“You know,” said my old mate Paddy, as we downed another pint of Mother McGuire’s at the Old Duck and Bucket, “the thing about gold and suchlike is that it’s not actually about what gold itself is doing – it’s more about what everyone else is doing. And never mind whether what they’re doing is actually sensible or not? That’s really not the question. Your job, my friend, is to stay ahead of the crowd. And that means staying distant and analytical.”
I nodded gently, in that agreeable way that you do after a few beers and your synapses aren’t firing particularly well. If only I’d hadn’t switched my mobile off, I’d probably have jotted down a memo to self: “Inform yourself properly about what drives currency alternatives.” Not that it would have helped me very much, because it would have been a very short Google search. For reasons I’ll explain.
The gold rush of 2019
Whatever we might think about the virtues (or otherwise) of an analytical approach to this most emotional of investments, it’s been an excellent year for gold bugs. July saw the gold price beating $1,450 per ounce by quite a comfortable margin, which would have made you very happy if you’d bought it at $1,200 in January, and happier still if you’d bought it, as a Briton, when sterling was stronger than it’s been during those dismal pre-Brexit summer weeks where the prospect of a sterling/euro parity was starting to look alarmingly likely.
See below for more on that last depressing prospect, which has seemed a lot less likely since the US Federal Reserve has finally started to turn dovish on American interest rates. (Lower interest rates and bond yields tend, on the whole, to be bad for currency strengths and consequently good for bullion prices.)
But what if the gold bugs were right for once this time? What if the herd has really caught the downwind whiff of something in the distance that doesn’t smell right? But somehow it hasn’t yet identified exactly what it is that’s bothering it? The noise maybe, or the direction of travel, or just some primal animal fear?
Reasons to be cheerful
Okay, let’s try and leave the fear factor aside for a moment. And let’s concede that second-quarter US profit margins do indeed seem to be confounding the doomy expectations of an imminent cyclical top. (Or at least, they did as August approached.) US unemployment figures were low, and consumer sentiment seemed to be absolutely fine.
And even though the expansionary impact of Donald Trump’s $1.6 trillion tax handout spree seemed to be slowing, there was a growing perception that he would simply launch another one in his bid to secure the 2020 election, and let the grandchildren pay for it. Oh dear.
Yes, we’ve always been told that government borrowing in a recession is a good idea, but borrowing when an economy is running at full tilt is both unnecessary and unwise. But the modern reality is that Trump’s enthusiasm for busting all the system’s traditional shibboleths is becoming mainstream, for better or worse, so it’s rather hard to tell whether this phase is reckless lunacy or the start of a whole new brand of logic. We really don’t know what’s coming next, and the logical certainties of the past don’t hold up so well in this decade.
The thing that also makes the current situation so difficult to call is that the allure of precious metals is generally inversely related to share prices. And, as August 2019 hove unsteadily into view, there seemed to be no obvious reason for expecting that the S&P’s bullish run was over yet. Or that the Shiller p/e on the S&P is ready to drop back toward its long-term mean of 16. (At the time of writing it was 31.5.)
Reasons for the gold rush?
Most importantly, and most embarrassingly for the doomsayers, US inflation levels were much lower than the doomsters had expected, which was the main reason why the Fed had changed its mind on higher lending rates in the first place. So what might it have been that drove this summer’s surge in bullion activity?
- Could it have been, as some claim, that the minority of analysts who forecast a catastrophic global collapse, 2008-style, had suddenly reached some sort of a tipping point? That the accelerating downturn in Chinese GDP, the threats to Gulf oil, the Brexit debacle, the Iran situation and a probable eurozone recession were all set to create a perfect storm in which the loud yahoos from an insular Wall Street might finally be forced to accept that their pink sparkly bubble was out of synch with the mood in the rest of the world?
- Or could it perhaps be that demand from India and China, two of the world’s biggest gold bug nations, was set to soar still further? Hadn’t the Economic Times of India reported on 23rd July that the country’s net gold imports had outweighed the entire total for incoming foreign portfolio investment for eight solid years now – and that not even a 2.5% hike in the government tax on bullion had slowed the surge in demand. (Rather, it had provoked a short-term buying spree ahead of the deadline.)
- Hadn’t China reported in June 2019 that its central bank purchases of gold had now risen for six straight months, because the People’s bank of China had been proactively trying to diversify its currency holdings away from the US dollar, where a looming trade dispute and the likelihood of a weaker greenback had been unsettling nerves?
- Hadn’t George Soros, the arch-exponent of strategic currency positioning, just come back into gold after a two-year exile from the market, purely because he thought that Brexit would spark a surge of British bullion purchasing, from which he hoped to profit?
- And hadn’t Soros’s expectations been borne out by the Office of National Statistics in June, when it dropped a strong hint that UK gold purchasing had been behind a sudden sharp rise in the first-quarter current account deficit?
It’s hard to be sure of anything – but then, that’s becoming the norm these days. Either we’re entering a new golden age in which debt and the Shiller ratio don’t matter any more, or – oh heck, I’m just repeating myself…..
Two key questions
Let’s ask ourselves two questions, then. Firstly, what are the bond markets saying? And secondly, just for comparison’s sake, what did the bullion markets do before the 2008 financial catastrophe?
The first one is relatively easy. The defining feature of the day, for many bond analysts, is that yield curves in many countries are currently turning inverted, which means in effect that short-dated bonds have a higher yield than long-dated bonds. According to Morningstar in late July, three-month US Treasuries were yielding 2.08% against 2.05% for 10-year bonds. And that, said Morningstar, ran against the usual logic because investors would usually demand a higher yield because they were tying up their money for longer.
We’ve seen that the US Federal Reserve is under constant pressure from President Trump to cut interest rates, which effectively reduces bond yields, which in turn makes gold a better option for investors who might be in the middle deciding which way to jump.
More to the point, perhaps, an inverted yield curve may denote a coming recession – and indeed, it generally does, but it’s never quite clear what the time lag between the two events will be – the equities party may continue for some time yet. And some analysts insist that an inverted yield curve only suggests a recession when monetary policy is tightening, which is very much not the case at present.
All clear? No, I thought not. Let’s try again with our second question. Did the gold price tell us anything useful about 2008?
When we look at the gold price chart for that era, with all the benefit of hindsight, we notice something rather odd. Although the dollar price had bumbled along in the $600-660 range for a couple of years through the mid-noughties, it surged in second-half 2007 to an eventual peak of $975, and then actually fell again once the September stock market rout had got properly under way. (Before assaulting the $1,200-$1,700 peak again more than two years after the event.)
There are many things we could read into that price development – and the behaviour of bond yields would certainly be one of them, because tight yields do indeed tend to imply a higher bullion price, all things being equal. But what seems evident is that collapsing equity markets didn’t drive higher gold prices in 2008 – instead, they actually went retrograde for several months. The smart investors were the ones who saw the 2008 crisis coming, more than a year before it happened, and who then sat out the dance until a smashed equity scene had bottomed in early 2009.
They were, in short, ahead of the rest of us. Which shouldn’t surprise us at all, given the coolly mathematical heads that drive the bond markets, and by extension the slightly less rational bullion bugs. Of course, that’s an oversimplification because there were wild cards in play during 2008 and 2009 – quantitative easing, for one, and a crashing oil market for another. But to my mind, if we were looking for evidence that the bean-counting fiscal-watchers are cleverer than the stampeding equity brigade, I’d say that we’ve got it.
Does that suggest that this year’s sharp rise in bullion prices (and the accompanying tightening of bond yields) implies a watch-out-it’s-coming premonition from the fiscal watchers and a bandwagon that we surely ought to be joining? Not automatically.
We do, after all, live in exceptional times. America is being run by an economic illiterate (and proud of it!) who doesn’t hesitate to dictate his (ahem) unconventional policies to central bank economists who are paid to know better. Britain is entering a period of considerable economic uncertainty in which alternative currencies such as gold must surely seem an attractive hedge against a violently volatile pound. Europe is in the doldrums, China is refocusing, and everywhere is the prospect of global trade wars which are never going to be a zero sum game.
Oh, and then there are the crypto-currencies which may yet have the power to lift the money supply completely out of the political control of national governments, and which have no accountability to economics because they have no fundamentals whatsoever. Unlike fiat currencies, of course, whose fortunes are at least vaguely related to national economic performance, political power and trade bargaining.
You’ll have noticed that this year’s erratic surge in the bitcoin price has been impressive, and you’ll also be watching the progress of the new Libra currency which Facebook proposes to release before very long. Unfortunately, you may have missed the more telling event, which is that dozens of smaller cryptos are being squeezed out of business by their bigger rivals, and that they tend to disappear with a loud pop that leaves absolutely nothing behind them. In cyberspace, as Ridley Scott (Alien) might have said, nobody can hear you scream.
The irrational allure of scarcity
Owning gold is a little like holding some of the tickets to the lifeboats on a cruise liner. As long as the sea remains calm and blue, and as long as everyone’s enjoying the ride, everyone will think you’re nuts for missing out on the party. It’s when the wind gets up, and the tide’s running the wrong way, and you’re too near the rocks, that you’ll start to look like a smart operator. Even if the boat doesn’t actually flounder.
And that’s when the inverse logic of holding something that’s in strictly limited supply comes into its own. When the barometer says storm and the world is beating a path to your door, you’ve achieved a level of gearing that owes absolutely nothing to the intrinsic qualities of what you’re holding.
That’s when a true gold bug stops minding that his investment hasn’t ever brought in any dividends; that a gold bar costs money to store safely (assuming that it’s physical and not some sort of gold-backed paper or ETF); and that sometimes it may have attracted additional costs such as VAT. (Very much more so for physical silver, which is often touted as a gold proxy but which hardly moved at all during the first seven months of this year.)
So should we be worried that cryptocurrencies might suck all the surplus liquidity out of a bullion-loving world where the Chinese in particular have a lot of spare cash, but where gold isn’t necessarily the favourite place for investing it? Should we fear the fact that some governments (Japan, Switzerland, Germany, Sweden and even Britain) have been seriously studying the masked marauders, and that a few (Venezuela, Senegal, Tunisia, Uruguay and probably Russia before long) have actually launched cryptos of their own?
I don’t know, and nor does anybody else. All I know is that, given the choice between a physical asset that they aren’t making any more, and a row of digital ones and zeroes that they most certainly are, I’ll go for the one I can properly own, every time.