So You Can’t Decide If You Should Save In Gold?
So you’ve heard all the obvious statements, and it’s all been really not that convincing?
Let’s give you a highbrow overview of four main points as to WHY a portion of your portfolio should be in physical gold …
1. GEOPOLITICAL RISK – GOLD CAN OFFER A DEGREE OF PROTECTION IN AN UNCERTAIN WORLD
Geopolitical risk can refer to a number of threats and disruptions that alter the political climate, such as wars, border disputes, mass migrations, and trade and security disputes. These issues in turn can impact on global or regional trade, capital flows and the financial system in unpredictable ways and so lead to heightened uncertainty and less clarity about the future.
These events can and do occur without warning and sometimes have devastating effects on seemingly unconnected economies due to an increasingly interdependent global economy. When uncertainty rises, financial markets become stressed, and investors manage the heightened risk via a ‘flight to quality’ i.e. a move into real assets that are known to preserve purchasing power and that act as currency or inflation hedges.
Gold is one of the main beneficiaries of this flight to quality. Gold is a finite asset, and is no one else’s liability, it has no counterparty risk and no default risk, and it is universally accepted as a high quality asset when the value of other financial assets becomes questionable. These characteristics make gold the ultimate safe haven asset.
During periods of market turmoil the gold price tends to increase as other financial asset prices are falling. When UK investors own gold, it provides a degree of wealth protection from geopolitical risk and a level of financial insurance from the system and its accompanying risks.
2. MONETARY RISK – WHEN YOU BUY GOLD YOU ARE SELLING A DEBASING CURRENCY
Monetary risk refers to a set of risks that may alter the existing monetary system.
In the UK, the monetary system is made up of the Bank of England acting in consort with the UK commercial banks. The UK commercial banks augment this money supply through fractional reserve banking and credit creation. The UK monetary system interacts with other economies and currency zones to create the international monetary system.
When external risks arise, the Bank of England is forced to alter monetary policy, sometimes in extreme ways, which can have the effect of radically altering the monetary landscape that investors have previously taken for granted.
When the global financial crisis hit in 2008, central banks around the world feared that the international monetary system would collapse so they coordinated on implementing monetary policy changes. These changes are still reverberating around the world today, because the problems were not fixed, merely postponed.
Since 2008, major monetary authorities such as the Bank of England, the US Federal Reserve, the European Central Bank, and the Bank of Japan, have embarked on near zero interest rate policies, debasement of their currencies, and in some cases they have embarked on quantitative easing by buying their country’s treasury bonds. This affects UK savers who, instead of being rewarded for saving, are being penalised by the Bank of England for saving, due to the Bank of England’s negligible interest rates.
When the UK banking system was brought to the brink during the 2007-2009 UK banking crisis, there was a real risk that the UK monetary system could have collapsed. This was a severe monetary shock to the economy and one which was never envisaged for an economy with a banking system as strong as the UK.
This massive increase in global money supply has created potential inflationary risks, since the rate of inflation is, in a lot of cases, above the rate of return available on bank deposits, and the expansion of the money supply has reduced the purchasing power of Euros.
The increased money supply has also generated potential asset bubbles in the UK stock markets and arguably a similar bubble in the UK property market.
Gold has been proven to be an inflation hedge and a hedge against the debasement in the value of paper currencies. As inflation rises, gold’s price also rises, and so it retains its purchasing power. Gold is a monetary asset that will help protect UK investors from monetary risks over the coming years.
3. SYSTEMATIC RISK – BANKS LIE, GOVERNMENTS LIE, GOLD TELLS THE TRUTH
Gold bullion has long been held by investors seeking to protect their wealth from the risks posed by systemic events. Systemic risk refers to the possibility that the entire financial system could become unstable and potentially collapse.
Normally a financial system is stable, and does not transmit shocks through the financial sector or into the wider economy. However, on occasion, the failure or potential failure of a financial firm or institution may create a domino effect and impact the health of similar firms.
Often, if investment or financing problems are perceived at a bank, the broader marketplace will not want to lend to that bank and perceived problems become real problems. If certain assets or investments in one bank become problematic, this can affect the value of similar assets at other banks. This is called financial contagion and can also be responsible for transmitting systemic risk.
These concepts are best illustrated by the events of 2007 and 2008 which most famously led to the collapse of US investment bank Lehman brothers in September 2008 and the earlier collapse of Bears Sterns, another US investment bank in 2007. Both banks experienced large losses on investments tied to US subprime mortgages. This led to panic in the global interbank lending markets beginning around mid-September 2008, and the associated bailing out of US banks.
However, the effects of this crisis hit the UK earlier than most in the form of the panic surrounding Northern Rock in 2007. As the credit crisis began to hit in August 2007, Northern Rock, which primarily used the money markets to fund itself, found that it could not get the required funding due to increased interbank borrowing costs, and it therefore needed to ask the Bank of England for emergency funding. This caused a bank run on Northern Rock, the first British bank run in over 100 years, and the intervention of the Chancellor to provide a guarantee to all UK bank deposits.
On a wider scale, banks around the world stopped lending to each other and wholesale money markets froze up, creating liquidity problems throughout 2008. Central Banks around the world had to flood the markets with emergency financing and take low quality assets as collateral in return to providing financing to banks.
Since the interbank lending market is global, there was a systemic shock in the form of the credit crisis and many UK banks found it difficult to raise financing. This caused insolvency risk and a fear of illiquidity for bank depositors. The Government had to step in by recapitalising banks and giving loan guarantees. Some of the better known recipients of these bank recapitalisations were Royal Bank of Scotland, Lloyds TSB and HBOS.
The gold price rose strongly before and during this crisis. Before the crisis broke, gold’s price was bid up by the market in anticipation that these systemic risks were coming to the fore. During the crisis in late 2008, gold price’s performed well as it was correctly seen as a safe haven asset that would provide shelter from the market turmoil. The problems from the 2008 crisis have never been resolved and are merely being papered over. Central banks continue to intervene to prop up bond markets via quantitative easing. Stock markets increasingly rely on the support and liquidity provided by these central bank interventions. There is still the risk of another Lehman moment, maybe increasingly so.
4. MACRO-ECONOMIC RISK – WITH ENORMOUS BOOMS AND DEVASTATING BUSTS, GOLD IS SEEN AS A HEDGE THAT CAN HELP BALANCE A PORTFOLIO
For an investor, macro-economic or macro risk refers to unexpected changes in the value of their assets due to shocks to real economic growth. This essentially means shocks from downturns in the business or economic cycle, in other words recessions, or in extreme cases, depressions. Since the global economy is interdependent, shocks to economic growth in the major industrialised economies would tend to be the most concerning, however, with the rise of emerging powers such as the BRICS, macro risk can also come from emerging economies.
The factors that create macro risk for investors would include real economy variables such as the unemployment rate, the health of the construction industry and industrial production, and also monetary variables such as interest rates and exchange rates. Macro risk factors can even include commodity price shocks such as oil or gold price changes.
In turn, these economic shocks can exist in the presence of inflationary shocks, so could lead to a recession accompanied by deflation, or high inflation, or even hyperinflation, or less likely but possible, a stagnant economy with high inflation, known as stagflation.
A potential looming economic shock to the UK is Scotland’s potential future exit. There is no definitive view on how the type of macro-economic shocks that might hit the UK economy if Scotland exits the United Kingdom.
What is clear is that there would be a noticeable effect on both the economic growth of an independent Scotland, and the remaining union of England, Wales and Northern Ireland. Primarily the initial period following a Scottish exit would create uncertainty, and uncertainty is not good for economic growth or financial markets.
An investment in gold has been proven to help impact the macro shocks that adversely affect other financial asset classes when uncertainty about the future threatens economic growth.
Hopefully this article has assisted in better informing you of some very valuable reasons why you should own physical gold!
Alan Butler, VIP Business Partner
Alan is married to Heidi and has four children. He has been a Karatbars Affiliate since 2016, and has over 130 partners and customers in his Karatbars business.