An Uncertain Time for Gold

Wednesday, 27th May, 2015
Melbourne, Australia
By Kris Sayce

  • Yellen yaps again
  • A new era for the ‘world currency’
  • They may be communists, but they aren’t stupid

A big change is coming this year.

It’s perhaps the biggest change in the world’s money system since the Plaza Accord in 1985, and possibly even since the Bretton Woods agreement in 1944.

It could affect the world’s economies, currencies, and even gold. More on this in a moment.

First, the markets…

Yellen yaps again

Let’s quickly see what day it is. Ah, that’s right, the US markets close on Friday near a record high.

You know what that means don’t you?

That’s right. It means that the US Federal Reserve needs to open their jabber-jaws to warn the market that an interest rate rise is drawing near.

Fed chairman Dr Janet Yellen says that interest rates could still rise this year. And how does the market react?

That’s right, the market falls from the record high. The Dow(n) Jones Industrial Average fell 1.04%. The S&P 500 index fell 1.03%.

And as if by magic, the Aussie dollar resumed its slide. It’s now down 4.5% against the US dollar since mid-May.

It’s a good thing I told Tactical Wealth subscribers to buy some ‘insurance’ against the Aussie dollar in the May issue of Tactical Wealth.

That insurance involves buying the Betashares US Dollar ETF [ASX:USD]. It trades on the ASX just like any other share. When the US dollar rises against the Aussie dollar, this ETF goes up. When the US dollar falls against the Aussie dollar, this ETF goes down.

That makes it a good hedge against the falling Aussie dollar. Now, if you own foreign assets, then it’s not necessary to own this ETF. By owning foreign assets, you would already have non-Aussie dollar exposure.

This ETF is mostly for those investors who don’t hold any foreign assets, and who are therefore vulnerable to a big fall in the Aussie dollar — that’s inevitable if (as I suspect) Australia is a full-blown participant in the global currency wars.

Speaking of which, rising and falling interest rates aren’t the only aspect to the currency wars.

A new era for the ‘world currency’

It’s possible that you’ve never heard of special drawing rights (SDRs).

These are an obscure ‘world currency’ managed by the International Monetary Fund.

In truth, SDRs aren’t an actual currency that you can use to buy things. Rather than being a standalone currency, SDRs are a unit comprised of a number of national currencies.

As at the last review of SDRs in 2010, the currency weightings are:

  • US dollar: 41.9%
  • Euro: 37.4%
  • British pound sterling: 11.3%
  • Japanese yen: 9.4%

It’s a very cosy Western-centric system. That’s not surprising. SDRs were created by the IMF in 1969, when the West (and Japan) dominated the world economy.

But this isn’t 1969.

The world’s economy is no longer so Western-centric. The world’s economy today has much more of an Eastern feel to it. And by eastern, I of course mean Chinese.

That’s why folks are looking forward to the next rebalancing of the SDR currency weightings. There is now a belief that China’s renminbi currency will earn a spot as one of the SDR’s underlying currencies.

If that happen, it will be a big step, and will be another blow to the US dollar’s dwindling status as world reserve currency.

Now, if the weightings were purely based on GDP, China’s currency would have a weighting of around 20% or so. But it’s not all about that.

For instance, the UK has a GDP of around US$2.7 trillion, whereas Japan has a GDP of around US$4.9 trillion. Yet, British pound sterling has a higher weighting than Japanese yen in the SDR basket.

So China will get a gig, but don’t expect it to get the weighting it deserves.

It’s hard to see the US, Europe and Japan giving up much ground to the Chinese. The whipping-boy could be the UK, whose weighting is far too high considering its diminishing influence on anything in the world.

You can tell that China’s inclusion is a virtual certainty. After the US and most of the West had spent years criticising China for ‘currency manipulation’, they’ve recently gone conspicuously quiet on the subject.

It doesn’t always provide a complete picture, but the Google Trends tool can show you the rising and falling popularity of certain terms.

Here’s the Google Trends search results for the term ‘China currency manipulation’:

Source: Google Trends

The peak ‘interest’ in stories about China’s currency manipulation was in late 2012 and early 2013. That’s when the US was at the height of its money-printing program.

The US resented the fact that China’s peg to the US dollar meant that as the US Fed devalued the dollar, China’s authorities had to devalue their currency in order to maintain the peg.

That prevented the US from getting as big a bang for its buck as it would like.

But even the US can’t ignore the inevitable, and that is the prospect of China becoming the world’s biggest economy in as little as 12 years.

However, the one thing that most folks haven’t focused on is the impact this could have on the gold price. It could have a bigger impact than most people think.

They may be communists, but they aren’t stupid

Everyone knows the Chinese love gold.

The Indians love it too. As do most in South East Asia.

But as much as they love it today, is there any guarantee they’ll love it 20, 30 or 50 years from now, especially as their economies become more developed?

It’s an interesting thought. I can’t claim the credit for considering it either.

The idea came from our buddies at Money Week in London, in an article written by their resident gold guru, Dominic Frisby.

Here’s what he wrote:

There are even rumours (mostly unfounded, I suspect) that the Chinese government is planning some kind of partial return to a gold standard.

But will that change?

People in the East want (and in many cases already have) the luxuries that we in the West take for granted – fridges, cars, computers, and all the rest of it. As they become more “Westernised”, might they lose interest in gold?

Because over here, once upon a time, gold was money. Gold sovereigns were the old pound coins. Gold played an almost daily role in our lives. The gold standard was the monetary rock on which the Great British trading empire was build. The value of gold was known and appreciated.

But over the past 100 years, attitudes have changed. Now gold couldn’t be more irrelevant.

Perhaps as the East develops, gold will become as irrelevant to them as it has to us in the West. We’re already seeing signs of that. Jewellers report that young people in India prefer 18ct gold to the purer 24ct stuff their parents would choose. Perhaps as they get wealthier and more secure, they lose sight of gold’s utility as a portable store of value.

I get both sides of this argument. The Asian appreciation of gold is clear, but it’s also conceivable that gold will fall in significance there just as it has here. It’s an argument that we won’t know the answer to for another generation or so.

Understand who wrote that. Dominic is about as ardent a gold fan as you’ll find. I’m certain he will have gotten a bunch of letters from irate goldbugs telling him he’s wrong.

But he makes a great point. It’s true that many Asians love gold. But that was true of most Western Europeans a century ago.

It was true of the Aztecs and the Incas, and the Romans.

But that didn’t guarantee anything.

By all accounts, China has spent the past six years stocking up on gold. It is estimated that central bank gold reserves may have increased fourfold.

Other central banks, such as Russia’s have done the same. But now that China is on the verge of achieving central bank ‘respectability’, and acceptance into the Western-dominated monetary system, will gold retain its importance?

It’s doubtful that the IMF will include the renminbi in its SDR currency basket without some written and unwritten rules.

The written rules will probably prohibit currency manipulation (obvious currency manipulation that is). But of more interest could be the unwritten rules. For instance, will China have to assure the West that it won’t exceed a certain level in terms of gold reserves?

After all, all the world’s currencies are backed by little more than the word of a national government and its central bank. As long as they all play by that rule, they’re mostly safe.

But if one renegade central bank decides to increase its gold reserves far in excess of every other central bank, that could create problems.

The issue is: what’s more important to China; building a strong and sound currency or gaining acceptance to the world stage of banking and finance?

They may be communists (by name), but they aren’t stupid. So we’ll wager it’s the latter.

The end for gold?

So, what does that mean for the gold price? Should you get the heck out of it before the price plummets?

Not a chance. I still hold the view that you won’t see the real bottom of the gold price until it falls below US$1,000 per ounce. That’s when you’ll see the final ‘fair weather’ gold owners abandon ship.

But long term, regardless of what China does with its currency, and regardless of how Asians may change their view of gold, one thing remains certain…

Throughout history, paper money has always failed as governments and central banks find it irresistible to print money and devalue their currencies.

This is no different. Arguably, the abandonment of gold by the East could be the point where this latest experiment in paper money and world money starts to unravel.

Remember, gold isn’t necessarily an asset to hold because you think it could make you rich. Gold is an asset to hold because of the certainty that governments will manipulate paper money and use inflation to erode the public’s wealth.

Whatever happens this year with SDRs and China’s new role on the world stage, don’t sell gold. If anything, it will be the time to buy.

Coming soon!

In the coming weeks you’ll see more commentary on SDRs, the value of money (including the ‘death of money’), and the outlook for gold when we introduce you to the global economic insight of a new face in the Port Phillip Publishing stable.

Stay tuned. We’ll have more news soon.

In the mailbag

It’s a disappointing day for ‘tiny’ stocks today. Only two have doubled!

Source: CMC Markets Stockbroking

But, not a single one of today’s biggest percentage gainers (at the time of writing) is greater than two cents.

And again, to the folks who say it’s not possible to make big gains on stocks, I continue to get letters from readers telling me how they’re doing just that. Such as this letter from Will:

I wish you luck with the project.  I’ll be interested as it might save me some work.  For years I have been doing this and I did trade CuDeco and made a lot of money in a few days.  I was worried when I left my computer for a few minutes only to find it had gone into a trading halt after rocketing up.  When it came out of the trading halt a few weeks later (I think) I locked in my profits as it climbed again and then settled at a lower price.

My latest of these trades was Aziana (AZK.asx) which I bought at 5.3 cents and sold a few weeks later at 52.5 cents for nearly $50,000 profit in my SMSF.

Will, go careful making profits in your SMSF, the government and vested interests will accuse you of ‘hoarding wealth’. Heaven forbid that anyone should ‘hoard’ their own money to do with as they please.

Anyway, I’m glad Will mentioned CuDeco. It’s a stock I remember well back in my stockbroking days. It went by a different name back then — Australian Mining Investments.

I explain why in the Project 100 to 1 video series. Check in here for details.

And just in case you think we only ever publish favourable letters from subscribers, this letter should put paid to that thought:

I am a subscriber in Tactical Wealth and to date it has been the worse [sic} publication that I have ever subscriber [sic} to.

Tactical Wealth subscriber, Sam

This is what happens when you live out on the fringe as a contrarian financial analyst and publisher.

Like any business, we’re always looking to bring on new subscribers. Most of our subscribers come to us because they’re on the same wavelength as us.

But sometimes, as we cast the net to attract more people to our service, folks join us who don’t really ‘get’ what we do. They’re used to the mainstream investment advice that tells them stocks only ever go up (unless it’s a bear market when the mainstream will tell them that stocks only ever go down!).

So they don’t like it when we warn them that stocks could fall.

They don’t like it when we explain the government and vested interests are gunning for their super savings.

They don’t like it when we tell investors to have at least 10% of their portfolio in precious metals — although 20–40% would be better.

And they don’t like it when we tell them to hold non-Aussie dollar assets as a hedge against a collapse of the Aussie economy into recession.

As the saying goes, we can’t please everyone. As it happens, we don’t even try. We publish what we believe is the right financial advice and leave it up to the individual to decide whether that advice makes sense for their personal situation.

Cheers,
Kris [+]

PS. Remember to send your comments, feedback, and questions on our services, the stock markets, wordsmithery, or lexicography to letters@portphillipinsider.com.au.