Things continue to boil over in Europe.
On Wednesday, Italy’s fiscal crisis worsened to the point they staged a media blackout. SBS informed viewers hoping to catch the Italian news that their Italian broadcasting partner had failed to submit anything. As if to mark the fall of Italy, SBS played sad opera music and weather maps instead.
Meanwhile, gold has snuck past the financial news, recovering from its recent poor performance. Is gold proving its metal in this time of financial uncertainty?
We finished last weekend’s Markets and Money pondering how governments might ruin your gold investment. And promised to discuss how they might do it.
Some readers staged a pre-emptive strike, writing to tell us there is no need to write about the confiscation of gold. ‘Government won’t do it’, they said, for all sorts of reasons. But they missed the point. As pre-emptive strikers often do…
It’s not confiscation the average gold investor should worry about. After all, as another reader pointed out, we live in an Ineptocracy.
Ineptocracy (in-ep-toc’-ra-cy) – A system of government where the least capable to lead are elected by the least capable of achieving, and where the members of society least likely to succeed or even to sustain themselves, are abundantly rewarded with goods and services paid for by the confiscated wealth of a diminishing number of producers.
The Ineptocrats and their dependents have long figured out how to bleed others dry without confiscating gold. But there is another kind of risk gold owners face. One much more worth thinking (and reading) about.
It has to do with the Gold Matrix. Not the movie The Matrix, where a computer nerd comes to realise the world we live in is a computer program created by machines that now rule the earth. If it was about that Matrix, we’d write about people suddenly waking up to the reality that fiat money is a scam. That fractional reserve banking is a fraud. And that interest rate setting by a central bank causes the business cycle.
Maybe that’s what it should be about.
Anyway, we mean the other kind of matrix – the mathematical one.
It looks like this:
Each number in the table represents one of four different scenarios you face as a ‘non-American’ gold investor in the future. You can insert your currency of choice in the top right-hand box, as long as it’s not the US dollar.
Why do people who don’t use US dollars to buy gold need a special matrix for their gold investments? Because gold is priced in US dollars. In order to obtain the gold price in a currency other than the US dollar, gold is first priced in US dollars and then converted to your currency. That means there is currency risk for non-US-dollar-based investors. This adds to the scenario of possible outcomes for gold investors. The value of their gold depends not only on the gold price, but also on the exchange rate. And governments are increasingly messing with exchange rates. In other words, governments can meddle with the value of your gold without actually meddling with the gold itself.
Let’s go through each scenario in the matrix, step by step.
In Scenario 1, the Aussie dollar and gold both go up in value. (The Aussie measured in US dollars.) In this situation, the increase in the Aussie dollar will offset the gains in the US dollar gold price. If gold goes up more than the Aussie, the gold price in AUD will go up. And vice versa. So the net outcome is uncertain for Aussie gold buyers. Regardless of gold going up, their Australian dollar denominated asset could go either way depending on the move in the exchange rate.
Scenario 4 is similar. If gold and the Aussie dollar both go down, the price of your gold in Australian dollar terms depends on which goes down more. Australian dollar gold could go either up or down.
The remaining two scenarios are more conclusive. If the Aussie dollar goes down and gold goes up (Scenario 2), the Aussie dollar gold price will rise even faster than the US gold price. If the Aussie goes up and gold down (Scenario 3), Australian gold investors lose out on both counts.
Navigating the Matrix
What’s interesting here is how likely each of these scenarios is to play out. And what kind of economic situation will lead to which scenario. Remember, gold is a macro play, meaning your decision to invest is probably based on how you expect the world economy to perform. So it’s the economic situation that is relevant to gold investors.
Scenario 1 – Gold and AUD both go up
This scenario is likely to occur with high inflation in the US, coupled with an economic recovery around the world. Gold rises in price because people buy it to protect themselves from inflation – the buying power of an ounce of gold today is roughly the same as it was 5,000 years ago. The Aussie dollar is likely to rise if there is a recovery, as the world buys our resources when times are good. This creates demand for the Australian dollar, both to invest in us and to buy our resources. Whether gold or the Aussie rises more is hard to know. But, in real terms, an Australian gold investor will be better off, as their money and assets rise in value relative to other nations’ currencies. Holidays overseas and online shopping would become cheaper for you.
Scenario 4 – Gold and the AUD fall
Mild deflation, or another financial crisis, is likely to cause this scenario. Gold will be in less demand during deflation and so will the Aussie dollar, so the price of both will fall. It is likely that gold will fall less than the Aussie in this situation, as gold is perceived safer than many assets when banks are struggling (which happens during deflation). This is probably the reason gold didn’t collapse in 2008. As a commodity-based currency, the Aussie dollar would have much to lose in an economic downturn. People wouldn’t want to buy our resources or invest in Australia. So in this scenario, the Aussie gold price may outperform other investments.
Scenario 3 – Gold down, AUD up
This is the worst-case scenario for Australian gold investors. Gold falling in price and the Australian dollar rising would crush the Australian dollar gold price. For this to happen, central bankers would have to pull off the greatest tightrope walk in history. Upside down. (Your editor used to teach people to tightrope walk. (Proving that those who can’t do, teach.) We never saw anyone but a clown manage to do it upside down.) Anyway, it is safe to say this scenario is rather unlikely. Still, it’s interesting to explore. A sizeable economic recovery, coupled with low inflation and the vanishing of crushing debt loads would see the demand for gold diminish. And the demand for Australia’s dirt grow like only the Australian government’s tax forecasts dare to hope for. It is the low likelihood of this scenario that makes gold buyers buy gold.
Scenario 2 – Gold up, AUD down
This is the best-case scenario for Australian gold buyers. The fall in the Aussie dollar will add to the gains in the gold price. Some inflation in the US combined with a slowdown in global economic growth would see this scenario happen. In other words, in order for this to happen money printers need to print money and unemployed construction workers need to stop building buildings. The two are usually linked in that the money printers are called into action when the builders stop building. Economists call such a scenario ‘stagflation’ – a combination of low growth, high unemployment and inflation.
Which scenario are you betting on?
Right now, foreign governments are doing their damndest to manipulate exchange rates. The US senate, for example, has put tariffs on Chinese goods as a retaliation for the Chinese policy of a devalued currency. The Japanese recently intervened to lower their currency and even the Swiss have been trying to lower theirs.
And as an Australian gold buyer, you need to watch these developments carefully. Will Australia join the so called currency wars? And will the Americans succeed in lowering the value of the US dollar?
One thing is clear. Currency manipulation could make or break your gold investment. But that manipulation is mostly hedged in buying gold. The US price of gold should go up about the same amount that the Australian dollar rises because of US currency devaluation. After all, the US dollar is being debased against both gold and the AUD at the same time. Similarly, if the Australian dollar falls, the Australian dollar gold price will hold up.
Gold is an excellent asset for Australians who agree with the idea that there will be inflation in indebted nations and tough times ahead for Australia. We’re pretty sure all of the editors here at Port Phillip Publishing own gold bullion. But after its impressive rally since the Markets and Money first suggested it as the trade of the decade over a decade ago, is it still a good investment?
And if yes, should you go with bullion? Or stocks?
Markets and Money Weekend Edition