Gold is not “original money.” Gold is merely one in a list of several commodities that has occasionally been used as money, a list that includes wampum, iron, leather, tobacco, silver, wheat, rice, cattle, and innumerable others, and it certainly wasn’t the first commodity to be used as money. Just because a money is based on a commodity does not preclude the possibility of rampant inflation in that money; see Spain in the 1500’s, or any “boom” mining town in the American west for counterexamples. Similarly, commodity money is not immune from Cantillon effects, with the same counterexamples immediately springing to mind.

“Gold is money” proponents will point to “government” central banks settling some accounts in gold. Again, this is only one of many ways in which “governments” settle accounts with each other; they also use a multitude of paper fiat currencies, as well as barter/exchange methods (e.g., allow this military base here, buy these weapons from this manufacturer, permit this oil pipeline, etc.).

While we still live in a world with powerful “governments,” gold will never have widespread acceptance for exchange amongst citizcritters. The “governments” won’t allow that. Kublai Khan was one of the earliest experimenters in paper money inflation, and one of the first proofs that military might can enforce acceptance of inferior currency. Ever since Kublai disclosed the magic power of fiat currency to enrich a “government” through Cantillon effects, all “governments” have increasingly moved towards debasing their currencies for the triple aims of (1) indirectly taxing all holders of their currencies, (2) providing “first user” benefits to qualified rent-seekers, and, in the last century or so, (3) allowing creative inflation of useless, imaginary statistics like “GNP.” Gresham’s law would state that bad money drives out good, although I’ve read papers discussing various “tipping points” at which that no longer holds true. While those tipping points of hyperinflation aren’t yet reached, and while the JBTs, er, LEOs, can still enforce “legal tender” laws on legitimate, “registered” businesses, we commoners will be virtually forced to choose a “government” fiat currency to conduct our business in.

To press for an “official” gold-backed currency is a mistake. It misses the point rather completely. When a “government” controls money, even commodity money, it will manipulate the situation to its advantage. Some gold bugs, at least, recognize that a gold standard is fiat in disguise, but not all of them do. “Governments” prefer fiat currencies because they’re easier to manipulate, but they would still, just as they have in the past, manipulate commodity currencies even if they could somehow be “forced” to use them. The real solution is private money, but that is probably not going to happen in my lifetime … or yours.

From time to time, gold has offered some really good trades, even over years or decades out-performing the stock market. Of course, depending on your choice of beginning and end points, you could point out where trading in gold has been “dead money” compared to the stock markets. This is true of most commodities, and gold is not exceptional in this regard. There are many ways for a retail trader to play gold, and these include physical gold, the futures markets, futures-tracking ETFs, and the stocks of gold producers and users.

Buying numismatics is a rube’s game. It is similar to buying Van Gogh reproductions for the value of the ink and canvas. The proper way to play the physical commodity is through bullion, but one needs to consider holding costs, insurance, shipping, assaying, and bid/ask of the transactions.

The old saw of buying stocks because their earnings are levered to the price of gold is horse hockey. While they may have speculative levering in the minds of buyers, the bottom line is that virtually all commodity producers have heavily hedged their selling prices into the futures markets. As an additional hedge, there are various grades and locations of gold ore veins, and the companies will mine the most costly veins when gold is expensive, and the least costly veins when gold is cheap, which tends to equalize their profits. The objective of the company is typically to have easily projectable expenses and profits, not to make windfall losses and profits as the spot price moves. You can sometimes assess the actual amount of hedging done through a thorough reading of the quarterly and annual reports, but not always. You should also keep in mind that there are very few pure plays in any one metal; often they mine as much copper, molybdenum, and silver as they do gold, or they have interests in coal mining, wire production, or other businesses. When some “adviser” tells you that a company that earns $50 an ounce at $400 gold will earn $100 an ounce at $450 gold, don’t walk, run.

The futures markets have their own issues. Looking back over the last twelve years, the price of gold has gone from about $380 an ounce to over $615, which looks like a nice profit, until! A back-adjusted contract price was really closer to $540 in January 1995, implying that gold has been in a contango for much of the time, making the cost of carry on the contract eat most of the profits. Depending on your roll strategy and commissions, carrying long gold futures could be a net loss for you, despite the increase over the last year or so. The main advantage of the futures is the approximate 18:1 leverage available under the contract, but at that level it wouldn’t take much to engender an overnight margin call. Leverage just increases risk; one must be right about direction.

As an example, the Feb ‘07 closed at $619 on Friday, but the Dec ‘07 closed at $648 with the second-highest open interest. The highest open interest in 2008 is December at $681. That implies a hefty cost of carrying the contract, if the price of the underlying doesn’t appreciate before then. If the December contract at $648 pulls down to the current level of $619 as the most recent month, that would be a loss of $290 – less than ½ of a percent in the price of gold, but almost 10% of the initial margin required to purchase a contract. A declining market in contango could accelerate down as longer-term speculators get washed out.

To the extent that contango and cost of carry might impact the ETF’s expense ratios, it might be a concern; but in reality, probably the easiest and best way for a retail trader to play gold is through an ETF like GLD.

Some perma-bears are fond of saying that parabolic up moves are always followed by crashes. Of course, they’re usually referencing the stock market of 1999-2000 when they say this, and not usually referencing gold, as a large portion of the perma-bear community are also gold bugs. One can see some serious parabolic moves on this longer-term chart; note that the last parabolic up move left gold in a roughly twenty-year bear market.

A multi-year chart places support below $500, and that presupposes a continuation of trend.

One can easily say that resistance is now between $640 and $660. Possibly we now have a $560 to $660 trading range; perhaps $600 is the bottom for a trading range; regardless, it looks as if there will be a prolonged consolidation before any possible renewed up move. One could trade the range, either bullish or bearish, of course. On a longer timeframe, I would be inclined to a bearish play.

I have discussed gold before, most recently in commodity exposure and neither long or short gold. I currently have no position in gold, sold my gold-related portfolio holdings over the summer, and am not looking for another position at the moment, but I’m keeping GLD on my watch list. Gold is also the subject of the Monday show at Wallstrip, and I can’t wait to see what they do with it. I believe Howard of Wallstrip fame is still long gold. Should be a fun show!