Is gold set to replace paper money?

A few nights ago, my wife and I were at a dinner party, and Cassie (my wife) happened to be seated next to an ex-investment banker (currently a business consultant, used to be an investment banker). Before long, the conversation turned to the Gold Cruise and the fact that I was scheduled to give a talk on gold.

His response was immediate and enthusiastic: "Oh wow, that's great! Gold is really hot right now! Precious metals are the place to be!"

The point of that little anecdote is that the word is clearly out. When you get that kind of response at a dinner party, people know. It's no longer our job to "evangelize" anymore. We don't have to go out and pound the table for investing in energy and metals. As recently as a year ago, we did, telling everyone and their brother to buy gold and oil stocks, but now people get that. They see the opportunity is here. But does that mean our job is done? Not at all. In fact, our job is just getting started, just like these trends.

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There are only a few ways for the bull market in gold to play out, and supposedly a fixed ending in all cases.

The yellow metal's dollar price will violently launch into orbit at some point, arc into a near-vertical crescendo and ultimately burn itself out supernova style. Either that or a long, drawn-out grind - a steady sloshing higher over the course of years, punctuated by occasional hiccups and countertrends to keep us on our toes. Or perhaps a combination of both, in homage to the disco era - a multiyear rise capped off with a blaze of glory.

But no matter how it happens, gold will eventually return to Earth. The fixed ending is a return to normalcy, which in gold's case equates to dormancy. After all, what goes up must come down. Right? It's only logical. That is what everyone expects.

Yet what if, this time, the future doesn't look like the past? What if gold were to climb to new highs, breaking the $1,000- an-ounce barrier, and never return from whence it came? With apologies to Thomas Wolfe, what if the bankers can't go home again?

Now that would be something.

Gold: sound money?

In the long run, I believe, the fiat money bankers will not be able go home again. The role of gold in the 21st century is not just to act as a barometer of financial anxiety, but to ultimately return to the fore as sound money.

Even with gold at 25-year highs, only a modest percentage of the population continues to insist - and to remember - that gold and silver are money. It is surprising, and sometimes breathtaking, how quickly modern man forgets his past.

Born of Nixon's infamous utterance, fiat currency is little more than a brief experiment in the grand scheme of things - still shy of its 40th birthday. Gold and silver, on the other hand, have functioned as money for roughly 98% of recorded financial history, dating back to the Lydians in the seventh century B.C.

Some dismiss gold as "just another commodity." Those who say that gold is just another commodity either have a hidden agenda, a blindness to human nature or both.

While true that gold responds to supply and demand just like any other commodity, it is also the only commodity to have been bound up with the human psyche for thousands of years. As Peter Bernstein recounts in his excellent book The Power of Gold: The History of an Obsession, gold has been driving men to great lengths of desperation since time immemorial. There is something deeply moving about it.

Gold: just another commodity?

Some things are just bred into us. Certain habits die hard or never die at all. Modern suburban man, for example, has a deep attachment to his lawn. There is just something about owning a piece of fertile land, even if it is barely the size of a postage stamp, that makes a guy feel like king of his castle. This feeling can be traced back to our ancestors, for whom possession of sufficient hunting and gathering territory was a matter of life and death. The man rich in land was rich indeed. Gold inspires a similar primal connection. It is not just another commodity.

Gold represents more than just the wealth of kings. On a more everyday level, gold is simply money - a store of what you have worked hard to earn and keep. Money you can sink your teeth into, hide under your mattress, store up in your vault. Real money.

In our modern world of bits and bytes, money is brushed off as an abstract concept. Talking heads regularly maul and distort its meaning at will. Yet money is one of the most important "abstract concepts" in history. It prices the fruits of our labour and the value of our efforts.

It makes savings and investment possible. Money is not wealth in itself, yet it measures out the wealth of nations. Mentioned in the Bible more than any other topic, money speaks to the state of a man's soul. Ultimately, money is linked to something even older and more abstract: the concept of trust.

So how is it that when you follow modern money to its birthplace, you wind up in a politician's headquarters - a place utterly devoid of trust if ever there was one? This does not make sense. It is an anachronism of 20th-century government, a byproduct of industrial oligarchy and short-lived economies of scale. As free market capitalism evolves, the temporary arrangements that gave birth to fiat currency will not survive. The hoary old concept of trust, on the other hand, most certainly will. This is why gold will rise again.

Gold: what will happen in the long run?

Successful traders have a saying: "Avoid the middle like the plague." Basically what this means is that you can make money in the short run and you can make money in the long run, but the middle is often a fog.

In the short run, you have what I call "pockets of clarity" - moments where all the pieces fall into place and you can see, if only for a few precious moments, what is likely to happen next. Finding and exploiting pockets of clarity is the bread and butter of successful trading. In the long run, you can see the big trends, "megatrends" as some call them, that will eventually run to inescapable conclusions. The only things absolutely certain are death and taxes, but some other things come close. A few major cycles, rooted deeply in human nature, have the predictability of gravity or the sun rising each morning - but only over the very long term.

In discussing the return of gold as money, this talk is clearly focused on the long run - where the current trends we are seeing will ultimately lead us as far as gold is concerned. The evidence to support our conclusions is right before our eyes... but in terms of how long everything will take, we cannot know.

It is the middle span that is truly hard to predict, yet as investors, we must get through it. We do not know how long it will take for certain trends to play out, but we do know the long run shapes the middle as we go from here to there. When you have conviction, patience is your ally. It is easier to get through the valley when you know the mountain is in the distance.

By Justice Litle for The Daily Reckoning. You can read more from Justice and many others at www.dailyreckoning.co.uk.

Recommended further reading:

For more on the gold vs. paper money debate, see Why gold is better than paper money and How high would gold rise under a new gold standard? Then visit our section on investing in gold.

Justice Litle is an editor of Outstanding Investments. He has worked with soybean farmers, cattle ranchers, energy consultants, currency hedgers, scrap metal dealers and everything in between, including multiple hedge funds.