On Monday I said that we should have some gold ferreted away – at least 5% to 10% of our portfolios, in my view.
In response, one reader comments: “I can see the case for gold, and the related (hyper)inflation and money printing arguments. What I can’t understand is how MoneyWeek can be so pro gold and so anti property/land?”
It’s a great question. And one that I’ve grappled with myself. The question as to whether property is as good as gold is certainly one that I’ve grappled with too. In fact, thinking about this question has been very helpful to me. This is just like therapy.
Property is a real asset
Now, I have yet to meet a British person that doesn’t like housing. In fact, some of the fiercest property bears I know still own their home. What’s more, it’s usually a significant part of their overall wealth. And the MoneyWeek guys are no different.
Personally, I’ve got a reasonable slug of property in southern France. I’ve even written about German property investing in the past. It’s a shame that I didn’t have the time to take my own advice on that a couple of years ago. German property prices have risen as worried savers have turned to property. Fears of ‘eurogeddon’ mean that many German savers have come to the same conclusion as our reader – property is a real asset! Just like gold!
And yes, it is. But you need to tread carefully here.
But debt could destroy property values
The big problem with any kind of investment is how much leverage (or debt) is in the system. And note that I say ‘system’ – your own debt level is not the only consideration.
Investors and owner occupiers in residential housing tend to be highly leveraged. Just last week I was going through the business plan of a buy-to-let investor who was looking to offload her properties. There’s no equity in the property portfolio at all (even assuming her valuations are up-to-date); but thanks to low rates, the business is making an OK profit.
But what happens when rates go up? Her company, with its portfolio of 50 properties, could go bankrupt in the blink of an eye. There won’t be time for inflation to raise the value of the portfolio if they’re foreclosed. So rising interest rates could wipe her out – and take property values with her.
The gold market has proven to be frail under stressed conditions in the past. During the 2008 financial bust-up, gold took a pasting. You see, just like in housing, there’s an awful lot of leverage in the system. The vast majority of precious metals trading occurs on the highly leveraged paper-based futures exchanges.
Some estimates suggest that for every ounce of physical gold in existence, there’s a hundred ounces traded in the paper markets. And when things turn ugly investors and banks need to cut down leveraged positions, like they did in 2008. There was an almighty scramble for cash.
It’s important to note that investors without leverage suffer just the same. You might stash your gold coins under the floorboards and own a property without a mortgage, but your wealth could still fall.
“Well, I’m not selling!” is the usual answer. And fair enough, it’s a reasonable response. But at the same time, you may not be in a position to buy either. That’s why I’m in favour of a decent slug of cash in your portfolio right now. That’s the ammo we need if things turn ugly.
But it’s not just cash I think you should be holding. There are fundamental changes afoot in the financial industry. Changes that could make gold a very shrewd hold too.
Gold recognised as real money
You’ve probably heard about the Basel accords. A powerful committee of central bankers meet in the Swiss town of Basel. They decree how much capital financial institutions should hold, and what type of capital.
As I said on Monday, over the course of the last 40-odd years the world has turned to paper assets. So the Basel accords have (until now) decreed that the best type of capital a bank can have (tier 1) is cash and top-rated government bonds.
Lower down the pecking order (tier 2) you’ll find more dubious assets such as mortgages etc. And at the bottom (tier 3) are speculative assets – including gold.
The idea is that the more safe capital (tier 1) the bank has, the more it can leverage up its balance sheet.
So during the crisis, banks were inclined to sell gold (tier 3) and use it to buy government bonds or cash (tier 1).
But as of 2013, it’s understood that the incoming Basel III accord will bring with it a change to gold’s status. Stand back, wait for it…
Gold goes to tier 1!
For the first time in 42 years, gold will be considered as good as cash. No longer a third-rate asset.
Mortgage debt on the other hand will remain an outcast. Let’s not forget that many banks are reining in loans on the basis that they are trying to build capital reserves in order to meet the new Basel III accord.
The verdict on physical gold
The point is this. If we’re plunged back into crisis, I don’t think the gold price will fall like it did in 2008.
The perception of what gold is and what it does is changing, whereas the perception of paper is weakening, especially residential mortgage paper.
So, to finally answer the reader’s question: no, I don’t think property is as good as gold. Sure, bricks and mortar without debt can be a much better investment than a batch of paper promises. But remember, its value (in real terms) can plunge. My advice is to stay diversified and hold some physical gold.
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