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This Thing Called Gold
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(November 19, 2011) Gold, with its intrinsic characteristics of brilliance, malleability, and resistance to corrosion, has an allure that affects people unlike anything else found on the periodic table of elements. The blunt question so often asked is: what is gold worth?

Today, in our age of people who play virtual games online, and even pay virtual currency for virtual tools to further their chances at virtual victory and self-aggrandizement, it would seem that the dense yellow element called gold would have a difficult time finding a place in this world. 

Before there was an Internet, and actually before there was anything resembling a modern computer, gold had already been tagged as a "barbarous relic," an ancient, creaking, obsolete memento of monetary times gone by. Up until 1971, when President Nixon cut the ties between the US dollar and gold, the United States was the last nation holding on to a modified gold standard to support its currency. Before 1971, foreign central banks could convert their dollars to gold, or gold to dollars, anytime they felt like it. 

When that convertibility came to an end, the dollar went from its decades-long status as ‘cold hard cash’ to being, well, just a paper dollar. Our US Treasury established that our dollar, after some 175 years, was no longer a measure of gold. The dollar became ‘fiat’ money, Today, online game purveyor Zynga does much the same thing, providing a virtual currency ("Zynga Game Cards for in-game currency to buy the items you want") so that its players can acquire virtual "stuff."’

Our Treasury maintains the dollar by monetary and fiscal policy, backed by what is known as the full faith and credit of the US government. Additional apparent strength comes from the substantial presence of our enormous economy, which is supported by the largest military presence on Earth, today or ever.

But the simplest measure of a currency’s value remains how much gold it buys. On Friday November 18, gold prices settled in New York at $1,725.10, a figure more than six times its closing price of ten years ago. (On November 18th, 2001, gold traded at $272.90 per ounce).

So, we see that two months after the 9/11attacks, gold was "worth" about $273. This past Friday, it was "worth" $1,725. Did gold really become that much more valuable in the span of ten years? That doesn’t seem plausible – the supply of gold in the world doesn’t vary much from decade to decade, and demand for gold in jewelry, dentistry, and industry has actually gone down over the past few years of economic recession.

To further unravel the puzzle, consider that The Financial Times ran an unsigned editorial piece on Saturday 11/19/11, entitled, not surprisingly for a British newspaper which periodically displays an anti-gold prejudice, "All That Glisters:"

"Some commodities bewitch investors, then lose their appeal for ever. Tulip bulbs will probably never again arouse the passions they did in 1636; anti-comet umbrellas are unlikely to regain the popularity they enjoyed in the heady days of 1910. Bursts of enthusiasm for gold, however, recur again and again."

"The latest group to succumb to the urge to gobble up ingots are the world’s central banks ..(who)..as a whole have become net buyers for the first time since 1988."

"…Today’s central banks are buying…more in sorrow than in madness: their purchases are largely a response to the persistent fall in the dollar’s value."

"Nevertheless, along with their enthusiastic gold sale over two decades, the central banks’ recent spree has the makings of an unorthodox sell-low-buy-high strategy. For investors with more conventional tastes, now is probably not an obvious time to be buying gold.

"Unless, of course, one believes that there is a large enough supply of goldbugs to keep the gold price rising for some time yet. Or one believes that the crisis in the world economy presages a monetary Armageddon, in which gold bars were one of the few remaining stores of value. This may comfort central banks – but in the case they will have far weightier issues to worry about."

The "sell-low-buy-high" line certainly strikes a nerve, particularly in Great Britain. It was there ten years ago that Britain’s then-Chancellor, and later Prime Minister, Gordon Brown, infamously sold off some 400 tonnes of British gold reserves for an average price of US$275 per ounce. As they say, timing is everything.

But in a time of runaway deficits in the US, in Europe, and yes, in Great Britain itself, it seems odd that a leading financial publication which has reported in detail about much of our current economic crises, endless bailouts, and rampant monetary creation to solve all of the world’s problems, would choose to editorialize that the ten-year upward trend in gold prices has been caused by "goldbugs" (whatever they are) and nervous central banks.

A more through exploration of what’s driving the price of gold can be found in the World Gold Council’s release this week of November 2011’s "Gold Demand Trends,"

The World Gold Council (www.gold.org) in London is the trade group for the major gold mining firms worldwide. Their research on gold supply and demand trends, conducted by GFMS Ltd., is thorough and authoritative, and widely quoted around the world.

If you are interested in gold as an investor or potential investor, there is probably no better source for information about gold than in the WGC’s quarterly reports. We found the current report to be one of their best concerning the major changes in global gold demand that have occurred over the past few years and decades.

In a nutshell, demand has shifted from West to East:

"The geographical shift of gold demand since 1970 has been quite remarkable. A look at the first year of each of the five decades since the price peg was removed shows how dramatic the shift from North America and Europe to the Indian Sub Continent and East Asia has been. North America and Europe has a combined share of 47% of the global market in 1970, growing to 68% by 1980. This fell to 38%, 28%, and 27% respectively in 1990, 2000, and 2010. The drop in global share was compensated for by the Indian Sub Continent and East Asia, rising from 35% in 1970 to 58% by 2010."

Other bits from the report:

- China now is the largest gold producer in the world, at 13% of the world’s mine production.

- South Africa, which in 1980 mined over half of the world’s gold, now accounts for only 8% of mine production.

- Gold demand in Europe and North America combined equals less than that of India or China. 

- The number of new gold finds has been falling for the past six years, despite higher gold prices.

And in direct answer to the FT’s editorial about central bank purchases of gold, "…Current account imbalances generated along with the emergence of BRIC countries and other have created an increased desire for sizeable holders of foreign exchange reserves to diversify."

In other words, the more of today’s ‘money’ that increasingly accumulates in the banks of nations that produce and export, the more those entities need a true store of value. To say the least, Gordon Brown’s trading much of Britain’s gold reserves for a basket of currencies has pretty much shown the world owning a variety of fiat currencies is not, in the end, an effective diversification of assets.     

Looking at the state of world currencies today, any moderately curious investor will discover that these financial times demand nothing less than gold. 


 

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