Gold has been receiving a lot of attention in 2016, and for good reason: It’s already had one helluva run. At today’s price ($USD 1,347 as I write this), the price of gold has increased about 28%. Of course, many of us view gold not as a commodity, but as a form of money, and take this price movement not as a sign of any fundamental change in the intrinsic value of gold itself, but a reflection of the declining value of the dollar. This should come as no surprise given the huge inflation in the money supply engineered by the world’s central banks through increasingly innovative and bizarre methods since 2008. So far, all this money “printing” has not resulted in price inflation (at least not in the USA), but it has resulted in asset bubbles that are pushing the global financial system to the point of crisis.
The surest sign of an unsustainable financial bubble is the distorted market for sovereign debt. There’s $13+ trillion worth of bonds in the world right now have negative yields, much of which is issued by bankrupt governments (like Japan), and this is madness. There is a “going out of business” in process for fiat currency, and still no one wants it… trillions upon trillions in fiat currencies - and the world’s money managers are looking for somewhere to put it. In a world of limited options, they tend to put it where they CAN, rather than into productive uses that a growing economy would offer. Bonds are at the end of a 40-year bull market (more or less coinciding with the scrapping of the gold-backed dollar reserve system in the early 1970s), which has pushed bond prices to all-time highs and bond yield to all-time lows. Negative yields, which were unthinkable not too long ago, are now an accepted fact of life.
Fact: This is not a sustainable situation! Interest rates WILL rise. When that happens, bond prices WILL plummet, and bank balance sheets will collapse as assets prices (i.e. value of bonds and loans) crater and capital is wiped out. The inevitable result is a financial crisis that will be perceived first as a liquidity problem. This will cause central banks to pump increasing amounts of money into the financial system (making the problem worse). In short order, it will be recognized as a solvency problem. We’ve seen this before in previous crises of ever-widening scope, and the next crisis will crush not only hedge funds, insurance companies and banks, but finally the Central Banks that are at the root of this rotten money system. Eventually, the “smartest men in the room” (and women) will sit down and engineer a global monetary re-set, as has been done on multiple occasions over that past 100 years – most famously at Bretton Woods NH in 1944. I don’t know if the paradigm shift will be a “gold standard”, but gold will certainly play a role, and investors are waking up to this possibility.
In the meantime, gold can continue to increase in value. It’s increased significantly in 2016, but it’s still far below its all-time high, unlike stocks and bonds. For now, managers of huge cash pools favor stocks and bonds because they really have no choice. They rely on extremely large markets to provide liquidity. That’s why they end up buying government bonds, even when yields are low (or negative) – there’s nowhere else to turn. The market for US Treasuries, for example, is $19 trillion, so even if you’re managing $200 billion, the market size for US government bonds is big enough that you could easily snap up Treasuries. It’s the same with stocks: the market size of large public companies is worth tens of trillions of dollars, big enough for major funds to invest.
But here’s the problem: Almost every market and asset class that’s big enough for major institutional investors is at or near its all-time high. Yields on government bonds are at the lowest levels in recorded history (and in many cases even negative), and stocks are at record highs at a time when corporate profits are in decline. Many large companies with huge cash hoards and nowhere else to turn, such as Apple, are actually issuing huge amounts of bonds to borrower money they don’t need, in order to buy back their own shares. Even small increases in accumulation rates by large investors in the gold market will push prices.
Where is a small investor, justifiably concerned about preserving wealth, supposed to turn in such a crazy, messed up financial world?
My opinion:
- Bonds have nowhere to go but down! Forget what you’ve heard about stocks being riskier than bonds. Might have been true once. Today that’s crap!
- Stocks WILL crash if there is a financial meltdown, and fundamentals are not supportive of real long-term appreciation, but at least stocks MIGHT provide a hedge against inflation if that’s where we’re heading. Most of us are in the same boat as the big players – we own stocks because there’s nowhere else to turn – especially in 401k plans and the like.
- Cash is smart for its built-in optionality. Nothing wrong with keeping your powder dry in an uncertain world, although hyperinflation IS a real threat.
- Unlike stocks and bonds, gold is NOWHERE NEAR its all-time high, at least in US dollar terms. Gold can still appreciate nearly 50% before it breaks its previous price record, meaning that GOLD is about the only major asset class that isn’t anywhere close to its all-time high. Also, at a $7 trillion “market cap”, it’s still a big enough market for big players, such as institutional investors, central banks and sovereign wealth funds. Even small increases in participation from these players can drive the price up significantly. Motives for doing so are compounded by the fact that a global “re-set” could actually involve a deliberate policy by central banks and the IMF to peg the global monetary base to a non-inflationary price of gold that could be many multiples of today’s spot prices. That’s a topic for a different post.
As a small investor, the case for owning at least a small amount of gold as a hedge against inflation and currency collapse is obvious. DON’T sell everything and buy gold! But consider giving it a place in a balanced portfolio. For most people, an amount that will both allow you to sleep at night and provide a meaningful hedge is lower than many may assume – perhaps 10%, more or less. All depends on the individual’s style, temperament, and goals.
I’d love to continue the conversation under the GOLD tag if others are interested.