Bullion: Safe Haven or ‘Barbaric Relic’

The swings in the gold price have caused consternation among investors who had increased their holding of the precious metal with the hope that prices were headed northwards. Gold bugs flirted with edges and were eyeing a breach of the $2,000 per oz mark. However, the plunge in the price of the precious metal to $1,321 per oz on 16 April 2013 left investors doubting their rectitude over gold. The ides of April shook safe haven investors who had locked value in gold above $1,600 per oz. When the bullion prices gapped down to $1,321per oz and rebounded to above $1,400 per oz by end of May 2013 with resistance around $1,429 per oz a new reality dawned. Is gold fitting into John Maynard Keynes description of a ‘barbaric relic’ or it is a structurally disturbed safe haven asset?

Mr. Nouriel Roubini, a New York University professor and head of Roubini Economics, reopened the debate on bullion’s asset status when he forecasted that gold will plunge to $1,000 an ounce by 2015. Well, Roubini is not a fly by night economist having forecasted the decline in the housing markets in 2008. That should be instructive rather than scaring to investors since past successes rarely repeat. However, the weight of a prediction by an analyst or an economist is taken on the accuracy of past forecasts. Roubini, a decedent of Iranian Jews, has a high reputation given that the 2008 crisis is probably the worst crises of our time. Simply stated, Roubini’s arguments against gold are;

·  Firstly, gold is not a perfect substitute for currency since it fulfills only the store of value and not the unit of account and medium of exchange functions of money. In this regard, the argument is that bullion investing is a faulty play on the debasement of fiat money.

·  Secondly, the global economy is on the mend and the drivers of the ‘gold rush’ are busted. Essentially the bubble has burst and the current bear trend is a correction.

·  Thirdly, gold is an inferior asset to bonds or shares because it does not pay interest or dividend depending solely on capital appreciation and therefore not attractive in a stable global economic environment.

Roubini’s assertion of weak gold fundamentals may in part explain the sell- off in gold that led to a gap in the metal’s price on 16 April 2013. Gold buying is probably a ‘relic’ that investors desert when the global economy is becoming stronger. The major reason for the recent sell-off is gold does not produce income and when prospects for capital appreciation are under threat exiting gold and investing in bonds or shares is a prudent portfolio rebalancing move for mutual funds. This is the reason why investors reduced gold holdings by 479.2 tons this year. Secondly, gold as an asset reflects speculations on the performance of the global economy and when real production is on the back burner it rallies as a safe haven asset and partly weakens with the commodity cycle. The dominant driver determines the direction of prices.

Notwithstanding, a widening gap between global productivity and the growth of the stock of money drives economic participants into panic over the acceptability of currency money and nudges gold prices upwards. In the event that such a scenario becomes the absolute reality, then gold will become the underlying value of money. It will act as a store of value, a unit account and medium of exchange through the issue of certificates of deposit. The entire financial system will reboot at that stage.

The transition of gold holdings into certificate of deposits and then into currency is the achilles’ heel of Roubini’s argument against the value of gold as a currency. Gold is the ‘soul’ of the existing monetary system and whenever the system is under attack it searches for its soul. The post emergent economies of China and India have been leading on gold purchases motivated by both high physical demand and currency worries. In the first quarter of 2013, China bought 372t of gold from Hong Kong compared to 776t in 2012. March had record purchases of 223t which fell to 125t in April because of thin trades at low prices. The table below shows bullion holdings of major economies as at 30 April 2013.

Table 1: World Official Gold Holdings

Country / Tonnes / % of reserves
United States / 8,133.5 / 75.1%
Germany / 3,391.3 / 72.1%
IMF / 2,814.0 / -
Italy / 2,451.8 / 71.3%
France / 2,435.4 / 69.5%
China / 1,054.1 / 1.6%
Switzerland / 1,040.1 / 10%
Russia / 976.9 / 9.5%
Japan / 765.2 / 3.1%
Netherlands / 612.5 / 58.7%

China, the second largest economy, stands on 6th position in terms of gold holdings and has the lowest percentage of its reserves allocated to gold. Heightening worries over the global economy has been at the centre of China’s angst with regards to the structure of its portfolio of reserves which is overweight in the green back. With Exchange Traded Funds (ETFs) selling and China buying we have a market that is consolidating. Perhaps only a trap of the proportion of the 2008 crisis will see gold touching $1,000 per oz. In my view, another sweet spot for gold has been created.