In the first few months of 2018 (especially in April), it seemed to be only a matter of days before gold (NYSEARCA: GLD) would break out over its $1350 resistance level and quickly rise to higher levels. But the hope of the gold bulls was a little premature, and the precious metal has instead entered a pretty severe downtrend, constantly declining over the past few weeks, losing about 13% of its value compared to April 2018.
And although we still can’t be sure if gold has found its temporary bottom, I want to present four different reasons in the following article why everybody should own gold in physical form - and not just as an investment, but also to protect oneself against any potential black swan that might be lurking around the corner. In the first part of the article, I will make the case for gold as a buy-and-hold-forever investment, and the second part of the article will take up the question of whether we should buy gold right now or wait a little longer.
1) A Safeguard For Crisis
In times when investors seem to think in time frames of three months from one earnings call to the next and CEOs are measured by the performance of the last two quarters instead of looking at many years or decades, it might seem strange to talk about a crisis or a crash, as such an event hasn’t happened for almost a decade (in the United States). I probably will lose a few readers (and investors) at that early point when writing about events that have nothing to do with the current market conditions and therefore seem irrelevant (and a waste of time). However, in my opinion every, investor should have a game plan and protection against such rare, but catastrophic events. As these events seldom happen, they catch most investors by surprise, and especially when assuming one doesn’t have to be protected, the consequences of missing protection are severe.
There has been a lot of discussion on what gold really is. Is it an investment, is it speculation or is it money? In the end, it is mostly a safeguard for crisis:
- Gold can’t be inflated as easily as fiat currencies like the US dollar or the euro. It is no coincidence that gold is performing well in times of high inflation and that people trust in gold when they are losing trust in other currencies or are at least afraid these currencies will be less valuable in the future.
- Gold has an extremely long history of being treated as a valuable asset and has an extremely long history of trust. Out of the many different asset classes we can think about, there are only a few which have been in place for centuries. Stocks and publicly traded companies have existed since the 16th century, but over the centuries, companies have come and gone as well as currencies have emerged and disappeared from the financial world stage. In order to find a good example, we do not even have to talk about crypto-currencies but can stick to real currencies. German citizens in the 20th century could “enjoy” six different currencies (seven, if you count the separate currencies of West and East Germany). To be fair, we also have to mention Pound Sterling as the oldest currency with a 1,200-year history. Another asset class that has existed for a long time is real estate, but unless you own some Egyptian pyramid or Roman palace that has been around for centuries, your real estate won’t last forever. In the end, it is gold that has withstood the test of time.
Gold has - and I am tempted to say will always be (although I know such statements are extremely dangerous) - a safeguard for crisis, especially because it is easily transportable (compared to land, for example). However, it is extremely important to hold gold as physical asset. You certainly can own gold in different other forms - there are countless derivatives or certificates on gold covering all scenarios one can think of. But when looking at gold with regard to protection against crisis (and I mean real crisis), you have to own it in physical form, as all the other assets could be worthless within days.
Of course, this is an extreme point of view and focusing on rare events that don’t happen every year or every decade. But they might very well happen every 50, 70 or 100 years, and the possibility is quite high that each and every one of us blessed with a long life may suffer through one of those crises. Thankfully, in Europe and North America, the last real crisis of great magnitude was World War II, but there have been events in between which we easily forget, as they often didn’t happen in the United States. Right now, I would call your attention to Turkey or Venezuela. Cyprus, for example, had capital controls from 2013 till 2015 in place, and those thinking inflation rates like in Turkey right now won’t happen in developed countries should open their US history books around 1980.
2) Great Investment In The Past
An investment should usually serve two functions: it should generate profits and earn money for the investor, but a good investment should also offer protection against downside risk (for example, against high inflation rates). Gold is definitely a great protection against any crisis and a protection against downside risks, but it is also a good investment with solid returns - at least in the past decades. During the 20th century, the United States was on the so-called gold standard for a very long time, meaning that the gold price was fixed - at first at $20 per ounce, and after Roosevelt changed it, at $35 per ounce. After the end of the Bretton Woods system, gold was trading at the worldwide exchanges and the price started to fluctuate.
Some investors - Warren Buffett probably being the most famous among them - don’t really like gold as an investment, as it has characteristics of a speculative asset (but Buffett himself was invested in silver a few decades back). First of all, gold doesn’t pay any kind of dividend or reward investors in a similar way. It also doesn’t have an intrinsic or fundamental value. Like other precious metals, gold is needed in industrial processes, but that doesn’t justify a price of $1,200 per ounce. That number is solely the result of people trusting in other people ascribing to gold the same value as they would themselves - and these are characteristics of a speculative asset.
Nevertheless, those who bought gold in the past decades have been rewarded and probably don’t regret the decision. Since 1970, gold can look back at an annual return of 7.5% per year until today (until 2011, the annual return would have been above 10% per year). If we compare the return of gold to the return of the S&P 500 (NYSEARCA:SPY), we have to state that gold is outperforming the general stock market, as the S&P 500 “only” generated 7.35% annual return. I am very well aware that it depends on the time frame you use, and the data can therefore easily be "manipulated". When comparing the two investments during the '80s and '90s, gold wouldn’t stand a chance against the S&P 500. The following chart shows the development of gold, silver and the S&P 500 (red line), as well as the Dow Jones Industrial Average (NYSEARCA:DIA).
I only want to point out that gold isn’t such a bad investment like many people usually claim, and although a good stock picker will generate higher returns than a gold investor, you shouldn’t despise gold as an investment - especially as it will diversify your portfolio in a healthy way.
Aside from Warren Buffett, many other famous investors recommend that your portfolio should consist of gold besides other asset classes. Usually it is recommended that about 5-10% of your portfolio should be invested in gold, and it goes without saying that gold should be owned in physical form and not as paper gold.
The underlying principle is diversification (and even Warren Buffett wouldn’t argue against diversification). Ray Dalio and Bridgewater Associates have tried to create a portfolio reflecting the principles of diversification with the end-goal of performing well in every market condition. The result is an All-Weather portfolio that should perform well in growing markets as well as in times of high inflation. While stocks, for example, will grow according to the revenue and net income growth of the underlying business, gold doesn’t have a similar growth rate (why should it) but is responding to inflation and is usually outperforming other asset classes in times of high inflation.
4) James Rickards And The $10,000 Price Tag
On August 15, 1971, the United States brought the Bretton Woods system to an end and also ended a system of fixed exchange rates that had tied the dollar’s value to gold. Since then, the gold price is fluctuating, as well as exchange rates and many other assets. I already mentioned above that the attention span of the average investor seems to be a few years at best, and in the light of these developments, it must seem totally ridiculous to think about the possibility of another gold standard, as this was almost 50 years ago. Most people would probably be tempted to say that a gold standard won’t never come again.
But one of the most important rules on Wall Street is to never say never. James Rickards is publicizing the idea of a new gold standard in several books and on the podcast "The Gold Chronicles" with new insights every month. He is also providing a short and simple calculation for what gold could be worth in case of a new gold standard. He is assuming there are about 33,000 tons of gold out there right now, and about $24 trillion in global money supply. Gold standards in the past have usually backed 40% of money supply by gold, and James Rickards is using the same number, which leads to a gold price of about $10,000 per ounce. In some historical cases (England), only 20% of money supply has been backed by gold, and using that number, an ounce of gold would trade for “only” $5,000.
In the end, this is just one scenario and rather a speculation about the future - but at least a very interesting speculation, and one that is redirecting our focus to the fact that financial markets are extremely complex and anything can happen.
One Reason To Buy Now (Or Soon): Technical Picture
If we look at the bigger picture, gold is either trading at a comparably low price level or still at a high price level - depending on your point of view. When you look at the past few years since 2011, it is trading at rather low price levels. When looking at the long-lasting bull market that started in 2000 and ended in 2011, the correction we witnessed so far looks rather puny, but we have already corrected 50% of the last upward bull wave.
I see the potential for a second corrective wave, but we find some strong support levels a little way down the road. At about $1,070, we find the former low, followed by the two 200-month moving averages: at $1,042 we find the exponential moving average, at $983 we find the simple moving average. If that shouldn’t be enough to push prices higher again, we have the 38er Fibonacci retracement as well as the spike of the 1980 high at about $870-880, and finally, at about $700 the highs of 1980 (leaving out the spike).
On the other hand, there are two points speaking for a buying opportunity right now. The first is the weekly Commitments of Traders report. Since the beginning of June, the number of managed money short positions increased from 46,795 in the beginning of June to 187,753 right now. This is one of the highest reported numbers of short positions in a very long time and is reflecting a very bearish sentiment. But as we know, sentiment is often a contraindicator, and as gold has been declining for weeks now, we might have reached a bottom.
A second important number has been pointed out recently by Victor Dergunov in his article “Gold Is Melting: Why This Is No Time To Panic”: In the past few decades, there was an obvious correlation between the gold-silver ratio and the further price development of both precious metals. Whenever the gold-silver ratio was extremely high, we were near a temporary bottom and a rally followed. In 2011, as gold was trading at its highest level so far, the ratio was extremely low (as it was in 1980). Right now, the ratio is at about 80 once again, and in the past, this has always been the beginning of a gold rally.
I can’t tell you if right now is the best time to buy gold, as it might very well be possible that it will decline further. However, if you don’t see gold just as a speculation to make a quick profit but as a long-term investment, and especially as a safeguard for your portfolio, now is certainly a good time to buy gold. But remember to buy it in physical form in order to use it as safeguard and protection in turbulent times.
One last thought: Considering the extremely overvalued stock market (especially in the US) after a bull market lasting nine years, we have to question whether stock investors (on average) will make a profit over the next few years. Compared to that rather bleak outlook for stocks, gold might outperform easily, as it has been declining for the past few years and probably might already have found its bottom.
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 own gold in physical form as well as derivatives that profit from an increasing gold price.