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Monday, February 9, 2009

Gnome-o-gram: All the Gold in the World

In earlier gnome-o-grams, I've discussed gold as an asset of ultimate refuge in a portfolio, and tried to visualise the trillions of U.S. dollars now seemingly being routinely voted in “bailout” and “stimulus” packages.

Now, let's try to pull these two threads together and, in the process, imagine what may happen to the price of gold should investors lose confidence in paper money and investment vehicles denominated in fiat currencies and begin a flight in earnest to the only asset which has preserved its purchasing power over millennia. The essential property of gold which makes it a long-term store of value is not its mellow yellow glow, but rather its rarity and cost to mine and refine. Unlike paper money, which can be printed at essentially no marginal cost, the amount of gold in existence is, over the short term, essentially constant, as new production in any given year is a tiny fraction of the already-mined gold.

So rare is gold that the total amount mined since the beginning of human history is just 145,000 metric tonnes. Of this, about 19%, or 27,550 tonnes, is held in the vaults of central banks around the world as gold reserves. Now let's compare the value of this gold, at current market prices, to that of the paper money being created out of hot air these days.

Gold is usually priced by the troy ounce (approximately 31.1 grams), and the price of gold at this writing was around US$890 per troy ounce. Doing the math, this is equivalent to US$28,614,164 per metric tonne, so we can immediately calculate that the value of all the gold held as reserves by all of the nations of the world amounts to US$788 billion. Or about as much as the typical bailout or stimulus bill before the U.S. Congress in the last year. The present market value of all the gold in the world, from Fort Knox to the wedding band on your finger, is just US$4.14 trillion, or around half of the bailouts and stimuli to date, with much larger sums expected in the future.

The key thing to take away from this number crunching is that at its present market price, all the gold in the world is comparable in value to the quantity of new paper money being created by politicians on a routine basis as they try to spend their way out of a debt liquidation crisis created by precisely the same policies they're proposing as its solution. And it means that if holders of all that paper money suddenly lose faith in the government pixie dust that backs it and opt for an asset which, notwithstanding its vertiginous rises and falls, has never, ever gone to zero, there isn't all that much gold to go around compared to the oceans of paper money chasing it. One might, then, expect its price to rise.

Again, recall the perspective which informs these scribblings: preservation of capital. If you own gold and there's hyperinflation, you haven't “made a killing” if your gold goes from 900 dollars an ounce to 100 billion; if the same ounce of gold still buys the same amount of goods you're interested in buying, you haven't made a profit at all, only escaped the pauperisation which befell those who placed their confidence in the politicians and their printing presses. You may, of course, in such an apocalyptic situation, end up comparatively better off than others and be in a position to acquire assets at once in a lifetime bargain prices, but the primary goal is to survive the worst, not to profit from the misfortune of others.

If you expect a rush to gold in the offing, gold and stocks of gold mining companies may be excellent vehicles for speculation, but we don't do speculation here (which is not to say that I don't indulge in it myself, for my own account).

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Posted at February 9, 2009 22:52