Gold is neither a good nor bad investment

Numerous commentaries in the media would have the investment world believe that gold is a bad investment

Numerous commentaries in the media would have the investment world believe that gold is a bad investment.

These articles miss the point because they treat gold as an investment. To fully understand gold’s role in an investment portfolio, we need to adopt a new mindset — a gold mindset.

Simply put, gold isn’t a bad investment or a good investment: It isn’t an investment at all. It is money.

Although many people think that gold is an archaic relic that has no role in today’s sophisticated, computerized, paper-based monetary system, three facts contradict this popular misconception:

• Gold, silver and platinum are traded on the currency desks of the major banks and brokerage houses, not the commodities desks. Traders understand that gold is money to be traded against paper currencies.

• The world’s central banks hold about 30,000 tons of gold in reserves. Although there has been a lot of media attention given to central-bank sales in the past, gold holdings have declined only by about 2,000 tons since 1980. Central banks have become net buyers since 2009 and have been adding gold to their currency reserves.

• The turnover rate among members of The London Bullion Market Association is more than $20 billion per day, with volume estimated at five to seven times that amount. Clearly, this has nothing to do with jewelry sales and everything to do with the exchange of money.

The definition of “investment” is the commitment of money or capital to purchase financial instruments or other assets in order to gain profitable returns in the form of interest, income or appreciation of the value of the investment.

Through this transfer of capital in the expectation of a profit, investors give up their capital and put it at risk. The investors receive a return in dividends or interest as compensation because their capital is at risk; they may get back less than they invested or they may get back nothing at all.

However, physical gold bullion or physical paper currencies locked in a vault aren’t invested; they are simply being stored. As neither is invested, they don’t earn interest or dividends, but they don’t have any counterparty risk.

The major difference between gold and currencies kept in a vault, however, is that gold’s purchasing power increases while paper currencies lose purchasing power year after year.

Both gold and currencies can be taken out of the vault with ease, and the proceeds invested by giving them to someone else in return for dividends or interest.

An interesting perspective can be gained by calculating whether the proposed investment is likely to return more gold ounces than were originally invested. For example, the value of the Dow Jones Industrial Average in terms of gold was 44 ounces in 2000 but has dwindled to fewer than nine ounces today.

You might as well have left the gold in the vault. Because gold maintains and even increases in purchasing power, there is no need to put it at risk in order to earn a minimal amount of interest or dividends.

It is crucial to recognize that physical gold bullion, held directly or on an allocated and insured basis in a vault, is not an investment, because it is not someone else’s promise of performance or someone else’s liability. All other forms of gold ownership, including paper gold certificates and unallocated bullion accounts, are investments.

They may have their place in a portfolio, but they are all investments. We hold physical gold in a vault, we hold physical currencies in a bank, but we invest in financial assets.

Nick Barisheff is president and CEO of Bullion Management Group Inc.