Yesterday (the 18th June 2014), my friend Greg Mckenna, who blogs daily for Business Insider on all things markets and economics, wrote an excellent piece on gold, titled: “TRADING INSIDER: Here’s why Gold Polarises Traders and Divides the Market”.

You can read the full blog post here, and I highly recommend anyone who is active on social media to follow Greg via his twitter handle @gregorymckenna

I really enjoyed Greg’s article, which wasn’t pro or anti-gold at all, but rather perfectly captured what I’d characterise as the mainstream debate about gold (or lack thereof), and whether or not it’s a “good” or “bad” investment.

Essentially, as Greg points out, gold tends to polarise investors because they seem to either love it or hate it, with little room for balanced debate.

“You are a gold bug” was the very reaction I received 10 years ago when I wrote my first paper advocating gold ownership for a group of high net worth investors who had a huge allocation at the time to US residential property, and it was much the same again a few years later when I wrote similar research for a large asset manager, who like most, had no gold exposure in their portfolios.

Worse than that, they didn’t even look at it as an asset in their portfolio construction process.

The lack of balanced debate about gold and precious metals in general is strange, and in many ways saddening, as this is not how most people, be they finance professionals or individual investors debate other asset classes like equities, bonds or property.

With those markets, analysts and investors will focus and debate things like earnings, valuations, inflation rates and the like, but its generally done in a civil manner, with a recognition that all of these asset classes can and typically do play an important role in a well constructed investment portfolio.

With that in mind, the following is a response of sorts to Greg’s article, highlighting what the ‘gold haters’ tend to overlook, and why I still invest in Gold,

It is not because I’m a gold bug, but because I’m a gold bull.

What the Gold ‘haters’ overlook

As Greg rightly points out with his quotes from William Jennings Bryan and William Stewart, the debate about Gold and its monetary qualities goes back a long way.

Whilst the comments those gentleman made about gold captured the mood and the debate of their time, in reality gold’s role as a monetary asset goes back pre-dates Bryan and Stewart by millennia.

To illustrate this, readers might enjoy what has become my favourite gold quote over the years, which comes form Albert Gallatin, the longest serving US Treasury Secretary of all time, who once stated:

“Nations, differing in language, religion, habits, and on almost every subject susceptible of doubt, have, during a period of near four thousand years, agreed in one respect; that gold and silver have, uninterruptedly to this day, continued to be the universal currency of the commercial and civilized world”

For a link to all my favourite quotes on gold, please click here.

Having said that, the purpose of this article is not to focus on gold as a monetary asset per se, but rather gold as an investment asset, as since 1971, when Nixon abandonded the gold standard, that is what gold has in effect become.

Back to Gregs article and as he states, “there are also many in the investment and trading community who see gold as a commodity with no real intrinsic value apart from that which it derives from the global jewellery trade.”

This is no doubt true, many ‘analysts’ do think this way, but in my opinion, it’s a huge oversight, and represents an overly simplistic way of looking at the gold market.

Yes jewellery demand is a big part of gold demand the world over, but its important to remember that, particularly in places like China and India, gold jewellery and investing are largely indistinguishable.

Over 80% of Chinese people see 24k gold jewellery as an investment as well as a display of wealth, whilst in India; gold jewellery is used as collateral for lending (often for agricultural loans).

If you want more information on these subjects you can read it about by clicking on this report about gold demand in China and Gold loans in India.

Clearly, jewellery demand, especially in China and India, which are the biggest markets for it, is not just about wanting to wear bling.

Gold ‘haters’ who just look at jewellery also ignore or overlook the fact that gold remains a major reserve asset for most of the worlds largest central banks, including the United States, who maintain over 75% of their foreign exchange reserves in gold today.

A list of countries and their gold holdings are a percentage of foreign exchange reserves can be found here.

Astute observers looking at the Wikipedia link will have noted that at present, only roughly 1% of Chinas 4 Trillion in reserves is sitting in gold, which is why they’re importing over 1000 tonnes a year of the metal now, despite already being the worlds largest producer.

If gold has no real value anymore, why on earth are central banks the world over hold roughly 30,000 tonnes of the stuff, and instead of selling it, buying more instead

Greg then goes on to rightly point out that many ‘gold haters’ don’t think we’ll ever go back to a gold standard, and that the idea of using gold as money is ‘bunkum’ because they “note the difficultly of using gold as a unit of exchange. It is inherently indivisible”

Of all the critiques of gold as money, this is easily the stupidest. Prior to 1971, Americans weren’t walking around with gold bars in their pockets. They were using paper notes, just like they are today.

The only difference between then and now is that the dollars in their pockets pre 1971 were effectively redeemable in gold.

Today, those dollars are not redeemable for anything, other than other dollars, which are effectively issued by a government that is over $17 Trillion in debt and a central bank that has printed trillions of dollars in the past few years.

Using gold as money doesn’t require us to carry around gold and silver coins, though people might well want to ask why it is that the coins they carry around in their pockets look the way they do.

Why I’m still bullish on Gold.

I’m bullish on gold in 2014 and beyond for much the same reasons I was in 2004 when I first wrote about, and first started buying gold and silver.

Supply is not only scarce but essentially fixed, and this can no longer change in any meaningful way, due to the unique nature of the gold market where annual mine supply (roughly 2,700 tonnes) is only 1.60% of the total supply of gold that has been mined through history and is known to be in existence today (roughly 170,000 tonnes)

This is what is known as the stock to flow ratio, and it is critical to understand, as it is what makes gold unique amongst commodities. We actually filmed this video to explain it in detail.

Couple that with the fact that I suspect that demand will continue to rise substantially, as it has for the majority of the past decade, and economics 101 tells you prices will rise.

Why will demand rise.

Apart from continued rising demand from China, India and other emerging markets (who already account for over 2,000 tonnes of gold demand per year), demand will also likely rise in the West going forward for a number of reasons.

Not least of these is just how hard it is likely to be to preserve, let alone grow capital in traditional assets (stocks, bonds and cash) in the coming years.

Looking at cash we are in a negative real interest rate environment the world over, with interest rates below the rate of inflation. This is not going to change any time soon, for the world is even more in debt than it was when the GFC hit.

Indeed we only have to look at the ECB which a few weeks ago actually implemented negative interest rates, or our own RBA who may need to cut rates below 2.50% in the coming months to know we’re going to be in a low rate environment for years, if not decades.

Cash is dying a death by a thousand cuts, and will continue to do so, and it will lead people to seek an alternative. Currently that’s stocks and property. In future, some of it will go to gold.

If we look at bonds, we’ve been in a secular bull market for bonds which goes back to the start of the 1980’s. Government bond yields are now at the lowest level in centuries, as this article attests.

Even junk-rated securities are at all time highs according to Barclays.

A normalisation of bond yields in the coming years would see investors lose substantial portions of their capital. It doesn’t mean you shouldn’t have bonds in your portfolio, but going forward, defaults, inflation and falling prices represent a triple threat to bond holders.

Finally we have stocks. In a low rate, QE world, it makes sense why people are buying stocks, and this will provide support to markets going forward, but that doesn’t mean stock markets aren’t without substantial risk going forward either.

Firstly, earnings per share (EPS) is being propped up by stock buy backs, with JP Morgan last year assessing that 60% of the EPS growth that S&P500 companies reported was due to buy backs, rather than via healthier revenue growth or even cost control.

Valuations are stretched too, with even Warren Buffets favourite valuation indicator (Wilshere 5,000 total market cap index relative to GNP) suggesting a pricey market (if not a bubble), whilst the S&P500 Cyclically Adjusted Price Earnings ratio, currently around 25, suggests markets are 50% above their long term average

This 6 month old piece from Henry Blodget (also on Business Insider) highlights the risk in stocks going forward

It’s not alarmist to point these facts out. It’s an accurate representation of where markets are at. It’s also not meant to imply that investors shouldn’t have any exposure to these asset classes.

But what it does suggest is that, much like the last decade, more and more people will realise they might want to balance out their portfolio with an allocation to precious metals, and as the market is essentially demand driven, that will mean higher prices.

As gold tends to prosper in periods of low to negative real interest rates, as PIMCO highlight in the piece attached, that is likely to be a wise decision, as we are still in the perfect macro environment for gold price appreciation.

As gold tends to prosper in periods of low to negative real interest rates, as PIMCO highlight in the piece attached, that is likely to be a wise decision, as we are still in the perfect macro environment for gold price appreciation.

Considering that for every $100 of investment capital out there, there’s less than $1 in gold and over $99 that is in stocks, bonds and cash, even a 5-10% portfolio reallocation away from these assets which face significant headwinds, towards precious metals (which has significant tailwinds) will see prices head much higher.

The Bitcoin Analogy

The article also touches on the Gold and Bitcoin comparison, which many are maing now between the two, looking at the incredible rally (and then crash) in Bitcoin prices that have occurred in the past couple of years.

Considering just how many ‘gold bugs’ have warmed to Bitcoin, I’m not surprised Bitcoin was brought up, but, as impressive as the Bitcoin technology is, Bitcoin is no Gold 2.0 as some say.

For anyone wanting more information on that, this piece I wrote covers why

Bringing Balance to the Gold Argument

Ultimately, the purpose of this missive is to try and help bring proper education about gold and precious metals to a wider audience, and to bring balance to the gold argument.

Like all asset classes, precious metals have pro’s and con’s, but it would be nice to debate the investment merits or otherwise of precious metal investment just like we do other asset classes, rather than the simplistic ‘gold bugs’ vs. ‘barbarous relic’ which makes gold appear as an ‘all or nothing’ investment.

This is something Greg acknowledges is sorely lacking, as in his article he states; “In the end the gulf between the gold bugs and naysayers is too big to breach”

It doesn’t have to be, and proper education is the key to changing that. Lets hope this article is a step in the right direction.

Until next week

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