The Rational Gold Investor

Allow me to introduce a very rare bird. I’ve been trying to find him for a long time.  It’s a rational gold investor.

Most gold investors aren’t rational. If you’ve met one, you know. The garden variety gold investor is an all-or-none thinker. Whatever your investment question, gold is the answer. The world as we know it, the gold bug says, is ending. The only thing anyone can do is own gold. There is no point in talking about Google, whether home values will recover, or anything else because it is all going to end. Get ready for a world of money burning in wheelbarrows.

The rational gold investor is different. This one is named Shayne McGuire. He manages gold investments for the Texas Teacher Retirement Fund. Although the amount of money is large, he is quick to put it in perspective— it is less than 0.5 percent of the roughly $100 billion fund. Even so, it’s more than most pension and endowment funds anywhere in the world have committed to the precious metal.

Talking over breakfast and reading his book, “Hard Money: Taking Gold to a Higher Investment Level” (Wiley & Sons, $35), Mr. McGuire makes a clear three point case for why we should own some gold. You might want to consider those points now, while gold is below its $1,420 December peak. Here are his three basic reasons.

Gold has never been more under-owned as an asset.

Historically, gold was money. It accounted for a substantial part of global assets. It was a universally recognized store of value and medium of exchange. Today, it is only an asset as a commodity. The value of all the gold in the world, he points out, is about 0.6 percent of all financial assets. This is down from 2.5 percent as recently as 1980.

So gold is rounding error. The value of the largest gold exchange traded fund (ETF), at $57 billion, is less than the market capitalization of McDonald’s ($79 billion) and only a fraction of the most valuable stocks, such as Exxon-Mobil ($403 billion), Microsoft ($246 billion) or Apple ($316 billion).

After years of being net sellers, he points out, governments are now net buyers of gold. Moreover, institutions such as pension and endowment funds now have vehicles for investing in gold. Long prohibited from owning physical gold, these funds can now own it through exchange traded funds such as SPDR Gold Shares (ticker: GLD). Significantly, State Street Global Advisors annual report on ETFs shows that GLD was the 5th most traded ETF in 2010.

With gold accounting for so little of global assets, he says, only a small shift in asset preferences— from currencies to gold or bonds to gold— would cause a major price increase in gold. Unlike most gold bugs he is not talking about financial Armageddon. He’s simply talking about decisions by institutions, pensions and sovereign wealth funds to sell some bonds and put the cash in gold.

The supply of gold is difficult to increase.

When people want to own stocks there is never a problem with supply. Wall Street will create it. Similarly, governments around the world are producing a worrisome supply of debt. More debt, many worry, than will ever be repaid. But the supply of gold can’t be ramped up quickly, whatever the demand. Worldwide gold production has been declining for years.

Again, any change in asset holding preferences would likely produce a much higher price for gold. How high? No one knows. But let’s do a back of the envelope exercise. Suppose that worry about government debt forced governments to back their bonds with gold. With the world government bond supply at $30 trillion and the world gold inventory at 4.8 billion ounces, you can make a case for gold valued around $6,250 an ounce.

Financial leverage in the world economy has never been higher.

This, he points out, is usually a precursor to financial instability and inflation. When that happens, both people and institutions look for the exits. One of them is gold.

How do you buy gold? In addition to discussing gold exchange traded funds and gold stocks, Mr. McGuire also tells us the ins and outs of buying non-numismatic gold and silver coins.

This book is a keeper, one every serious (and rational) investor should have in his library.