Dear reader, let me leave you with that thought and tell you a small story. Or rather a memory. Or possibly a life lesson.
In the late 2000s and the early 2010s, I was what you would call a bit of a gold bug. This happened because I had read some Austrian school economics that firmly believes in the idea of sound money backed by gold. And those were days when central banks of the Western world backed by their democratically elected governments were printing money left, right and centre and creating it out of thin air, which went against the very idea of sound money that Austrian school economics believes in.
Back then, I was still naïve enough to believe that what I wrote made a difference in changing the minds of my readers. Now, with nearly a decade and a half more on my side, I humour my ego in other different ways.
So, this naivety basically led me to interview all kinds of gold bugs; interviews my editors were happy to publish in the Monday edition of the newspaper I used to work for at the time. As any veteran editor of a business publication will tell you, it’s most difficult to fill up the Monday edition of a newspaper.
And these gold bugs gave me all kinds of forecasts for where the price of gold was headed. It started with a forecast of gold crossing $2,000 per ounce (one troy ounce equals 31.1 grams). Then someone said it would cross $3,000. This was followed by forecasts of $5,000, $10,000 and finally $55,000 per ounce. (I am not sure about this but someone even told me that the price of gold would touch infinity. I wonder what they meant by the price touching infinity. I say I am not sure because I couldn’t Google up that piece.)
Of course, having been in journalism for some time by then I had figured out that people like Big Round Numbers, and hence, such forecasts usually became the headline of these interviews with gold bugs. Nonetheless, the thing is, rarely did these forecasts come with a time frame. They were supposed to come true in the future or a few years down the line. Nobody specified a year. Like gold will touch $5,000 per ounce by 2015, or some such thing.
The trouble was that not even one forecast turned out to be true. In fact, gold reached its then all-time closing high price of $1,895 per ounce on 5 and 6 September 2011. It didn’t even touch $2,000 per ounce. And gold bugs were throwing numbers that were five times larger than that number.
This made me realise that how little I knew in the overall scheme of things (That’s the trouble. The more you know the more you know that the more you don’t know.) And that good headlines were just that. Indeed, just because a lot of money was being printed did not mean that the price of gold would continue going up endlessly. There were endless other factors at work.
As John Kay and Mervyn King write in Radical Uncertainty: “We live in a world of radical uncertainty in which our understanding of the present is imperfect, our understanding of the future even more limited, and in which no one person or organisation can hold the range of information required to arrive at the ‘best explanation’.” But if one starts believing in this, how does one make a living, given that one worked and one still works in the business of explanations.
This lesson from Kay and King has stayed with me since. That little knowledge is a dangerous thing and that ignorance is not bliss. But there is a lot more to it than just this.
*****
Now, why am I writing about gold in this issue of the newsletter? The simple reason lies in the fact that the gold bugs have been coming out of their woodwork in the recent past. And forecasts of gold touching $5,000 per ounce soon are being made all over again.
As I write this on the afternoon of 23 October, the price of gold stands at $2,752 per ounce. The yellow metal has delivered a return of close to 40% in the last one year in dollar terms. In rupee terms, the one-year return has been around 29%.
If you read analyses around this, multiple reasons are offered for this fantastic return.
First, central banks after all these years of printing money left, right and centre are now buying gold, leading to an increase in demand for the metal. As The Economist explains, the share of gold in central bank reserves has been declining for decades, dropping from nearly 40% in 1970 to just 6% by 2008. However, in recent years, it has been steadily increasing, reaching 11% last year—the highest level in over two decades.
Second, the gold bugs have come out of the woodwork and have been buying gold because they believe the world now is a much more unsafe place, with the multiple wars that are on, than it was a few years ago. This is what one would call safe-haven buying. And this has also pushed up the price of the yellow metal.
Dear reader, the more you dig into this topic, the more reasons you will eventually come up with for why the price of gold has been going up and why it will continue to go up. But the most important thing is whether you have invested in gold or not. Because if you haven’t invested in gold then all the reasons for its price rise are essentially useless to you.
Now, what follows is one of the most important investing lessons I have learnt in the last five years of my investing journey, which began in 2005. Most times it’s difficult to predict the direction an asset class will take. Will its price rise? Will it fall? Or will it continue to stay where it is? Because the price of any asset class is the result of what millions of investors who buy and sell that asset are thinking at a given point in time. And predicting that with surety is not possible. Which is why I find it very difficult to take seriously anyone who is in the business of predicting big round numbers.
Slightly misquoting the economist John Maynard Keynes, in order to be able to predict the direction of any asset class successfully, one should know what the average opinion expects the average opinion to be, ad infinitum. And that clearly is not possible.
So the only way to get around this is to stay invested in different asset classes at any given point in time, depending on the level of risk at which you can comfortably sleep at night. Also, the idea should be to take a level of risk that is not ludicrous and something that keeps you in a position where you can continue to take on some risk in the years to come as well.
*****
Now, this does not mean that one shouldn’t understand anything about gold. That’s not what I am trying to say. Consider the following point, which is a rather fundamental point.
What has helped gold to become a part of safe-haven investing is its ‘uselessness’. Despite the fact that it is highly malleable (can be beaten into sheets easily), ductile (can be easily drawn into wires), and the best conductor of electricity, gold does not have many industrial uses like other metals have.
This is primarily because there is very little of it going around. Also, what does not help is the fact that gold is as soft as putty. This softness makes it practically useless for all purposes that need metal. Also, when commodities are used as money they are taken away from their primary use. Therefore, if rice or wheat is used as money for daily transactions and to preserve wealth, it would mean a smaller amount of rice and wheat in the market for people to buy and eat. This, in turn, would mean higher prices of grains, which are staple food in large parts of the world. The same is true for metals like silver, iron and copper, which have industrial uses.
Gold does not have many practical uses. So, if people hoard gold it does not hurt anyone. As the blogger FOFOA put it to me in an interview many years back: “And because [gold] is not used for many things other than mere hoarding, the act of hoarding gold is not an infringement on the natural rights of others.” This uselessness of gold needs to be understood along with what is known as the Lindy effect to understand the point I am trying to make.
Now, what is the Lindy effect? It has been popularized in recent years by Nassim Nicholas Taleb. As he defines it in Antifragile—Things That Gain from Disorder: “For the perishable, every additional day in its life translates into a shorter additional life expectancy. For the nonperishable, every additional day may imply a longer life expectancy.” Taleb offers the example of a book that has been in print for a hundred years and says that it is likely to be in print for another hundred years.
He further elucidates: “The nonperishable is anything that does not have an organic unavoidable expiration date. The perishable is typically an object, the nonperishable has an informational nature to it. A single car is perishable, but the automobile as a technology has survived about a century (and we will speculate should survive another one). Humans die, but their genes—a code—do not necessarily. The physical book is perishable—say, a specific copy of the Old Testament—but its contents are not, as they can be expressed into another physical book.”
How does this apply to gold? How does gold benefit from the Lindy effect? Gold is a non-perishable item that has been around for hundreds of years. A large number of people like to invest in gold whenever they do not feel confident about the political, economic and/or financial system at a point in time. It’s their haven. It has been so for hundreds of years. And safe-haven investing doesn’t take gold away from its primary use because it has no other primary use.
Of course, gold is used to make jewellery, but then jewellery, if you think about it, is also a haven. And that is not going to change one fine day.
This is so well-ingrained in the minds of people that governments can’t fiddle around with the idea of people owning gold as they have with cryptos (this does not mean that governments haven’t tried; they have and they have succeeded as well.) Also, unlike crypto, gold, despite being largely useless, cannot be manufactured from thin air.
Once these things are taken into account, the conclusion that can be drawn is that gold has to be a part of every investing portfolio. Of course, Warren Buffett does not believe in this. He does not like the idea of owning gold. But then, most of us are not as smart as Buffett, or as psychologically competent as he, to be able to carry out value investing of the kind he does.
As Scott Galloway writes in The Algebra of Wealth—A Simple Formula For Success: “Outliers make for great inspiration… but lousy role models.”
Given this, we lesser mortals need gold in our portfolio.
Disclaimer: The writer has investments in gold through a mutual fund and an exchange-traded fund.