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Do Gold and Gemstones Have Intrinsic Value?

Do Gold and Gemstones Have Intrinsic Value?

One complaint often leveled against gold and gemstones is that they have no intrinsic value and are therefore “fads” or “speculations”.  A perfect example of this lunacy is an article I recently read titled “Gold Is No More of an Investment than Beanie Babies“.  The author, a professor of economics at Pomona College named Gary Smith, unequivocally argues that gold, gems and other valuables aren’t assets because they don’t pay dividends or interest.

All I can say is good grief!

Sometimes economic professors get so caught up in their textbooks and theories that they forget to look out their ivory tower windows into the real world.  So let’s try to answer the question of whether or not gold and gemstones have real intrinsic value.

No, gold and gemstones do not produce cashflow, but not every asset does.  There are about 4,800 U.S.-listed equities that don’t currently pay a dividend.  In addition, there is a type of debt instrument called a zero coupon bond that pays its par value at maturity, but makes absolutely no interest payments until then.  Warrants, options and futures also pay no income.

As you can see, demanding that a security pay a stream of cash flows in order to be considered an investment is an excessively restrictive definition.  In other words, all things that pay income are investments, but not all investments pay income.

But this doesn’t really definitively answer our question.  Lots of things don’t pay interest or dividends, but only a very small proportion of them could convincingly be called investments.  Maybe examining the meaning of the word “intrinsic” can help us make a determination.

According to Dictionary.com, the definition of the word intrinsic is: “Belonging to a thing by its very nature: [for example] the intrinsic value of a gold ring.”

We’ll set aside for a moment the fact that the dictionary definition of the word intrinsic specifically references gold.

When critics declare that gold and gemstones have no intrinsic value, what they are really saying is that they have no practical uses.  In other words, when stripped of their decorative, monetary or status-enhancing applications, gold and gems (allegedly) possess no industrial usefulness.

First, I will comment that it seems a little unfair to discount their primary strengths.  It is like asking what good cotton is if you can’t weave it into fabric.  But even with this considerable handicap, gold and gemstones still have a significant number of uses, thus endowing them with substantial intrinsic value.

For starters, gold does pretty much everything copper can do, except better.  Other than its exorbitant cost, there is no reason you couldn’t make all the plumbing and electrical wiring in your house out of gold.  And it would last pretty much forever, to boot.

Of course, gold has a lot of other uses besides giving copper an inferiority complex.

Almost every cell phone, laptop and desktop computer on the planet contains small amounts of gold, where it is used to plate vital electrical circuitry.  This is because gold does not tarnish or corrode, even under the most hostile environmental conditions.  It is safe to say that the computing revolution of the past few decades would have been impossible without gold.

Gold is also used in dentistry, where its chemical inertness and durability make it a perfect material for filling cavities.

Even the medical profession has adopted gold for some specialized situations.  The gold-based compounds auranofin and sodium aurothiomalate are sometimes used to treat rheumatoid arthritis.  In addition, tiny radioactive gold seeds have been implanted into cancerous tumors, helping to shrink them.

Space exploration is another industry that is heavily dependent on gold.  It is not only found in the computer components of every satellite and spacecraft, but is also lavishly used in orbital telescopes and space suits.  These gold coatings reflect solar radiation, thus helping to regulate temperatures and prevent heat damage.

Glassmaking also relies on gold.  A highly prized type of deep red glass called cranberry glass or ruby glass can only be made by dissolving gold salts in a pool of molten glass.  High-rise skyscrapers also rely on an ultra-thin coating of gold on their windows to help with climate control.

Much like gold, gemstones often get a bad rap as unnecessary baubles that have no intrinsic value.  But this ignores the modern world’s reliance on their unique physical and optical attributes.

First up are diamonds.  These covetable gemstones are the unsung all-rounders of the gem world.  Diamond’s superior hardness and toughness means that it is perfect as an abrasive or cutting edge.

Diamond drill bits are a mainstay of the oil, gas and mining industries.  And construction workers frequently use diamond-impregnated saw blades to quickly and easily cut concrete.

Another, less well-known application is the diamond-scalpel in medicine.  Diamond scalpels are used in any situation where an ultra-sharp, long-lasting blade is necessary, like eye surgery.

Perhaps diamond’s most interesting scientific use is the diamond anvil cell.  This high-tech tool skillfully exploits the tremendous toughness and near perfect transparency of diamond in order to crush a test sample between two opposing diamonds.  This allows for massive pressures and temperatures, similar to those deep within the earth, to be replicated in the laboratory.

Sapphires are another gemstone that has widespread industrial applications.  Titanium-sapphire lasers are commonly used in spectroscopy, LIDAR and other research applications.

But sapphire also has more down to earth uses, as well.  It is often employed anywhere a small, perfectly clear window of extraordinary toughness is needed.  For example, many luxury watches have sapphire crystals to protect their dials.  And Apple’s iPhone 7 made news when it was announced that it would ship with a sapphire camera lense.

Even more prosaic gems like garnet and quartz have extensive industrial uses.

Garnet sandpaper has been used as a cheap and reliable tool by woodworkers for many decades.  Indeed, it can be employed anywhere that a super-hard abrasive isn’t needed.  For more demanding applications, stepping up to aluminum-oxide (which is just another word for sapphire!) sandpaper makes more sense, although it is slightly more expensive.

Quartz possesses an unusual property known as the piezoelectric effect.  This means that it turns mechanical pressure into a small electrical impulse and vice-versa.  The most practical use for this strange property is in time-keeping.  As a result, a tiny quartz crystal resides in the heart of every quartz watch and clock on the planet.

I suppose that the biggest complaint a skeptic could have about the intrinsic value of gemstones is that their industrial roles are typically fulfilled by laboratory-created synthetic gems.  But I don’t think this takes anything away from the desirability of naturally mined stones.

To the contrary, naturally mined gems are merely being employed in their highest and best use.  Highest and best use is an economics concept that basically states that while an item might have many possible uses, it will tend to be primarily employed for its most valuable purpose.  And it will also be bid to a price commensurate with this highest and best use.

The fact is that the highest and best use for gold and gemstones are as jewelry, decoration and money.  This might confound and disturb uneducated critics, but thousands of years of human history confirm it.

 

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Are U.S. Federal Reserve Notes Backed by Anything?

Are U.S. Federal Reserve Notes Backed by Anything?

When someone asks if anything backs the U.S. dollar anymore, the answer is usually: nothing but confidence in the United States economy and/or government.  And this evaluation is true…sort of.  After having conducted some in-depth financial research, I can confirm that this assessment isn’t technically correct (which, as everyone knows, is the best kind of correct).

It is a little known fact that Federal Reserve notes are legally backed by certain assets sitting on the balance sheets of the United State’s 12 Federal Reserve Banks.  I have pulled a pertinent explanation from the notes of the Federal Reserve’s 2017 audited financial statements:

Federal Reserve notes are the circulating currency of the United States.  These notes…must be fully collateralized.  All of the Reserve Banks’ assets are eligible to be pledged as collateral.

To satisfy the obligation to provide sufficient collateral for outstanding Federal Reserve notes, the Reserve Banks have entered into an agreement that provides for certain assets of the Reserve Banks to be jointly pledged as collateral for the Federal Reserve notes issued to all Reserve Banks. In the event that this collateral is insufficient, the Federal Reserve Act provides that Federal Reserve notes become a first and paramount lien on all the assets of the Reserve Banks.

At December 31, 2017 and 2016, all Federal Reserve notes outstanding, net, were fully collateralized.  At December 31, 2017, all gold certificates, all SDR certificates, and $1,554 billion of domestic securities held in the SOMA were pledged as collateral.  At December 31, 2017, no investments denominated in foreign currencies were pledged as collateral.

So surprisingly, the currency in your pocket is actually backed by something more than unicorns and fairy dust!

Now for the caveats.  This backing only applies to physically printed U.S. Federal Reserve notes.  It doesn’t include digital U.S. dollars, like those in your checking or savings account.  This is in spite of the fact that dollars in deposit accounts can generally be freely exchanged for Federal Reserve notes on demand.

It also excludes U.S. coinage, which is considered fiduciary money.  Incidentally, this is the same reason you can’t use a dump truck full of pennies to pay off your mortgage.

 

Federal Reserve Assets Pledged As Collateral Against Federal Reserve Notes

 

Book Value Market Value
Dec. 31, 2017 Exchange Dec. 31, 2017
in millions Rate in millions
Gold Certificates  $            11,037 @  $42.22/$1302.50  $         340,477
SDR Certificates  $             5,200 @  $                     1.42  $              7,405
Treasuries & MBS  $     1,554,000  $      1,554,000
Grand Total  $      1,570,237  $      1,901,882

 

The first collateral specifically mentioned in the Fed’s financial statements is gold certificates.  These are holdovers from the pre-1934 era, when the United States was still on the gold standard.  Originally, $20.67 was exchangeable for a single troy ounce of fine gold.  However, gold was gradually revalued during the 20th century until its official government price was frozen at $42.22 in 1973.

So the $11 odd billion in gold certificates on the Fed’s balance sheet actually represents a claim on approximately 261.4 million troy ounces, which is very nearly the entirety of the United State’s gold reserves.  At the December 31, 2017 spot price of $1,302.50, these gold certificates had a market value of over $340 billion.

The next asset used to collateralize Federal Reserve notes is SDR certificates, otherwise known as Special Drawing Rights.  SDRs are composed of a basket of national currencies that are important in global trade and finance.  Right now each SDR is composed of 0.58 U.S. dollars, 0.39 euros, 0.09 British pounds, 1.02 Chinese Yuan and 11.90 Japanese Yen.

The SDR currency basket is reweighted every 5 years to reflect changing economic positions, with the next reassessment scheduled for 2021.

The Federal Reserve Banks have pledged all 5.2 billion of their SDRs as collateral against outstanding Federal Reserve notes.  Each SDR had an exchange rate of $1.42 at December 31, 2017, giving this collateral a total value of $7.4 billion.

The final collateral backing Federal Reserve notes are domestic SOMA (System Open Market Account) securities.  SOMA securities consist primarily of U.S. Treasuries and government agency MBS (mortgage-backed securities) that the Fed has purchased on the open market.  As of Q4 2017, there were $2,546 billion of Treasuries on the Fed’s balance sheet and $1,818 billion of MBS.

Because the Federal Reserve Banks have only pledged $1,554 billion of these SOMA securities as collateral against Federal Reserve notes, it is anyone’s guess as to how much of the collateral is Treasuries versus MBS.

The Federal Reserve measures compliance with its collateralization requirements by using the book value of its pledged assets (excepting SOMA securities, which use par value).  Using market value instead results in a slight over-collateralization, mostly due to the Fed’s gold certificate holdings.  So at the end of 2017, the $1,571 billion of U.S. paper currency in circulation was actually backed by $1,902 billion in Federal Reserve assets.  This represents a 121% collateralization ratio.

Of course, all this talk of real assets backing our cash sounds great at first blush.  But there are still some serious drawbacks to the arrangement.

For one thing, U.S. currency is not officially redeemable for anything – not even the collateralizing assets!  In fact, it is difficult to conceive of a situation in which the Fed would be forced to redeem Federal Reserve notes using its pledged assets.

The next stumbling block is that gold certificates and SDRs represent the lion’s share of the central bank’s “hard” (i.e. non-dollar denominated) assets.  There is simply no way the Fed (or the U.S. Government for that matter) would allow these vital anchor assets to be paid out to currency holders.

In addition, the bulk of the collateralizing assets (81.7% by market value) are Treasury and MBS securities.  But if these were actually paid out to dollar holders, it would only entitle them to receive more currency in the future, which would presumably be Federal Reserve notes too!  The logic here is a bit circular, as you can tell.

As a final blow, the provision requiring all Federal Reserve notes to be collateralized does nothing to restrict additional future issuance.  All the Fed must do in order to legally issue more currency is purchase additional Treasury or mortgage-backed securities on the open market (with digital dollars created out of thin air) and then pledge these fresh assets as collateral against newly printed Federal Reserve notes.

So in the final analysis, the Federal Reserve assets backing U.S. paper currency is more of an accounting relic from a bygone era of responsible central banking, than a true safety net.  Because of this, I recommend that investors hedge some of their dollar exposure with tangible assets like precious metals, antiques and gemstones.  That way, if the worst should ever happen, you don’t have to hope that the Fed makes good on its (almost certainly) empty promises.

 

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The Top 5 Mistakes Collectibles Investors Make

The Top 5 Mistakes Collectibles Investors Make

Thinking of investing in vintage collectibles or antiques?  Don’t make these 5 big mistakes that plague many collectibles investors!

 

1) Believing that what worked in the past will work equally well in the future

Although this myth isn’t unique to collectibles investors (indeed it is often shared by financial advisors and pundits), that doesn’t make it any less dangerous.  The logic goes like this:

Because this (fill-in-the-blank) collectible has appreciated strongly over the past 5, 10 or 20 years, then it must be destined to deliver good returns in the future as well.  So you should load up on those late 1970s Star Wars toys, Mid-Century Modern furniture or vintage Coca-Cola memorabilia.

But this superstition runs afoul of the old investing adage, “past performance is no indication of future results.”

What happens instead is that the collectible in question eventually runs into the law of large numbers.  In a nutshell, this dictum states that it becomes increasingly difficult to compound growth as values rise ever higher.  I’ve already discussed this fascinating concept in greater detail as it applies to the rare U.S. coin market.

Let’s conduct a thought experiment.  Early Star Wars toys are valuable today because the movies were so successful – an outcome nobody expected at their initial release in 1977.  Everybody in the world has heard about Star Wars at this point.  How does the franchise get any bigger or more famous?

If you are buying vintage Star Wars toys today hoping to see the same investment returns they’ve experienced over the past 40 years, you are implicitly hoping Star Wars becomes even more culturally influential in the future.  While this outcome isn’t completely impossible, it is exceedingly unlikely.

 

2) Expecting low quality collectibles to appreciate in value

Collectibles investors are faced with a marketplace that is absolutely saturated with low quality vintage junk.  Antique malls, thrift stores and flea markets are all overrun with poorly made plastic and cardboard memorabilia from the 1970s, 80s and 90s.

Beanie babies, Cabbage Patch Kids, (post-1980) baseball cards and (modern) comic books are just a few examples of these junk collectibles.  These throw-away items (and many, many others just like them) were mass-produced by the millions with little thought given to their durability, craftsmanship or future desirability.  This sad state of affairs is reflected in their pricing, where these collectibles are almost universally available for just a few dollars each (and oftentimes even less).

It can be a minefield trying to avoid these junk vintage items.  For example, in the 1980s the Swatch Watch was a cultural phenomenon.  These boldly colored and strikingly styled wristwatches were churned out by Swiss watch manufacturers in an attempt to win back some business from the flood of cheap quartz models that had decimated their market share in the late 1970s.

But Swatch Watches were meant to be low-priced, consumable fashion items.  They were usually made from plastic cases with either cheap mechanical or quartz movements.  In contrast, Seiko – a Japanese mid-tier watch brand – built mechanical watches during the same period to a much higher standard than Swatch Watches.

As a result, although vintage Swatch Watches look like they should be great collectibles, they are actually pretty terrible.  On the other hand, collectibles investors can’t go wrong with desirable vintage Seiko mechanical wristwatches.  Quality matters.

 

3) Ignoring demographic trends

Many collectibles investors don’t understand that (at least part of) the antiques market is a popularity contest driven primarily by demographics.  In other words, popular vintage collectibles are generally fondly-remembered childhood items from the prime collecting demographic – people aged from their mid 30s to early 60s.  Today, this primarily means collectibles from the 1970s and 1980s.

But while this is a well-documented phenomenon, collectibles investors will have a hard time cashing in on it.  This portion of the collectibles market is often driven by whacky, unpredictable fads that make entry and exit points impossible to time with any degree of accuracy.

For instance, Elvis Presley memorabilia was huge in the 1980s and 1990s.  Middle-aged Silent Generation and Baby Boomers couldn’t get enough of Elvis, who had been a staple of their youth.  Late night television infomercials hocked Elvis commemorative plates, compact discs and figurines, among other things.  Antique stores burst at the seams with vintage Elvis items.  And it all sold too.

But where was the peak for Elvis memorabilia?  Was it in 1983?  Or perhaps 1989?  Or maybe it was in 1996?  I don’t know the answer to that question.  And I doubt anyone else knows the answer, either.  However, during those heady days it would have been seductively easy to convince yourself that the gravy-train would never end and that Elvis collectibles would remain popular forever.

But if you did believe the hype, you would have eventually paid for it.  Today, Elvis’ fan base is dying off and his memorabilia is in terminal decline, with prices relentlessly dropping year after year.

Instead of chasing mercurial demographic fads, I believe most collectibles investors would be better served by sticking to high quality items with classic styling.  Even if they go out of fashion temporarily, they will always become popular again at some point in the future due to their high build quality and timeless air.  The Antique Sage’s 5 rules for investment grade antiques can help you choose the right vintage items.

 

4) Buying items that are damaged or in poor condition

Nothing can tempt a person to buy like low, low prices.  And collectibles investors are all too human in this regard.  But many times those low priced vintage items are cheap because they are either damaged or in poor condition.

However, savvy collectibles investors understand that there is no substitute for good condition.  Yes, sometimes an item with certain material defects or age-related issues can be successfully restored.  But even a successful restoration will invariably lower the value of a vintage piece versus a pristine, unrestored specimen.

The lesson here is clear.  Always keep a close eye on condition (including any restorations) and don’t be afraid to walk away from a collectible or antique that has taken one too many dings.

 

5) Being unwilling to pay a modest premium for superlative pieces

This is a topic near and dear to my heart because I’ve learned about it the hard way.  I previously wrote an antique investing article recounting my personal experiences with “the one that got away“.  Unfortunately, this theme – failing to pay-up for terrific specimens – dominated the article.

One day you will come across a particularly fine collectible or antique.  It may be in completely original, perfect condition.  Or perhaps it will be an extremely rare item.  It is even possible that a confluence of many different factors will combine to create a truly outstanding piece.

But when that day comes, you should open your wallet and happily pay the seller his asking price.  As long as the price tag isn’t truly exorbitant, you will almost certainly make money by following this strategy.  Don’t let $100 or $200 stand between you and a proverbial investment gem.

 

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2018 Hard Asset Collector’s Holiday Buying Guide

2018 Hard Asset Collector's Holiday Buying Guide
Photo Credit: LOPRE

Welcome to the Antique Sage’s 2018 hard asset collector’s holiday buying guide, where I will help you choose the finest Christmas gifts for the tangible asset enthusiast, antique collector or other special person in your life.

 

Vintage British Sterling Silver Hallmark Pendants

In the 1970s rampant international inflation led to a widespread loss of confidence in fiat currencies.  As a result, gold and silver bullion investing was all the rage.

So it shouldn’t be surprising that British High Street jewelers adapted to the times by crafting sleek, ingot shaped pendants for the fashion conscious.  These lovely British sterling silver hallmark pendants have a streamlined sensibility that fits well with the modern aesthetic.

Although most were produced in the late 1970s, vintage British hallmark pendants can date anywhere from the mid 1970s to the early 1980s.

Each one of these pendants is made from high purity, .925 fine sterling silver.  This is attested to by the stately lion hallmark, which has been used to certify the purity of English sterling silver since the mid 16th century.

Collectors love the fact that the British hallmarking system is so well regulated.  It easily allows anyone to identify a piece of jewelry’s city and date of manufacture, along with its maker.

For example, a leopard’s head hallmark indicates a piece was made in London.  An anchor hallmark is the symbol for Birmingham and a crown hallmark is the emblem for Sheffield.

As an added bonus, pendants made in 1977 were given a special, one-year-only hallmark with the head of Queen Elizabeth II in commemoration of her 25th coronation anniversary jubilee.

With prices ranging from only $25 to just over $100, a vintage British sterling silver hallmark pendant from the 1970s would not only make a great gift, but also be eminently affordable.

 

Japanese-Style Woodblock Art Prints

Moku Hanga is the term for traditional Japanese woodblock printing.  And truth be told, I have fallen in love with these masterpieces – hence their positioning in the hard asset collector’s holiday buying guide.

Japanese-style woodblock printing has become so popular that Western artists have fully embraced it, turning out some really compelling original art prints.  This is partially because Moku Hanga is an art that demands to be mastered.

But it is also an art form that demands respect.  As a result, classic Japanese themes like nature, animals and landscapes often dominate, even in Moku Hanga prints produced by non-Japanese artists.

In the typical Japanese-style art print, the artist painstakingly carves a flat block of cherry, birch or shina wood with a special, razor-sharp tool.   Then an additional block using a slightly modified design must be carved for each different color in the final print.

The print itself is usually transferred onto high quality, acid-free paper that is either cotton or mulberry-bark based.  This ensures that the resulting Moku Hanga art print will last for centuries to come.

Pricing is usually quite reasonable, with many fine Japanese-style woodblock prints available for just $100 to $200.

 

Antique Fractional European Gold Coins

Everybody loves gold coins.  And nearly everyone is familiar with modern gold bullion coins like the American gold eagle, the Australian kangaroo and the Canadian maple leaf.

But did you know that during the late 19th and early 20 century, many European countries struck small gold coins for circulation?  These intriguing coins are often well over a hundred years old and hail from some of the most storied nations of the time.

For example, the French, Belgians and Swiss – as part of the ill-fated Latin Monetary Union – struck 20 franc coins that contained 0.1867 troy ounces of pure gold.  The British minted their internationally renowned gold sovereign coin (0.2354 troy ounces), which is still being issued to this day.  Germany’s workhorse denomination was the 20 mark coin, which sported 0.2304 troy ounces of fine gold.  And Czarist Russia struck both 5 rouble (0.1244 troy ounce) and 10 rouble (0.2489 troy ounce) gold coins bearing the legendary double-headed imperial eagle.

But perhaps most surprisingly, these desirable antique gold coins are rather affordable today.  In fact, common specimens in nearly uncirculated condition rarely go for much more than bullion value.

Because of this, old fractional European gold coins earn their place on the hard asset collector’s holiday buying guide.  With spot gold trading at around $1,200 a troy ounce, most of these coins are trading just under $300, although some smaller pieces can be purchased for less.

 

Handcrafted Fine Hardwood Jewelry Boxes

I’ve always believed that a fine gift should be presented in an exceptional box.  And that’s why I’ve decided to feature handcrafted hardwood jewelry boxes on the Antique Sage’s 2018 hard asset collector’s holiday buying guide.

These exquisite storage boxes use some of the finest temperate and tropical hardwoods known to man.  Magnificently-grained exotic woods like koa, mahogany, walnut and sapele, not to mention elegant wood burls, vie for your attention on these works of art.

Although I call them jewelry boxes, the fact is that almost any compact treasure can be stored in these boxes.  They could just as easily accommodate cherished family photos and keepsakes as valuable watches and jewelry.

And they are durable as well.  If properly cared for, a well-made hardwood jewelry box will easily last a lifetime.

Given the superb craftsmanship and beauty of handmade hardwood boxes, their $50 to $200 price tag seems absurdly low.

 

Artisan Hand-Poured Silver Bars

There is nothing quite like holding a hefty bar of pure silver in your hands.  It is at once covetable and gorgeous; the essence of true wealth.

One of the most intriguing trends in the silver-stacking community is the proliferation of artisan-made silver bars.  These works of art are cast from .999 fine silver that is hand-poured into graphite or iron molds before being hand-stamped with their maker, weight and fineness.  Each poured silver bar is absolutely one-of-a-kind, with unique pour lines and irregularities.

Because hand-poured bars are more labor intensive to make than struck or extruded silver bars, the large bullion fabricators do not make them anymore.  So the torch has been taken up by specialized firms that are crafting these artisan silver bars in small batches.

One of my favorite makers of hand-poured silver bars is Vulture Peak Mines, also known as VPM.  They are a poured-bar specialist company located in Bandon, Oregon, on the Pacific Coast.  Most of VPM’s employees are former miners or veterans, all of whom share a passion for poured silver bullion.

The wonderful thing about artisan hand-poured silver bars is that most of them only sell for modest premiums over the spot price of silver.  For instance, with the spot price of silver currently at $14.50, you can expect to pay a very reasonable $22 per troy ounce for VPM poured silver bars, give or take.

 

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