Is gold still worth its weight in gold?

The streets are paved with gold. Or so we are told. As far as many investors are concerned, that’s probably all it’s good for. Since time immemorial gold has been seen and treated as the ultimate store of value and the epitome of a hedge against inflation. Yet, through the uncertainty of the pandemic, the hiatus of the Ukraine war and the return of proper inflation it has singularly failed to perform. Gold now has some of the most experienced and otherwise successful market players scratching their heads.

Alchemists believed that they should be able to turn lead into gold. But there are many big players, amongst them some of the world’s leading hedge fund managers, who would sooner argue that we live in an age when gold is turned into lead and one otherwise utterly rational investor I know generically refers to gold as the “lead metal”. He had looked at all the economic and monetary factors, had read all the research, had done all his thinking, went out and bought gold as a sure-fire winner. It went nowhere. He cut his losses and that was that. Why gold failed to do what it was supposed to do and head for US$ 3,000/troy ounce rather than struggling to get to and stay above US$ 2,000 still perplexes him.

Over the weekend, I received an email from a US-based French reader with whom I worked some 30 years ago. He was then trading US pay eurobonds but went on to do emerging market debt and is now earning his crust running funds in agricultural commodities. Or is it agricultural land? Whatever it is, it’s something about which I know very little. After a few encouraging words, he went on: “I await your much anticipated view on gold, it’s manipulation and it’s future as I idle away the hours on a Nantucket beach.“ 

Other than vaguely tracking the gold price on a more or less daily basis – and now often not even that – I too have given up. I was trained in an era when every self-respecting investment portfolio included between 5% and 10% in gold. It was the rock-solid anchor which kept riskier investments such as equities at bay. My old Dad kept a small stash of gold coins. He had been born in 1922, was 19 when the war broke out and when Europe was devastated from the Chanel coast to the Volga. Tens of millions of displaced people were milling around but my old man argued that whatever might befall the human race, one would always be able to trade a gold coin for a loaf of bread. We might laugh at that now but in 1945, 1946 and into 1947 this was the stark reality for many. That is what is meant by gold being a store of value.

There is endless speculation as to why it defies the laws which have governed it for so long? If in doubt, blame Russia. There are many rumours circulating that the Central Bank of Russia has been an ongoing seller, and in size. The government does, after all, have a war to finance. Reports on the Bank’s holdings in precious metals do not reflect that kind of activity but then again, do we believe anything Moscow tells us? Personally, I am doubtful as to the validity of the rumours. I never trust rumours about what central banks might or might not be surreptitiously doing. That said, in their case what you see is very rarely what you get. On the other hand, we were there in 2009 when Britain’s former Chancellor of the Exchequer and later Prime Minister Gordon Brown dumped 401 of the UK’s 715 tonnes of gold reserves into the global market at an average price of US$ 275/oz – I still wonder how he can sleep at night – and even that didn’t meaningfully kick the stool out from under the price. He realised £ 3.5 billion. Worth now? Ouch!

So, what is my view on gold? A bit of thinking has been required. The first thing one must take into account is that gold pays no coupon and delivers no dividend. On the contrary. Physical gold needs to be safely stored and insured. Holding it costs actual money which in financial terms is referred to as a negative carry. It is an opportunity cost. The higher interest rates go, however, the greater that opportunity cost becomes and more the holding has to perform in pure price terms in order to justify itself. A further factor to bear in mind is that gold is conventionally priced in US dollars and that its value in sterling or euros or yen will, like all other commodities be affected in accordance with the movement of the dollar. Thus, some people treat is as a currency while others see it as a commodity. It was for a long time held up as not being a commodity for it has no meaningful industrial usage. That changed in the 1970s when it became useful and common as a conductor in solid state technology, and I recall the great urban myth of people who had got rich by buying up defunct computers and extracting the gold.

Britain had suspended the gold standard in 1931 and the US did the same in 1933, albeit only de jure. At Bretton Woods in 1944, it was agreed that the dollar would be exchangeable against gold at US$ 35/troy oz and that other currencies would be traded against the dollar. Not until 1971 did President Richard Nixon dump Bretton Woods and the dollar/gold link and the system we know today of free-floating currencies took hold. Thus, for many decades and certainly when I first set foot in a trading room in the mid-1970s, the gold price was to be found on the foreign exchange pages.

But does gold still have relevance in an investment portfolio over fifty years after the demise of Bretton Woods? The rise of cryptocurrencies and the insistence by their proponents that bitcoin and its friends and relations have replaced gold as a store of value and an inflation hedge has revived the debate while at the same time rattling some of the shibboleths attached to it. The argument that gold’s specific strength was that it is of no industrial use is certainly reflected in cryptos. I might just be a grumpy old luddite, but I cannot, no matter how hard I try, see the value of bitcoin. I can’t see the value because I can’t see its utility. I can’t see what it can do better than existing currencies can do in terms of any currencies’ principal roles which are to firstly be a means of exchange and secondarily a store of wealth. Bitcoin is great for trading although outside of the metaverse it still generally has little value, if any at all. Any currency that can in a day move by more than a seller of goods’ net profit margin is of no wider commercial use. End of.

So, where does that leave gold? Is it still a meaningful asset in a diversified investment portfolio and a hedge against catastrophes or has it just become another, albeit posher than bitcoin, widow maker? In July 2003, 20 years ago, it was to be bought at US$ 385/troy oz. According to the US Bureau of Labor Statistics, the buying power of US$ 1.00 in 2003 is today that of US$ 1.65. On that basis alone and even without an income stream it would have been a steal as it is now at US$ 1,960. Remarkably, gold did its best not when it was a hedge against inflation but in a period when there was little to none. In February 2022, when Russia invaded Ukraine and when inflation began to go into overdrive, it was trading at US$ 1,880/oz. 18 months on it is only US$ 60 higher.  

I hate this platitude but has gold lost its lustre? The economic arguments in its favour as an insurance against inflation have clearly given up working. The other great support was supposed to have come from the rising middle classes in India where wearing gold jewellery was, and to some extent still is, a visible expression of economic success. Was that behind the near doubling in the price between July 2019 when it cratered at US$ 1,180 and its topping out at US$ 2,055 as recently as April? But then why not before? Did gold benefit through most of the last two decades from the low interest rate environment which made its zero income less uncompetitive? Then why hasn’t it collapsed as rates have started to rise again?

Is gold, perish the thought, now not just another form of crypto currency which is great for trading in search of the greater fool but of no meaningful value? Without its credentials as a hedge against inflation, I’m afraid that’s most likely all it is. To the over-50s it is hard to think of an investment portfolio without it. To the under-50s, it is hard to explain its classification as an investment asset any more than iron ore or, forgive me, lead. I shall continue to hold a bit of a physical gold ETF in the portfolio and keep a few gold coins in the safe because that is what I have always done. Whether there is a rational explanation for gold to be defined as an investment asset any more than bitcoin or etherium or any of the other of the thousands of cryptos is a question best not asked.  

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