Bullion – a viable alternative to fiat currencies

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Gold bullion has risen by $105 (11.6%) since its low of July 9, breaching $1,000 a few days ago and now trading at levels last seen at an intraday high of $1,033 in March 2008.

Gold bulls argue that the yellow metal stands to gain from rising inflation expectations as governments engineer the biggest asset price reflation in human history. On the other hand, John Mauldin (Thoughts from the Frontline) is of the opinion the rise in gold does not really tell us anything about the future of inflation. It is his belief that if the Fed were to withdraw from the current economic battle, the forces of deflation would be felt in short order. Mauldin contends the answer to the question “Will we have inflation in our future?” is “You better hope so!” But gold may not be a bad performer in a deflationary environment either as a store of value as the economy sinks into the abyss.

Although the declining dollar has been one of the catalysts for gold’s rise, it is also important to note that gold bull markets are usually characterized by the metal making headway in all currencies. As shown below, this is now happening with bullion rising in terms of most major (and minor) fiat (paper) currencies.

gold-price-in-various-currencies

Source: Plexus Asset Management (based on data from I-Net Bridge)

gold-price-movements-in-various-currencies

Source: Plexus Asset Management (based on data from I-Net Bridge)

I believe another driver of the rising gold price is China’s loss of confidence in the greenback. The Chinese are more than a little concerned about the large exposure they have to the US dollar (most of their foreign reserve holdings are invested in US government bonds) and have been diversifying into other currencies such as the euro and the yen, as well as gold and other commodities. In fact, it was recently announced that China has doubled its gold reserves to 1,054 tonnes in the last few years, making China the world’s fifth-largest holder of gold, just ahead of Switzerland, and among the six nations plus the International Monetary Fund that have reserves of more than 1,000 metric tons.

According to John Mauldin, the steady rise in gold over the last eight years to the current level has roughly tracked the emergence of China as a superpower in foreign reserve holdings, which now stand at $2 trillion.

In view of all the uncertainty regarding the sustainability of the current improvement in the global economy I am of the opinion that one should have gold in one’s portfolio. The last words go to long-timer Richard Russell (Dow Theory Letters) who summarizes the investment case as follows: “Gold is the standard, it can’t go bankrupt, it will rise in value if the dollar tanks, it will rise in value if inflation takes off, and it will sky-rocket if the US tries to inflate its debts away.”

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4 comments to Bullion – a viable alternative to fiat currencies

  • Ian Nunn

    “Bullion – a viable alternative to fiat currencies”: two points.

    My wife bought me a 1 oz wafer many years ago, from the Bank of Nova Scotia which was about the only retail source at the time.

    First we paid a currency conversion fee from CDN to USD even though the gold remained in Canada. Then we we paid a shipping fee from Toronto to Ottawa, even though the wafer may never have been outside Ottawa. I can’t remember if we paid a premium on the wafer over spot.

    When it came time to sell, we paid the same fees again plus a fee to have it re-assayed.

    This is not a liquid or financially viable form of investment. If you want to hold bullion, use an ETF.

    The second point is, the issue is not gold, but any hard asset in an age where fiat currencies are being debased. Gold is compact, semi-liquid, and relatively fixed in terms of supply – the properties one is seeking.

    However, let’s be clear that gold is not, and never will be, a currency substitute.

  • Stevie b.

    “gold is not, and never will be, a currency substitute.”

    But it’s a near-substitute – and I can sell my Krugers on ebay with a bigger premium than I originally paid for them. So to be more precise and perhaps depending on real interest rates, maybe we should be saying currencies are a near-substitute for gold…

  • Frank W

    A number of arguments have been raised to explain the rise in the price of gold such as anticipated inflation, currency weakening, fear of regional bank failures, etc. I’m sure each of these make some contribution, but surely the big lift must be due to all that buying by the Russian and Chinese Governments. There is nothing like pure demand to lift prices.

  • Anonymous

    Gold is in a bubble. If you put your cash in a bank/bond getting the cash rate and compound the interest (with a basket of quality diversified currencies) you would arguably be substantially better off than just buying gold which has no utility.

    If you buy gold in these bubble periods it could take you 20-30 years to recover your investment if you dont exit before the bubble collapses:

    http://static.seekingalpha.com/uploads/2009/7/10/164535-124721965029684-Mike-Stathis_origin.jpg

    However, managing to sell before the bubble collapses then I guess it could be a winning strategy — I am not good at picking tops.

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