The Other Reason to Own Gold

Mar 14,2008 – Everybody knows that gold is an inflation hedge. That’s why most people buy it. They know from experience that the purchasing power of all national currencies is being constantly eroded by inflation. But they also know that their purchasing power is preserved by owning gold.

For example, the price of crude oil has been rising for decades when viewed in terms of dollars or any national currency. But when the cost of a barrel of crude oil is viewed in terms of ounces or grams of gold, its price is essentially unchanged. In other words, the dollar price of crude oil and the dollar price of gold are both rising more or less lockstep.By owning gold instead of US dollars, you can today purchase basically the same amount of crude oil as at any other time since 1945.

In other words, gold is an inflation hedge. But that is only one of gold’s advantages. There is also another valuable reason to own gold, and significantly, this other reason is becoming increasingly important.

Gold is also a catastrophe hedge. Gold enables us to protect our wealth from a financial meltdown because it does not have counterparty risk.

I wrote about counterparty risk last August in an article entitled “As Financial Tremors Reverberate, Focus on Counterparty Risk“. I recommend re-reading that article for a refresher course on the nature of counterparty risk and how it arises. It is I think important to recognize that the financial tremors are indeed reverberating, and are doing so with growing ferocity.

The monetary and financial system is rapidly spinning out of control. We are witnessing the unwinding of decades of reckless credit expansion. Borrowers – corporations, hedge funds, homeowners, etc. – who no longer have the financial capacity to repay their debts are defaulting on their obligations in increasing numbers. In that environment, the safety of one’s wealth becomes paramount, to protect against the catastrophe of default in all types of financial assets.

In short, promises are being broken, so in an environment in which financial assets are becoming increasingly doubted, one needs to own tangible assets. Own things instead of promises, and there is only one money that is not dependent upon someone’s promise and that’s gold. So buy gold; it is the best catastrophe hedge. But also buy gold because it remains the best inflation hedge.

For example, gold was $670 on August 10, 2007 when my article on counterparty risk was published, and crude oil was $71.50 per barrel. When viewed in terms of gold, crude oil was 3.3 goldgrams per barrel.

Gold today is $992, and crude oil is $109. So both prices have risen considerably in dollar terms, but the price of crude oil today is 3.4 goldgrams per barrel, essentially unchanged from last August. Gold performed as expected, being a nearly perfect hedge against inflation.

So when considering all of its advantages, gold provides what everyone wants – peace of mind knowing that the portion of your wealth placed in gold is safe.