Why gold is the ultimate insurance

published 1 March 2011

Mostly, when you buy insurance, you hope it won't ever turn out to be necessary. You pay annual premiums for your car insurance, but that doesn't mean you secretly hope someone will knock you off the M25; you pay a fortune to insure your house, but that doesn't mean you want it to be burnt to the ground during your summer holidays (mostly).

The same goes for gold. When I started buying it back in 2002 or so, I did so largely because the supply and demand balance seemed out of whack. But as the decade wore on, I began to see my holdings much more as an insurance against pretty much all the things that have always gone wrong in the past and that will almost definitely do so at some point in the future.

Last week, I wrote about normalcy bias: the tendency most of us have to extrapolate the near past indefinitely into the future. Gold bugs those who just can't bear not to hold gold have this tendency, too. They just have a slightly longer-term version of it than most people.

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So, instead of assuming that the dollar won't collapse because it hasn't in the past few years, they assume that it will because all people-pleasing paper currencies implode under the weight of their promises at some point. If you offer everyone a standard of living that you can't afford and then print money to pay for it, that is generally how it ends.

And, instead of assuming that world peace will hold because it has for 50 or 60 years, they note that peace has historically been a fragile sort of thing. They also assume the regular appearance of black swans they expect that something they can't yet conceive of is likely to change the world around them, with very little warning. So they hold insurance against all these things in the form of gold the one global commodity that has held its value for thousands of years, regardless of what happens around it.

Right now, that looks like the right thing to have done.

The behaviour of the central banks in the West over the past decade is not the kind of thing to engender much in the way of confidence in their currencies. Monetary policy has been far too loose for decades and now the almost routine printing of money via quantitative easing along with the huge sovereign debts of almost all Western nations should make even the most firm believers in paper currencies feel a little tense.

Just how tense? Usually, when geopolitical tension kicks off around the world, investors rush for the safe haven of the dollar. It might be a sign of just how much confidence they have lost in it the last few years that, even as the Libyan crisis unfolded, the US currency barely budged. Those after a safe haven headed for gold instead. For the first part of 2011, the gold price fell from its December high of $1,420 right back to $1,320 around 7% in total. It started rising again in the first few days of this month and is now back to $1,412.

So what next? The usual reasons for holding gold stand, regardless of the jump in the price. Supply is tight but demand of all kinds is rising. Angelos Damaskos of the Junior Gold Fund points out that global gold consumption in the third quarter of last year was 12% higher than in the year before. Demand for gold jewellery rose 8% and retail investment demand rose 25%. Of particular interest is the rise in demand for gold in China: in the first ten months alone of 2010, it imported five times the amount it imported in all of 2009.

At the same time, money printing (and the inflation that follows) remains a worry. Clearly, the more paper currencies are debased, the more you want to be holding a real store of value. That should keep demand moving.

My children have a large box of coins they play with endlessly. They are all either the remnants of totally defunct currencies or the inflation-wasted denominations of currencies that still exist (British halfpennies, for example). The children use them to play at shops. I use them as a reminder that paper currencies rarely keep their value. One day and probably a day long before my grandchildren take over the game the box will contain a variety of dimes, quarters, euro coins and pounds.

The final thing I would note at the moment is that the world's banks haven't been particularly kind to the ousted and semi-ousted dictators of the world this month. Mubarak, Gaddafi and Ben Ali have found that, far from standing by them, their Swiss banks have been all too keen to freeze their accounts. You might say this serves the old tyrants right. And of course it does. But it also reminds the rich that electronic money which is all our money is anymore isn't real money.

That's good for gold, as well.

This article was first published in the Financial Times

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast - but still writes for Moneyweek monthly.

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.