Buy gold to shield your portfolio from danger and uncertainty

This is an era of unprecedented money printing and more bailouts may soon be needed. The geopolitical backdrop is shaky too. In short, there have never been so many reasons to hold gold, says Dominic Frisby.

When I last covered gold for MoneyWeek magazine in September 2019, it was trading around $1,500 an ounce (£1,200/oz). It had had a great year, gaining 20%, and things were looking good, if a bit frothy. It slid back a little before something happened to do with a bat in a wet market in Wuhan.

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When Covid-19 panic hit and governments around the world announced extraordinary stimulus programmes, gold rebounded to all-time highs in sterling (£1,445/oz), euros (€1,635/oz), Japanese yen, Canadian dollars, Australian dollars, Singapore dollars, Swiss francs and pretty much any currency you care to mention bar the US dollar itself. The US dollar high was $1,788/oz – about $130 short of the 2011 all-time high of $1,920/oz. 

The economic turmoil; ongoing trade wars and other geopolitical uncertainties; the promised money-printing and looming inflation; and risky stock and debt markets: all the stars seemed aligned for gold. Since then the price has slid a little. So what next?

A short-term supply shortage 

Let’s take a look at some of the market forces driving the gold price, starting with supply. The price of copper or zinc is determined by new supply from mines. A shortage of supply and an increase in demand (or expectations around either) will quickly push up prices. But traditional supply-demand dynamics do not affect gold in the same way. That’s because gold does not get consumed. Rather it is hoarded, whether in the form of jewellery or bars. Almost all of the gold that has ever been mined still exists in some form or other. 

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Nevertheless one of the dynamics that pushed up the gold price in March and April was a shortage of supply. Three of the world’s largest refineries, Switzerland’s Valcambi, Argor-Heraeus and PAMP, were closed as governments ordered shutdowns of non-essential industry. 

Meanwhile, from South Africa, Peru and Mexico to parts of Canada and China (now the world’s largest producer) gold mines were also closed down. At one stage the Comex, the main gold futures market, ran out of bars for delivery, though this logistical problem was soon remedied.

This supply dynamic is slowly changing. Precious metals refinery Valcambi (the world’s largest) said on Monday that it had received permission to reopen and that it would operate at around 85% of normal capacity. The others will no doubt soon follow and mines around the world are also slowly starting up again. In short, the shortages were temporary and new mine supply is coming back online, albeit slowly.

It’s all in the mind

But the biggest driver of the gold price is psychology. Gold is the most emotional of metals. In March and April there was panic. When there is panic, a rush to gold soon follows. The bigger the panic, the bigger the rush. The longer the underlying problem remains, the longer people’s need to own gold will last. 

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Coronavirus panic has subsided a little and so has the urgency to own gold – hence the slipping price. Perhaps those who panicked most were governments themselves. Part of governments’ reaction was to pledge extraordinary sums of money, whether to pay for furloughed staff, bail out broken businesses, or increase healthcare facilities. A narrative quickly emerged that this would lead to inflation and so there was a rush to gold.

Cranking up the printing press

The big question we now have to ask ourselves – and we have to ask ourselves this question honestly and without political bias – is where will all this money printing end? Will it work? Or is it going to bring us Venezuelan- style monetary turmoil? The answer to that question determines whether you should be a significant buyer of gold now.

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The amounts of money that have been created in the last two months are truly extraordinary. In the UK the coronavirus panic prompted the announcement of quantitative easing (QE), or money printing, worth about 50% of the post-financial crisis plus Brexit-QE total of £435bn. 

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In the US the $2trn package amounted to more than 50% of the 2008-2016 total. Meanwhile, borrowing costs (money is created by borrowing, when banks write loans) have been slashed to the lowest levels in the 326 years that central banks have existed.

Will this lead to inflation? Or is the damage to the economy – the broken businesses, the unpayable debts, the tightening of lending (and hence of the money supply) we are about to see, as well as falling asset prices – going to mean deflation? Rather like 2008/2009 we are probably going to see both forces at work.

Money printing is the new normal

Unlike in 2008, however, which was a largely financial event, this time around the real economy has been hit much harder. Restaurants, pubs, bars, retail, theatres, cinemas, concert halls, transport, airlines (of course) and goodness knows what else are all suffering. 

Money printing is now normalised. Unless the economy can quickly get back to what it was, and that does not look likely, I don’t see it being that long before more bailouts are required. We may not see wage inflation, but that bailout money is going to make it into the real economy in a way that it never did post-2008. Surely it is going to manifest itself in all sorts of unexpected ways. How though?

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Post-2008 we got a huge boom in financial asset prices (especially equities), house prices (especially in London), and more obscure areas such as fine art. Where will the money go this time? Those who favour limited government and free markets will argue that governments’ reaction to 2008 created huge levels of inequality. Wages were largely stagnant, while asset prices rose. It was great if you owned the assets in question, but if you didn’t you got left behind. Economic inequality, whether between generations or between rich and poor, was the net result. 

There are many who feel that the reaction to the crisis of 2008 was justifiable in that it saved the overall system. In any case, however, even greater levels of fiscal stimulus are being demanded now. Many people advocate Modern Monetary Theory (MMT), which essentially argues that money can be printed to finance government spending and any inflation that ensues can be dealt with by raising taxes or issuing bonds to reduce the amount of money and velocity of money in the system.

You can see the temptation. Over six million jobs in the UK have been furloughed. Many of them will not come back in the post-Covid-19 world. How will this be addressed? Universal basic income suddenly becomes a lot more likely than it looked three months ago. How will that be paid for? MMT. Do you side with the interventionists, or do you take the hard-money view that this is all going to end in inflationary tears?

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