Investors are increasingly investing in gold as a hedge to inflation and financial uncertainty. Due to unprecedented debt levels in the West, numerous central banks have been printing money to boost stock and bond market prices artificially. While this money printing has succeeded in keeping the financial system afloat in the short term, the systemic risk to the system in the long term has been increased due to this manipulation. The price of gold has moved up in accordance with the increased fragility of the financial markets.
Why Gold Is a Safe Haven Investment
Gold has been recognized as a form of money for at least 5,000 years due to its unique physical properties. Gold is rare, durable, divisible and fungible. Because the supply of gold increases by approximately 1.5 percent annually from mining activities, it is an asset that cannot be inflated willfully by governments to cover their debts, as with paper currencies that constantly lose value. Since gold is also recognized universally as a form of money, it can be taken anywhere in the world and converted to a local currency with ease. Given these characteristics, gold has tended to perform well historically during times of economic instability.
Why the Gold Bull Market Is Not Over
During the last few decades, Western nations have experienced a substantial increase in their standard of living due to the expansion of credit. As the gross domestic product (GDP) of these nations grew, the assumption among the populations of these countries was that this growth was a permanent feature of modern life and economics. As the recent financial crisis in the Eurozone has shown, there is a limit to the expansion of credit tolerated by investors. At any moment, investors who are deterred by high levels of debt may dump the bonds of a nation, causing interest rates to skyrocket and leading potentially to a national default.
Similar to the situation in the Eurozone, the United States has experienced tremendous economic growth fueled by credit expansion. Currently, the national debt of the United States is almost $17 trillion, which is the largest debt in the history of the world. However, the United States possesses the global reserve currency, the dollar, which allows its central bank, the Federal Reserve, to print trillions of dollars to lower interest rates artificially and stimulate its economy. So long as the dollar remains the global reserve currency, the United States will be able to print money to pay off its debts. Increasingly, other nations are abandoning the dollar due to its continual debasement to keep the American economy afloat. The dollar may therefore lose its coveted status as the global reserve currency within the next couple of decades.
The price of gold has been rising steadily as a result of global money printing, since it is a form of money with a restricted supply. As a hedge to inflation, the gold price rises in proportion to the devaluation of paper currencies. If the bond markets and currencies of Western nations are to collapse, gold will retain its purchasing power and allow investors to maintain their wealth invested in the precious metal. In a financial collapse with high inflation, the value of gold may even rise temporarily above the level of inflation, bringing real investment gains, as the masses begin to recognize the true value of gold as a safe haven asset.
Global Currency Wars
In the global financial system today, there is a “race to debase” currency, as it is widely believed that a depreciating currency makes exports more competitive price-wise and therefore stimulates the economy. The problem with currency wars is that, as one nation depreciates its currency, other nations must follow in order to stay economically competitive. Though in the short term depreciating a currency may bring positive results, in the long term a global currency war may lead to hyperinflation, or a very rapid currency devaluation that gets out of control. Hyperinflation is devastating to an economy, because a currency becomes worthless and social instability arises. In a scenario of high inflation or hyperinflation due to the global currency wars, gold will retain its purchasing power.
Why Gold Is Not a Bubble
Though skeptics of gold as an investment claim that gold is a bubble, it is worth noting that gold has been called a bubble since it was at $800 per ounce, about half of its price today. Furthermore, by definition, a bubble must attract the masses, whose investment decisions are influenced by hype and caprice. Currently, the masses have shunned gold as an investment, despite its positive gains in the last 12 years. The masses are even selling their gold, as indicated by the proliferation of businesses that buy gold from the public for profit.
The Ramifications of German Gold Repatriation
Recently, Germany has requested that 300 metric tons of its gold be repatriated from the United States. In an agreement reached between both countries, the gold will be fully repatriated by 2020. Germany also plans to repatriate 374 metric tons of gold stored in France. Because non-Western central banks have made masses purchases of gold in recent years, it is believed by some gold investors that much of the gold previously held by Western governments, including on behalf of other governments, has been leased or sold, due to the belief that requests for gold repatriation would never occur. If this is true, it would explain why it will take seven years for the United States to send a mere 300 metric tons back to Germany.
Germany’s request for its gold is likely to spur other nations to request their gold, given the widely circulating rumor that gold not in the physical possession of a nation may be irretrievable. Currently, there is growing pressure in Switzerland to retrieve its gold. With a finite global supply of the precious metal, and emerging nations, such as China and Russia, in a frenzy of purchases, there may be an insufficient supply of gold should enough nations attempt to take possession at the same time. If other nations are to follow Germany’s example and begin claiming their gold, there may be a supply crisis that sends the price of gold at multiples of what it is today.
European Bank Holidays
Cyprus has grabbed international headlines recently due to its bank holiday. At this time, the government of Cypress is in negotiations with European lenders on how to cover the debts incurred from poor investments on the part on its banking system. Under consideration is the taxing of deposits of accounts with 100,000 euros or greater. If depositors are to be taxed, it will undermine the level of confidence among investors in the European Union and encourage capital flight away from bank accounts and into tangible assets such as gold.
When Cypriot banks reopen from this bank holiday, there will likely be a run on its banks, as the population scrambles to takes its money out of a teetering banking system. If the Cypriot banks collapse as a result of bank runs, it may trigger bank runs in other periphery nations of the European Union, such as Greece, Italy and Spain. A collapsing financial system in Europe will encourage investors to place their wealth into gold, which is largely immune to the machinations of global financial elites, since it is more difficult to track than money in bank accounts.
As the global financial system deteriorates, investors increasingly will place their money into gold, which has been viewed historically as a safe haven investment. There are a number of potential catalysts to drive the gold price much higher, such as massive debts, currency wars and bank holidays. When purchasing gold, it is important to do so with a reliable and reputable dealer, such as Monex.com. Investors should make sure they have an adequate amount of gold in their possession to survive the economic turmoil that is almost certain to worsen.