“The
desire for gold is not for gold. It is for the means of freedom and benefit.”
These words by Ralph Waldo Emerson sum up the reason why the yellow metal
continues to hold favour among investors across the globe. While retail
investors seek freedom from inflation, large buyers (read Central banks, hedge
funds) seek freedom from currency devaluation. In this era of
Quantitative Easing (QE) and artificial monetary support, markets are rewarding
gold for its sheer quality of maintaining purchasing power. If one cuts off the
incessant money printing across the globe, gold would be reduced to a worthless
asset in the end. To put it simply, it is not the value of gold that is going
up, but the value of currencies that is coming down.
The US Federal Reserve’s balance sheet was just
under $900 billion in early 2008, but it has expanded to just over $2.8
trillion currently. The gold mine production rate has remained flat in
comparison.
More importantly, balance sheet inflation continues
at the same pace. The Fed recently announced another round of QE policies that
could see around $1 trillion being added to the Fed’s balance sheet every year
till they decide to stop printing money. With the re-election of Japan’s
Liberal Democratic Party, the nation is poised to witness an easier money
policy in a bid to boost economic growth. It is such synchronised efforts from
Central banks across the globe that has further accentuated gold’s role as a
monetary alternative. The fiscal role of gold is gaining more ground with the
Basel Committee on Banking Supervision as it is considering defining gold as a
‘tier 1’ asset in line with cash and AAA government securities. It is expected
to open doors for gold to compete with cash and government bonds on bank
balance sheets.
Yet, gold remains one of the under-invested
assets. Currently around 1 percent of global financial assets are
invested in gold. We believe gold is far from being in a bubble
phase. Gold price performance in all G7 currencies in the past five to 10 years
stands testimony to the fact that it’s a broad-based rally.
Fixed Income and equities have generally found more
favour with investors as these are income-generating assets. Fixed Income
provides interest; equities provides dividend. Gold generates neither. However,
things have been changing with real interest rates moving into the negative
territory across the globe and dividend yield on equities being far from
encouraging further investments. With even currencies being consciously devalued,
gold is emerging as an alternative to fiat money with more fundamental value to
provide to investors.
However, one would note that gold prices have not
really moved significantly higher in the recent past in spite of such easy
money policies. To understand why, let’s look at the US QE programme.
When the Fed engages in QE, it does so by buying
assets in the open market, such as Treasury notes or mortgage bonds. When the
Fed buys a government bond in the open market, it creates the money to pay for
it out of thin air and the payment is credited against a commercial bank’s
account at the Federal Reserve. However, since banks have largely refrained
from lending it out into the economy, the velocity of money has not matched the
pace of money supply. In most cases the
money is either deposited with the Central bank or with other banks. Hence, the
money that the Fed creates is not in circulation. However,
when these large sums of money do start flowing into the economy, we would see
inflation rising, which would further fuel demand for gold.
But is QE really the only answer to the current
global crisis? If yes, then it would be difficult to explain why the US economy
continues to struggle. The rate of economic growth and the distribution of
income and wealth in a country are closely related to export growth. A weaker
currency acts as an important stimulant for favourable exports growth. Hence,
most of the economies have engaged in a race towards devaluation.
India has been thriving on its domestic demand
advantage for a long time now. However, a large part of this strong demand is
focussed on buying gold that is hurting foreign exchange reserves. The
government has been trying several tactics to reduce gold bullion imports as it
has started taking its toll on the country’s current account deficit. Apart
from hiking the customs duty, the government recently barred banks from
financing gold purchases. To dissuade retail investors from buying physical
gold, the RBI is considering promoting gold investment in dematerialised form.
While most of these investment alternatives do prove to be viable investment
options, they fail to address the fundamental reason for the surge in gold
imports like high inflation and macro economic instability.
The banking crisis of 2008 left world-renowned
corporate houses bankrupt and prompted unprecedented Central bank actions
across the globe, which have led to most of the toxic debt getting transferred
from private balance sheets to government balance sheets. The race towards
competitive devaluation is set to intensify, leading to further deterioration
in the value of currencies. Here we say again, “Gold is good money”. Most
commodity bull markets run for 16 to 17 years and gold is just concluding 12
consecutive years of positive returns. Investors still have time to enjoy the
freedom and benefits of investing in this unique asset class that acts as a
hedge against governments’ mismanagement of money.
Source : Forbes
Your Friend,
Vivek
