My Gold News | 21 February 2023

Gold Expectations Versus Reality in 2020

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There are lots of ways to invest in gold today from exchange traded funds, otherwise known as ETFs, to buying coins to buying jewellery. There are even ways to invest in companies that mine gold and realize gains off of their profits selling gold. However, the expectations of all these different channels tend to be common categories, from protecting value from other risks in the financial world to realizing additional value growth because gold is such a shared valuable asset, regardless of which culture or part of the world one is in. The reality of what happens with gold, however, can diverge from expectations and often does so during the most stressed times. As a result, gold has folks in different camps, some swearing by it as a safe haven asset and others swearing off gold and never wanting to be associated with it. These are not new attitudes; they’ve been around for decades. What a gold investor, new or experienced, should be focused on is why gold matters personally.

A Vintage Asset Past Its Time

A good number of modern economists and financial types will regularly argue that gold investing or holding is an archaic activity that has no business in modern investing. Further, paper currency is about to join gold in the historic trash bin of useful financial tools as well. This perspective relegates gold to a shiny thing that might still have some function in jewelry, but no serious financier would be fiddling with a gold position today with all the benefits possible via electronic investing and digital trading. For a gold investor it is a good thing to keep in mind that while the digital finance world does have a lot to offer, 99 percent of it is based on paper positions and computer reports. All of these elements depend on a protected system to maintain their value. If the market and trading system becomes vulnerable, then so do the positions staked out in those systems. To understand what this means in practice, one just needs to look at what happened to the U.S. stock market in May 2010. In the space of five minutes a flash crash occurred as computers took over market trading and burned through multiple transactions, driving the Dow down 600 points. Then it went back up. The roller coaster unsettled nerves and the market was frozen until the matter was investigated. This was one of the first “flash crashes” that occurred again and again. It was also 10 years ago and computer networks are far more advanced today, emphasizing the fragility of a digital market that can implode in a day and wipe out millions of dollars of capital. In the meantime, gold assets stayed put. Yes, they went up and down in value, but a computer had no bearing on how many bars or coins of gold an investor had during this time. The number stayed the same and in fact the value went up because of the regular market’s instability.

Can Gold Return as a Form of Money?

While there are some who would like countries to go back to a gold standard, which currencies based on gold, it’s unlikely to happen. And gold as currency itself is only going to occur if governments outright collapse in the near future. Granted, gold was definitely used as a form of premium currency for centuries, dating as far back as 560 B.C., and continued through the Greek and then Roman Empires. The dynamics that prevent gold from being a practical currency today, however, have to do with monetary policy of governments. Gold, fundamentally, would be limiting. A gold standard would objectively put a cap on how much currency a government could have and issue. And doing so would then bar that same government from issuing more currency until it had more gold. A prime example of the gold standard problem occurred during World War II. As the Germans invaded Europe, they specifically went after central bank gold holdings in the countries they invaded. They were not alone. As countries began to fall one-by-one they looked to England and France and then to the U.S. to protect their central bank holdings, literally shipping gold bars out of Europe to avoid capture by the Germans. The Russians were not idle; their personnel worked feverishly to secure gold from failing countries to bring it back to Moscow.   Ultimately, Russia and the U.S. became this biggest holders of gold by the end of the War because it was the only asset that could be used to guarantee steady supplies of ammunition, equipment, and support. But aside from the historic transfers, the move also made the U.S. the biggest central bank repository of gold in the 1950s, allowing the country to generate far more in currency and financial lending than anyone else. The U.S. shared this wealth by rebuilding Western Europe later as well as countless countries receiving foreign aid, but it wasn’t until the 1971 that the U.S. felt the pinch of the gold standard and made a change to go to gross domestic product (GDP) as a currency standard. Once done, the U.S. had the ability to produce billions in currency on paper formula versus a physical asset holding. That model continues today and practiced by countries all over the world. Again, this makes it highly unlikely gold would return as a currency standard unless the known modern world falls apart again. 


Today’s Gold as a Safe Haven

Like any investment aside from an insured bank, the money one puts into holding gold through an investment channel is at risk of loss as well as opportunity of gain. And the precious metal’s value, indexed by the market price of a troy ounce of gold, has gone up and down over the years. Where in the 1970s gold floundered at around $400 USD/oz today it has broken $2,000 USD/oz in 2020 and hovers below that value market. Because this valuation is independent of the market in terms of a direction relationship, i.e. the movement of companies does not have a direct relationship on gold’s value and it can’t be controlled by a single government like a currency, gold has been viewed as independent of the market. That creates a benefit of a safe haven for value if gold is moving in the opposite direction of markets and economies. However, gold is not an automatic value increaser. Gold’s value is driven by market supply and demand. The metal has only so many units available worldwide, and only a limited amount of new gold can be produced each year. That makes for a very stable supply side for the metal. As a result, when everybody wants gold, the price goes up, and when people want other investments, it goes down. The instability of markets in 2020 due to COVID-19 and market weakness has clearly pushed many into gold to protect their money and value. No surprise, gold’s price shot up tremendously when it was expected to otherwise retract a bit after a strong 2019 performance. Is gold a safe haven then? That depends on a number of things associated with market stability, but one has to consider that major governments around the world have spent a tremendous amount of resources on market stabilization and stimulus, while workers are still very much unemployed. Both create an untenable situation if markets don’t recovery and being producing growth and more jobs. Assuming no change in this direction, then there’s a good argument gold will hold its value for at least another year if not longer and will easily rise in price if a major recession kicks in by 2021.

Gold is a Good Hedge, Right?

The answer to whether gold works as a good hedge against other investments depends on what one invests in. Just investing in gold doesn’t give an investor an automatic protection to invest haphazardly in other channels because gold provides some kind of a safety net. In fact, many times gold will move concurrently with certain types of other assets and in the same direction. If that’s the case for a given investor, the losses could be double or more when gold prices drop. Gold’s famous hedge, or myth of protection, again centers around the idea that people gravitate to gold when other forms of investments and value protection seem unstable or are falling in value. This pattern of investment behavior has been seen again and again in modern historical times, and especially during times of serious instability. Some have played with the idea that investing in companies that mine gold provides a hedge instead as the industry is so different from others in the market. It’s important to understand that a mining company and gold are two very different things. Gold is a commodity and valued accordingly. A mining companies succeeds or fails on how it is run as a business, and it’s strategy oftentimes has nothing to do with the value of gold aside from how much money the company will get selling what it mines. Investing in successful gold mining companies can be lucrative. As the companies succeed, their stock value rises, provided a gain for the investor. Some companies also pay dividends to their shareholders, providing another form of new income as well. The key factor in this investment channel is that the company has healthy cash flow and isn’t saddled with serious debt. If both are bad, the company is probably not a good bet as an investment, even if the price of gold itself is going through the roof.

Gold is Topped Out, So It’s Probably a Bad Time to Invest, Right?

No one has a perfect crystal ball that can definitely say in two months’ time gold is going to rise 15 percent and then after that drop 30 percent to return a year later by a net 5 percent overall. So, such prediction tool exists. What is possible is to consider the possibilities of what is going on in 2020, and how various factors could drive the price of gold higher. Then the followup question is, how strong are these factors and their likelihood of occurring? The first big factor are movements of government. Due to COVID-19, governments are financially weak at the moment. They are bleeding billions in currencies to pay for health costs, social safety networks, and vaccines. At the same time, an increased amount of insecurity exists across multiple platforms. Many people are out of work or earning less. Hospitals are flooded with patients, and their resources are being strained significantly. All of these elements cost money to tax revenue coffers, and governments are spending more with tax cuts as well as economic stimulus spending. The entire combination is more money going out the door than coming in. And a financially-weakened government system spells trouble for service cutbacks later on as well as increased taxes to make up the difference down the road. The second big factor involves economic movement and labor employment. While many markets are climbing back from the shock of March 2020 due to COVID, many average people are unemployed or working with less due to salary cuts. That reduces consumer spending dramatically across all industries. Consumer debt is rising without any means to pay for it as well. The last time the debt picture alone got out of control was when people stopped paying their home loans and the real estate bubble popped due to worthless mortgage-backed securities in 2009. That was a mild economic quake, better known as a recession. The third big factor involves how much has already been invested in gold. The precious metal has been on a value increase run since 2013. Again, may thought 2019 was the topping out for gold, but that was proven wrong by the beginning of 2020. Yes, one could easily argue the current position of gold is very well stocked and could use a retraction, which happened in the middle of August 2020. However, the underlying causes for the flight to gold are still present and active, as noted above.

Expectations are Rarely Met, Analysis Matters More

The expectations that surround gold are often emotional and driven by personal needs versus objective financial analysis of gold increasing as a value investment. No surprise, many can find themselves frustrated by gold’s performance when they absolutely felt it should turn left instead of right. However, gold has no stake in anyone’s business success or strategic monetary policy. It is simply an asset everyone shares a view of being valuable and worth having to trade later for more value. If investors can reign in their expectation of holding gold being some kind of key to the future, gold can be very functional as a value protector at the right time. It is an investment tool, no more, no less. Use it correctly, and the tool becomes very reliable. To get more insights on investing in gold, read more at MyGold’s website or see us in person located in the centre of Auckland’s business district. We’re easy to find, just 200 metres from the Auckland Sky Tower and Auckland’s Central Business District. We look forward to hearing from you soon!