In the last year the price of gold is up by 17%. It’s broken out of its trading range of the last few years and cruised through the US$1,500/oz mark. This article investigates why and examines the case for gold as an investment.
Chart: World Gold Council 24/8/19
Gold – some key facts
• No one knows how much gold there is above the ground, but most estimates are around 175,000 tonnes, which would cover a soccer field to a depth of 1 metre.
• It’s estimated that there is around 50,000 tonnes left in the ground that is able to be mined.
• New gold is being mined at the rate of 1,200 tonnes per year – adding around 0.7%pa to the total above ground.
• Around 50% of the new supply goes into jewellery, less than 10% into industrial applications, 20% is bought by Central Banks, with investors buying the rest.
• Central Banks around the world are sitting on around 35,000 tonnes and have been slowly accumulating more since 2008, particularly emerging countries.
• The biggest Central Bank holders of gold are, in order- USA, Germany, the IMF, Italy, France, Russia and China.
So, why the rush?
Gold prices can spike for a number of reasons. Firstly, when there are serious economic, financial and geopolitical risks in the economy. In the extreme these are the times when we dig bunkers and stock them with guns, canned food and gold bars.
But these can also include times when the safety of bank deposits and government bonds are called into question. For example when interest rates are zero or negative or when various currencies have been debased through reckless government mismanagement.
Gold also rises when there is high inflation, as it’s a ‘scarce’ resource, a store of value that needs to be revalued in money terms. High inflation is certainly not the case now, but gold can also rise when markets are confronted with interest rates that have fallen to a rate that’s lower than economic growth. This potentially means higher inflation down the track and in the meantime gold can become an alternative to cash whilst sitting out a recession.
Right now, a number of these worries are coming together at once. There are negative yields on a growing number of bonds around the world (14 countries currently and growing, mainly in Europe and Japan), due to a combination of recessionary fears and extended monetary easing. The yield on gold may be zero but’s it higher than any government bond with a negative yield. So the opportunity cost of investors holding gold today is much lower. And the supply of new gold is limited whereas the supply of new bonds is never ending due to increasing government debt around the world. But perhaps the major reason is that the escalation in currency and trade wars is spooking investors, causing them to look at alternatives and renewing debate on alternative currency systems. For example, last week Mark Carney, the Bank of England Governor called for a new digital global currency linked to basket of currencies including the Chinese renminbi.
So should we jump in with a large allocation to gold? Sadly gold’s protective properties in times of stress are unreliable. Gold didn’t help during the global financial crisis. It was just as volatile as the assets that crashed. It doesn’t move with normal business cycles having had just two major spikes since the second world war, in 1980 and 2011. With hindsight these were clear bubbles – a gold investor who bought in 1980 had to wait 25 years to turn a profit. And despite its run, the current price is still 20% behind the 2011 peak. A buyer today could hardly say gold looks cheap. If course it’ll seem cheap if the price moves again into a bubble!
Is gold a viable currency alternative?
A currency works if it is practical for payments, is a recognised unit of account and provides a steady store of wealth. Sadly for the gold bugs, it fails the first two tests. The world has moved on since debts could be paid in gold – it’s simply not practical. Similarly no-one thinks of the value of anything in ounces of gold. We only think of value in our home currency or a dominant currency like the US dollar or Euro. These days the attraction of gold is really just the “store of wealth” idea when other forms are being questioned. Indeed Mark Carney didn’t set out any role for gold in his musings on a new digital super-currency. His vision was seemed more like Facebook’s Libre proposal. It’s interesting to note that the cryptocurrencies like Bitcoin probably pass the practical tests of “payment” and “unit of account” but haven’t demonstrated themselves to be a reliable “store of wealth”. Although, after spectacular crashes in 2018, the cryptocurrencies are climbing again for reasons not unrelated to gold’s strength.
Is gold a viable long term investment?
Opinions differ sharply on the merits of the investment case.
Gold is easily traded via exchange traded funds (“ETFs”) on the ASX. Most gold ETFs are backed by equivalent holdings of gold bars in bank vaults. So purchasing and storing it is easy.
There’s no doubt it’s a transcendent symbol of beauty, wealth and immortality that’s long been coveted by pharaohs, pirates, miners and financiers. But today, gold has few practical uses. The gold standard was widely used in the late 19th and early 20th century to control exchange rates and country debts but Switzerland was the last major country to cut currency linkages with gold in 1999.
John Maynard Keynes called it the “Barbarous Relic” (and he died in 1946!). Warren Buffet has always preferred income earning assets over gold, specifically stocks and shares for the long term. One of his many quotes is “The magical metal is no match for American mettle!”.
Like other investments prone to bubbles, there is no consensus on how to value gold. It’s physical use in jewellery and industrial processes is less than annual production supply each year and is absolutely dwarfed by the volume of gold bars sitting in bank vaults around the world. Any sustained selling (or buying) by any major country’s central bank would change the gold market price in an instant.
Yet anything that is easily traded and has a price that has trended upwards over long periods deserves consideration in a diversified portfolio. Particularly if it has unique characteristics and a low correlation with other asset classes. Hedge Fund king Ray Dalio has said that those who shun gold “know neither history nor economics”. His current view is that gold has a place in portfolios in times like now when the value of money is being depreciated and there is rising domestic and international unease. His concern is that the tensions and inequalities of the world today may precipitate more financial blow-ups and forced wealth transfers.
Plenty disagree with Mr Dalio but there’s no doubt that gold is back on the radar. So we’ll leave the final words to the English poet Lord Byron (1788-1824) who perhaps had a premonition of today’s monetary conditions: “O Gold! I still prefer thee unto paper, which makes bank credit like a bark of vapour”.
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