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There's GOLD in them thar hills! But not for me.



December 15, 2006 – Comments (3)

Gold gets mentioned quite a bit here in CAPS - and a lot of Fools have a lot of opinions, so I thought I'd share mine.

Gold is one thing I've never invested in, and I don't have any plans to start now. Sure, I do have one underperform call on a gold play (though it's more of a 'junk business' play than a gold play), and one outperform call on a Brazilian company that has some mining operations, but gold, as an investment? Not for this Fool.

The reason?

While gold is a great inflation hedge, that's about all it is in my opinion. When one invests in gold, one is not investing in what I call an economically generative act. Gold bullion just sits there, and while it can go up or down in price, it doesn't actually *create* wealth.

Companies, however, do create wealth by taking a bunch of inputs, and adding value - with the output of greater value to the business, and society, than were the inputs. In the long run, investments (like businesses) that actually *create* wealth are going to prove to be far, far better investments, in my view, than things like gold bullion which don't.

Now, this isn't to say that mining companies don't create wealth. They most certainly do. They add value by taking a resource of little value (gold buried under the earth's surface) and add value by extracting it and turning it into something far more useful (gold above ground that can be used to make jewelry, among other things).

So if I ever were going to invest in gold or other precious metals, I'd do so via investing in mining companies. At least there, in addition to the fluctuation in gold prices, I'd be investing in an economically generative act - and one that should, in the long run, if one chooses the right company, outperform an investment in gold itself.

3 Comments – Post Your Own

#1) On December 15, 2006 at 3:58 PM, 11Below3 (30.39) wrote:


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#2) On December 18, 2006 at 1:28 PM, metoo105 (27.94) wrote:

Ah, but what does it mean to *create* wealth? And what counts as an "economically generative activity"? Does the market participant act in an economically generative mode when he or she adds to market liquidity by buying and selling on open markets with greater frequency than most folk? Has not one "created" wealth, when through one's participation with the collective action of others reset a price upward where the "intrinsic value" of an asset ought to have been before? And lastly, is there not an economically generative act in storing something - maintaining possession, preserving by avoiding its waste by others, ensuring chain of title -- for prospective use at a later time?

These are fuzzy questions with fuzzy answers as I assume your asterix were meant to express.

One clear disadvantage of the miners is that they are and theoretically should be much more price sensitive to the underlying price of gold unless they are able to hedge with perfect accuracy their entire future production. So assuming that the shape of future prices takes a normal shape, when gold walks one, miners often walk two, which is a disadvantage, and which, I believe, should depress the "intrinsic" price of the asset somewhat according to finance theory. A corollary of this, aside from the volatility, is the threat of your investment going all the way to zero, since if the cost of production at a particular miner is close to the price of gold, then a fall from $600 to $300 could send a mining company into bankruptcy, but your coins would still be worth something.

This is not to say that I disagree with anything you've written. I agree that mining companies are the way to go if you've got some kind of secular view on the price of gold. The problem with any gold investment is that the penalty for making a mistake is too high.

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#3) On December 18, 2006 at 2:11 PM, scosan (22.03) wrote:


Ditto on the gold comments. I'm a cash flow buyer. Gold tends to be a supply/demand proposition. I remember when gold traded around $950/oz in 1980. Now it's $600 - or a loss of 30 % in 26 years.

Compare that to any of the "good" stocks over the same period and one will understand why Cash flow is king.

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