Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 13

An historical (not hysterical) look at gold

Around the world in the last two weeks, people have rushed retail stores to buy physical gold. Perth Mint has reported sales are at their highest level in five years, and they traded over the weekend to cope with demand. People are queuing across Asian cities in panic-like conditions, while the US mint has been forced to cancel sales of its gold coins. Buyers are responding to the rapid price fall to USD1,322 per ounce in mid-April, the lowest level for two years.

What is most extraordinary is that retail investors usually react to rapid market falls in the opposite way. When equity prices drop, investors usually panic from fear it will fall further. Inflows to managed funds are always at their strongest when the market is at its peak, and outflows at their highest when markets bottom. But something else is happening with gold.


Source: Compiled by Grant Williams of Mauldin Economics from various public sources.

A brief look at gold price history

Most of the time over history, one ounce of gold has been able to buy items worth the equivalent of around USD500 in today’s dollars adjusted for inflation. It has done so for much of the past 2,500 years through many societies. Occasionally the gold price (when measured in paper currencies) surges when paper currencies devalue, but it then falls back again in real terms. If bought below its long run level, gold can provide a hedge against the devaluation of paper, but if bought above the level it is speculation, not ‘investing’. It is not a matter of whether gold represents a store of value or some other safe haven characteristic. For an investor, it is only worth buying when it is cheap.

The gold price reached USD1,900 per ounce on 5 September 2011 in the midst of the US debt ceiling and credit downgrade crises. Since then it has fallen by more than 20%, including a 10% fall on 15 April 2013, triggered by fears that Cyprus and the PIIGS may have to sell their gold reserves to repay debts.

Gold may shoot up to USD4,000 or USD5,000 in one of two scenarios: (a) an extreme left wing outcome resulting in run-away US inflation leading to a breakdown of society; or (b) an extreme right wing scenario with a Tea Party-led Republican government bringing back the gold standard. These scenarios look remote. People who bought gold in the last bubble in 1979-80 are still waiting to get their money back in real terms after inflation 33 years later.

Investors cannot consider gold without also thinking about currencies and inflation, as the three are inextricably linked. Long term holding of gold makes sense as an inflation hedge or as a store of value if bought at or below the long term price around which it has oscillated for thousands of years. However, if paper currencies collapse, the nominal value of gold expressed in paper money terms can rise dramatically. So gold has most appeal if the investor’s home currency is about to experience massive hyper-inflation which destroys the value of paper money, which is unlikely in Australia in the near future. Or since the price of gold is expressed in USD terms, any expected rapid destruction in the value of a home currency may merit purchases of gold.

Of course, profits from short term trading are always possible as a more speculative bet, but long term portfolios are designed to look after long term needs, such as producing income and protecting wealth.

A copy of our comprehensive 2012 study of gold can be found here.

 

Ashley Owen is Joint CEO of Philo Capital Advisers and a Director of Third Link Investment Managers.

 

1 Comments
scottb
May 03, 2013

"Investors cannot consider gold without also thinking about currencies and inflation."

Indeed. But in considering inflation, Mr Owen has forgotten that governments purposely and systematically understate the amount of actual inflation so as to make it possible for debtors everywhere – and governments are the greatest of all debtors – to repay obligations in a devalued currency, thereby enabling the ongoing operations of a debt and liquidity-based economy. The U.S government reports inflation at about 2.5% (the basis of Mr Owens analysis), but in fact it's most likely significantly higher...close to 10%. Check out Shadowstats.com.

Adjusted for true inflation, gold peaked in 1980 at about $5,000 which would suggest there's some room to the upside today.

And one can't ignore the size of the monetary base today. A look at the the ratio of the St. Louis Adjusted Monetary Base to the price of gold shows it above 2.0 ...almost record levels. All previous gold 'booms' have only stopped when the ratio falls below 0.22. And we are a very long way from that.

And consider this. In January 1980 when gold peaked at $875, the average price for gold for the month was $669. The monetary base in January 1980 was $132 billion, which means it took only 198 million ounces of gold to cover the monetary base. In January 2012 when gold averaged roughly $1,600, the monetary base was $2,750 billion. Thus it would take 1.7 billion ounces to cover the monetary base. To get the same coverage as in 1980, gold would have to be trading at almost $14,000.

Or maybe you can look at it like this. If the US actually has the 8,133 metric tonnes of gold they claim they have in their reserves (World Gold Council - World Official Gold Holdings) and the US used that gold to back the US monetary base, gold would have to rise $9,745 per ounce. Even backing 40% of the monetary base would see gold at $3,900 an ounce.

 

Leave a Comment:

RELATED ARTICLES

What do fund managers mean by Quality Investing?

1979 US Government defaults: what happened next?

Nassim Taleb on managing investments for rare events.

banner

Most viewed in recent weeks

Vale Graham Hand

It’s with heavy hearts that we announce Firstlinks’ co-founder and former Managing Editor, Graham Hand, has died aged 66. Graham was a legendary figure in the finance industry and here are three tributes to him.

Australian stocks will crush housing over the next decade, one year on

Last year, I wrote an article suggesting returns from ASX stocks would trample those from housing over the next decade. One year later, this is an update on how that forecast is going and what's changed since.

Avoiding wealth transfer pitfalls

Australia is in the early throes of an intergenerational wealth transfer worth an estimated $3.5 trillion. Here's a case study highlighting some of the challenges with transferring wealth between generations.

Taxpayers betrayed by Future Fund debacle

The Future Fund's original purpose was to meet the unfunded liabilities of Commonwealth defined benefit schemes. These liabilities have ballooned to an estimated $290 billion and taxpayers continue to be treated like fools.

Australia’s shameful super gap

ASFA provides a key guide for how much you will need to live on in retirement. Unfortunately it has many deficiencies, and the averages don't tell the full story of the growing gender superannuation gap.

Looking beyond banks for dividend income

The Big Four banks have had an extraordinary run and it’s left income investors with a conundrum: to stick with them even though they now offer relatively low dividend yields and limited growth prospects or to look elsewhere.

Latest Updates

Investment strategies

9 lessons from 2024

Key lessons include expensive stocks can always get more expensive, Bitcoin is our tulip mania, follow the smart money, the young are coming with pitchforks on housing, and the importance of staying invested.

Investment strategies

Time to announce the X-factor for 2024

What is the X-factor - the largely unexpected influence that wasn’t thought about when the year began but came from left field to have powerful effects on investment returns - for 2024? It's time to select the winner.

Shares

Australian shares struggle as 2020s reach halfway point

It’s halfway through the 2020s decade and time to get a scorecheck on the Australian stock market. The picture isn't pretty as Aussie shares are having a below-average decade so far, though history shows that all is not lost.

Shares

Is FOMO overruling investment basics?

Four years ago, we introduced our 'bubbles' chart to show how the market had become concentrated in one type of stock and one view of the future. This looks at what, if anything, has changed, and what it means for investors.

Shares

Is Medibank Private a bargain?

Regulatory tensions have weighed on Medibank's share price though it's unlikely that the government will step in and prop up private hospitals. This creates an opportunity to invest in Australia’s largest health insurer.

Shares

Negative correlations, positive allocations

A nascent theme today is that the inverse correlation between bonds and stocks has returned as inflation and economic growth moderate. This broadens the potential for risk-adjusted returns in multi-asset portfolios.

Retirement

The secret to a good retirement

An Australian anthropologist studying Japanese seniors has come to a counter-intuitive conclusion to what makes for a great retirement: she suggests the seeds may be found in how we approach our working years.

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.