Why Gold Won’t Survive the Next Financial Crisis

Why Gold Won’t Survive the Next Financial Crisis

We attended the Mines and Money Asia conference in Hong Kong last week. There was plenty of talk on gold.

One of the panel discussions was called: ‘Gold and its role in investment portfolios’.

I didn’t really know what to expect.

Well, I had an idea…

Put it this way: If I was the only gold bear in the room, I wouldn’t have been shocked.

Contrary to expectations, however, the panel wasn’t all bullish. It was a shock. I’ve never attended a conference where the entire panel wasn’t made up of gold bugs.

It was refreshing to hear a mix of opinions…

I’ll explain…

The run-down

Andrew Ferguson, CEO of APAC Resources, was the most conservative professional on the panel. He owns gold, but calls it an ‘emotional’ investment.

We can’t say he’s wrong…

Gold is perhaps the most emotional metal on the planet. It’s been used as a currency for centuries, and it holds tremendous value across multiple cultures and countries.

Andrew Ballingal, CEO of Ballingal Investment Advisors, was the most bullish on gold. He said that gold started this century cheap, and it remains cheap. The bear market has lasted five years, with gold down by more than 35% from its 2011 high of US$1,920 per ounce.

He believes it won’t stay that low for another five years…

Similar to your in-house investment strategist Jim Rickards, Andrew believes there’s massive potential for gold. For that reason, Andrew is buying small and medium-sized gold companies which have a resource of less than one million ounces. That’s where he sees the most opportunity.

Frankly, we agree.

The best potential stems from ‘penny gold’ stocks. That’s because they’re already hated and underappreciated by most investors. The company merely needs to change the perceptions of investors via a resource upgrade or by finding the ‘treasure chest’ for expectations — and the share price — to grow.

Indeed, regardless of gold’s next move, the best ‘penny gold’ stocks can still make you massive returns. If a ‘hated’ company hits the mother lode, its share price is likely to re-rate to reflect the change in expectations…even if gold trades below US$1,000 per ounce.

Stefan White, Portfolio Manager of LIM Advisors, also joined the panel, providing a lot of level-headed comments. Interestingly, when talking about how much gold China owns, he believes there is a lot more than the country admits. He thinks that China wants the yuan to become the world reserve currency, backed by either gold or oil.

Will the next reserve currency be backed by gold?

Jim Rickards agrees with White…

Jim has argued for years that China’s up to something. He thinks the country will back its currency by gold, and that it’s underreporting the amount of gold it owns as it stockpiles bullion.

The panel seems to agree.

Andrew Ferguson told us that the PLA (China’s army) has their own, heavily-secured gold vault. He also noted that lots of official Chinese organisations are buying gold, and there’s absolutely no way to work out who or how much they are buying. As Andrew Ballingal said, China is a massive gold producer, and it has lots of reserves in the ground. ‘If you are a new buyer, the last thing you do is show your hand.

He makes a good point…

The argument for gold remains the same: The world economy is drowning in debt and, eventually, that will have to be written off or it will cause tremendous inflation. Gold is likely to benefit under either scenario.

We certainly don’t disagree with the big-picture outlook.

The question is: When will the next financial crisis take place? More importantly, when will the gold price start to take off?

Those timelines are up for debate…

I believe that gold is likely to get destroyed during the initial stages of the coming sovereign debt crisis. Gold’s likely to fall with stocks during the start of the crisis, until punters wake up and realise that government is the problem. That’s when everything should flip.

A lot of gold bugs would call me crazy. They will tell you to buy gold— and never sell — because the world is loaded with unsustainable debt. Frankly, they have been saying that for over three decades.

The gold promoters just don’t get it. To understand how gold works, let’s wind back the clock…

Will gold survive heading into the government debt defaults?

Gold increased slightly heading into the sovereign debt crisis of 1931–33. But, at the time, the world was on a gold standard — money was gold, and it was fixed to the US dollar. If you didn’t like holding cash, you could exchange it for gold.

Currencies across the world were pegged to bullion. Plus, until 1971, the gold price remained at a fixed price — it didn’t fluctuate like it does today. You can see this in the chart below.


Source: MacroTrends
[Click to enlarge]

Today, there is no gold standard. Gold isn’t money. You can’t buy bread at the supermarket using gold. Gold — like stocks, commodities, property and agriculture — is an asset.

History shows that gold crashed during nearly every financial crisis when it was an asset — one not fixed in price. Remember, gold only survived the Great Depression because it was both ‘money’ and ‘fixed in price’.

Gold crashed by 50% during the OPEC (Organization of the Petroleum Exporting Countries) crisis of 1974–76. At this time, there was a steep recession, with the stock market falling by 40%. Gold then rallied to a high of US$875 per ounce in January of 1980. (Note: The 1980-high shown on the chart above is incorrect).

When gold peaked in 1980, stocks, real estate, silver and commodities were booming across the board — not just gold.  But as I said, that was the peak. After 1980, gold declined for 19 consecutive years.

When gold formed its last major bottom, it crashed spectacularly during the 1999 tech bubble. Most recently, gold crashed by 40% during the 2008–09 financial meltdown. Remember, this was a time when gold bugs were calling for the ‘next Great Depression’.

Of course, this time could be different, right?

Unlikely.

That doesn’t mean you should ‘write off’ gold, or gold stocks.

It depends on when and what you buy.

I believe, similar to the panel and as explained above, the best value stems from the small gold and silver stocks at the moment. Producers will be good when the bull market takes off. We’re not at that stage yet; hence, our attention remains focused on uncovering ‘penny gold’ gems for Jim Rickards’ Gold Stock Trader readers.

Regards,

Jason Stevenson,
Editor, Markets & Money

PS: If you’re a fan of the battery revolution, check out Resource Speculator. Two of my lithium stocks are about to drill for the mother lode any day now. If they tap the ‘big one’, their share prices could skyrocket. These companies are extremely under the radar. While we wait for drilling, I’ll be tipping a few more battery stocks next week. To find out more, click here.

Jason Stevenson

Jason Stevenson

Analyst at Markets & Money

Jason Stevenson is Markets and Money’s resource analyst. He shares over a decade’s worth of investing and trading experience across resource stocks and commodity futures and options.

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Denis Ross
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Hi Jason, China probably wants to back its currency with gold as a precaution against economic instability that threatens the world from fiat monies. Traditionally, or at least in “modern times” since the inflow of opium into China starting in the 1840s and continuing to the 1920s, silver was the currency in China. When Mao Ze Dong coined a currency to support the Red Army it was a silver dollar, not paper money. I doubt the Chinese want their currency to be an international currency like the US dollar with all the attendant problems caused by inflation of the currency… Read more »
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