The Downside of Gold

While I usually do not get into investment issues on this blog, I decided to comment earlier today about some potential downsides to continued investment in gold, given the extraordinary run up in its price over the last few years as investors sought any vehicle that offered relative safety. Bear in mind, nothing on this blog is intended as investment advice, and the issues I point out below do not have to happen. But they could, and in the interest of weighing future possibilities, I am pointing out a few potentials snares and pitfalls that may theoretically await someone who invests the bulk of their funds in precious metals, particularly gold.

First, one of the biggest problems for gold are the ongoing discussions between the Indian and Iranian governments about securing India's fuel deliveries. Earlier this year, India was talking about a payment plan that included buying fuel with gold. Lately, other means of making payments are now considered to be bypassing international sanctions and hence unacceptable to India's central bank, which presumably means gold is back on the table as an option... perhaps even as the primary option.

Think about that. Set aside the immediate circumstances involved -- Iran's inability to accept normal payments for her fuel. If countries have gold reserves that have greatly increased in value, but are otherwise facing serious financial problems and a critical shortfall in domestic supplies of energy and food... then they are apt to start selling gold. Once entire national gold reserves start showing up on the market, either gradually or all at once, it will have an impact on availability and price.

Second, what do you think happens if several Middle Eastern countries fall and their mansions and palaces are looted by an angry populace? A lot of gold suddenly ends up in the hands of people who need things other than gold -- such as food, for example -- and that could abruptly add a huge amount of gold to the Mideast market, and ultimately the world's. Especially in places, like Libya, where the wealthiest lacked either the time or the inclination to flee. And this will be happening just as oil and food become increasingly precious.

Third, there are countries out there, like China, who hold a lot of gold, but who are keenly aware of the value of other resources. I suspect China, in particular, sees gold as a hedge against other financial issues, but ultimately as a tradable commodity that could one day be exchanged for things that it really needs. They've had a chance to see that gold increase substantially in value, but have no reason to hold onto it if it's value may start declining or even crashing. They may look at a run up in oil prices, and sales by India or in the Mideast market, and choose to start getting out as well.

Fourth, quite a few individuals in the world, including Chinese and American citizens, have bought and held gold. Quite a few of those same people are facing increasing difficulty in getting the bare necessities in life, and they will probably find things even more difficult should Middle Eastern oil exports -- and the global oil trade in general -- collapse. In which case, they may also sell.

Finally, gold has had a huge run up in price, and now there are quite a few individuals and organizations with so much invested in it that they can not afford to lose their principle. And unlike, say, oil, there is no substantial base demand for gold that has to be met in a heavily damaged economy. All of which means... If investors start to dump gold, they could all get out in a rush, leaving quite a few stalwarts stuck holding depreciated, if not near-worthless, metal.