Gold is dead, the dollar is now Gold:
It is a romantic notion we all want to believe; we pretend there is a safe haven asset able to protect our wealth and retain value no matter what happens. Historically this role as been ascribed to gold - the 'true' money that once backed all currencies of the world. However, those days are over and this view of gold investing is outdated.
What most people do not realize is when the gold backing was removed from the dollar, and the dollar became the global reserve currency, it replaced gold - taking on many of the characteristics people incorrectly assume to be true about the yellow metal. What I am saying here is that the most fundamental beliefs we have about gold are incorrect. Gold is not a safe haven, and the dollar is. The United States Dollar has become gold, and gold has become a commodity.
Why do People Believe Gold is a Safe Haven?
Gold is traditionally viewed as a safe haven asset investors can use to protect wealth during times of economic and political instability. Before I explain why this is not true, I want to first explore why this notion developed in the first place.
I think the first well known example of gold performing as a safe haven asset can be seen during the Napoleonic Wars of the early 19th century. During this period the major nations of Europe were at war, and as usual during times of heavy government expenditure many printed money (France stayed on the bimetallic standard) to finance debts. Savvy investors converted their currency into gold to retain purchasing power during this time of uncertainty.
It is vital to note that at this time most currencies were backed by either gold or silver, so people were simply buying the underlying value that propped up the currency. Also note investors were not directly hedging against the war itself, but rather seeking to protect themselves from the reaction (printing money) governments would take in the situation.
These two facts are important to note. While things have changed over 200 years, these two basic investor patterns remain the same.
How the Dollar Replaced Gold:
When the dollar was taken off the gold standard in 1971 it took the entire world off the gold standard and put us all on the Dollar Standard. This means the dollar replaced gold, taking on its properties as the only safe haven asset during times of economic uncertainty. Gold, on the other hand, became a precious metal commodity with a loose association as the inverse of the USD.
What this means is that in times of economic uncertainty the flight to safety will drive investors towards U.S. dollars and U.S. treasury bonds - the modern safe haven assets. Gold on the other hand, will actually lose value during this flight to safety, making it the diametric opposite of the safe haven asset it is commonly understood to be.
Breton Woods, 1940's when the dollar was made global reserve currency.
There are exceptions to this rule. For example, during an inflationary crisis such as the 'stagflation' in the 70's gold will rally. This does not occur because of the recession or the economic uncertainty though. Gold will go up during these periods because of the inflation alone. During a period of inflation everything will go up; from timber, to oil, to groceries to gold.
In every major gold rally, you will see oil, copper and the other commodities rallying with it.
On the other hand we have the U.S. dollar. Dollars are more or less the currency backing the rest of the world's currencies, and the medium all commodities are traded in. Just like investors flocked to gold during the economic uncertainty of the 19th century, modern investors will flock to the dollar during economic crises and recession. The precedent for this is overwhelming.
Dollar Index, Grey Bars Represent Recession:
Dollar Rallies Correspond to periods of international crisis:
The U.S. dollar will have massive rallies during times of economic uncertainty such as recessions and geopolitical crisis - I believe the recent stock market troubles in China gave the dollar a boost in 2015.
What About Gold?
Many investors believe investing in gold will protect them against economic uncertainty and/or recession, this is not the case. This understanding of gold is outdated because the U.S. dollar and the U.S. treasury have replaced gold as the safe haven asset.
The truth is that gold is actually at serious risk of correcting during times of economic uncertainty, tending to fall with the equities and commodities.
Gold Prices, Brent Crude Spot Price, Recession Bars in Grey:
Granted, gold is a much more stable commodity compared to oil, but gold prices will follow the same general pattern. Falling during times of economic uncertainty (unless inflation is involved) and rising during times of global economic progress.
To further solidify this point, remember gold tends to trade inverse to the dollar, and the dollar tends to strengthen during times of uncertainty. This more or less means gold not only lacks protection during these periods, but may actively punish the investor by falling as the dollar rallies.
The correlation between gold and UDN (short USD) has weakened over time, but this chart shows just how strong it can be. As the USD began to rally in 2008 UDN, the inverse of the dollar, fell - taking gold with it:
Why Has the Dollar Replaced Gold as The Safe Haven Asset?
The dollar is the global reserve currency, and America is the strongest economy on earth. During times of uncertainty there is serious risk of nations inflating away their problems, and this risk is mitigated by holding dollars. As the global reserve currency the U.S. has the ability to export its inflation to other nations who have a demand for the dollars to conduct trade.
In addition, the United States T-Bond is known as the safest asset in the world. During times of uncertainty a rush to safety drives investors towards dollar denominated assets such as the U.S. T-Bond, increasing the demand for the currency. Many nations also experience capital flight as investors attempt to limit exposure to inflationary currencies and untrustworthy governments by converting assets into USD.
Now you know why Gold Bug is bearish about gold in the short term. I am a Gold Bug who has not limited myself to the echo-chamber of disinformation that currently plagues the precious metals community.
There is one thing most gold investors have in common - we want to preserve our wealth. Over the long term physical gold is the best way to do this; however, many of us see a phony economy with recession looming on the horizon. And I recognize that gold will not protect me from this.
The common understanding of gold's role as an investment is outdated. Gold is no longer a safe haven investment, it has been replaced by the dollar. When it comes to hedging against uncertainty gold is dead, the mighty dollar is the new gold. I do not trust this global economy, so I hold the real safe haven asset until the dust settles.
I look forward to your comments and suggestions.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am not involved in any mentioned securities. Have a small speculative position in a gold stock for short term profits. Own some physical gold. Long term asset allocated is 90% USD.