Thursday, May 13, 2010

Still Searching for the Seven Cities of Gold

Suddenly, gold has become the hot new investment, reaching over $1,200 an ounce (in dollar terms) for the first time. Does this make gold a good investment? Consider history.

For the Spain of the 1500s, the New World was a fantastic tale of unimaginable wealth come true. In 1519, Hernan Cortes conquered the Aztecs, securing astonishing amounts of gold and silver, as well as vast territories. Next, Francisco Pizarro and his brothers conquered the larger Inca Empire with even fewer men than accompanied Cortes. Unfathomable amounts of gold and silver flowed to Spain, which had grown in the space of 50 years from a medium sized European kingdom to the enormous Spanish Empire.

As vast fleets of galleons transported gold and other wealth to Spain, inflation set in on the Iberian peninsula. Gold wasn't a magical store of value and wealth. Nevertheless, the Spanish Empire dedicated itself to obtaining as much gold and silver as possible, through conquest and then mining. Latin America, a region with tremendous amounts of natural resources, wasn't developed in the way of North America. By the end of the 19th Century, North America was an industrial powerhouse. The Spanish Empire was bankrupt.

Gold isn't a productive asset. Its only value lies in what it can be exchanged for--i.e., what other people think it's worth. In times of distress, it has value. With the Euro in decline from the sovereign debt crisis in Western Europe, the dollar wavering because of the financial crisis and recession in the United States, and the absence of any strong currency in wide circulation in Asia, gold has by default become popular.

Gold doesn't produce prosperity. It can be a good short term trading play, if your timing is right. But the value of gold is affected by innumerable variables--economic, political, cultural, commercial and industrial (there are a few industrial uses for gold)--and its price trends are notoriously difficult to predict. Gold has done poorly as a long term investment--adjusted for inflation, today's prices are not gold's all time peak (that would be the 1981 price of almost $600 an ounce, which translates to about $1,400 an ounce today). In the last 35 years, the stock market has done about twice as well as gold.

People become wealthy by working, earning, saving and investing, not by speculating in gold. Countries become prosperous by industrializing and strengthening their manufacturing abilities. The Spaniards who searched for the legendary Seven Cities of Gold (or Seven Cities of Cibola) roamed through vast areas of what are now the plains of the United States. They didn't find any gold, and they didn't recognize that the dry grasslands through which they marched would some day become part of the wealthiest nation in the world. They were searching for the wrong thing, and so are today's investors who think they've found a panacea in gold.

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