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.
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.
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.
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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