Gold can be a surprisingly emotive subject. There are those that believe it has no utility, yields nothing and costs money to store – so why would you bother investing in it? On the other hand, gold has over millennia consistently been used as a means of exchange and store of wealth. It is viewed by some as the ultimate hard currency and not so much a hedge against inflation but a hedge against all forms of stress in the global monetary system. In these times of rising debt, multiple quantitative easings and zero / negative interest rate policy, this should be a pretty alluring prospect.
The debate is highly pertinent to today’s markets. Last year, the Wall Street Journal opined “It is time to call owning gold what it is: an act of faith”, putting themselves squarely in the group that believe investing in gold is no more than speculation. They went on to explain what having faith actually meant, “the substance of things hoped for, the evidence of things not seen.” On the other side of the debate, Grant’s Interest Rate Observer commented that “Gold bullion is an investment in monetary and financial disorder,” going on to explain where signs of that disorder were already evident in markets today. By extension, Mr. Grant noted that “to be bearish on gold is to be bullish on the former tenured economics faculty members who guide the world’s monetary destiny.”
As a result, the argument is often framed another way – through the lens of current policymaking. Here we have in one corner the aforementioned faculty members, who unsurprisingly believe current monetary policy is on the right track. Their every word is scrutinised for meaning and direction by investors struggling to make sense of a complex world. The case for gold in this world is the most traditional one, purely as an inflation hedge. In the opposing corner are those who believe in the primacy of markets (and hard currency). Their view of the matter can be summed up in the following quote from the early 20th century economist Ludwig von Mises “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.” For the avoidance of doubt, this falls into the category of monetary and financial disorder, and here gold is fulfilling its role as a hedge against extreme outcomes of any sort.
Relationship between gold performance and financial stress
For those of a more practical nature, the real question should perhaps be a more pragmatic one. From where we stand today, does gold and hence also gold equities justify inclusion in an investment portfolio?
To answer this, we need to take a step back and analyse the context in which we are operating today. Not today as opposed to last week, but today in the context of both cyclical and secular trends. From this perspective, several things are noteworthy. First, global trend growth is clearly lower as the demographic dividend of the boomer generation becomes a headwind (plus millennials don’t want to buy stuff anyway, they want to share or rent it). Second, despite the marvels of Facebook, Uber and the like, trend growth is lower because global productivity growth appears to be struggling. In fact, it has been on a downward trend for some years. Third, the Chinese growth ‘miracle’ cannot and will not be repeated. Fourth, and to a degree reflecting the first three points, the global debt super-cycle continues, seemingly unaffected by the financial crisis. Remember, debt is nothing other than the pull-forward of future consumption or investment. Fifth, central banks have determinedly targeted asset values (and currencies) as a means to reflate the economy, believing that the resultant wealth affect will somehow compensate for the absence of growth in real prosperity. Instead, the free money has resulted in financial engineering and swathes of malinvestment. Sixth, geopolitics represents a growing hazard as economic strains worsen and a multipolar world becomes a reality. And finally, phenomena that only 10-years ago we would have struggled to even conceptualise have now either well and truly materialised (negative risk-free rates, for example), or are openly discussed as legitimate policy tools (say, ‘helicopter money’ and scrapping physical cash).
In short, by historic standards we are very well advanced into a fragile economic cycle and the structural underpinnings of the global economy look worrying, to say the least.
In terms of asset values, what is preventing all this coming home to roost? Most likely it is the much-cherished notion that central bankers always have your back, and that they can always do more should markets get really nasty. Ergo, should investors lose the reverence in which they hold the central banking fraternity, then that would be the most worrying development of all. In this regard, one can’t help but wonder whether the ‘unexpected’ reaction to the Bank of Japan moving to negative interest rates recently is the tip of that very dangerous iceberg. Central banks are always seeking to eliminate economic cycles, and though investors want to believe this is possible, they are always failing. And as is commonly said, when the tide of asset values does inevitably go out, that is when we discover who has been swimming naked. So unless you believe that it is somehow different this time, and that central banks have entered some sort of monetary nirvana in which there are no downturns, looking for something that might actively benefit from ‘monetary and financial disorder’ seems a sensible and precautionary thing to do. Something, to use Nassim Taleb’s concept, that is ‘anti-fragile’. And like it or not, gold has shown that exact characteristic in our view.
From a portfolio perspective then, there is only one prudent course of action: keep the faith.