Goldhead revisited

The following article first appeared in the print edition of The Spectator magazine, dated 4 May 2013.

Few assets are more misunderstood than gold. I might even refine that statement — if you’ll pardon the pun — and say that few assets are more misunderstood than money. Gold happens to be both. Technically, of course, we are constrained by government edict to use pounds sterling for the payment of our taxes and debts. My take on this dismal state of affairs, but also my optimism, can best be summarised in the title of Nathan Lewis’s recent book, Gold: The Once and Future Money.

Economists give money three attributes. It should be a unit of account (we can price things in it). It should be a medium of exchange — which avoids the inconvenience of barter. And it should be a store of value, something which enables us to maintain our purchasing power in real terms if we choose to defer spending and save instead. Our current ‘fiat’ paper money does a passable job of the first two, but is disastrous in relation to the third. To put it another way, since the 1913 establishment of the US Federal Reserve, which acts as America’s central bank, the US dollar has lost 98 per cent of its purchasing power. Over the same period, sterling has done even worse.

The likes of gold and silver developed as money in a free market. They were in competition with all kinds of other ‘monies’ such as cattle, shells, nails, tobacco and cotton; and they won. People tended over time to favour the precious metals as money because of their scarcity, durability, malleability, and beauty. Using paper certificates to represent reserved gold was a logical next step. But then the rot set in, when greedy bankers realised that they could print certificates for more physical gold than they actually possessed. Nothing really ever changes. The reason that heavily indebted governments and central banks have such a love-hate relationship with gold today is that a rising gold price signifies a growing suspicion by investors of the paper currency that governments are determined to print in ever more absurd quantities. And yet the world’s central banks have continued to build their gold reserves over recent years despite consistently higher prices. Cyprus, for reasons of urgent necessity, is a rare seller.

Goldbugs — those of us who believe that gold is a better store of value than unbacked paper currency — tend to see 1971 as ‘Year Zero’, because that is when President Nixon took the US dollar ‘off gold’. In severing the last link between paper money and the precious metal that had previously backed it, Nixon ushered in a 40-year experiment in money. A meaningful part of that experiment allowed the world’s central and commercial banks effectively unlimited powers of credit creation: if your printing of money is no longer constrained by finite bullion, you can print, and borrow, as much as you like. Now that a heavily indebted West has gone conclusively ex-growth, central banks are making the most of that privilege. Those of us nursing any exposure to paper money are paying the price. Every day of additional quantitative easing makes today’s pounds (or dollars, or Japanese yen) worth less tomorrow.

But when the price of gold fell below $1,400 an ounce last month from its earlier high of over $1,900 in 2011, commentators rushed to claim that the gold bull market was over. Well, perhaps. More likely, it simply reflects the fact that if investors and traders choose to dump 400 tonnes of gold into the market at one go, the equivalent of 15 per cent of annual gold mine production — as they did in mid-April — it causes indigestion and the price falls. At this point, it’s also worth pointing out that not all investors in gold are created equal. Some of them are purely speculators — they chase the price up, and they’re happy to sell short when the price goes down. They have no interest in taking possession of the physical asset and are content to play games on computer screens and futures exchanges. Could the same people that brought you Libor-fixing be guilty of manipulating the gold price? Do bears shed ballast in the woods?

But some of us are buying and holding gold for entirely different reasons. Not as a form of speculation, but entirely the opposite. In the words of the management consultant Andreas Acavalos, the decision to buy gold is not an investment. Instead, ‘It is a conscious decision to refrain from investing until an honest monetary regime makes rational calculation of relative asset prices possible.’ Will we ever see an honest monetary regime? That depends in part on how long the present grotesque fraud on savers lasts. I am not hopeful that we live in the most stable of banking or financial environments, which is why I put a premium on bullion.

Last month’s savaging of the gold price no doubt put the fear of God into recent buyers. It certainly triggered floods of uninformed commentary by the Twitterati. (We’ll know that our culture has improved when goldbugs are no longer being permanently digitally assaulted by the paperbugs who are their polar opposites, and who fail to grasp the principles of sound, honest money.) The reality is that investors have no idea where gold will be trading in dollar terms a day, a week, a month or a year from now. But unless and until politicians suddenly get religion and start running balanced budgets, or unless our central bankers suddenly stop printing money even as it goes out of fashion, it is entirely plausible to believe that the rally in gold has merely been temporarily halted. We know that central banks have been busily accumulating the stuff throughout the duration of our financial crisis. Are they doing that simply because they have a penchant for bling?

For those of us charged with shepherding the sacred assets of our clients through a period of unprecedented monetary debauchery, gold represents a flight away from dishonest money towards a haven that is scarce, independent and permanent. As my fellow investor Tony Deden of Edelweiss Holdings puts it, wherever the paper-money price of gold goes, before you decide to sell you should first decide why you own it.


Author’s update, July 27th 2015:


The latest plunge in the dollar price of gold has caused all sorts of paperbugs to come crawling out of the woodwork. Perhaps the highest profile among them was that of Jason Zweig, columnist for the Wall Street Journal, who suggested that

“.. even as Greece has defaulted, the euro has sunk against the dollar, and the Chinese stock market has stumbled, gold [has] been sitting there like a pet rock.”

Zweig is right that it is time “to call owning gold what it is: an act of faith.” But he fails to take the next logical step and ask for the corollary: why have so many investors (as opposed to speculators) undertaken this act of faith ? Just as pertinently, why does henot ask why investors (as opposed to milch cows) should retain any faith in the paper currencies that central banks are doing everything in their power to depreciate ?

As Zweig observes, it is legitimate to point out that unlike stocks, bonds and real estate, gold generates no income. But nobody ever demanded that it should. Crucially, as part of this debate, paper currency itself pays no income, either – an argument that even Warren Buffett has never acknowledged, preferring, disingenuously, to compare the apples of productive assets with the orange that is unproductive gold. Paper currency itself is comparably inert, but a lot more impermanent and flammable. Paper currency can only become an income-generative asset by converting it into a bank deposit, whereupon one relinquishes any last claim to financial independence and becomes an unsecured creditor of the bank. Perhaps gold is not a financial asset per se or “simply” a commodity. Perhaps gold, too, is money ?

JP Morgan certainly thought so, a century ago. So do central banks, today – or why else do they continue to hold gold as part of their reserves ? It is surely not, as Ben Bernanke once weaselled, just down to “tradition”.

The debate continues to rage because most of the debaters refuse to agree on terms. We ourselves regard gold as a monetary metal, an alternative currency and a store of value – over a period perhaps best described as ‘the medium term’. It is not an investment but, per Mr. Acavalos, a conscious decision to refrain from investing. Gold, in other words, is the part of the portfolio that isn’t “in the market”, so to speak. In our client portfolios we hold gold alongside more conventional investments such as high quality bonds (assuming they can be found), ‘value’ equity investments, and alongside less conventional investments, such as systematic trend-following funds. Do we expect each and all of these types of ‘assets’ to rise in value at the same time and to the same extent ? No, because they’re not correlated to each other. That’s precisely the point. The whole purpose of the exercise is to ensure that a portfolio contains genuinely independent parts that behave in different ways during different market environments. We will look to sell our gold holdings when the financial environment that gave rise to its purchase in the first place – one that included all-time high levels of debt, globally, and widespread currency warfare, and the risk of systemic financial crisis – finally transforms into something demonstrably more stable. The “fundamentals” of this environment have in actuality worsened even as the price of gold has slid in US dollar terms. That experience has been surprising, but any gains in value by more traditional assets over the period will have mitigated the surprise somewhat.

James Grant, writing in last week’s Financial Times, humbly suggested, against the spirit of the times, that

“Prices should be discovered in the market, not administered by a government. Actually, we do not all so agree. In response to the incentives set before them, investors pursue the main chance. In the case of European sovereign debt, they continue to buy, more or less without regard to the underlying strength (or lack thereof) of debtor states. They buy because the ECB has pledged to buy.

“The phenomenon goes further — much further. Be it the US Federal Reserve, the People’s Bank of China, the Bank of Japan or the ECB, central bankers’ first financial-markets objective is not the integrity of prices and exchange rates. It is rather crisis prevention — to keep the bouncing bond and stock market balls moving in their sanctioned orbits. (For an individual to fix Libor is a crime. For a central bank to suppress European bond yields is an act of financial statesmanship.)”

A question. Is there a price for any financial asset, anywhere in the world, that does not in some way reflect official price manipulation of one kind or another ? In the case of western bond markets, or Chinese stocks, the question answers itself. If gold were somehow divorced from this trend, the only difference would be that it is the only ‘asset’ whose price is being artificially suppressed as opposed to boosted.

We don’t know whether or to what extent the price of paper gold is being manipulated. We can observe that some of the games being played in financial futures markets make no commercial sense, other than to smash prices lower in the cause of making a quick momentum-driven buck. But we repeat: until the financial environment improves to a sufficient extent to make the requirement for portfolio and / or systemic risk insurance obsolete, we’re not changing a strategy founded on the principles of asset diversification and capital preservation. We still live with unprecedented monetary debauchery.

It’s not about what gold’s worth, in dollar terms. It’s more fundamental than that. What’s the dollar – or any other currency, for that matter – worth, as expressed in anything else ? Jason Zweig correctly refers to the decision to hold gold as an act of faith. He should ask himself what, then, is backing all those trillions of dollars, pounds, euros and yen all being cheerily printed out of nothing.