Using Gold to Protect Against Disasters

At one time, gold and other precious metals were the only form of stable currency, prior to what the emergence of fiat money. Fiat money has no real intrinsic value and it’s only value is derived by way of government decree as legal tender, together with a desire by the public to obtain it and trade it among themselves in exchange for things of value.

Currency used to be backed by precious metals such as gold, where it could be exchanged for it upon demand, and this added stability to currencies and also inspired more confidence in this paper money. In time, we moved toward pure paper money, and gold is now seen as a separate and distinct form of value.

Gold in itself derives its value from this desire and willingness as a means of exchange as well, and in many ways is similar to fiat money. What separates gold is the fact that it can be used for other things, its industrial uses as well as its appeal for such things as its beauty, much like art is, where fiat money only serves the sole purpose of functioning as money.

Perhaps most notably, people will tend to desire gold more in times of trouble, even the slightest amount, where money and other forms of financial securities tend to be shunned. This is the main reason, for practical purposes, why gold is seen as such a good shelter and hedge against economic crisis both modest and severe.

Wealth has to be stored somehow, and while a lot of wealth tends to be lost during financial disasters, it is currency and not gold that is so subject to this, due to devaluations caused by inflation. Germany once went through a devaluation of their currency so severe that it went from 4.2 marks per U.S. dollar to 4.2 trillion marks per dollar. A billion dollars’ worth of wealth held in marks prior to the hyperinflation was reduced to only ten cents worth in this extreme incident. This shows just how massive the effects of hyperinflation can be.

If one had their money in gold during this time, gold prices were stable, where one would have kept their money safe.

Gold does tend to keep its value during even the most extreme bouts of inflation, and we can say that the value of currency depends upon inflation where gold really does not, at least on the downside of things, the part we worry about.

Gold therefore does serve to be a great hedge against not only inflation in general, but major inflationary moves in particular, and there is no store of wealth that is anywhere close to being as inflation resistant as gold is.

How Much Should We Worry About These Things?

Today’s economies are managed much better than in the old days where there was much more risk of hyperinflation, and central banks act quickly to put out even the small fires, to avoid them getting larger and especially large enough to overthrow their economies.

It is not just these large fires that we need to worry about, and while it isn’t likely that we will go back to the double digit inflation we saw a few decades ago, and these things take quite a bit of time to develop generally, we do need to be aware of the risks of inflation growing and be prepared at least.

The risk of going from a well managed economy to hyperinflation is extremely small though, and prior to financial disasters, disasters of smaller magnitude manifest, so it’s not that we don’t get plenty of warning with these events.

Some worry that physical disasters may precipitate such events, and while such things as global nuclear war may be a concern to some extent, whether you’re holding gold or currency isn’t probably going to matter much, as there will be much more to worry about than wealth protection, staying alive for instance.

Should the worst happen and economies collapse during one of these events, the mechanisms of trade themselves will grind to a halt, and while currency will take a hit, so will gold trading, and the value of gold depends a great deal on the overall market for it, much more so than currency in fact.

You may be able to exchange currency for things in the face of extreme disaster, as currency is more easily exchanged among parties, better than gold is for sure. The amount of currency in circulation will be severely impacted by this, and among those who have stored away larger amounts at home, this could be a real advantage, but less so with those who hold large amounts of gold on hand.

With a lack of government organization, we could even say that preparing for these events with currency and not gold would even be the better option, for those who have so much money and are concerned enough about such things that they wish to have such a contingency plan. Holding cash at home isn’t efficient at all, but if someone is wealthy enough that they don’t care, this might become a good option.

Within a domestic market, currency doesn’t really change value very quickly, and price escalation occurs more gradually, as prices rise and people start requiring higher income to compensate. This isn’t really a concern during massive disasters though as people will still need a means of exchange and it’s just so much easier to spend bills and see them more widely accepted than with gold coins and bars which cannot be broken down into smaller increments very easily.

Gold therefore would have limited value in protecting against these events, and while people may still choose to have some on hand, the benefits are more psychological than anything, but that does count as well.

Gold as Protection Against Financial Disasters

The usefulness of gold in times of trouble depends greatly on the preservation of worldwide financial markets, in other words gold has to be traded as normal for this plan to really work, which would mean that the crisis would not be such a colossal physical event to bring down governments and what we call civilization.

As long as the crisis is economic, this is where gold truly shines, as it still can be traded on markets and is very much insulated against such crises, and in fact this is the time where gold really shines so to speak.

Everything else in an economy can take a big hit, currencies can become severely devalued, governments can go bankrupt, business can fail, the stock market can crash, bonds can default, businesses can go under, and so on and gold will not only remain stable but very likely will see people fleeing to it to the extent that it will increase in value instead of seeing a going down a lot in value like everything else.

For example, during the financial crisis of 1929, which saw the stock market get hammered over the next few years, the value of gold doubled during this time, in the 10 years after this historic stock market crash occurred.

Rather than the price of gold taking off in leaps and bounds after such crises begin, we tend to see a delay, as investors take stock of their losses and start to move to gold after a period of time where the reality of their situation kicks in more.

The Lag Between Economic Turmoil and Gold

Gold didn’t start its rise in this case until over a year after the stock market started to crash, and rose to its peak over the next 3 years, as more and more people moved out of the stock market and other investments and into the safer haven of gold.

During the recent period called the Great Recession, where the stock market took another huge hit, people didn’t exactly run to gold initially and in fact the price of gold declined during 2008, even though it ended up almost doubling between 2009-2011.

People tend to be stubborn and slow to react with their investments, and this is even the case when crisis like this hit, and these two examples are the biggest ones we’ve seen in the era of organized markets.

Why this is so significant is that a lot of people think that they have to well prepare in advance for these things by holding gold prior to the need for it, when the reality is that we see that we have plenty of time to react even after the event has occurred.

It may even be wiser to hold off on moving to gold when such events occur, first waiting for the market to react, otherwise we may even have to endure initial losses, such as what occurred between March 2008 and November 2008, which saw the price of gold drop by $75 an ounce.

This may not be seen as that significant, but when you see the market going down with something, that really isn’t the best time to invest in it, and it’s certainly better to wait until things are moving your way, even though you may be quite sure it will at some point.

People who hold gold as a hedge against these events are even further out though, as during the period of waiting the price of gold may move any which way, and in the mean time you are exposing yourself to this risk and really investing in it without any real plan at all, and not really receiving any tangible benefits from all of this.

Gold can be a fabulous hedge at the right time, but only at the right time, and it’s not that gold accumulates in value over time the same way that stocks have historically. The price of gold does indeed move, but the movement isn’t necessarily up, and you can hold a gold position for 30 years or more and still be well in the red with it, depending on the timing of the investment and how gold has moved over this long period,

Other than being used during difficult economic times, where we may expect with a lot of certainty that the price will go up, and go up quite a bit, if we are to invest in gold, we really need to be doing so with a view toward where it is headed, and confine our investing in it when there is at least a reasonable expectation of profit from the investment, which does not mean randomly entering positions with it.

As far as preparing for crisis, we are much better situated by actually waiting for these crisis to actually occur than setting a good deal of our wealth aside as a contingency for this, as there is no real advantage of doing so and the price we pay in the face of a bear market in gold does involve significant risks that ought to be properly heeded.

Gold can be a great investment, at the right time, and only at the right time.