A lot of investors think that gold is gold, in no matter what form it is held. The basic assumption is that if it is gold based – whether physical gold, gold stocks, or gold mutual funds and exchange traded funds – it will rise in price along with the underlying price of the base metal.
That may or may not be true, since physical gold has certain properties that make it a must-hold, especially if you believe that the economies and financial structures of the US and the rest of the world are headed for very troubled times. There are just certain functions that gold can fill that paper gold just can't.
Here are four reasons to invest in physical gold.
1. Physical Gold Has the Properties of Traditional Money
Gold is often considered to be a money substitute, which is to say that while it has the properties of money and has functioned as money thousand years – it has largely been replaced by paper and electronic money as the preferred way to hold cash, at least in the current economic and financial environments.
Physical gold has all of the properties of traditional money, including:
- It is recognized as a monetary asset around the world, and is held by all major central banks
- It's portable, and can be carried from place to place, and market to market
- It's divisible – you can use a 1 ounce gold bullion coin to make a purchase, and receive change either in smaller gold coins, in silver, or in other forms of money
- It can be held as a store of value, including in retirement accounts
- It can be used to settle international obligations
- It can be pledged as collateral for a loan
- Gold’s value is intrinsic – unlike paper or electronic money, it does not get its value by the decree of central banks or central governments
While it may be possible to use paper assets, including gold-based paper assets, as cash, none can be used readily. Physical gold on the other hand, already has the built-in qualities of money.
2. Paper Gold Doesn't Always Follow Physical Gold Higher
While the general track record is that gold based paper assets do tend to follow the price of gold fairly consistently, there can be variations, especially under extreme circumstances.
For example, gold stocks and funds can be affected by the performance of the general stock market, international disturbances, labor problems, and political and legal obstacles. For example, should political instability hit a gold producing Third World country, where a gold-mining company has significant operations, the value of the company’s stock could plummet even as the price of gold rises to new heights.
Both outcomes will occur for the very same reason, but the effect on the price of each will be radically different.
Still another example – an extreme one – would likely occur to the world were engulfed by a financial collapse. In such an environment, the price of gold would likely explode.
But the price of paper assets, including those related to gold, could go all the way to zero if the international security exchanges were to shut down. In such an environment, physical gold would have increased value, while everything else could conceivably become worthless.
This reason alone justifies having at least a small position in physical gold.
3. Physical Gold is the Only Investment Asset that Isn't Someone Else's Liability
This is an underestimated attribute that physical gold has. Virtually all paper assets are also someone else's liability.
Here are some examples:
- A certificate of deposit may be your asset, but it's the bank's liability; should the bank default, your CD could become worthless
- A corporate bond may be your asset, but it is the issuing company's liability; should the company default on the debt, your bond would become worthless
- A stock may be your asset, but it is the issuing company's liability, particularly if the stock pays dividends; should the company file for bankruptcy or go out of business, the stock would become worthless
- A US Treasury security may be your asset, but it’s a liability of the US government; should the government default on the obligation, the security will become worthless (there are different ways that the government could default on its debt, including hyperinflation, negative interest rates, or the issuance of non-redeemable securities)
- A case can even be made with real estate; after all, should you default on your mortgage, you'll lose the property and likely any equity that you have in it. That is also true of real estate investments that you may hold – should the principals involved in the property default, your investment could become completely worthless
The fact that all paper assets are also someone else's liability means that that liability could be defaulted on. If it is, the asset itself would become worthless.
This isn't to say that holding any of these assets is necessarily a losing proposition. But it is to say that the potential of default exists in the case of each asset. You can diversify around this potential outcome by holding some physical gold.
Since physical gold is not also someone else's liability, there's no chance of a counterparty default. That quality alone will preserve and extend the value of physical gold in the event of a major economic or financial collapse.
4. Physical Gold Will Likely Be the Best Port in a Future Economic Storm
Most of us are aware of the potential for financial defaults on a global scale. We came close to that during the Financial Meltdown of 2008/2009. Only multi trillion dollar bailouts by the world's major central banks prevented the worst from happening.
Could those same central banks prevent a global collapse of the financial markets a second time around?
If they can't, then physical gold could quickly become THE asset of the day. Given the fact that you hold it in your possession, that it can function as money, that it can't be defaulted on, and that it has a history of performing best during the worst of times, physical gold deserves a place in your portfolio.
Paper gold – gold stocks and funds – each represent a form of gold leverage. They are different ways to play the gold market, and can perform extremely well under certain circumstances.
But if you do plan to hold these assets, you should also plan to have a significant amount of physical gold in your possession. Because when things get really bad, there's no substitute for physical gold.