A Rational Reason to Buy Gold

By Dr. Steve Sjuggerud, President, Investment U
Friday, August 1, 2003: Issue #261

Gold rises in times of fear the old saying goes. And it is true. But how exactly do you measure fear?

It’s tough because fear is not rational.

However, right now there is an outstanding and very rational reason for the price of gold to continue rising for a long period of time. It has nothing to do with fear. It’s simple. It could lead to extraordinary profits. And I’ll share it with you today.

No chicken Little Here

Most gold writers push the fear buttons “The world is going to hell in a hand basket – you’d better own some gold,” they say.

I try to stay out of the fear crowd. I’m agnostic when it comes to investments I don’t love gold or love stocks. I just want a good buy. And right now, there is an excellent rational reason to buy gold. You can leave fear out of it.

Gold is attractive now because it’s attractive fear or no fear.
Let me explain

Money Flows Where It’s Treated Best

Gold pays no interest. It’s just a lump of yellow metal.

So if the bank is paying you 7% interest on your cash, then chances are you’ll prefer to have your money in the bank. It makes sense because due to compound interest, in 10 years you’d have doubled your money in the bank. But if you’d held gold instead, you’d still have the same lump of metal.

But consider this Imagine if the bank was paying zero percent interest then which is more attractive, paper dollars or gold? In this case, both pay no interest. And in this case, a rational investor would choose gold. The gold is still the same lump of metal, but a government could print money and make the paper money worth less. It can’t print gold.

Money flows where it’s treated best. If there are high interest rates, then gold does poorly, as money flows where it’s treated well. If interest rates are low or zero, then money flows toward gold. Gold can’t compete with high interest rates. But it is extremely competitive with zero-percent interest.

“But wait,” you say. “How did gold run from $100 to $800 the late 1970s?”

The “Real” Deal… Considering Inflation

If you’re just looking at the current interest rate, you’re not getting the whole picture. You have to consider inflation as well, to get to the “real” interest rate. For example, right now banks might pay you 1% interest. But inflation is 2%. So the “real” interest rate – the interest rate AFTER inflation – is actually negative 1%.

And that explains it all Right now, investors lose money to inflation by putting it in the bank. When faced with -1% interest in cash, or 0% interest in gold, the smart money is choosing to get out of cash and into gold.

Back in the 1979, short-term interest rates were 8%, but inflation was 13%. That means your “real” return was negative 5% a year on your cash. Gold went from $100 to $800 in no time.

Then at the end of the decade, Fed Chairman Paul Volker drove short-term interest rates through the roof. By 1981, short-term interest rates were 15%, and inflation was back into the single digits. That means investors got an outstanding “real” return on their money and gold tanked, back into the $300-plus range by 1982.

The Present Situation is Like the 1970s

Back in the 1970s, the “real” return on cash (the return after inflation) was negative. So money flowed out of cash and into gold. Today, for the first time since the late 1970s, we’re seeing the same thing. The “real” return on cash is negative.

It’s gold time. No fear-mongering necessary.

Good investing,

Steve

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