All aboard the Flight to Safety

After my article in last week’s Markets and MoneyA Quick Question From Bill on Bonds Versus Cash I received the following email:

Given your position on cash, what are your thoughts on holding physical gold (outside of the banking system). In theory it is the ultimate currency, and like cash, has no counterparty risk. If (or likely when) a major crisis envelops financial markets, I would think a flight to safety would include both cash and precious metals. Would be interested to hear your thoughts on this.


The Gowdie Family Wealth model portfolio includes a 20% allocation to gold.

However, at this stage in the investment cycle, I have not recommended this allocation be filled.
Instead the actual (as opposed to ‘model’) portfolio is invested 100% in cash.

At last year’s World War D conference in Melbourne, Jim Rickards and Marc Faber, both expressed the view that investors should hold a good percentage of gold in their portfolio.

I know Bill Bonner and a lot of editors within Agora hold the same view as Jim and Marc.

Once again I am swimming against the tide.

In late 2012, I attended a Bonner Family Office conference in Nicaragua. The conference was unlike any investment conference I had ever attended in my financial planning career. The content was first class and unbiased. The attendees were very knowledgeable, wealthy individuals with very inquisitive minds. The conversations were lively and full of robust ideas and views.

One particular conversation I had with a very successful US property developer was about holding gold in your portfolio.

This gentleman was in his early ‘80s but had a zest for life equal to someone half his age. He was passionate about gold. He had physical gold holdings (tens of millions of dollars) stored around the world…including Perth Mint.

At the time he was thinking of adding further to his gold holdings (as he did not need income) and increasing his portfolio weighting to 50%.

He was taken aback when I told him that I held absolutely no gold in my portfolio. This piqued his curiosity. He was curious as to why I wouldn’t have exposure to the ‘ultimate store of wealth’.

When we had our discussion the gold price was around US$1,700. Since then the gold price has fallen 35%. In Aussie dollar terms, the fall in the gold price has not been as steep thanks to the cushioning effect of our dollar weakening against the greenback (we are down from $1600 to $1500 — a fall of only 6%)

My reasoning then, as it was last year, and as it is today, is fairly simple.

If we look at the USD price activity in gold in 2008 (the year of the GFC) gold touched US$1,000 in March 2008. After Lehman Brothers tanked, gold fell to US$700 in October 2008 — a fall of 30%.

Why did gold sell off so heavily?

There was a need for liquidity.

In a deeply indebted world, borrowers want to be repaid in CASH. How do you get your hands on CASH in times of financial upheaval? You are forced to sell your best stuff; blue chip shares, quality property, precious metals. Try finding a buyer for your ‘specky’ miner in a busting market and you’ll be waiting an awfully long time to receive ‘pennies on the dollar’.

When push comes to shove and only cash is required, you have to sell quality assets…at a discount.

Gold was sold off during the GFC and the US dollar strengthened (the Aussie fell to 60 cents) because the primal need in a financial panic is for cash and security. Investors with cash rushed into US Treasury Bonds (which meant they needed to buy US dollars). It didn’t matter that US Treasury Bonds had moved into negative interest rate territory…it was all about return OF capital.

After the GFC, the Fed’s over-zealous QE programs gave rise to concerns about hyper-inflation. The gold price soared to a high of US$1920 in September 2011.

Hyper-inflation has given away to deflation and since its peak the gold price has fallen over 40% (in US dollar terms).

The GFC was, in my opinion, a trial run for the BIG one. The mother-of-all credit crises. The one the Fed and all other central bankers will be powerless to stop. The next one will finish the job the GFC was meant to do…purge the system of the excessive debt load that is retarding its growth.

Thanks to the McKinsey report released earlier this year, we know the world is US$60 trillion deeper into the red than it was in 2008.

Given the precedent set in 2008, the scramble for liquidity (cash) and security will be a fully-fledged stampede.

The US dollar (due to the demand to buy US Treasuries) will be the hottest ticket in town. I expect our dollar to fall below the 50 cent level.

A super strong US dollar spells big trouble for those businesses and emerging market nations that have borrowed in US dollars.

According to The Economist March 2015:

…more than $9 trillion in borrowing in [US] dollars by non-financial companies outside America

To give you an inkling of the pain a strengthening US dollar would have to this debt heap, imagine if that whole US$9 trillion had been borrowed by Australian companies. If our dollar did hit 50 cents, they would owe the equivalent of $18 trillion in Aussie dollars. Ouch!!

What do you do when your debt commitments (principle and interest) in your home currency suddenly doubles? You sell, and preferably, you sell something in US dollars.

Australian shares aren’t priced in US dollars. Australian property is not priced in US dollars. What investment is priced in US dollars? Gold.

So when ‘push comes to shove’ to repay some (even 10%) of the US$200 trillion debt pile the individuals, corporates and governments of the world have managed to accumulate over the past 40 years, gold will be dumped along with all other saleable assets.

I expect in the near term gold will rebound from its current level, but this will be a temporary bounce.

When GFC MkII hits, my guess is gold will fall well below US$1,000. From an Australian dollar perspective this fall will be somewhat cushioned by the slump in our dollar against the greenback.

The only flight to safety in the next crisis is the flight to destination CASH.

All other flights to safety — gold, blue chip shares, property — are going to crash and crash hard.


Vern Gowdie,

Editor, Gowdie Family Wealth

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Vern Gowdie has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top five financial planning firms in Australia. He has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession. Vern is is Founder and Chairman of the Gowdie Family Wealth advisory service, a monthly newsletter with a clear aim: to help you build and protect wealth for future generations of your family. He is also editor of The Gowdie Letter, which aims to help you protect and grow your wealth during the great credit contraction. To have Vern’s enlightening market critique and commentary delivered straight to your inbox, take out a free subscription to Markets and Money here. Official websites and financial eletters Vern writes for:

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