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Sunday
Jul242011

Silly Reasons Not To Invest In Gold

We are currently bullish on gold. We would not consider ourselves gold bugs or perma-bulls. Sometimes we think gold prices go up, sometimes down, sometimes sideways and we place trades to reflect our view at the time. The purpose of this article is not to place gold on an alter and worship it, we are simply aiming to dispel some of the mythical reasons put forward by gold perma bears as to why one should not invest in the yellow metal. Once these reasons are eliminated from one's analysis, then one can form a more accurate view on whether gold prices are going up or down. Keeping these arguments in one’s decision making process will only make for distorted analysis.

We scoured the internet looking for reasons not to invest in gold and now present the reasons that we think should be eliminated from the bearish side of the debate.

The most ignorant reason we could find not to invest in gold was that apparently gold can be easily manipulated. According to this bizarre argument, “unlike paper currency that is impossible to manipulate in any way, gold can be accumulated by a group of connected buyers for the sole purpose of eliminating supply from the market.” The author then went on to cite the Nelson Bunker Hunt’s attempt to corner the market as an example.

We will concede that a driver behind silver hitting $50 in 1980 was largely due to the Hunt’s efforts to corner the market. We will also concede that central banks could dump their gold holdings on the market and this would decrease the price. However saying that paper currency is impossible to manipulate is one of the most preposterous things we have ever heard. Paper currencies are designed so that they can be manipulated by central banks. The central bank controls the supply of and interest rate earned on the currency. Gold has no interest rate, so cannot be manipulated in this way. Gold is also in limited supply and cannot be printed at will by central banks.

In the interest of putting the author’s arguments into context, they were written in March 2009 and gold prices have increased more than 50% since then.

Another amateur argument against gold is that for some 20 years (1980-2001), gold prices did nothing and anyone who had invested in gold would have lost money. Anyone who uses this argument clearly does not understand one of the fundamental features of financial markets. Markets are cyclical in nature and assets undergo both bull and bear markets. To put this as simply as we can, prices can go up or down.

To say that gold did nothing for a 20 year period and therefore is not worth investing in now (ignoring its terrific performance in the last ten years and the bull market that preceded 1980) is ridiculous. Market conditions change constantly. Sometimes they are bearish for prices, sometimes they are bullish. One must assess these conditions to form a view, not just extrapolate a trend from a handpicked segment of time.

Perhaps a more reasonable argument for not investing in gold is that it provides no income. In fact it almost always costs the investor to hold gold. This is sometimes referred to as “negative carry”. By purchasing gold the investor has forgone the interest that his/her money could have earned in the bank. They may also have to pay storage costs for physical bullion or a management fee for a gold ETF or other fund. However in today’s market environment, the interest foregone is minimal and some may even consider it negligible.

For example, instead of investing in gold one could have instead bought a risk free asset such US Government Bond. But with 2 year Treasuries yielding just 0.35%, is it really that big of a deal?

The point is that although it will cost you to own gold, this cost is dwarfed by the capital gains that one could enjoy. One does not invest in gold for a stream of income, as one might invest in stocks or bonds. Given that gold gained around 30% in 2010, chances are you shouldn’t be too concerned about forgoing the interest that money could have earned in the bank nor dividends that could have been earned in the stock market.

One of the most common anti-gold arguments put forward by those who do not understand gold is that one should not invest in gold because it has no utility. Oil can be used as fuel, corn can be eaten, steel can build bridges and buildings, but apparently all gold is really good for is looking pretty and a few dentistry applications. The major oversight here is that although gold may have some attributes that apply to commodities, it’s primarily function is as an alternative, independent, impartial currency.

The very fact that it doesn’t have many uses makes it a suitable currency substitute. Oil cannot be a currency as one day we will run out of oil. Corn cannot be a currency as we grow and consume corn so there is not a stable amount in circulation. Metals such as copper are not suitable as they are often “used up” in industries such as constructions (here we are using the phrase “used up” to indicate that copper would either be inside walls as wires so it cannot be removed and traded, or has been used in the manufacturing of a product where the cost of recovering the copper is higher that the market value).

Gold’s value comes from the same fundamentals that other currencies derive their value. It’s a function of purchasing power, global interest rates and inflation. Gold can even be thought of as a currency where the central bank that controls it has set interest rates are zero forever and fixed the money supply forever. In an uncertain world, the certainty surrounding gold makes it a strong currency.

Perhaps the most famous reason not to own gold comes from perhaps the most famous investor of our time; Warren Buffet. Buffet is an outstanding investor with a stellar reputation and we do not wish to take any credit away from his remarkable achievements. However Buffett shuns gold as an investment as he believes it has no utility. We would agree that gold has not utility in that it cannot be made into energy like oil or eaten like corn, but that is not the point. Gold is more a currency than a commodity. So how much utility do British Pounds have? Or US dollars? Or Yen? They have no more utility than gold. One cannot eat or use any of these currencies, so how are they different from gold? Would Buffet refuse to hold any currency since they have no utility? Of course not, but he would not view gold as a currency.

We will concede that other currencies pay interest, but they interest is minimal in the current environment. Gold is a store of value. Gold is a currency. Gold has no utility, which is what makes it a suitable alternative currency.

A classic argument for not buying gold would be that it has gone up significantly over the past decade. People do not want to buy when prices are high, they want to buy when prices are low. This is a reasonable argument. However following that theory, all those who subscribe to it would have been buying gold in the late nineties and over the turn of the decade, therefore they would have enjoyed significant profits to this point. But the reality often is that those who use this argument have never owned gold.

So whether you are bullish, bearish or neutral on gold prices, we would suggest that you take these reasons out of any analysis you are doing. These reasons are irrelevant and those who use them really do not have a solid understanding of the dynamics of the gold market. If you have a bearish view on gold and it does not include any of the reasons above, then that is fine. We are bullish on gold, but we could be wrong and everyone is entitled to their view. However in our opinion using these reasons as an argument not to own gold will result in distorted analysis and an invalid conclusion.

At SK Options Trading we have a strong focus on gold and we provide our subscribers with simple straight forward trading signals as well as market updates and commentary. Our signals are executed on US options based on ETFs, so are exactly the same as regular stock options.

The key stats on the performance of SK OptionTrader are as follows:

Our model portfolio is up 338.11% since inception That's an annualized return of 117.00% We have an average return of 40.41% per trade including losses We have closed 81 trades, 78 closed at a profit The average trade is open for 46.27 days

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