Gold's Intrinsic Value

By Kevin McElroy

NEW YORK ( TheStreet) - The past two days I've discussed some ways you can protect yourself from the effects of a currency crisis, as well as higher food and energy prices.

But let's face it, the whole subject is a major drag.

I compounded the problem on Wednesday night when my wife and I watched The Road, a very good, but uber-depressing movie about a father and son's struggle to travel through a post-apocalyptic wasteland.

If you haven't read the two pieces, I urge you to do so. (See Wednesday's article on food riots and Thursday's article on the oncoming scarcity .) For now, I'm going to focus today's issue on a slightly more entertaining, and possibly just as informative topic.

There's an important theory of valuing assets, including investments known as "intrinsic value."

Now, before I go on, we should come to a mutual understanding that all value is subjective. That is, the small differences in preference among people will always mean that a given asset will be valued differently according to whom you ask.

For instance, my wife is crazy about fresh, perfectly ripened peaches. She'll gladly pay top dollar at a roadside stand to buy more peaches than we could possibly eat.

On the other hand, my father grew up with a peach tree in his backyard. By the time he was 10 years old he had consumed a lifetime's worth of peaches, so he'd probably rather go hungry than to eat another peach.

But I think we can all agree that a peach has an intrinsic value, in that it can be eaten, it has a certain amount of calories, vitamins, fiber, sugar, and protein. It has a shelf-life, as well as pretty specific storage requirements.

So while my wife and my father may have very different ideas about what they'd pay for a peach, they can both agree on the intrinsic value of the peach. A peach is worth something -- regardless of any external factors. Even my father would agree that peaches have a value -- in that he realizes that lots of other people do enjoy eating them.

On the converse side of the "intrinsic valuation" argument, there are actually people who think that the value of a peach is tied directly to what it costs to produce, or how much work goes into producing it.

That's known as the labor theory of value. People who prescribe to the labor theory of value (like Karl Marx) believe that an item is best valued by the amount of labor someone put into it -- not what it can actually do for someone.

I'm sure you can see why the labor theory of value is flawed. Spending time or energy on a good or service does not automatically imbue it with value to anyone else.

The most famous example of this flawed theory of value, is the story of a snowball salesman on the north pole.

It would take lots of effort to start a business on the north pole. It would be really expensive to set yourself up with enough food supplies, heating fuel, a storefront and advertising. But no one lives at the north pole. Moreover, no one who might wander by your store would have much interest in buying snowballs from you at any price approaching what you'd need to charge to cover your costs.

But according to the labor theory of value, you should be able to demand a price that would cover your costs, and that by law people should have to pay that price.

If you spend your time and labor in a way that does not result in a good or service that's valued by other people, then you have wasted your time and you shouldn't expect other people to fund your wasteful exploits.

So what's the point of this lesson?

I think we all know people who can't seem to wrap their heads around the idea that gold has intrinsic value -- in that, it's desired for the specific traits of "goldness."

Like the peach's peachiness, gold is desired for the particular qualities inherent to gold. While peach's are good to eat, and so they serve a useful function as food, gold's qualities are the exact qualities you'd want if you were to design money.

You'd want your money to be durable, rare, but not too rare, divisible, consistent, convenient and be recognized as such by a preponderance of people.

Why durable? You wouldn't want to use a peach as money. With such a short shelf-life, you'd have to spend it immediately, or risk having it's worth go to zero. Gold doesn't tarnish, rust, dissolve, rot or blow away in a stiff breeze. It's durability means that the value it has today will not be eroded by common elements, like a peach.

Why rare, but not too rare? As we all know, an asset's relative rarity is a huge part of its value. If gold could be easily mined, refined or produced, you'd quickly see the value of your gold diminish as new supply flooded the market. But gold's rarity means that the amount of gold supply is relatively static. You can't print gold at will like you can with paper.

Divisibility, consistency and convenience are obvious bonus traits. You can't very well have money that's impossible to divide, or a money that's inconsistent or inconvenient.

So gold, more than any other known substance, displays the particular traits that humans require in their money.

It has utility because it's an especially good substance to use as money -- not because it's expensive to mine.

So the next time someone tells you that gold is useless, tell them that it's actually the best money commodity yet discovered, and if they know of anything better, they should let us all know.

Have a great weekend,

Kevin McElroy, editor of Resource Prospector

Wyatt Investment Research, founded in 2001 as a publisher of newsletters, offers independent investment research of financial markets, stocks, bonds, ETFs and mutual funds to about 250,000 individual investors. The company is led by founder Ian Wyatt, who serves as publisher and chief investment strategist.

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