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Uncertain Times Require Certain Diversifications

Topics [ gold investing financial crisis gold prices ]



Mark O’Byrne, head of research and executive director of GoldCore,
provides a European perspective on gold.


Gold is serving as a valuable hedge and safe haven, particularly in times when tail risks predominate

On hedging with gold, a leading institute has recently stated: “Gold can serve as a hedge against declining values of key fiat currencies.”

These are not the words of some so called ‘gold bug’ warning that fiat currencies are losing their value. Rather, they are part of the recent findings of the UK’s influential and respected Chatham House, or the Royal Institute of International Affairs.

“Holding gold – the world’s only independent currency – gives you some protection against the incompetence and idiocy of Europe’s bickering politicians. So keep it.”

The second quotation is from one of the Financial Times’s personal finance columnists – Money Week editor Merryn Somerset Webb.

Chatham House and Ms Somerset Webb are part of a growing band of journalists, advisers, investors and institutions who realise and acknowledge the importance of having an allocation to gold as part of a diversified portfolio.

We are living in volatile financial times and investors in the UK and internationally face tremendous challenges in the coming years.

History shows that debt crises tend to lead to currency devaluations. The one common thread that runs through the majority of economic crises throughout history is that gold protected people’s wealth from declining values in stock, bond and property markets and from currency devaluations. Similarly in recent years and again in 2011, gold has been one of the very few assets to have risen in value in all currencies and preserved people’s wealth.

Gold rose by more than 9 per cent in 2011 against the pound, the euro and the dollar or rather all fell against gold. Most currencies have fallen sharply against gold so far in 2012 and gold is consolidating around £1,100/oz, ¤1,300/oz and $1,700/oz.

Investors, pension funds and many creditor nation central banks are diversifying into gold in order to protect themselves from the real risks posed by a possible global recession, by the intractable EU debt crisis and the risk of a US and global debt crisis.

They are also diversifying into gold to hedge against financial and systemic contagion and from currency debasement.

A bubble or off to $3,400/oz?

Is gold a bubble today at close to £1,100/oz, ¤1,300/oz or $1,700/oz? Or will it rise to more than $3,000/oz and the equivalent in sterling and euros in the coming years?

Respected investors who foresaw this economic crisis such as Jim Rogers and Marc Faber say that gold will rise to thousands of dollars, euros and pounds per ounce in the coming years.

While gold has risen six times in 11 years, it is worth remembering that in the 1970s gold rose 24 times in nine years.

The financial and economic risk of today is of a much greater degree than that of even the 1970s.

Gold will have to reach $2,500/oz or the euro or pound equivalent just to reach the actual real price from 1980 – adjusted for inflation. Today gold remains more than 35 per cent, or $800 per ounce, below its real high in 1980 of $2,500/oz.

JPMorgan and UBS recently forecast gold would reach $2,500 (from $1,700/oz) before the end of 2012. Citigroup recently said that gold will rise to $2,400/oz in 2012 and by $3,400/oz in “the coming years”.

It is not just large pension funds, hedge funds and central banks who are buying gold today. Rather, there is broad based global demand. In particular, interest from China, India and the rest of Asia has grown very significantly.

The growing middle classes in Asia believe in and trust in gold as a better store of value than their local paper currencies deposited in domestic banks.

In China especially, chairman Mao banned gold ownership in China in 1950, and the ban continued until 2003. This means that the per capita consumption of 1.3bn Chinese people is increasing from near zero levels.

Importance of real diversification

The stipulation of ‘Investment 101’ – diversification – remains less understood when it comes to gold. Gold should be owned as part of a diversified investment portfolio.

Besides the evidence of history, there is a large and growing body of academic evidence pointing to gold’s importance for investors.

This was illustrated in November in an academic paper on gold by Constantin Gurdgiev of Trinity College Dublin, who is a member of the GoldCore Investment Committee, at a conference hosted by the Bank for International Settlements (BIS), the European Central Bank and the World Bank. The research paper clearly shows gold’s importance as a long term diversification tool due to its “unique properties as simultaneously a hedge instrument and a safe haven”.

Financial, economic and monetary history shows that gold protects people in uncertain times – be that from natural disasters, wars, economic collapse, sovereign default, bank holidays, deflation, hyperinflation, inflation, stagflation and currency devaluations.

While cash has been king in recent years, the recent past only goes to show that cash can become trash through currency depreciation and devaluation.

Gold is less volatile than many stock indices internationally but is somewhat volatile and has the same volatility as the FTSE All-Share index at 20.05 (January 1970 to December 2011).

A 5-10 per cent allocation gold as a safe haven is prudent in these uncertain times.

Chatham House correctly concluded in their recent report that gold may “continue playing a significant role in the international monetary system, serving as a valuable hedge and safe haven, particularly in times when tail risks predominate”."

(This article first appeared in FT Adviser.)

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