Gold as an Investment
Gold bullion is an essential investment in times of uncertainty. It is considered by many to be currency par excellence as it is very rare, it is a means of exchange and it is indestructible and cannot be debased. When placed in your portfolio it tends to maintain its buying power over time whereas traditional paper based currencies lose buying power due to inflation. Investors typically view gold as a means of savings, a safe harbour for their wealth. Gold is a hedge against inflation, deflation, geopolitical, macroeconomic and systemic risk.
Six compelling reasons to invest in precious metals
- Diversification – Precious metals have a historical negative or weak correlation to price movements in the financial markets, especially the stock market.
- Liquidity – Excellent liquidity with bullion markets trading continuously around the globe and no determination of market value required by investor upon resale as the price is based on a live market price and thus not the subjective opinion of an auctioneer, valuer or vested interests. One can automatically sell one’s bullion at any time of one’s choosing unlike a house which can be on the market for months and sometimes a buyer can pull out at the last minute and occasionally no buyers can be found for a property.
- No Liabilities – Gold and silver are millenniums-old finite mediums of exchange or currency that do not represent any government’s liability or ability to repay; confidence in issuing entity is 100% due to ability to assay precious metals for purity.
- Safe Storage – Well-established, secure and regulated intermediaries such as the AAA rated Perth Mint exist for long-term storage and insurance if holdings do not fit in or investors do not feel secure enough to store bullion in a private residence or safety deposit boxes.
- Protect against uncertainty – Gold, silver, platinum and palladium are asset classes which were in a bear market for over 20 years, after their phenomenal investment returns in the stagflationary 1970s when they rose by some 3000% from $35 to $850. Precious metals were disdained by Wall Street, much of mainstream finance and the majority of investors and were massively oversold. But since 2001, they are exhibiting signs of accumulation and increasing macroeconomic and geopolitical instability has led to an increase in demand.
- Better then paper money – Gold is an asset that central banks will may increasingly use to shore up confidence in increasingly debased and volatile fiat currencies as excessively loose monetary and fiscal policies which may cause monetary instability. There is a likelihood of paper money or fiat currency competitive devaluations going forward in order to maintain exports.
History of Gold
Gold has been sought after for its unique blend of near indestructibility, beauty, rarity and because of its status as a means of exchange and universal currency par excellence for centuries.
Empires and nations have sought to possess gold as a medium of international exchange, as a store of wealth and in order to increase and preserve power. Individuals have used gold as a store of wealth and as insurance against the fluctuations and depreciation of paper money and to protect against other macroeconomic and geopolitical risks.
Throughout history, perhaps no other asset in the world has had the universal appeal of and safe haven properties of gold. This appeal has increased in recent times due to the very significant macroeconomic, geopolitical, environmental, monetary and systemic risk facing our modern global financial system and economy.
Gold as a Hedge against Inflation
Gold has been and remains a good hedge against inflation. Throughout history, from ancient Greek and Roman times to Europe in medieval times to Germany in the 1920s and many other countries in the 20th century, gold has protected people’s savings and wealth from the debasement of paper currencies and from the scourge of inflation.
As recently as the 1970s and the stagflation of that decade, gold again acted as a hedge against inflation.
Contrary to misguided recent claims based on a selective use of data that gold is not a good inflation hedge, it has been academically proven that gold is a good hedge against inflation.
Many studies have shown that, precious metals are one of the few asset classes with a positive correlation coefficient with inflation. According to Ibbotson Associates, precious metals are the most positively correlated asset class to inflation. From a strategic point of view, Ibbotson determined that portfolios could reduce risks and improve returns with a 7-15% allocation to precious metals bullion.
In another important comprehensive study, Wainwright Economics, the respected independent research firm, said that gold is the most effective indicator of rising inflation. Their research proves gold’s role as effective protection against inflation shocks and shows gold as the most accurate indicator of future inflation and, when used alongside other inflation shields, is an effective inflationary hedge.
Wainwright Economics research shows that gold is a superior predictor of inflation when compared with other measures such as the Consumer Price Index (CPI) and oil. The research provides strong support for gold’s long assumed role as a hedge against extreme events and economic shocks, including inflationary shocks. Because gold is an asset that goes up with inflation and actually increases at several times the rate of inflation, it is an excellent choice to be used alongside inflation indexed bonds.
Most investment portfolios have no allocation to precious metals whatsoever. As a result, they are not protected from inflation or other systemic vulnerabilities, and are neither balanced nor diversified. An allocation to gold bullion hedges against inflation and reduces portfolio volatility and improves returns over the long term.
Real diversification means diversifying and remaining diversified with gold, silver and some platinum bullion.
Gold as a Hedge against Deflation
Gold has been and remains an important hedge against deflation and deflationary recessions and Depressions.This is because while gold is a commodity – more importantly it is an asset that has no corresponding liability and is an important reserve asset and finite currency.
There is a common misconception that gold does not perform well during periods of deflation. This is inaccurate as was clearly seen in the Great Depression of the 1930s. Then, the dollar which was backed by gold (unlike today in our modern floating fiat currency monetary system) was sharply devalued and gold revalued overnight by Roosevelt from $20.67/oz to $35/oz.
Thus, President Roosevelt revalued gold by some 70% and devalued the dollar by some 70%, from $20.67/oz to $35/oz. It is worth remembering that the Dow Jones fell by 90% from peak to trough and property prices fell by more than 50% in the early years of the Great Depression.
Gold performs well in a deflationary environment because gold has been used as money and a store of value throughout history. In deflation the price of goods and services falls versus money or more accurately the purchasing power of money increases. This was seen clearly in the Great Depression and again in recent years.
Gold remains an important currency and monetary reserve today. It is still considered an important reserve asset by most central banks and is the only reserve asset that is no-one’s liability. This means that, unlike a currency, the value of gold cannot be affected by the economic policies of the issuing country or undermined by inflation in that country.
Gold still has an important role as an important, finite safe haven currency within international currency reserves and within the monetary system. Cash is king when deflation takes hold but gold has been emperor and has outperformed even cash in deflationary periods and is thus an excellent hedge against deflation.
Gold as a Hedge against Systemic Risk
Today, our global financial system is more connected and integrated than ever before and the sheer size of many corporations and banks and the huge levels of debt at all levels of society and increasingly with governments means that the global financial system is more at risk of contagion and a systemic crisis than before.
Gold, unlike corporations, banks and indeed governments cannot go bankrupt. While gold rises and falls in value like other currencies and assets, its scarcity and finite nature mean that it always retains some value.
Gold has a track record of holding its real value over the centuries. Since gold is no-one’s liability, it cannot be repudiated and holding it is a safeguard against potential unforeseen crises such as an international monetary crisis or a systemic crash. Gold also brings much needed diversity to investor, pension and central bank portfolios due to its low correlation with key currencies and its strong inverse correlation with the US dollar.
Gold bullion that is owned outright and not kept within the financial system is a good hedge against systemic risk. Unlike property and other assets that are normally financed through debt (and are therefore often liquidated in order to pay off the debt or liability), gold bullion is no one else’s liability.
It has also been shown in numerous academic studies that gold, and indeed precious metals, are the only one of the seven asset classes with a negative average correlation to the other asset classes. Meaning that gold generally rises when the more popular asset classes (such as equities and property) fall and gold falls in value when other asset classes rise.