At the heart of the wild volatility and trading volume we saw last week is the underlying credit and monetary crisis: the value of many debts is becoming increasingly difficult to identify, and as the US government continues to agree to expand the money supply to bailout overleveraged banks and brokerage houses, the value of the US dollar is becoming suspect as well.
In times of monetary uncertainty, gold has historically been viewed as a safe haven -- and so, unsurprisingly, we saw gold make a record jump as well. Many economists, particularly those who subscribe to the Austrian school of economics, believe these problems are far from over, and view gold as a sound long-term investment.
This begs the question: why is gold a safe haven investment? And will it continue to be one?
Gold has historically been thought of as a safe haven currency because it was, for much of history, real currency in virtually every part of the world. There was sufficient global demand and supply to make it easily exchangeable -- a key quality of any reliable currency. Even up until 1973 the US dollar was backed by gold, meaning dollars could be exchanged for gold at a fixed rate.
Many economists predicted that with the end of gold convertibility, the value of gold would fall. Instead, the opposite happened: gold rose, and the US dollar fell. That trend still is intact today, and gold continues to be viewed as a safe haven investment -- in spite of the fact that it has declining utility value (meaning real use value), as well as the fact that no currency with significant circulation is pegged to gold.
So will gold continue to rise in value? In the event of a global monetary crisis, something that seems increasingly likely, will gold become a currency?
Certainly there are some indications that this may be the case. One such example is in Vietnam, where a volatile currency is causing some assets to be priced in gold.
I personally do not like to bet against thousands of years of history, and thus view gold as a key part of any wealth preservation strategy in a turbulent economy. With that said, below are some arguments why gold's status as a safe haven investment, and thus its rise in prices, may be in question:
- We live in times of great speculation, as evidenced by the record setting trading volume we saw this past week. With speculation so accessible, it could be argued that the best form of wealth preservation is diversification. If diversification via speculation replaces buy and hold as the dominant investment strategy, gold may benefit -- but not as much as those who are very bullish on gold would suggest.
- Synthetic investments, like ETFs, are a natural by product of an increased appetite for speculation. Moreover, synthetic investments create a new opportunity to diversify risk across an array of assets, and thus could be viewed as an increasingly valuable risk management tool.
Which begs the question: with the ability to enable greater liquidity and risk-diversification, could a well structured synthetic investment be a safe haven? Moreover, could the right synthetic be a currency? Some may say fiat currencies -- currencies like the US dollar and Euro, which are unbacked by "real" assets -- are already synthetic investments, just not ones that are diversified well enough, and where supply and demand are not balanced enough.
Certainly we are in revolutionary and unprecedented economic and financial times. Many compare our current climate to the stagflation environment of the '70s or even the Great Depression of the '30s -- though there are some key differences, most notably the increased role of credit in today's markets, increased globalization of trade, and greater securitization of assets. As such, these factors may suggest a radically new form of monetary policy is necessary.
Of course, as noted earlier, I am reluctant to bet against history, and thus remain very bullish on gold over the long-term -- I would imagine for at least three years. Though I'll be on the lookout for new synthetics. Maybe a starting point is the gold ETF (NYSEARCA:GLD), which jumped last week as well.
Disclosure: I have a long gold position.