Gold: A Hedge for All Seasons

Markets are a reflection of human behaviour and endeavour. In financial markets and in an economy, nothing happens in a vacuum. Eleven years of central banks’ money expansion while maintaining artificially low interest rates has pushed up asset prices, creating asset price inflation and moral hazard. Public and corporate debtors are taking on more debt, not less. Counterparty risk (the probability that the other party in a trading or investment credit transaction may default on its contractual obligation) brought down Lehman and AIG during the financial crash, and it is much higher today than it was in 2009! Gold is the only traded asset that is not someone else’s liability and that always retains a ‘bid’.

Gold moves on fear, principally the fear of a fall in paper currency’s purchasing power. Since 1930, the US dollar has lost 98% of its value against gold, while in that time gold has been a proven hedge against the rising cost of fuel, food and cost of living. Since Nixon took the USD off the gold standard in 1971, gold has gained 3,000 per cent.

Gold ETFs (exchange-traded funds) give the investor an exposure to the gold price, but unlike physical bullion, investors in ETFs may find themselves as unsecured creditors to a counterparty risk during a crisis of liquidity like that of 2008. Due to the convenience of holding a paper receipt, investors and managers often overlook this.

The amount of gold and precious metals owned by investors in the US at the height of bull markets during the past 30 years is 7%. In spite of the recent rally in gold, US ownership of gold and precious metals is still only around 0.5%. If this figure were to reach the 30-year average, the price of gold would quadruple.

Gold is an insurance against central banks expanding the money supply and debasing the purchasing power of the USD and other Fiat paper currencies. The gold price moves inversely to the US dollar. Gold is a proven store of value. Unlike paper currency, it cannot be printed, and unlike crypto currencies, it cannot be hacked.

Today the US 30-year Treasury Bond (the global credit benchmark) has a negative real yield (nominal yield adjusted for inflation). Meanwhile, investors in European sovereign bonds with a negative nominal yield (in terms of actual value of capital invested) receive no yield while they wait. As a hedge in a crisis, gold compares favourably with treasury bonds that now give a negative real yield.

We know that deflation, inflation and stagflation may occur over the next decade. What we cannot know for sure is in what economic order this will occur, or which will take precedence. In all of these scenarios, gold both protects and gives an opportunity for capital appreciation.

Gold should be a part of any capital preservation strategy. If wishing to preserve the purchasing power of our capital, we should remember that the stock market can stay irrational longer than we can remain solvent.

Jeremy Blatch TEP
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