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Posts by: Simon White

Why gold is the currency of first resort

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Simon White looks at pricing and the weakness of depreciating money. When we want prices to represent real value, he says, gold is the obvious choice for a currency, as it allows us to understand the true value of things

What is a price? This may sound like an innocuous question, but there is a subtlety involved that escapes most people’s attention. A price, whether it is the cost of a £25,000 car or a $12 cocktail, is not one standalone number, but in fact consists of two moving parts. Not only does it indicate how many dollars or pounds one needs to exchange for a cocktail or a car, a price is also implicitly telling you how many dollars or pounds a cocktail could buy. All prices are two-way streets.

To appreciate this idea more fully, we can consider a straight swap of goods. Imagine I wanted to swap my iPhone for your laptop. In this situation, you will very quickly size up the two sides of this offer. You will consider not only whether you think one iPhone is worth your laptop, but you will also consider whether your laptop is worth my iPhone. But when it comes to a conventional transaction, e.g. our $12 cocktail, people instinctively ask “is that cocktail worth $12?”, only very rarely do they ask the converse: Is $12 worth one cocktail?

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People omit this question because of the implicit assumptions regarding what money actually is: 1) it should be a medium of exchange; 2) it should be a unit of account; and 3) it should be a store of value. Paper currency fulfills the first two attributes, but it is the third where it becomes unstuck. It is this common misconception people have that means they tend not to think about prices in a two-way fashion.

Because if the “numeraire” – the fancy term economists use for a unit in which prices of all goods and services are expressed, such as pounds, euros or the South African rand – is not a store of value, then you need to start looking a damned sight more closely at what that numeraire is.

Over the centuries and millennia that numeraire has been many things. In Canada, in times of the Hudson’s Bay Company, it was beaver pelts; fishermen and whalers exchanged the pelts for food and fishing equipment. In Africa and South-East Asia, the cowry shell was a form of money right up until the 1850s, where, in Western Africa, it was used, among other things, to facilitate the slave trade. In parts of Europe, peppers or squirrel skins were used at various times for money. Cigarettes have been used as money in prisons all around the world, with even ramen noodles being used as currency in some US prisons where the quality of the food declined.

The Revanant

Pelt trading was tough… and there are better currencies to use. (Credit: Creative Commons)

Fast-forward to today, and all countries use their own, or someone else’s, money as their numeraire.  The main advantages of paper money over beaver pelts, squirrel skins or cigarettes are durability, reliability, and portability. Beaver pelts can degrade and cigarettes can get crushed.  Carrying 60 squirrel skins is cumbersome (and might smell). Paper money, though, gets tops marks for convenience, but its record as a store of value is abysmal, and its value continues to deteriorate even as we speak. That is why it is crucial we consider it on the ‘other side’ of a price.

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To think about money’s store of value, we talk about its “purchasing power”. This is what I can exchange for money in physical goods or services. Twenty dollars today cannot buy what it could 5, 10 or 20 years ago. Indeed the US dollar over the last 100 years has lost a whopping 96% of its value in terms of what you can actually buy with it. In simplistic terms, the amount of money it would have taken you to buy 25 pints of beer in 1913 would only buy you one pint now. Perhaps that’s great for alcoholics, but not so great for the rest of us.

dollar down over time

The decline of the dollar’s purchasing power

And here’s another shocking fact: most paper currencies eventually collapse and become worthless.  There are 177 paper currencies in use around the world today (several of very dubious value), ranging from some of the newest, e.g. the Sudanese pound introduced in 2007, to the oldest, such as the pound which dates from 1694 when the newly formed Bank of England began to issue paper denominated in pounds sterling. However, for every surviving currency, there are over three times as many – 600 – paper currencies that have collapsed and are no longer around. The median age for all the currencies in use today is a confidence-sapping 37 years.

A yardstick not made of paper

So, why do people not pay more attention to the numeraire when considering the prices of things?  That is an open question we cannot definitively answer, but what we can do is suggest a much more suitable numeraire: gold. Unfortunately most people view gold as a commodity – the car or the cocktail in our earlier example of a transaction – they don’t view it as something to denote prices in.  But in reality gold is almost the perfect numeraire as it is one of the world’s best stores of value.

In the chart below, we can see the purchasing power of gold has been constant for most of the past 500 years, and in more recent years has even increased relative to where it was half a millennium ago. It is also well documented that an ounce of gold would buy you a decent toga in Roman times. At today’s price of around £1,000, an ounce of gold would buy you a decent suit. That is long-term storage of value in the fullest sense.

gold over the last 500 years

The price of gold over the last 500 years

Thinking about gold as a numeraire is an epiphany. It gives us a truer insight into whether other goods are cheap or expensive. For instance, if we look at crude oil, in US dollar terms, it is more than twice as expensive as it was in 1990. But in gold terms, its price is virtually identical. Similarly, the S&P 500 is more than 7 times what it was in dollar terms in 1990, compared to only 2.5 times in ounces of gold.

oil in gold  (NAV at 100 in 1990 to show the divergence of these prices rather than their actual value)

The price of oil in gold (NAV at 100 in 1990 to show the divergence of these prices rather than their actual value)


S&P 500 in gold  (NAV at 100 in 1990 to show the divergence of these prices rather than their actual value)

The S&P 500 priced in gold (NAV at 100 in 1990 to show the divergence of these prices rather than their actual value)

So when looking at the prices of things, it is crucial to consider what they are priced in. A reliable numeraire must be something that is itself a store of value over the long term. Gold, in use as money for at least 2,500 years, has proven its mettle, quite literally, in this respect, yet today it is looked on as a mere commodity, something that is to be priced rather than doing the pricing.

The writer Proust once said: “The real voyage of discovery comes not with seeking new landscapes, but in having new eyes”.  People who view gold as a currency will find themselves standing on the threshold of a new investing landscape, where the true value of things can clearly be seen.

Simon White is the managing editor of Variant Perception, a leading independent investment research provider advising institutional managers, hedge funds and family offices – he writes here in a personal capacity

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Political and economic flux prove gold’s worth

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Flux & gold

Simon White, managing editor of Variant Perception, sets the geopolitical variables to max to analyse not only how gold can futureproof your portfolio but how, by buying now, you can get significant alpha from the yellow metal

It was the fourth day of unprecedented turbulence in the markets. Interest rates were over 10% and being pushed higher by central banks frantically trying to rein in rampant inflation. Global equity markets were touching the lows last seen during the depths of the financial Crisis of 2008. That depression had been seen as a nadir but this crisis was more acute, more savage and more poignantly shocking, as years of apparently resilient markets had disguised the notion that stocks could move so disastrously. Reality was now unmasking the lie and wealth built up over lifetimes was atrophying in a few, unbelievable moments.

The above scenario may seem unlikely to us now, but it is not impossible or irrational given the macro-economic and geopolitical variables of the world we are currently living in. To underpin this, imagine that president Trump had catastrophically lost his bid for re-election, to be replaced by a more extreme populist. Trump had promised a financial renaissance to voters disenfranchised by globalisation, but had let them down. Angry and now with nothing to lose, they had voted in a new leader who had made explicit pledges to rescind every major trading agreement of which the US was a part. To detract from the economic woes unleashed by these damaging policies the new president had become increasingly hostile to China. Near-run skirmishes between Chinese and US naval vessels in the South China Sea had become common, and it would only take one minor misstep to escalate the situation irreversibly.

Imagine such a rise in tensions was perceived as opportunity: North Korea launches missiles over Japan or Alaska; while in the Middle East a rejuvenated Islamic State strikes the Jordanian capital, Amman. Sequentially Israel, besieged and facing increasing intimidation, is considering pre-emptive strikes on IS-held Iraq, and a resurgent Iran, itself suspicious of Saudi intentions in Yemen.

Political volatility can infect markets, but rarely gold

Yet markets, have, until this omni-crisis, miraculously, held up. Central banks had kept monetary policy extraordinarily loose to counter the geopolitical volatility. Calm begets calm leading to complacency the same way as panic begets panic leading to mayhem — both approaches are irrational. The deluge of liquidity let loose by the central banks’ policy of quantitative easing had kept markets grinding steadily higher, while recency bias lulled investors into a false sense of security. This had created a very good environment for gold.

To keep monetary policy so loose, central banks, like the Federal Reserve in the US and the Bank of England in the UK, had to create lots of new money. For a long time, the banks got away with this, but then people started to notice. Prices started to rise, modestly at first, then more quickly. People suddenly found themselves much poorer as their salaries couldn’t buy as many goods, and the savvier among them began buying gold to protect against the devaluation of their currency. Therefore, gold kept steadily rising in price.

Better than a hedge

Gold has always been held back by the misguided belief that it is an asset just like any other. Warren Buffett supremely misunderstood gold when he remarked that we dig it out of the ground, then “melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility.” But it’s not supposed to give you a utility in that sense, much in the same way you wouldn’t utilise the paper your house insurance is written on to wrap a present.

Gold is, rather, the perfect insurance against currency debasement and instability. Through times of great turmoil gold is, in the words of historian Peter Bernstein, “the ultimate certainty and escape from risk”. In our imagined near-future above, where the world is riven by uncertainty and precariousness, people will flock to the safety and certainty of gold, which has been used as money and as a store of wealth for millennia.

One wants to be invested in gold before this rush happens. The total weight of above-ground gold comes to 186,000 tonnes, which, at today’s prices, is $7.5 trillion. Global financial assets on the other hand, consisting mainly of stocks and bonds, are worth over $330 trillion. Even if only 1% of this were to be moved into gold, it would be equal in value to almost 50% of all the gold ever mined, and equate to 26 years’ current annual mining supply. Gold’s price as a result, would go vertical.

Warren Buffett is also repelled by gold as it pays no yield. But again, this is to misunderstand what it is. To paraphrase Samuel Johnson, gold is no more supposed to provide a yield than a dog is supposed to walk on its hind legs.

Nevertheless, even the logic of the central banks means that not only is gold a sure thing, but also an asset that can actually provide a yield: Interest rates today are near record lows, and are even negative in the eurozone, Switzerland and Sweden. Something paying 0% interest, such as gold, is better than a negative interest rate, which is equivalent to paying a tax. People notice this state-sponsored mugging and move into assets beyond the reach of governments and their central banks, such as gold.

Proven provenance 

As well as providing insurance, gold’s other main purpose is as a store of value. No other asset has held up its real value better over the long term than gold. In Roman times, about 2,000 years ago, an ounce of gold would have bought you a good toga. Today at about £1,000, an ounce of gold would buy you a good suit. Indeed, studies have shown that from the mid 16th century to the late 20th century in England and from the early 19th century to the late 20th century in the US, gold’s purchasing power — that is what products and services you can exchange for it — remained constant.

Demand for gold has continued to rise, driven by exchange traded funds (ETFs) and central banks, while supply, especially from mining, stagnates. China is a big part of the rise in demand since it became a member of the World Trading Organization in 2001. Their demand is likely to remain undimmed in future years as they manoeuvre the yuan to become a credible replacement for the dollar as the world’s reserve currency. One iron law of investing in recent years has been: own what China is short of. This applies no less to gold.

In the more chaotic and unstable world we imagined at the beginning of this article, gold would very likely surge as the perfect storm of geopolitical uncertainty and years of monetary largesse, raged. But one wants to be protected well before this happens. The time to buy insurance, after all, is before your house catches fire.

Glint believes a new global currency can provide an answer to many of the issues raised here.
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Simon White is the managing editor of Variant Perception, a leading independent investment research provider advising institutional managers, hedge funds and family offices – he writes here in a personal capacity