“May you live in interesting times” – it certainly seems as if we have all fallen victim to this ancient Chinese curse. We are living at a time that our children will consider to be an important inflexion point in man's economic and financial history. On the one hand there is the massive deleveraging and destruction of credit that is causing deflation and on the other hand there are the stimulus packages and liquidity infusions being passed by the world’s governments and central banks that point to future inflation.
While deflation has the upper hand the only safe asset is cash, but if inflation were to rear its ugly head once again, cash will be the single worst asset to invest in. Inflation would lead to an increase in price levels and hence a loss of purchasing power. To protect wealth one should hold assets that can preserve or store value in the face of a general rise in prices: Real Estate, commodities such as Metals, Coal, Crude Oil and Precious Metals are excellent choices in this scenario.
However deflation would remove the shield that these assets provide. Faced with the “ice” of present deflation and the “fire” of future inflation many investors have been reaching for Gold as an anchor in these stormy times.
Gold has certain characteristics that make it special and different from everything else. All the Gold ever mined in human history, approximately 1,50,000 – 1,60,000 tons is still with us. The supply of Gold is very stable and is around 2% of the total Gold. It takes around 9-10 years for a new Gold mine to come online and then a further 5-7 years for production to hit the market. Thus from exploration to sale Gold from new mines takes about 14-17 years by which time existing Gold mines are in decline. Thus this supply is not very likely to change over time. In fact in recorded human history there has been only one time in which the supply of Gold has increased dramatically, that's when Spain took the Gold of the Incas and Aztecs in the 1600s and flooded Europe with it. Thus if Gold were to be used as money it would be relatively free from increases in supply.
Gold has very little industrial use – other than investment its major use is in jewellery. Gold is almost indestructible and when held as coins or “biscuits” is relatively portable. Gold Markets are very deep and very liquid in fact in Foreign Exchange markets Gold trades like any other currency.
But most importantly when owned without any leverage and in metal form, Gold has no counter-party risk. Like all tangible assets – Gold is no one’s liability and hence when used as a store of wealth is not held hostage to someone’s ability to repay.
Because of these reasons – every prudent investor should own physical Gold as an insurance against unpredictable and “interesting” times.
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