When It Comes to Gold, Markets Will Never Get the Message

When gold prices rise, you can be sure of one thing: somewhere, something isn’t right with the world. There’s a lot wrong in the global economy today, be it slowing growth or low interest rates. Usually, the latter is used as a way of fixing the former. But that’s not holding true anymore. We’re living in times of record low interest rates, even as growth prospects sink to levels not seen since 2008.

Despite that, safer assets like gold remain an afterthought for many investors. What doesn’t pay doesn’t matter…right?

But owning gold is becoming increasingly important. The precious metal is a buffer against global volatility. Which is exactly what we’re seeing playing out on gold markets now.

Overnight, the price of gold broke through a 200 day moving average. It surged by 1.84%, to US$1,187 an ounce. Aussie gold is up too since the beginning of the week. Prices are up AU$41, to AU$1,620 an ounce since October 12. Since August 4, Aussie gold has risen by AU$150.

We haven’t yet reached the halfway point of October, but bullion is already up 5% this month. Not since January has gold made such gains in the space of a single month. Then again, there’s rarely been more uncertainty about the future direction of the global economy.

Yesterday, another month of disappointing US retail figures helped push gold up.

Retail sales barely budged during September. Spending last month rose by just 0.1%. In fact, the bubble burst two months ago in August. Officials yesterday revised down August retail sales to 0%. So we’ve had two months of hardly any growth.

You could read into this in one of two ways.

For one, consumers tend to delay spending when they expect prices to fall in the future. That’s just the lay of the land when it comes to deflation. This suggests that consumers are wary about believing the Federal Reserve’s stance on interest rates.

It’s almost as if consumers are saying they expect more economic stimulus in the future. Something like, say, another round of quantitative easing. Or it might just be that households are feeling less certain about their financial positions.

Either way, fear over deflation is not strictly a US problem. It’s quickly becoming a global one too. And it’s reducing the likelihood of any upcoming US rate hikes. The Fed is wary about what rising rates would do to global capital flows. Something that could aggravate the global economy further still.

As long as interest rates remain low, illiquid, non-paper assets like gold will win out. Other metals, like silver, fall into this bracket too.

Gold benefits from weaker rates in a couple of different ways. How you see it depends on whether you’re a gold bug or not.

On the one hand, institutional investors prefer cash assets when interest rates rise. Why? Because higher rates improve returns on assets that generate interest. Whereas gold doesn’t pay out interest.

But gold bugs stick steadfastly by gold for another reason altogether. Their fear is that, eventually, this current low rate driven credit boom will implode. Once it does, it could lead to the kind of wealth destruction not seen since 2008. Especially in assets like stocks, cash or bonds. The types of asset classes that rose on the back of irresponsible credit expansion.

There are economists who ridicule gold investors that think this way. They say it makes them sound like kooks. But they have good reasons to worry about what follows the end of this credit binge. Even German finance minister Wolfgang Schabule questioned central banking policy recently. Here’s what he said:

Fewer debts, fewer crises, more sustainable growth…that is the best policy we can produce in these times. We shouldn’t pass on the bill for the tasks that are facing us now to future generations. Being in favour of more debt and further flooding on the markets with central bank money is neither original nor serious.

‘Too much growth in credit does not solve any structural problems but leads to financial and debt crises. Central banks’ monetary policy measures can do little to change this in the long run’.

You’ll never hear RBA governor Glenn Stevens utter those words. Nor Fed chairwoman Janet Yellen for that matter… You won’t it hear it from any central banker in fact. After all, as every good central banker knows, you solve problems by throwing money at it.

When there’s too much money, and the problems still remain, you pull the rug out from under everyone.

That’s what the Fed is threatening right now. By pulling the levers on easy credit, assets that boomed for nigh on seven years will feel the prick of a pin. One that puts the global wealth, stored up in stocks in particular, at great risk.

But you know that. Most people realise the situation is precarious. Yet it’s hard divorcing yourself from the herd mentality. Investors may never see gold for what it is — a store of wealth. It explains why gold, despite its recent gains, remains something of an outcast. As long as we think of gold in terms of gains, we’ll never understand why it should be a lynchpin of every investment portfolio.

Is gold undervalued? Paul Singer thinks so

However, gold is winning supporters in high places.

Paul Singer, the billionaire founder of hedge fund Elliott Management, is upbeat on bullion. So much in fact that he doesn’t understand why more people don’t share his enthusiasm:

In a world where the value of paper money is affirmatively aimed at being degraded by central bank policy, it’s kind of surprising to me that gold can’t catch a bid.

‘I like gold. I believe it’s under owned. It should be a part of every investment portfolio, maybe five to 10%’.

Like most gold bugs you imagine, Singer is sceptical of the central banking policies. And why wouldn’t he be? Aussie rates are at 2%. US rates are at 0.25%. And the European Central Bank sets a negative rate policy.

The effects of these reckless policies are evident in booming stock markets. The S&P500 is up 1,259 points since 2009, to 1,994. The ASX200 gained 1,862 points, to 5,206, since 2009 as well.

Yet as Singer rightly points out, the value of paper money is eroding. It should make gold something of a haven for investors. But it isn’t. Not yet anyway.

We need to get past a point where earning interest is the only thing investors care about. Uncertain times call for prudence when investing. Not everything must be tailored to make returns. Some things, like the safety of your wealth, are more important than mere gains.

Either way, gold prices should enjoy a period of stability in the coming months. Particularly now that US interest rate hikes are off the table.

Whenever the Fed does decide to lift rates, and send gold inevitably tumbling, we’re still some way off. Goldman Sachs reckons a rate hike before March 2016 is ‘extremely unlikely’.

Yet the conversation on gold won’t change. Supporters will argue the benefits of owning the precious metal. Detractors will maintain that it’s a useless asset paying no returns. It’s always been that way.

But as volatility rises, and gold prices edge higher, bullion won’t look like such an oddity anymore.

Mat Spasic,

Contributor, Markets and Money

PS: Gold bugs don’t pay much attention to bullion prices. It’s reassuring watching gold prices rise, but it’s not the reason many own gold. What’s more important is that gold safeguards wealth. Prices become irrelevant, because gold never loses its value.

In a global economy filled with so much uncertainty, owning gold seems more necessary than ever before. While Australia weathered the 2008 GFC, it might not be so lucky this time around.

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Download your free copy today to learn how to protect your wealth from the fallout of the crash. To find out how to download his free report right now, click here.

Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors.

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