Do You Hold Cash or Gold in the Coming Crisis?

Gold Chart 4

Gold is the proven, quality, long-term wealth store during a slide into deep crisis — the one which everyone else comes to in a bit of a panic.

Bullion Vault

This statement sums up the popular belief of gold…the ultimate store of wealth.

But is it a true?

I deliberately chose the weekend edition of The Daily Reckoning to explore the merits of holding gold when the next credit crisis hits.

This way I buy myself a couple of days reprieve before receiving a barrage of emails from the gold faithful.

Bill Bonner, Jim Rickards, the late Richard Russell, Marc Faber et al all recommend holding gold as insurance against the financial recklessness of central banks and government.

How much gold should you hold as insurance? Some say 10% or 20% and others are all-in.

Long, long term an ounce of gold keeps pace with inflation. In maintaining that inflation hedge, the gold price sure goes on one hell of a wild ride.

The 1970s was the pin-up decade for gold.

From a low of US$35 in 1970, gold finally topped out at US$850 in 1980…a 24-fold increase.

There are numerous reasons given for gold’s meteoric price rise during the 1970s:

  • Nixon abolishing the gold standard in 1971
  • The Hunt brothers trying to corner the silver market
  • Runaway levels of inflation
  • Oil crises
  • Iranian hostage situation

Collectively these events together with the usual price push from the ‘late to the hottest investment party’ crowd, drove gold to a level it would not see again for nearly three decades.

In 1987 the planning firm I worked for believed there was going to be a market crash followed by a depression. It was recommended clients have 25% invested in gold.

Well the market did in fact crash. We did not experience a depression, but we did have ‘the recession we had to have’ in 1990. Interest rates rose towards 20%…not unlike the interest rate environment in the late 1970s.

We were pretty much spot on. What happened to the gold price? It went from US$460 in October 1987 to US$350 in 1991…a fall of nearly 25%.

Besides losing 25% in value, clients had not received any income on their gold investment for that four year period. Ouch. We were right but ended up wrong.

For clients who held onto their gold exposure, the 1990s was sheer torture.

The gold price finally bottomed out in 1999 at US$250.

From its glory day high of US$850, gold had fallen 70% in value over a 20 year period.

That’s a lot of hurt in anyone’s book.

Gold’s resurgence since its low of US$250 has been a ray of sunshine for the true believers.

Gold marched steadily towards the US$1000 mark. With only the briefest of interruptions in 2006, gold hit US$1000 in March 2008 — six months before the fireworks in Lehman Brothers went off.

With all that uncertainty leading up to September 2008, gold failed to hold its ground and slipped back under the US$1000 level. You’d think with the smart money sniffing a crisis in the air, gold would take off, but it didn’t.

When the GFC hit, gold was sold off with every other asset. Gold fell to US$700 in late 2008. My theory is investors wanted liquidity — cash — there were debts to be repaid in US dollars.

But once the initial panic was over and Bernanke announced the printing presses would be fired up gold was off to the races.

Hyper — or at least higher — inflation was coming. Grab your guns and gold and head for the hills.

This sentiment is what sent the gold price parabolic from early 2009 to September 2011. Reaching a high of US$1900.

The long suffering gold believers were ‘cock-a-hoop’, their faith was rewarded. But this was only the beginning, gold was just warming up…US$5,000 here we come was the call at that time.

From being the great unloved in 2000, gold in 2011 was suddenly the investment darling. Bullish sentiment abounded.

The skyrocket taking gold to US$5,000 ran out of hyperinflation fuel. The central banks were handing out trillions of newly minted dollars at next to no cost, but inflation did not come to the party.

Instead the dreaded ‘D’ word — deflation — started to make it into the data and then into the headlines. This is not how it was supposed to go.

The Weimar Republic money printing formula was straightforward — crank out currency, bring a wheel barrow, go shopping. Gold was money printing’s kryptonite.

But that hasn’t happened…at least not yet.

The squillions of printed dollars/yen/euro/yuan have all gone into asset prices — shares and property (specifically capital cities like London, New York, Sydney, Zurich).

Whereas the gold price, since 2011, has lost nearly 40% of its value. Again those who invest based purely on momentum have suffered a four year decline in value AND received no income.

There is asset price inflation, but economic deflation — the world can make far more widgets than there is demand for those widgets.

Since 2008 countries, corporations and households (to a lesser degree) have all taken on more debt. And hell, why not? When central banks are giving it away in plentiful supply for next-to-no cost.

Therein lies the problem with the next crisis. A lot of this newly acquired debt is in US dollars. Emerging markets have US dollar based debts to the tune of US$9 trillion.

It’s reasonable to assume some of this US$9 trillion has been lent to a few ‘good time Charlies’ who really aren’t good for the money. When the next (and even more severe) credit crisis hits, the scramble is going to be on to pay back those US dollar debts.

Everything goes on the auction table in a crisis…everything except cash.

In my opinion gold will — rightly or wrongly — be sold off as borrowers rush to raise US dollars to satisfy the creditor demands.

This brings me to two questions:

  1. What about gold in Australian dollar terms?
  2. How safe is cash?

The Australian dollar got hammered in 2008/09 as investors rushed to buy US dollar base Treasury Bills. I expect the same to happen next time, but only a much harder fall. We could well see the Aussie dollar touch below 50 cents (which it has done once before in the early 2000s).

From our dollar’s current level that would be a fall of 30%.

If the US dollar price of gold also falls 30% (back to the US$700 to $800 range), then it is a zero sum game as far as the Aussie dollar price of gold.

You can play with those percentages but the falling Aussie dollar will soften the impact of a falling US dollar gold price.

If you think this is a probability, then in my view it is simply better to own US dollars and pick up the entire 30% currency depreciation gain.

How safe is cash? Will there be a bail-in? Will cash be made illegal? Will we be limited as to how much the ATM can dispense on a daily basis?

The simple answer is, I’m not sure. Until the system is tested we do not know the level of pressure it can withstand and what the policymakers’ responses will be.

As it stands today, we have a Government guarantee to protect deposits up to $250,000 per taxable entity per approved deposit taking institution. Personally I think the government will honour that guarantee — for no other reason than if the government wants to restore calm and maintain any shred of confidence in the banking system, it must stand behind the guarantee.

Will there be cash controls? Probably. So make sure you have a few dollars tucked away somewhere safe.

However the bigger issue for me is not whether I can get my hands on actual dollars but whether I’ll be able to electronically transfer money to say the Perth Mint to buy gold, CommSec to buy shares or a Solicitor’s Trust account to buy property.

I think electronic transfers will still exists — otherwise no one will be able to buy or sell anything and the whole system comes to a grinding halt.

How will Woolies buy goods to stock the shelves with if they can’t transfer funds electronically to suppliers? How will you be able to sell a house? What about buying a car?

The ability to exchange cash for goods and services will be crucial to keep the system operating. While that exchange may not be physical cash, electronic transfers will do me just fine to buy assets that are on sale at the discount table…including gold.

Because I do think gold will come into its own after the next crisis.

When faced with a crisis, far greater than 2008/09, central bankers will literally go for broke.

Then it’s a fair bet we’ll see the inflation genie released from the bottle.


Vern Gowdie

Editor, The Daily Reckoning

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Vern Gowdie

Vern Gowdie

Vern Gowdie has been involved in financial planning in Australia since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning, was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top 5 financial planning firms in Australia. He is a feature contributing editor to The Daily Reckoning and is Founder and Chairman of the Gowdie Family Wealth advisory service and editor of the Gowdie Letter To follow Vern's financial world view more closely you can you can subscribe to The Daily Reckoning for free here.

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