Gold Coins or Gold Slippers?

By DAVID MOON, Moon Capital Management
September 3, 2006

Cynics wouldn't keep saying it if there weren't some truth in it: By the time an investment idea becomes so popular that it is offered in $5,000 increments, the profit potential is probably gone; the financial institutions have probably sucked the idea dry.

It's happened with all sorts of asset classes. Office buildings, via the limited partnership craze. The film industry. Railroad cars. Foreign currency. Silver. Oil and gas drilling.

It is our nature to be followers. We don't want to stand out from the crowd. We want to wear the same tennis shoes as Michael Jordan and carry the same handgun as 50 Cent. And we want to own the investments being touted as winners on television, in the newspaper, on the Internet, or at the barbershop.

Most of these 'winners' are the assets that have already significantly appreciated, providing healthy profits for the early investors.

Scientists tell us that human beings use as little as 10 percent of our brain capacity. As we used to say in Alabama, imagine the quality of our decisions if we would use the other 50 percent.

I thought about this as I read last Sunday's News Sentinel article about gold coins.

Now that the price of gold has almost tripled, investors can buy gold coins at a kiosk on Chapman Highway.

I have no idea if the price of gold is near a short-term peak, but it certainly isn't near a bottom. There's no good way to calculate a true value for gold, since there are limited economic uses for it. Unlike a house, you can't live in it. Unlike silver, gold isn't used to produce jet engines or batteries. And enriched uranium has its own special sorts of uses.

More than 80 percent of the world's gold production is used in jewelry.

In the short term, price is determined solely by supply and demand. Demand can be affected by many things: the newspaper, Jim Cramer, someone's charisma, nice brochures or a kiosk. But in the long term, the price of an asset is a function of its value ' determined by financial issues, such as the utility of the asset.

Gold has been used as a hedge against inflation for centuries. The problem with this strategy is that you must endure years of negative returns to enjoy the occasional spike in gold prices that provides the hedge. This is an expensive hedge.

Another useful long-term inflation hedge is a well-run money market fund. The rates on these funds are much more highly correlated with inflation than gold prices. As a result, the rates move much more slowly. So there isn't as much 'action.' Who wants to own a four percent money market fund? I want to triple my money in gold!

Of course, from 1980 to 1983 gold prices declined from $850 to $318 an ounce. But not a penny was lost in money market funds. The rates steadily declined, as did inflation.

My favorite kiosk purchase these days are those fuzzy house slippers at the mall.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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