One of my friends sent me an article from Knoweldge@Wharton (reference: Gold May Glitter, but It Doesn’t Stack up as a Long-term Investment, published 30 April: http://knowledge.wharton.upenn.edu/article.cfm?articleid=1946) on the relative unattractiveness of gold.
The article informs us that, in the US, profits on GLD (the exchange- tracking fund on the metal) attract income-tax rates as high as 28%, while capital gains on stocks and most mutual funds are taxed at no more than 15% if the investment was held for at least 12 months. That gives away the policy bias, not to mention academic bias, in favour of financial investments in the US.
When equities had a great 20th century, two things helped: first, starting valuations were low and, second, dividend yields were high at the beginning of the century. When the 21st century began, both these powerful supports went missing. So, it remains to be seen how the story of equities in this century would be written.
For the most part, the developed world faced disinflation starting from 1880s. Yes, there were episodes of high inflation. But, looking at the period from 1871 to 2007, American inflation was low (below 4%) in 100 of those 136 years, and below 3% in 85 of them.
That may be about to change. Expansionary monetary policy pursued at every hint of crisis without allowing forces of creative destruction to work has brought the ghost of inflation back to live among us permanently.
The most important reason for inflation to return is not speculation in commodities or climate change or the advent of China and India as big consumers. It is loose monetary policy pursued since 1998 not just by the US of A but to varying degrees and for varying lengths by other countries such as Japan, England, Switzerland, the Eurozone and now by many emerging economies — particularly oil producers such as Russia and West Asian countries.
So, the return of inflation is the biggest scourge of paper money and the biggest argument in favour of gold. Therefore, to look back at history and discredit gold is not very rigorous since, I believe, inflation resurgence makes the case now for gold, if it did not do so earlier.
Equities are denominated in paper money and when paper money loses its sheen, so would paper-backed assets. At least partially, that anxiety drives the campaign to discredit gold as a potential alternative asset for investors.
Equally important is America’s systematic abuse of trust and confidence placed in the US dollar as a global reserve currency by other nations. It has enjoyed a massive discount on its borrowing costs because of its reserve currency status. There is an implicit contract between the “reserve currency” country (RCC) and others who lend or invest in it that the RCC would not debase or systematically abuse the trust in its policy or economic systems.
I believe that the US has not kept its end of the bargain. The transgressions in the last 10 years have been well documented. As is the case with most empires whose powers have peaked, the decay has become more rapid in recent years. Yet, many countries — for reasons not fully clear — continue to finance America’s profligacy and borrowing exclusively through public funds.
This massive transfer is overwhelming, is becoming costlier and is yet continuing even more strongly than in 2004-07! However, it would be extremely dangerous to assume that this would continue or end without massive disruption to the global financial order. There is no real alternative to the US dollar yet. When the US dollar is discarded and when there is no real alternative, it might be good to have some non-paper alternative such as gold and silver handy. This scenario, in my view, is a question of “when” and not “if”.
These analyses and arguments apart, in the end it is no one’s case that gold should make up a significant chunk of one’s assets, let alone the whole of it. It is good to have it in such magnitude that it at least attenuates potential losses in paper assets when a major disruption in the status of the US dollar occurs.
If such a disruption does not occur, investors could be happy that a substantial portion of their portfolio would have kept their value. Nonetheless, I feel that the risk is sufficiently large for an investor to seek protection against it via diversification into commodities in general and precious metals in particular.
Finally, if we have to reduce all the above arguments into one statement on whether the current price of gold is an opportunity to implement the above recommendation, upon accepting the logic behind it, a simple one-word answer is yes.
V. Anantha Nageswaran is head, investment research, Bank Julius Baer & Co. Ltd in Singapore. These are his personal views and do not represent those of his employer. Your comments are welcome at firstname.lastname@example.org