interest whatsoever?

The answer, as with most things in life, is simple this: It depends. Let me explain why YOU need to understand exactly WHY it depends!

It's called inflation. Gold Loves inflation.

Take R100 or $100 or whatever. Chuck it into a bank account for maximum interest. In South Africa as our interest rates (inflation) is higher than most the current central bank interest lending rate is around 8%. Banks will charge their best customers about 43.75% more than this (nice profit margin there) - a rate of 11.5%.

This is the rate at which you and I can borrow money, if we are PRIME customers.

But for our example, the interest paid on deposits is around 7% or so. So after a year your 100 of whatever currency will have grown to 107.

The theory behind this is simple enough. If inflation is less than 7% you will be able to buy more for your 107 currency units at the end of the year than at the beginning of the year when you only had 100 of them. If inflation though, is greater than 7% you will be able to buy less - leaving your worse off for not having spent your money sooner.

And so we get into the great inflation debate.

Gold has love of inflation. Inflation is poorly understood by the man in the street and frankly, my personal belief is that if the man in the street DID understand it we'd be back on the gold standard in a heartbeat and there would be some very dead politicians, shot against the proverbial wall in the revolution that would follow.

Inflation is very simply this. Government prints up money. In effect it creates wealth out of thin air. When we had a gold standard, government would only be able to print money to the amount of the increase in gold. And yes, South Africa (!) no longer has a gold standard - you'd be surprised how many people seem to think we do! Hence, each unit of money (in this case a South African Rand) could be swapped for a (small) amount of physical gold.

Try that today. If you go to the Reserve Bank and ask for gold in exchange for your Rand, guess what you'll end up with? A swift frog march out of the building and peals of derisive laughter.

That worries the living daylights out of me. Because, really, when all is said and done, what is a Rand really worth?

The answer is: Your Rand is worth precisely NOTHING. The only value it has is that which we have all been conditioned to give it. Nothing more, nothing less. It is propped up on faith alone, a faith that we can use Rands to exchange for goods and services.

Inflation is the process by which more currency ends up in circulation. Because our central bank makes as much of it as it likes, the overall quantity of money in circulation 'inflates'. Hence the 'value' per unit drops - as measured against what it can now purchase (seeing as how we have no gold to back it up any more). Government can literally print itself stupid - Zimbabwe is a case in point - each Zim dollar printed is de valued by 1200% a year. The solution? Stop printing money! The pain of the economic aftermath will be substantial I can assure you, but it's coming anyway.

Fortunately we're not alone. The lumpen working masses don't know any better. We all continue to use currency to pay for things. No one goes to the store and whips out a Kruger Rand to pay for the groceries.

No! We whip our credit cards, pay for the stuff with our currencies and that's that. That worries the living daylights out of me. We're buying things and paying for them with something that's utterly worthless. And the only thing that keeps the illusion up is that everyone else is doing it - the herd mentality!

Getting back to inflation.

Now we have our reserve bank targeting inflation as if it is a bad thing (it is) at a rate of between 3 and 6% annually. How do they measure inflation as a matter of interest? Do we really know? Do we really WANT to know?

Consider your 107 currency units after a year. Do they buy you more, or less, of the stuff YOU use. If we think about spending it on petrol, guess what? After one year you'd be down around 23% - that's how much petrol has gone up just one year! What about food? Have you measured what the price of potatoes really is, or has become? I think you'd have a nasty shock to be honest.

Government generated inflation figures, and in fact ANY government generated figures I automatically double if they are not in my favour, and I halve them if they are in my favour. After many years, I'm about right with what has been happening to MY money out of MY back pocket. So my guess is that right now with an 'official inflation rate' of 4.5% the reality for actual human beings who work and earn and spend actual money the rate is around 9%.

Saving money in a bank will make you poorer. No question, no argument and no debate. Ned of story. You can argue until you are blue in the face - and you will be wrong in 100% of all cases.

So why Gold then?

I stated earlier that gold loves inflation. Why?

It is because all currencies that are not backed by gold have failed. Every single one. One of the longest lasting is the US Dollar. The fact that it is one of the longest lasting 'currency backed by nothing but faith experiments' you might have guessed by now worries me. Faith is reserved for religion and deities, not men who print money and ask us to 'believe in them because this time it's different!'. Deities earn our faith, fallible men in power deserve our scepticism.

In pre BC an ounce of gold could buy a man a good set of clothes. Today, an ounce of gold can do the same. A dollar in 1920 can not buy you the same things in 2006 it could buy you then. In fact, it can buy you less than 3% of what it could in 1920. And in real terms gold should be priced at over $2000 an ounce to keep up with it's true intrinsic value.

Against the backdrop of history there is only one store of value that has endured as long as man has. It is gold. Paper backed currencies, conch shells, animal skins  and other stores of value have ALL failed. Every single one and the lesson is repeated ad nauseum. We are doomed to repeat it, and soon. Sentiment is changing slowly, and when it does there will be a rush to gold the likes of which the world has never seen (because we have never had as deeply a troubled paper based currency as the dollar).

And because in 2 or 3 or  5 or 10 years time I'd like to know that my money can still buy me what it is worth today (with hopefully some capital appreciation thrown in) I recommend you buy gold.