Precious Metals: The Unseen Risks

Precious metals have been a core investment vehicle for very good reasons since before the beginning of recorded history.  In periods of crisis, by and large, precious metals – especially gold – maintain their value to a much greater degree than other media of exchange.  In times of complete political and social collapse, in turn, precious metals – again, especially gold – are often accepted in exchange for goods and services when nothing else has any exchange value at all.

Just now, many people are waking up to the relative security that precious metals offer as compared to fiat currencies, and here again, there are very good reasons for that.  In the United States and elsewhere, central banks are frantically trying to evade the inevitable results of decades of spectacular mismanagement and massive financial fraud without doing anything to correct the mismanagement or prosecute the fraud.  One of the lessons taught most consistently by economic history is that this won’t work, but the attempt is being made anyway, and the increasingly dubious gimmicks employed in this fool’s errand are leading to a crisis of confidence in the entire structure of global finance.

Over the last decade or so, as that crisis of confidence has grown in intensity, it’s played a major role in turning an already lively rush to precious metals into a stampede. Investors who would have dismissed precious metals a decade ago as a fringe concern now, as often as not have at least some exposure to gold and silver.  At a time when widening cracks in the global economy impose massive downside risks on nearly all other investment vehicles, this shift is understandable. Even so, while precious metals are less vulnerable to the downside than most other investments, no investment is a sure thing.  Including precious metals in your personal strategy for wealth preservation is wise; relying on precious metals alone may not be.

Wealth and Money Revisited

In order to make sense of the unseen risks facing the precious metal investor, it’s crucial to start with the difference between wealth and money, the theme I explored last month in “Wealth, Money, and Economic Crisis.”  To recap, wealth has two kinds of value.  It has use value – that is, you can use it yourself to satisfy your own needs and wants – and it also has exchange value – that is, you can give it to someone else in exchange for some other kind of wealth that will satisfy your needs or wants.  Money, by contrast, only has exchange value.  You can only use it to satisfy your needs and wants if you can find someone who will take it in exchange for real wealth.

As long as the mechanisms of exchange work the way they’re supposed to, this difference doesn’t matter.  If we lived in an era when the mechanisms of exchange weren’t cracking under the strain of the decades of mismanagement and fraud mentioned above, there would be no need for this essay – or, for that matter, this website.  We don’t happen to live in such an era.  Instead, it’s a safe bet that as we proceed further into the future, the easy certainty that money can be equated with wealth will sooner or later be replaced by the unwelcome discovery that a great deal of what currently counts as money can lose most or all of its exchange value in a hurry.

A growing fraction of investors are becoming aware of this.  So far, however, most of the discussion of these points in public forums has focused on the forms of money that most obviously risk losing their value.  Fiat currencies issued by central banks are one obvious example, and deservedly so; as the politically motivated manipulation of currencies has replaced any saner form of economic policy across most of the industrial world, the ability of those currencies to function in their basic roles as means of economic exchange and stores of value is coming increasingly into question. 

That realization is an important start, but it doesn’t go far enough. While the different forms of money differ drastically in the ease with which they may be manipulated by governments and private interests, every form of money is at risk of slipping out of sync with the underlying economy of real wealth. Yes, that risk is shared by gold and other precious metals as well.

Gold as Money

Unless you need high-end dental work or have one of a very few specialized industrial processes in mind, gold has no use value. The other precious metals are less specialized, but even so, it’s a safe bet that investors who are stockpiling silver aren’t planning on using it for photography.  Precious metals are precious because they’re relatively stable stores of exchange value; that is to say, they’re money.

What makes gold and the other precious metals a better investment in troubled times than Federal Reserve bills or commercial paper is simply that the former are less vulnerable to the vagaries of political and economic authorities than the latter.  The Fed’s frenzied attempts in recent years to prop up financial markets by flooding them with torrents of freshly manufactured money are only the most recent reminder of what happens when governments have the power to print currency at will, while the vast overhang of unpayable debts, insecure securities, and, frankly, hallucinatory derivatives currently being heaped up by the corporate sector demonstrate that the private manufacture of claims to wealth can be as irresponsible as anything governments can do.

Outside of certain unusual circumstances, by contrast, the amount of gold in circulation is fairly stable.  It’s not difficult to figure out how much is likely to be mined next year, how much of that will go into high-end dentistry and other uses, and how much is left to be snapped up by worried investors. Matters are similar with the other precious metals. Until somebody makes good on the promises of the old alchemists and starts turning lead into gold in industrial amounts, we’re safe from any but the most limited attempt at quantitative easing in the gold supply.

That has not always been the case, and the results of sudden surges in the gold supply are worth examining. In each of the major gold rushes of the nineteenth century, for example, the area around the gold fields experienced wild distortions in the value of gold relative to ordinary goods and services. That’s why the people who made the most money off the gold rushes were rarely the ones out there digging for gold.  Levi Strauss was among those entrepreneurs who realized that providing goods and services for the gold camps – in his case, sturdy denim trousers – was a much more certain route to wealth than prospecting for gold directly.  Every time you put on a pair of blue jeans, you’re paying homage to the hugely profitable business Strauss built on that realization.

For an even starker example, consider the economic history of the Spanish empire between 1550 and 1750.  Once the conquistadors finished their bloody work, the proceeds of the immense gold and silver mines of Mexico and Peru gave Spain the ready money to build the first global empire in history and then to destroy that empire through hyperinflation. Spain’s currency wasn’t merely gold-backed; it was a straightforward gold and silver coinage, but doubloons and pieces of eight poured out so relentlessly from the Spanish mints that galloping inflation spread throughout the Spanish empire and beyond, shredding the once-vibrant Spanish economy and ultimately crippling Spain’s efforts to expand its power base in Europe. 

Just at the moment, the only continent where previously untapped gold mines are likely to be found is Antarctica, and any gold rush there will have to wait until the ice sheets collapse – and if that happens, of course, we’ll all have more pressing things to worry about.  Thus it’s unlikely that imperial Spain’s experience will be repeated in our own time.  Still, it needs to be remembered that there’s more than one way that money and wealth can get out of sync with one another and cause inflation.  The obvious way, the way that gets most of the discussion these days, is for the money supply to expand while the supply of goods and services doesn’t.  The other way, the way that too often gets ignored, is for the production of goods and services to contract while the money supply doesn’t. It’s this latter form of disconnect that we’re likely to face in the years ahead.

Precious metals, to recap, are worthwhile investments just now because most other forms of money are far more volatile, not to mention far more vulnerable to manipulation by central bankers trying to prop up a failing system. It’s nonetheless important not to confuse money and wealth – even if the money in question consists of precious metals – and equally important not to lose track of the potential risks as the production of real wealth begins its inevitable decline.

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This is a companion discussion topic for the original entry at