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Category: Money

To get gold’s best investment value we should see it as a currency

Liquidity, transparency and the integrity of the market naturally make gold a currency and can mean significant, market beating, returns writes Ch...

22 December 2017


Liquidity, transparency and the integrity of the market naturally make gold a currency and can mean significant, market beating, returns writes Christopher Cruden

It doesn’t matter to me if you think gold is a genuine currency. Nor does it matter to me if you don’t. The fact is, it’s now widely accepted that you can use virtually anything as a currency (Maybe even bitcoin?).

You can certainly use a commodity as a currency. And were you to do so, the commodity you would most likely choose would be gold. Why is this?

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Let us consider the basic attributes of gold. Gold is convertible 24/7. It is a high quality and liquid asset. Gold is a store of value. It’s a non-corrosive metal that is ideal for preserving wealth and has been throughout the ages. Gold is a medium of exchange. It can be used to purchase goods and services. Additionally, the forward curve of gold is in permanent contango, meaning gold goes up because the value of money goes down overtime.

On a tick-box basis, it would be realistically and rationally difficult to say that gold is not a currency but there are other criteria that make gold attractive as a currency.

Many years ago (and I do mean very many years ago) I was taught there were seven things that made a market investable. Age has diminished the memory somewhat, but I do remember the first three. They are: liquidity, transparency and market integrity. These three things are immutable requirements for any investment and most certainly for any currency. (Holders of bitcoin might wish to re-read the previous two sentences.)

In terms of liquidity, according to the Bank for International Settlement, the central banks’ bank, the daily trading volume of gold would make it the fourth most active currency in the world (behind EUR-USD, USD-JPY and GBP-USD). From our perspective as investors, and given our needs, gold easily meets the high standards of liquidity we require.

In terms of transparency, there are myriad markets, instruments and venues that price gold for all the world to see and transact in. Gold is unquestionably fungible.

In terms of market integrity and the risk of external interference and market manipulation, gold is no more or less susceptible to these things (by central banks et al) than any other market or any other currency.

Somewhat bizarrely, this makes the case for gold being a currency. It may be worth considering that the control exerted by governments over gold (and their disdain for it) versus the same control they have over interest rates and stock markets, is minimal.

The gold market is comprised of globally dispersed producers, consumers and investors who have very different needs and requirements. They have very different points at which they become buyers or sellers. They use a wide variety of instruments – from physical to derivative on derivatives – to transact. These things constitute the very definition of a true market: a place where buyers and sellers meet to establish price. Other than in the very short-term, gold would not be the speculators’ first choice of target.

As gold investors we have our own XAU/G7 strategy where we trade gold versus each of the G7 currencies in precisely the same way that FX crosses such as EUR/USD, GBP/USD etc are constructed, represented and traded.

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In other words, treating and using gold as a currency is precisely the point of what we do. We look at how gold moves against the US dollar, the euro, the pound, the yen, the Swiss franc, the Canadian dollar and the Australian dollar.

The instrument we use is rolling spot. We do not use futures, options, warrants or other wacko instruments. In every sense, the portfolio is made up of plain-vanilla FX crosses. The only difference is that the reference currency is gold and not another currency.

Further proof of the integrity, transparency and liquidity of the gold market is that these trades are executed at every major bank and broker that has a foreign exchange desk. This means gold is traded not only just like a currency but as a currency. These trades do not happen in precious metals departments. The cost of trading these gold-crosses is on par with G7 FX crosses and spreads are minimal, in the same range as FX trades.

The strategy is entirely bidirectional. This is mandated and facilitated by the fact that the FX market is entirely bidirectional. We have no view and no bias as to the price direction of gold, or any of the currencies. The old saying “up is down seen from above” applies.

So, there we are: Gold is a bidirectionally tradable investment medium that can be used as a currency to produce elevated levels of uncorrelated alpha that every portfolio would benefit from.

Is Gold just another currency? No. It is much, much more.

Christopher Cruden is principle director of Insch Capital Management

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