Gold vs the pound

In today’s letter: why gold is still the ultimate crisis insurance, for private investors, savers and powerful Russian autocrats alike. Let’s dive straight in!

By the way, it’s publisher Nick O’Connor here. I’ve locked Boaz in the studio here at Southbank Investment Research HQ to work on a project you’ll hear more about next week. More on that at the end of today’s letter.

But first: do you have “insurance” to protect the value of your savings in the case of a currency crash? I ask you because that’s precisely why I own gold, and why I buy more every month. My own allocation is around 15% of my total savings.

There are three motivating factors in that decision. The first is personal. I have a young family. I’m unlikely to retire soon. I want to protect the value of my savings over a pretty long time horizon. Owning gold and other hard assets is my solution to the threat of inflation, low rates and financial mismanagement of the currency. I’m also uncomfortable keeping money I’m saving for my son entirely within the banking system. I want “hold in my hand” control over at least a portion of it.

Which brings me to motivation two. I’d describe this as “domestic”. It pertains to the specific circumstances we’re seeing in Britain today: an incompetent government making a total mess of Brexit, and a socialist opposition that plans an all-out war on wealth (and admits its policies would likely lead to a run on the pound).

In the worst-case scenario those factors lead to a collapse in the pound and a spike in inflation. We got a taste of that in 2016 after the referendum. Gold – valued in pounds – spiked higher then. Like I said, it’s insurance.

Motivation three is global. Since the global financial crisis the world has accumulated a weapons grade level of debt. Central bankers have shown themselves willing to take big risks with how much money they print. And “populist” leaders (though I hate that term) all have one thing in common: they want to spend like there’s no tomorrow. My concern is that all this is inflationary. Gold is, again, the perfect solution to that problem.

By the way, I don’t hope any of the problems I just outlined come to a head. But sound financial planning, in my view, involves taking measures to prepare for the worst. Not with every penny you own. But with enough to insure yourself against crisis.

The pound has been trading in a tight range for a year. Effectively that means it has gone sideways. In fact the pound has been very stable even as our political situation has become depressingly unstable. Eoin’s view of where we go from here is pretty blunt:

The breakout occurred two weeks ago when no-deal was taken off the table. The pound is now well established above 1.15 and I’d be surprised to see if come back down. This is exactly what I predicted back in the summer.

There is going to be a deal and it is membership in all but name. If you voted for Brexit you are getting screwed. I see the pound going up a lot on the basis of that conclusion, at least until the next election which is going to be a monumental s**t show. All those Brexit voters are going to be hopping mad.

Gold has been very steady against that background but it going to be hard to rally while the pound is strong in the short term. The clear winner is gilts in the short term. That’s where the trend is, it’s got massive commonality with the rest of the world and there is no way the Bank of England is going to be able to raise rates even though it has to.  

Short version: pound up in the short term, as Brexit dies in Parliament. Its unlikely gold will rise when measured in pounds in that scenario. But the next election could unwind any short-term gains we see. I won’t be selling my gold, anyway.

Eoin and I agree in our view on the global outlook for gold though. Populism is inflationary and inflation is good for gold. That’s the argument.

And of course, if you’re a gold mining firm you don’t care about the price of gold in sterling terms. You care about the dollar primarily. The pound could strengthen, weakening the price of gold in the UK – while gold miners soar globally.

Moving on. I’m not the only one who turns to gold to protect myself against financial volatility and currency weakness. Turns out Vladimir Putin is following the same logic. At least, so it would appear from the outside. According to Bloomberg, Russia has quadrupled its gold reserves in the last decade: 

Within the span of a decade, the country quadrupled its bullion reserves, and 2018 marked the most ambitious year yet. And the pace is keeping up so far this year. Data from the central bank show that holdings rose by 1 million ounces in February, the most since November.

The data shows that Russia is making rapid progress in its effort to diversify away from American assets. Analysts, who have coined the term de-dollarization, speculate about the global economic impacts if more countries adopt a similar philosophy and what it could mean for the dollar’s desirability compared with other assets, such as gold or the Chinese yuan.

I think me writing about “de-dollarisation” would make me pretty unpopular with Boaz. That’s one of his big themes. So I’ll sidestep that issue and offer an alternative explanation. Russia is an energy power. Its strength and prosperity are linked to the oil price. When oil falls, Russia suffers. One manifestation of that suffering comes via currency weakness. Oil and the ruble are connected at the hip.

It doesn’t take a huge logical leap to see that perhaps a good way to prepare for a weaker oil price would be to increase gold reserves. It won’t help the ruble in the face of a lower oil price. But it would insure the nation’s finances against the weakness. Which brings me back to my own approach to my household finances. Neat.

By the way, I tried making this “Case for Gold” to one of my staff last week, to no avail. I was talking to a big small-cap investor – and someone who says he’ll never buy gold. His argument is that he’ll always trust small, innovative businesses to grow his capital. He calls it 2 + 2 = 5. If a business can take “inputs” worth £4 and charge £5 for them… well, that’s the kind of innovative alchemy a market economy enables.

My point: there’s room for both concepts in a portfolio, isn’t there? I own gold as insurance. Gold miners are insurance on steroids. And small caps are where your big, long-term capital gains are going to come from. I see them all working together. They aren’t mutually exclusive.

Which is all a rather long-winded way of saying, if you don’t own gold yet, you should consider it. At least learn more about your options.

Best,

Nick O’Connor
Publisher, Southbank Investment Research

Category: Market updates

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