In this article I’ll be addressing two important questions about gold; the sources of demand for gold and why gold should have a place in your portfolio.

For decades Warren Buffett, has been an outspoken opponent of owning gold. Gold said Buffett, “gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

However last week Buffett disclosed that his company has purchased about $500 million in Barrick Gold, one of the two largest gold miners in the world. Buffet’s disdain for gold is so well known that his willingness to buy shares in Barrick seems like a religious conversion. We’ll discuss Buffett’s purchase in next week’s article.

There is certainly some truth in Buffet’s criticism of owning gold. Gold pays no dividends and it will never split into more shares like a stock can. On the other hand, gold cannot go bankrupt because of mismanagement. Nor can it lose market share or become less profitable because of changing trends. Gold’s value will always fluctuate in relation to other assets but its value can never go to zero.

Gold may not pay financial dividends but it can offer other benefits. For the entire history of mankind gold has been the favorite metal of choice for jewelry and art. It is universally recognized for its aesthetic beauty and it is incredibly malleable. You can melt it, pour it into a form, shape it, carve it, hammer it as thin as paper, and buff it to a glorious sheen. Jewelry demand has been the bedrock of the gold industry for thousands of years. Although not what it once was, jewelry demand still accounts for 50% of all gold demand.

The following chart is a bit dated but it remains accurate in terms of showing the regular demand for gold from jewelry, investment, and technology.

In my previous article I noted that Gold has outperformed the S&P 500 and US Ten Year Treasuries quite handily since 2000, yet gold accounts for barely one percent of investment portfolios. Yet more and more people are choosing gold as a part of their investment portfolio because of the diversification it offers.

 

It is commonly thought that gold is a strong hedge against inflation. This mindset was forged in the 1970’s and 80’s when gold soared from $35 to $800 during the worst inflation scare our country has known.

 

After bottoming around $275 in 2000 gold has soared to $2,000 this year after a two decade period not marked by inflation, but disinflation. 

 

This brings us to what I believe is the main driver of the gold price today. It is not inflation or disinflation, but the loss of confidence in government.

 

Governments all over the world are producing debt like eggs in a hen house. The worst part is, just like the hen house where the eggs never hatch (there’s no rooster, get it?), our debt doesn’t go toward economically stimulative projects. It’s the worst kind of debt. It bails out bad companies and bad ideas. It produces nothing. And it’s gotten to the point that governments have made a mockery of their budgets, their bond markets, and worst of all their currencies. Is it any wonder citizens don’t trust their governments?

 

US debt has exploded. This chart goes to the beginning of 2020. Add another $4.6 TRILLION and you bring it up to date. I get dizzy just looking at it. The vast majority of this debt has been accumulated in the last 20 years. There is obviously no intention to ever pay it off.

The rise in global debt is just as alarming. Global debt zoomed past $250 trillion last year just in time for an economic depression thanks to the Coronavirus. So, governments are most in debt when they have a greatly reduced capacity to service that debt. Central bankers have picked up the slack by printing trillions. Is there an end in sight? If there is, I don’t see it.

 

Enter gold.  People around the world are adding gold to their investments as a safety net against government financial recklessness. Governments can destroy their currencies through money printing, but they cannot erode the value of gold. This is a fact: every currency in the history of the world has failed at some point in time. Gold has survived them all and is still considered money by billions of people.

 

(this is a 5 million Greek Drachma note my grandfather picked up after WWII when the currency was hyperinflating)

Speaking of central bankers, a new buyer has stepped up to the gold counter and they have very deep pockets. Since the 1980’s the world’s central banks have traditionally been net sellers of gold. The Bank of England infamously sold 410 tonnes of its 715 tonne hoard for $275 an ounce. Their poor timing cost the central bank at least $27 billion in liquidity.

 

But look who’s come to the party! Since 2010 the world’s central banks have been net buyers of gold. Not only have they been buying, they have bought consistently and at times, voraciously. Ever since the Great Financial Crisis of 2008-09 central banks have been exchanging their own (in my view worthless) printed currencies for a timeless tangible tingling asset called GOLD. Why would they do that? 

 

From 2002-2009 CB’s sold $53 billion in gold only to buy it all back since then (and more) at much higher prices? Again, I ask, why would they do that?

I’m sure there are several reasons that contribute to their new found conviction, but the most compelling reason is that most nations know that their currencies are becoming increasingly worthless due to their massive money printing schemes. Gold provides a time tested physical reality to central bank integrity in a world where money can literally be created out of thin air.

 

Next Week: Why Warren Buffett’s purchase of gold miner Barrick is such a big deal and why you should consider adding gold to your investment portfolio.