April 02, 2004
In response to last week’s column, Don wrote to say
that terrorism’s influence on the gold price does not make the metal
a bad investment choice. He makes the point that the biggest increase
in the gold price occurred during 1979 and early 1980, mostly due to tension
between the United States and the Middle East, exemplified by the Iranian
Hostage Crisis: a terrorist act. Don then asks, rhetorically, why that
would not have been a good time to invest in gold.
He goes on the say that people turn to gold during times
of political instability and uncertainty, and that the success of the
terrorist act in Spain (in changing the political climate there) indicates
that we are likely to experience more such atrocities. Given that terrorism
will continue to influence gold’s future, the prospect of increased
terrorist activity is a sound basis for investment.
I agree with Don almost entirely. History confirms that
people tend to buy gold during times of trouble and uncertainty. The situation
today is quite analogous to the late seventies. There is tension between
the United States and Muslim countries and as far as terrorism goes, things
are likely to get worse before they get better. It is also true that a
lot of money could have been made buying gold during the late 1970s. But,
and this is where I disagree with Don, buying gold in anticipation of
increased terrorism, or the threat of continued political and social uncertainty,
is not a good investment idea.
Predicting the timing and severity of terrorist activity
is nearly impossible. Even if we are certain that terrorism will increase,
we don’t know whether there will be a major strike this year, or
next. Perhaps nothing will happen for three years. Or maybe there will
be a spate of activity later this year, and then a lull. Either way, most
people are likely to feel the urge to buy gold when there is an increase
in terrorist activity, or uncertainty, or both, precisely when gold will
be trading at higher levels.
Similarly, they are most likely to sell their gold when
peace and calm prevail, since they would no longer feel compelled to own
a non-income-producing metal; precisely when gold is trading at lower
prices. That is why most people tend to lose money on their gold “investments”.
To state the obvious, you have to buy when the price is
low and sell when the price is high. For gold that means you buy it during
times of peace and calm, when the threat of terrorism seems remote and
the price is relatively low. You should sell gold when there is turmoil
and the price is high. After all, if you bought gold as an investment,
you intended to make a profit.
So while I agree completely with Don that the probability
of increased terrorist activity is high and that the gold price could
rise as a result, the unpredictability of terrorism and human nature do
not make increased terrorist activity a sound basis for investing. Buying
gold in anticipation of terrorism could, however, be an excellent speculation.
Also, gold is a superb form of insurance against increasing political
and social turmoil. The difference is psychology, not semantics.
Investing requires a high degree of certainty in the worth
and timing of your expected return, with a clear understanding of the
risks attached. Good investments can often be held for long periods of
time, with relatively low risk, and a fairly certain return on capital.
Buying gold on the basis of increased terrorist activity, even if it occurs
and you make money, does not qualify as an investment. It is pure gambling
because predicting the extent of paranoia, and hence the extent of the
increase in the gold price, is not possible. At best you could only have
a low level of confidence in the outcome and timing of your return. And
if you bought gold in anticipation of increased terrorist activity and
such activity does not materialize in the short term, what do you do?
Gold is, however, an excellent form of insurance. But, as
with any insurance policy, you are always better off if you do not have
to collect on it. The psychology of buying gold as insurance is very different
from buying gold as an investment. There is no profit motive and it makes
sense to buy gold during times of increased terrorist activity, which
is what the public tends to do. If you end up buying gold at elevated
prices because of an increase in uncertainty, or as in our present case,
an increase in terrorist activity, you can logically justify the decision
because you are merely buying insurance during times of turmoil at a higher
premium. But then don’t turn around and feel blue if the gold price
declines when things calm down. If you didn’t need to cash in your
gold to stay alive, or to take care of other needs, you should be thankful.
It was an insurance policy that, at the end of the day, you did not need.
People speculate (gamble) on just about anything -- gold
is no exception. Astute speculators, like successful gamblers, understand
their game intimately. A speculator’s gold market is very different
from an investor’s, or someone buying gold for insurance.
A speculator might buy gold on the assumption that terrorism
is on the rise and therefore the gold price is likely to do well. Don’t,
however, confuse that with investing. A true speculator will know when
to cut his losses or ride a winning streak much better than someone who
is under the impression that he is investing when in reality he is gambling.
Whether you buy gold as an investor, for insurance, or as
a speculation does not matter. But in order to profit you must know into
which category you fall, and be very clear about your own strategy and
As an aside, if you’re curious how much the
war in Iraq is costing the United States, take a look at www.costofwar.com.
Paul van Eeden
Paul van Eeden works primarily to find investments for his
own portfolio and shares his investment ideas with subscribers to his weekly
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