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Investing in Gold? Mind the Stairs

Investing in Gold - Mind the Stairs

Gold generates a lot of interest from the investment community lately – and with good reason.  It is the world’s premier tangible asset and hard currency.  It does not rust, corrode or oxidize.  Its beauty is immutable, having been treasured by nearly every civilization on earth for the last 5,000 years.  But there is one little known fact about investing in gold that must be understood in order to generate the best possible returns from this precious metal.

Gold is often seen as a hedge against inflation and the depreciation of fiat currencies.  And while these things are absolutely true, they omit some important details.  Specifically, gold does not tend to steadily appreciate, little by little over time.  Instead, its price gains usually occur in a distinct, stairstep pattern.

The above chart shows the price of gold from 1900 through 2016 on a logarithmic scale.  A logarithmic format has two advantages over a traditional price-axis chart.  First, it allows the chart to clearly express very large changes in dollar value in a way that is easily comprehensible to the viewer.  Second, it normalizes price changes, so that any given change in value – a doubling or halving, for instance – will always have the same scale at any point in the chart.

The value of using logarithmic scale becomes apparent when we examine the chart closely.  It quickly becomes obvious just how closely the historical price of gold has followed the stairstep pattern during the 20th and early 21st centuries.  The flat parts of the “stairs” in the accompanying chart are highlighted with red horizontal lines that depict the average gold price over that period.  These flat areas are interspersed with step “risers”, which are the result of a sharply appreciating gold price, usually during a financial crisis.

From the late 19th century until 1933, the U.S. dollar was on a fixed gold standard.  During this period, the dollar was officially defined as 0.0484 troy ounces (1.50 grams) of pure gold.  This translated into a price of $20.67 per troy ounce of gold.  This gold standard was rigorously maintained for many decades until the Great Depression forced a devaluation.

In 1933, President Franklin Delano Roosevelt officially devalued the dollar by 41%.  Instead of each ounce of gold being exchangeable for $20.67, the government would now pay a full $35 for each troy ounce of the precious metal.  This new, $35 an ounce standard underpinned the prosperity of the post World War II global economic system.

In 1971, after many years of mounting budgetary and inflationary pressure, President Richard Nixon allowed gold to float freely.  This meant that the dollar was no longer exchangeable for gold at all.  Gold, now officially untethered from the monetary system, immediately began to rise in dollar terms.  This rapid appreciation persisted until 1980, when the gold bubble burst.

The yellow metal then spent the next 20 odd years experiencing a brutal bear market.  Investing in gold during this phase of its cycle was a poor idea.  But, in retrospect, this long period of persistently declining prices was really a two decade long price consolidation.  By the early 2000s, gold rocketed skyward again.

The price of gold most recently peaked at more than $1800 an ounce in 2011.  Since then, the price has gradually subsided to its current level of about $1,200 per troy ounce.  We are once again in a trading range – the “flat” part of the stairs.

Why does this stairstep pattern exist in the gold price?  The answer to that question in the first half of the 20th century is fairly easy.  At that time, the dollar was defined as a certain weight of gold.  As long as the U.S. Government was willing to exchange gold for dollars at a given weight, the price of gold was effectively fixed.  This policy naturally resulted in long periods of stable gold prices.

But once a financial crisis of sufficient magnitude occurred, the government was forced to devalue.  This created sudden spikes in the gold price that seemed to come out of nowhere.  But the reality is that economic pressures had already been building for many years before the official devaluation happened.

Since the advent of the 1970s with its free-floating currency regimes, the stairstep price appreciation of gold has become more irregular, but is still there.  I think that the stairstep pattern persists in the modern era because governments tend to use the gold price as an informal inflation barometer.  If the price of gold rises out of its trading range, central banks will usually raise interest rates, thus suppressing the gold price.

But this is ultimately an unstable state of affairs.  Even if the price of gold is contained, excessive debt and malinvestments still accumulate in the real economy.  These eventually lead to financial crises that central banks address by lowering interest rates and printing money.  This causes the price of gold to rise sharply and definitively break out of its trading range.  These are the times you want to be investing in gold.

However, it is obvious that gold’s price movements are more nuanced than they were before its demonetization in 1971.  Now gold tends to slightly overshoot in price at the end of its appreciation phase before settling back slightly.  This happened most recently in 2011.

The “flat” portion of the gold price step has also transformed into a fairly broad trading range.  This is where we are right now, with gold bouncing between about $1,000 and $1,400 per troy ounce.  This consolidation will continue until the next financial crisis drives widespread, safe haven interest in investing in gold.  The price will then spike violently upwards again, catching many investors off guard.

Gold is a great asset.  But if you want to get the most out of investing in gold, it is imperative that you understand the stairstep pattern.  Gold has been following this simple rule for the past century and now you can follow it too.

In Praise of Amber – The Gold of the North

In Praise of Amber - The Gold of the North

Before there was Lucite, Plexiglas, Bakelite or Celluloid, there was amber.  In many ways it is the original thermoplastic – nature’s precursor to the age of modern luxury materials.  Every synthetic plastic that mankind has developed since has been a poor attempt to rival the natural, honey-colored perfection of amber.

And oh, what a plastic amber is.  The golden-yellow gemstone is warm to the touch and extraordinarily light.  With a specific gravity of only 1.05 to 1.09, it is hardly denser than water.  In contrast, most other gemstones – although glittering and beautiful – can seem cold and aloof.  But this is not so with amber.  Instead, it has an inner glow that reflects the best emotional qualities of humanity – welcoming, cheerful and warmhearted.  Perhaps that is why it has so fascinated people across the ages.

Amber typically ranges in color from a light lemon-yellow to a vibrant honey-gold to a deep, reddish black.  The most prized colors for gem quality pieces are a bright, golden yellow or an intense, cherry red.  But a very rare blue variety of the gem found in the Dominican Republic is also quite desirable.  Amber can be opaque, translucent or perfectly transparent, depending on the distribution and number of tiny air bubbles in the stone.

While often referred to as fossilized, amber is technically the partially oxidized, polymerized resin of certain species of ancient, extinct trees.  This treasured, organic gem can range from 2.5 million years old to an almost unimaginable 320 million years old.  However, most gem quality material is usually 25 to 40 million years old.  Due to its sticky origins as ancient tree resin, it also isn’t uncommon to find small insects, plants and even tiny animals, like lizards, frogs or snails, perfectly preserved in amber nodules.

This amazing phenomenon gives scientists and collectors alike an unprecedented window back in time tens of millions of year.  These unbelievably detailed fossils trapped in transparent gold burst into popular culture during the 1990s with the debut of the movie Jurassic Park.  The movie, adapted from the book of the same name by bestselling author Michael Crichton, depicts the cloning of dinosaurs from DNA derived from mosquito fossils trapped in amber.

The warm, golden hue of this organic gemstone has been coveted by man for thousands of years.  In fact, amber has been excavated from northern European archeological sites that are over 10,000 years old.  Its most important historical source in ancient and medieval times was the south Baltic coast, on the shores of present day Poland, Russia, Estonia, Latvia and Lithuania.  Because of this, amber has traditionally been known as the “Gold of the North”.

Demand for the glowing gem was so high in the ancient Roman Empire that an extensive trade network developed to move large quantities of the Gold of the North from the Baltic region to the Mediterranean Basin.  Due to its distant source, many myths surrounding the precious golden gem and its origins sprang up in the ancient world.  For example, some ancient Greeks romantically believed that amber was the liquid rays of the setting sun, condensed into a perfect, golden gem.

Amber was also considered a gem with powerful magical properties in ancient times.  This was at least partially attributable to its propensity to easily acquire a static charge, causing it to attract small fibers of cloth or shreds of paper.  In fact, our modern word for electricity is derived from the ancient Greek term for amber – “elektron”.

The Gold of the North continued to be highly prized by the wealthy and powerful throughout the medieval period.  By the 13th century, the crusading Teutonic Order, having captured much of the Baltic region from its pagan inhabitants, promptly enforced a total monopoly on its trade.  The late medieval demand for rosary beads coupled with the Teutonic Order’s monopoly on amber production helped make the Baltic region fabulously wealthy during this time.

European craftsmen in the countries surrounding the Baltic coast became experts at working the treasured material.  The greatest of their creations was undoubtedly the Amber Room.  As the name implies, this was an entire chamber of sumptuously carved amber panels backed with mirrors and gold leaf to increase their reflectivity.  This magnum opus was created from over 13,000 pounds (6 metric tons) of the finest Baltic amber by the master craftsman of the Danish court, Gottfried Wolfram, and two additional master carvers from the city of Danzig, in the Kingdom of Poland.

Although originally commissioned in 1701 by Frederick I of Prussia for his wife, Sophie Charlotte, the Amber Room was given to Russia’s Peter the Great in 1716 as a gift to seal an alliance.  For centuries this masterpiece was widely considered the Eighth Wonder of the World until it was looted from the Soviet Union by the Nazis during World War II.  Tragically, the Amber Room was either destroyed or lost in the German city of Konigsberg (the modern Russian city of Kaliningrad) at the end of the war in early 1945.

Amber is truly an amazing substance.  At once lustrous and mellow, it radiates an inviting warmth absent from other, inorganic gemstones.  Is it any wonder that man has cherished the soft glow of the Gold of the North since he first discovered it upon the shores of the Baltic Sea so many millennia ago?

Rich as a Nazi – How Wealthy Was World War II Germany?

Rich as a Nazi - How Wealthy Was World War II Germany?

Many people think of Nazi Germany as having been an incredibly wealthy nation, albeit by looting the treasures of a conquered Europe.  Popular culture has certainly reinforced this view of an opulent Nazi Germany.  Countless movies and television shows have used the trope of hidden Nazi treasure as a plot device.  And the phrase “rich as a Nazi” has definitively entered the vernacular, denoting an individual of incredible wealth.

But the reality behind the myth is somewhat different.  Adolf Hitler and the Nazi regime had come to power in German in 1933, in part by promising to reverse the economic and political humiliation imposed by the harsh terms of the Treaty of Versailles that ended World War I.  And for a while this appeared to be the case.  Hitler initiated a massive domestic infrastructure building program, including construction of the famous Autobahn highway.  The Nazis also simultaneously spent lavishly on rearming the depleted Wehrmacht, or German army.

So while the rest of the world slogged through the Great Depression with high unemployment rates and weak economies, Nazi Germany prospered.  Rich as a Nazi indeed!  But the German economic boom was largely an illusion.  In reality, Germany was endowed with few of the key natural resources necessary for a modern military power.  Therefore, Nazi Germany was forced to buy these vital raw materials – oil, tungsten and chromium – abroad.  And its foreign trade partners would not accept German Reichsmark as payment, but only hard foreign currencies, like dollars or pounds, or gold.

By early 1938, Germany was rapidly running out of both gold and negotiable foreign reserves.  The Anschluss – Germany’s forced union with Austria in the spring of 1938 – gave the Nazi State a temporary reprieve.   Germany emptied the Austrian central bank’s gold reserves, which were about 100 tons.  This gave Hitler the monetary breathing room he needed to successfully launch his blitzkrieg war against first Poland in the east and then France in the west.

In contrast to the Nazi German government’s hand to mouth lifestyle, the United States, despite having been hard hit by the Great Depression, was a truly wealthy nation.  By the beginning of widespread hostilities in 1940, U.S. gold reserves amounted to a staggering 21,000 tons.

On the other hand, Nazi Germany only managed to steal a grand total of about 600 tons of gold after looting nearly the entire European continent.  And by the time Germany capitulated in 1945, it only had about 300 tons left, the rest having been used to purchase critical war supplies abroad.  The vast amounts of wealth available to the U.S. would have been almost unimaginable to the Nazi officials in charge of Germany’s national budget during World War II.

And these massive differences in wealth between Nazi Germany and the U.S. were apparent in everyday life as well.  In the lead up to World War II, Germany’s small denomination coins were alloys of bronze, aluminum-bronze or nickel.  Once war started in 1939, these coins were switched to cheaper zinc or aluminum in order to preserve every last bit of nickel and copper for the armament industry.  The larger denomination 2 and 5 Reichsmark coins, both made of silver, were discontinued after 1939 to conserve the precious metal.

The United States faced some of the same pressures that Nazi Germany did in the global conflict.  Specifically, the military’s demand for copper to use in wiring and shell casings was insatiable.  However, the United States, being almost obscenely rich during the mid 20th century, pursued radically different solutions to these problems than Germany did.

Most U.S. coinage during the 1930s was made from an alloy of 90% silver and 10% copper.  Not only did the U.S. Government not change this alloy during World War II, but they also added precious metal to the nickel, or five cent coin!  These silver war nickels employed a unique alloy of copper, silver and manganese to save precious copper and nickel for the war effort.  The only coin the U.S. mint truly debased during the war was the penny, replacing its bronze alloy with a zinc-coated steel composition.

During the development of the atomic bomb, copper was in such short supply that the Manhattan Project borrowed over 14,000 tons of silver from the U.S. Treasury to use in wiring and other electrical equipment at the famous Oak Ridge, Tennessee facility.  That’s right.  The U.S. Government was so insanely rich during World War II that it actually substituted silver wiring in place of copper wiring on an unprecedented, industrial scale.  The term “rich as a Nazi” is beginning to seem like a misnomer.  The German government couldn’t hope to compete with the U.S. level of wealth.

Our final wealth metric, and one that is particularly important for military powers, is oil production.  Nazi Germany was not blessed with substantial oil reserves.  Consequently, its domestic oil production was a paltry 4.5 million barrels annually in 1939.  Realizing this was insufficient to fulfill his military ambitions, Hitler directed German industry to first research and then mass produce synthetic fuel.  By 1941, Nazi Germany was creating some 31 million barrels of synthetic fuel per annum.

At first glance, this impressive level of fuel production lends credence to the idea of fantastic, rich as a Nazi wealth.  And while it was a tremendous technical achievement, it simply paled in comparison to the oil output of the United States during the same period.  In 1940, the U.S. produced approximately 1,460 million barrels of oil domestically, over 40 times the combined synthetic and natural German production levels!

Now it is true that the Nazi military machine thoroughly looted Europe, emptying many museums and private homes of famous paintings and sculptures, as well as central banks of their gold.  And this plunder certainly made a few high ranking Nazis incredibly wealthy.  In that respect, rich as a Nazi was a perfectly legitimate turn of phrase.  But the German State, as well as much of the German population, was actually rather poor during the Nazi era, at least compared to the United States.

A Brief History of Gemstone Valuation

A Brief History of Gemstone Valuation

Mention the word “gemstones” and it immediately brings to mind images of glittering riches.  Gems have been a byword for wealth in popular culture for hundreds of years.  So it isn’t surprising that many people think the gemstones that are most well known today – rubies, emeralds, diamonds and sapphires – have always been the most valuable.  But the history of gemstone valuation is not so straightforward.

Instead, we find that the historical desirability of various gems was dependent on a range of factors, including local availability, rarity, physical properties and, oddly enough, advances in science.  In his book “Natural History” written in the 1st century AD, the ancient Roman naturalist Pliny the Elder states that agate, a banded variety of quartz, was “formerly held in high esteem, but is not so now… (because it) has since been discovered in numerous other localities.”  This is, to the best of my knowledge, the first example of a once rare precious gemstone being devalued when new, large sources of material were discovered.

Agate wasn’t alone in this misfortune, either.  All members of the quartz group, such as cornelian, chalcedony, jasper, rock crystal and amethyst, were highly valued in ancient times.  But they gradually declined, in both respect and price, over the centuries as new deposits were exploited and long distance trade routes from Asia and sub-Saharan Africa expanded.  By the Middle Ages, the quartzes were no longer considered top tier gemstones in Europe.

There was one notable exception to this, however.  Amethyst, with its maddeningly deep purple hue – the same color valued so highly by royalty – remained a very expensive stone into the 16th century.  During the Renaissance, fine Indian amethyst traded for fully half the price of precious sapphire.

But the Age of Discovery, the period from the 15th to the 18 century when European explorers sailed to all corners of the globe in search of new lands, was not kind to the reputation of many gemstones.  Amethyst, the most valuable of all the quartzes, was one of those gems negatively affected.  Although it remained relatively scarce until the early 19th century, massive Brazilian discoveries flooded the market in the 1830s and 1840s, causing the value of amethyst to collapse.  Its price never recovered.  Even today it is possible to buy good quality amethyst for only a few dollars a carat.

Another ancient stone undone by the advancement of science was the highly prized carbuncle.  In ancient Greece and Rome, the term carbuncle referred to any deep red gem.  It is theorized that garnets, rubies and red spinels were all interchangeably considered carbuncles during this period.  However, as science progressed, it became obvious that these gems were actually distinct types of stones with unique physical properties.

This caused a divergence in the prices of these gems types.  Garnet, being softer and more common than its two look-alikes, rapidly dropped in value, while the superior ruby became the gem of kings.  However, ruby and red spinel, which are closely chemically related, were still confused with one other right into the early 19th century.  It was only after this time that the two doppelgangers were definitively, scientifically recognized as separate gems.  Subsequently, many famous “rubies” set in the crown jewels of European monarchs were discovered to actually be red spinels, thus boosting the reputation and value of real rubies even more.

Some things in the world of gemstones, though, have remained fairly stable for centuries.  Benvenuto Cellini, a renowned Italian Renaissance goldsmith from the 16th century, wrote in his memoirs that ruby was considered the most valuable of all gems.  Next was sapphire.  Diamond, although far rarer during the Renaissance than today and largely reserved for nobles, was only ranked third.  During that period, a fine diamond was only worth an eighth of what a similarly high quality ruby would bring.

Cellini’s list of relative gemstone valuation compares favorably to our “big four” gems of today, which are, in order of descending value: ruby, emerald, diamond and sapphire.  But even these rankings are a closely fought thing.  Emeralds and rubies have vied with each other for the top spot throughout the 20th century, trading place several times.  And white diamonds are just barely holding onto the number three slot.  Currently, a top quality, one carat, Burmese blue sapphire is nearly equal in value to a flawless, perfectly colorless, one carat diamond.

The latest development in the long history of gemstone valuation has been the rise of new, ultra rare gems.  These include stones like colored diamonds, alexandrite, demantoid garnet and Paraiba tourmaline.  All of these “new” gems are exceedingly beautiful, extremely rare and often exorbitantly expensive.  It is not unusual for fine examples of these stones to exceed the “big four” gems in terms of price per carat – sometimes by significant amounts.

Although fancy colored diamonds were known for centuries before the modern era, they were so rare and unusual that they were thought of as curiosities for most of that time.  Both alexandrite and demantoid garnet, first discovered in the mid 19th century, likewise remained exotic oddities for many decades.  It was only in the late 20th century that these extraordinarily rare stones, along with more recently discovered ultra rare gemstones like Paraiba tourmaline, have become quintessential luxury objects gracing the fingers and necks of billionaires around the world.

Although gemstone valuation has been constantly evolving over the last two millennia, I believe we have reached a point in history where major re-rankings will now occur much more slowly.  Most of the world’s major gem fields have been discovered already, so it is increasingly unlikely that the market will suddenly be flooded by a large quantity of any given gem.  Science has also progressed to the point where different types of gems are no longer confused with one another.  Of course, relative gemstone valuation will continue to change in the future as certain colors or looks fall into or out of style.  But I think the chances of major gems, like ruby, sapphire or emerald, devaluing severely are nil.