Why Gold is the Only Answer to Preventing ‘Booms and Busts’ – Part 1

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In this five part series, we’ll be exploring the reason why gold remains the only shield against boom and bust cycles. In part one, we’ll uncover some of the myths about gold’s underperformance of late.

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Gold has seen better days.

Since hitting a high of US$1,850 in 2011, the precious metal has done little to convince investors that it’s deserving of a place among portfolios.

Gold bugs have never needed any persuasion. They maintain that bullion is essential to any balanced portfolio. We can’t say the same of everyday investors, who view gold as little more than a curiosity. Or worse…junk.

And who can blame them?

Investors have watched gold stubbornly fluctuate between US$1,000 and US$1,400 for more than two years now. Matched against rising stock and property assets, gold prices have fared modestly by comparison.

However, as investors, we’re all guilty of occasionally thinking in the short term. We have a habit of losing sight of long term trends. And that tends to blur our judgement of the present.

That’s exactly the situation facing gold markets today. Investors have lost perspective of the wider, underlying trends in gold. We look at bullion prices from a narrow point of view, forgetting where they’ve been, and how far they’ve come.

Despite its relatively poor performance of late, the gold price has come against a backdrop of rapid price growth over the past decade.

Between 2006 and 2011, bullion prices rose by a staggering $1,000. If you held any gold investments prior to the global financial crisis, you would’ve done quite well for yourself. The rush of investors fleeing to safety amid the crash made it a very profitable time for investors.

Yet, as the global economy stabilised at the beginning of this decade, the gold rally tapered off. The reason for this, as I’ll explain, is largely the strengthening of the US dollar.

Since 2011, the greenback has proven itself an effective restraint on gold prices. The US dollar, the de facto ‘gold standard’ in global finance, has an inverse relationship with gold. It has the capacity to influence prices in a way that only supply and demand forces could.

In other words, whichever way the US dollar goes, gold tends to move in the opposite direction. This law, if you will, is a reflection of the overconfidence investors place in currencies in general. They see paper money as something solid and tangible, and not for what it is – a transient form of exchange.

Regardless, there’s nothing quite like the US dollar to get investors jumping.

As the world’s reserve currency, the greenback holds a special place among currency traders. And you can see that reflected in gold prices. Make no mistake; the dollar’s performance is the only thing keeping gold markets from re-entering bull territory today.

The dollar’s appeal comes from its perception as a safe asset. Part of this, as we’ll see later in more detail, is because of the greenback’s position as the world’s reserve currency. This gives it an all-important role in world trade, requiring nations to hold vast reserves of US dollars. Without dollars, you can’t buy, or sell, much of anything.

However, given the current strength of the US dollar, gold’s resilience could represent somewhat of a victory for investors. It’s arguable that gold should have fallen even further than it has, considering the pressures from a strong US dollar.

Up until September, US gold prices were holding firm since early 2014. While the strength of the greenback suppressed gold prices, it didn’t force them below $1,000 an ounce.

Gold trending well against other currencies

If you needed further proof of the dollar’s influence on gold, you only need to glance at bullion’s recent performance against other major currencies.

Gold has compared favourably against the euro, gaining over US$200 on it since the start of 2014.

Equally impressive is its recent performance against the Aussie dollar. Between November 2014 and February of this year, gold skyrocketed AU$300, to AU$1,650 an ounce. While it has since slipped back down to AU$1,487, the spot price has recovered to its 2013 level.

Despite these positive movements, there remains a sneaking suspicion among gold bugs that prices aren’t matching up with market realities.

It’s true that gold investors don’t all look at gold in terms of prices. They see the precious metal as a safeguard of wealth that never loses its value. For them, what gold trades for is irrelevant. But that doesn’t mean we can’t use prices to make general observations about the rest of the market. We keep an eye on prices because they can indicate underlying volatility in financial markets.

In times of falling prices, gold may present a world that’s never been in better shape. But is that what lower gold prices are really telling us? It certainly doesn’t seem that way.

Looking at the global economy today, all you see is turmoil. The global economy is hurtling towards its most turbulent period since 2008. And yet the price of gold isn’t reflecting the volatility taking place. Why is that? Are markets wrong, or are gold prices a poor indicator of economic well-being?

It’s a complex situation, and one that has broader repercussions than the price of gold alone.

Over the course of this five part series, we’ll provide answers for why gold is where it is today, and what the future holds for the precious metal.

By the end of it, we hope you’ll come away thinking (if you don’t already) that gold is the soundest investment you can make for the benefit of your wealth.

If you’re not already a gold believer, hopefully you’ll come away feeling confident about investing in gold.

You’ll learn why bullion remains the only answer to the boom and bust cycles our governments and central bankers create.

And, most importantly, you’ll come away convinced gold is the only form of money — yes, money! — that you can rely on to protect your wealth in the event of an economic collapse.

That’s as good a place as any to start. Join us tomorrow for Part Two of our special look at gold. We’ll be asking whether the next major global economic disaster is right around the corner. And we’ll explore the characteristics that made gold so coveted.

Mat Spasic,

Junior Analyst, The Daily Reckoning

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