Gold: Why a Civilized Investor Should Own the Barbarous Relic

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In our modern world of credit card transactions, electronic payments, crypto-currencies, and digital wallets, the idea of physical money has become somewhat outdated. At a time in which carrying cash has become largely unnecessary, the thought of executing transactions with hunks of yellow metal seems downright alien. Indeed, the practicality of using physical gold as a daily medium of exchange is somewhat questionable. But while gold has been derided as a “barbarous relic” for nearly a century, I believe there are four good reasons why a civilized modern investor should make it a part of his or her portfolio.

Hedge Against Currency Upheaval

Don’t be fooled by mainstream media types, who would have you believe that anyone who owns gold is a “gold bug” or a “kook.” If that were the case, it would mean nearly all central banks around the world are run by gold bugs and kooks, given that gold represents a major part of central banks’ reserves. Despite the fact that President Nixon officially took the U.S. off of the gold standard in 1971, gold continues to underpin the world’s financial system.

Globally, central banks currently own gold worth the equivalent of nearly 2% of world GDP, representing a major portion of global central bank reserves. What’s more, central banks, especially those in China and Russia, continue to accumulate gold at a torrid pace, as they have since the end of the Great Recession.

Since 2014, foreign central banks have also been reducing their holdings of U.S. Treasuries, diversifying their reserves away from the U.S. dollar in favor of gold, Euros, Japanese Yen, and other currencies. This has occurred in conjunction with a number of bilateral agreements between various nations to conduct trade in currencies other than USD. These agreements should have the effect of reducing global demand for USD (largely in the form of U.S. Treasuries).

The shrinking role of the USD as the world’s primary reserve currency increases risk for any dollar-denominated investment assets. However, it also increases the likelihood that gold rises in price, making gold an effective hedge against the fall-out of global currency reshuffling.

Store of Value in a Negative Real Interest Rate Environment

The “real” interest rate is defined as the yield earned on interest-bearing securities, minus the rate of inflation. During periods in which real interest rates are negative, owning bonds can lead to long-term value destruction, as inflation eats away the interest earned on the bonds (and more). However, gold has shown itself to be a good store of value during such times.

In the aftermath of the Great Recession, central banks around the world engaged in an effort to reflate the global economy by pushing interest rates below the rate of inflation. Ostensibly, the goal is to stimulate nominal GDP growth to the point that it exceeds the growth in debts.

Put another way, the debt/GDP ratio is too high (and rising) in many countries, and central bankers hope to reverse this trend by engaging in monetary policy that creates inflation. With debt loads (individual, corporate, municipal, and sovereign) at perilous levels, an extended period of positive real interest rates would be potentially devastating to the global economy and would likely result in cascading bankruptcies.

Accordingly, I feel confident that real interest rates are likely to remain extremely low or negative for the foreseeable future and that gold should provide investors with a means of maintaining purchasing power as inflation accelerates.

Effective Portfolio Diversifier

Historically, the price of gold has tended to be inversely correlated with the dollar and largely uncorrelated with stocks and bonds. This characteristic makes gold a potentially attractive addition to a portfolio of stocks and bonds, as it may help to lower overall portfolio volatility. The upside is that gold can help to buoy a portfolio’s value during bear markets; the downside is that gold may attenuate portfolio returns during ripping bull markets.

But given my view that stocks are grossly overvalued in many markets and that the USD is poised to weaken going forward, I believe that gold will prove to be a highly effective portfolio diversifier that helps reduce volatility when added to a portfolio of stocks and bonds.

Hedge Against a Weaker Dollar Resulting from Trump Policies

One of President Trump’s primary policy priorities is reviving U.S. manufacturing. This was a major pillar of Trump’s platform in the 2016 election, and it is a policy objective with the potential to affect a significant number of voters in key Midwestern states. In order to deliver on this objective, Trump needs the dollar to depreciate against the Euro, the Japanese Yen, and the Chinese Renminbi, such that U.S.-produced goods become more competitively priced in global markets.

There are several ways the Trump administration could try to depreciate the dollar. From a fiscal policy standpoint, Trump could work to reduce the value of the dollar by aggressively increasing the Federal deficit through a combination of infrastructure spending and tax cuts (we have already seen some of the latter), financing these increases with U.S. Treasury purchases by the Federal Reserve.

Alternatively, if Congress cannot be convinced to pass a sufficiently aggressive fiscal package, Trump could put pressure on the Federal Reserve to use monetary policies to drive down the exchange rate of the dollar. One possible policy avenue would be that described by Ben Bernanke in 2002, when he spoke about the Fed’s authority to print money and then buy foreign government debt. Such a policy would likely be directed at countries like China and Germany, which have the largest trade surpluses in global markets.

Regardless of the policy tools used, I expect Trump will be successful in reducing the value of the dollar during his presidency. Given the fact that other nations are already reducing their dollar reserve holdings, I believe investors in dollar-denominated assets should be looking for ways to protect their portfolios from dollar weakness. Gold has shown itself, time and again, to be a valuable hedge against dollar weakness while also serving as a stable store of value and effective portfolio diversifier. As such, I believe even the most civilized investor should consider owning the barbarous relic.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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