Gold remains the best insurance for a crisis
Gold remains the best insurance for a crisis
As central banks race to devalue currency private individuals are hoarding record amounts of gold
The price of gold might be falling,
but private individuals are buying record amounts of the precious metal,
and as fears grow about the outlook for the global economy the long
term attraction of gold remains.
Gold loses its shine
The strength of the US dollar and the threat from rising interest rates
have made it a tough year for gold. The yellow metal was down 9pc last
week to reach a five-year low at $1,083, and that marks a 43pc fall from
the all-time high of $1,900 reached in 2011.
However, the fundamentals, characteristics and attractions of gold are
undiminished because we remain in times of extreme intervention by
governments around the world, and for thousands of years gold has been
the best insurance during times of uncertainty.
Demand remains strong
This theory was proven in the latest report from the World Gold Council
that showed bar and coin demand increase by 33pc during the third
quarter to 295.7 tonnes, led by a 70pc year-on-year increase in Chinese
investment. UK demand for owning physical bars and coins jumped 67pc to
2.5 tonnes.
Chinese demand for gold rose in the third quarter Photo: AFP
The first rule of investment is preservation of capital. The second
is to go searching for gains or income that fit with your appetite for
risk. Gold has been the insurance of choice for thousands of years to
satisfy the first rule, despite the fact it generates no income and
actually incurs costs for storage.
US Dollar weighs on gold
It is that lack of income that is driving down the price of gold at the
moment. Gold’s big rival as a store of value is the US dollar.
The market expects the US Federal Reserve to increase interest rates in
December, marking the first rate increase for nine years. As the
returns from holding safe haven assets such as US government bonds
increase then the attractions of gold are diminished.
Bad money drives out good
One of the most interesting reasons that can be linked to the falling
gold price is to be found in “Gresham’s Law” that “bad money drives out
good”. The Tudor financier, Sir Thomas Gresham, found that: “When a
government overvalues one type of money and undervalues another, the
undervalued money will leave the country or disappear from circulation
into hoards, while the overvalued money will flood into circulation.”
Artificial currency devaluation is nothing new. It is as old as the
pyramids themselves. Sir Thomas Gresham was merely drawing conclusions
from the studies of the Islamic scholar and historian, Al-Maqrizi, who
noted the effect of currency devaluation during the Mamluk empire in
Egypt.
Al-Maqrizi observed the effect of a liquidity crisis on
the Mamluk dynasty in the early 15th century that caused money
circulation to dry up. The solution was mass enforced currency
devaluation through replacing the gold-and-silver-based Dinar, with
copper coinage, or Fulus, and for a period the Mamluk economy recovered
rapidly as trade once again flowed freely.
However, inflation
soon crept in and prices ran out of control as the currency was
repeatedly debased. All the while gold hoarding was taking place behind
the scenes.
Fast-forward half a century, and the money printing
continues apace, while demand for physical gold is rising sharply. The
latest government to devalue its currency to support the slowing economy has been China.
The People’s Bank of China is cutting interest rates and allowing the
value of the Yuan to fall. Chinese citizens concerned about their loss
of spending power are buying gold. Gold is simply the best insurance
against inflation, or deflation.
Tight supply
The other long term support to the gold price is that when prices fall
below $1,000 many miners will be forced to cut output. The gold mining
industry invested millions in projects that are only profitable when
prices are above those levels, and it has been absolutely hammered by
falling prices.
Barrick Gold, the world’s largest miner of the metal that is listed in
the US, has seen its shares fall as much as 30pc this year to a 25-year
low. In London Randgold Resources shares are down 10pc, and Mexican
precious metals miner Fresnillo has seen its shares fall 12pc.
The smaller listed miners had an even more turbulent time. Tanzanian
gold miner Acacia Mining is down 38pc; and the Russian miner
Petropavlovsk, which was founded by Peter Hambro, has seen its shares
collapse during the past five years.
The best insurance
The easiest way to get access to gold are through low-cost funds.
Popular physical gold exchange traded funds – or ETFs – include ETFS
Physical Gold (PHGP) denominated in sterling and ETFS Physical Gold
(PHAU) denominated in US dollars. Also BullionVault and GoldMadeSimple,
offer low-cost services where small amounts of money can be deposited,
which is then backed by gold.
For those who want to own physical
gold coins or bars then there are established dealers such as ATS
Bullion, BullionByPost, and Chard.
The Royal Mint has also extended its offering of gold and silver bullion to investors.
Questor wouldn’t recommend buying gold mining shares, or funds that
invest in miners, as it is too high risk. The first rule of investing is
capital preservation. And in the face of mass currency devaluation
around the world then an allocation of about 5pc in assets such as gold
looks sensible.
The future is uncertain and gold is the most effective insurance against that.
By
John Ficenec
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