Gold and Precious Metals

Why you still need gold

Mr T photo

Riots in Brazil (Brasil). Turmoil in Turkey. Portugal’s coalition government is collapsing, causing Portuguese bond yields to shoot up. A military coup d’etat in Egypt. At the root of all these events is the ongoing world economic crisis that started in 2007. But they are a reminder of why you still need gold.

In times of trouble gold is a great asset to have. It’s durable – meaning it lasts. It’s easily tradeable – meaning you can quickly use it to buy things. It’s portable – meaning if you have to get out of somewhere in a hurry you can take it with you. It’s hideable – meaning you can keep it private, especially if held in coin or small bar form.

In a sense gold is wealth. Most of us have the habit of measuring our wealth in terms of our local currency units. Reais, renminbi yuan, pounds, francs, euros, yen, rupees, roubles, dollars, etc. But paper currencies come and go, and always lose purchasing power in the long run.

Gold’s price, measured in any of those currencies, can go up or down. But in the long run a troy ounce of gold is a troy ounce of gold. The Ancient Egyptians were the first people to systematically mine gold, around 5,000 years ago.

One of your ancestors could have been given an ounce of gold back then, and handed it through the family for generation after generation, until it finally found its way to you. And it would probably buy you the same amount of basic stuff today – food, clothes, etc. – as it did back then.

Given what’s happening in Egypt today, I bet those Egyptians that own a bit of gold are feeling more secure than those that don’t. The government, the economy and the currency can go to pieces. But a handful of gold coins will keep a family fed for a year or more.

 …world could go bust, wiping out trillions of dollars worth of customer deposits…

But even in countries that appear to be more stable it’s worth owning some gold. It’s a great form of insurance against financial calamity. All the banks in the world could go bust, wiping out trillions of dollars worth of customer deposits. The few sensible people that owned physical gold, outside of the banking system, would be sitting pretty. They would be practically the only people with any money left!

If that scenario sounds fanciful, that’s because it is. But individual banks – and increasingly the governments that have bailed them out in the past – are still highly risky places to park your money. And don’t forget, when you make a bank deposit you are really making a loan to the bank. They don’t have a box somewhere full of notes with the words “Mr. Polo’s cash” written on the top.

So if a bank goes bust you are just one of many creditors. In theory many countries have deposit insurance schemes. But they are usually underfunded. And as many governments dig themselves into ever deeper debt holes they may not be able to step in to provide the bail-outs in future.

…inflation could have destroyed the purchasing power of the cash…

Even if the insurance schemes are fully functional, it’s still my bet that depositors wouldn’t see their money for several years. By that time inflation could have destroyed the purchasing power of the cash, especially if there is a raging financial crisis going on.

I’ll give you one good example of an overstretched bank. It’s the biggest currency trader in the world, has a massive fixed income and derivatives business (bond trading and associated products), and is Germany’s biggest retail and commercial bank. I’m of course talking about Deutsche Bank.

At the end of March 2013 Deutsche Bank’s assets were €2,033 billion (yes…that’s over 2 trillion euros!). But shareholders’ equity, which is also called net assets (total assets less total liabilities) or book value, stood at just €55.8 billion. That means Deutsche Bank is leveraged up by 36 times (2,033 / 55.8).

This is a huge amount of leverage, although admittedly it is below the 55 times leverage reported at the end of 2007, and massive 72 times leverage at the end of 2008, in the thick of the banking crisis. The safest and best run banks are usually only leveraged around 15 to 20 times.

A level of 36 times leveraged means assets only have to fall by 2.8% more than liabilities for equity to be totally wiped out. Shareholders (and depositors) of Deutsche Bank had better hope there are no slip ups in the bank’s risk control department…

Deutsche Bank is not alone. There are still plenty of huge banks that are overleveraged, in Europe, the US and Japan. In other words the global banking system is still a house of cards. One more gust of wind from a new asset crisis could blow it all down again. Owning some physical gold is a great protection against a new banking crisis.

Why you still need gold

In short, the price of gold may have fallen recently ($1,251 per troy ounce at time of writing), but the reasons for owning it are still very much intact. In short it’s a combination of the continued deterioration of developed country finances and the ongoing buying of physical gold by large emerging markets such as India and China. You can find more details here and here.

For small amounts of gold, which you can keep close to hand, you can buy small bars or 1 oz. gold coins such as Kruggerrands at any reputable gold dealer in your home country. But for larger amounts, or for overseas storage in a vault, OfWealth recommends BullionVault.

BullionVault is this the biggest provider in the world of gold bullion storage for private individuals. It’s also the cheapest that I have found – both in terms of dealing costs and storage costs (which include insurance).

Gold is allocated, meaning it is your direct property with no intermediary, and is stored in guarded vaults. My preferred vault locations are Switzerland and Singapore, since they are both stable countries with strong finances. And as financial centres with a focus on wealth management they have big reputations to protect.

You can also choose the USA (New York) or the UK (London). However I’d prefer not to have my bullion stored in financially weak countries such as those. The medium to long term risks of future capital controls (being unable to get the money out of the country) or outright confiscation are just too high.

…gold price may fall further…but fundamental conditions win out in the end.

Of course the gold price may fall further from here in the short term. But equally it may rise. Markets do what they please in the short run – but fundamental conditions win out in the end. Whatever happens, I recommend that all my fellow OfWealthers own some of the yellow metal. After all, nothing’s as good as gold as gold itself.

Until next time OfWealthers,

Rob Marstrand

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.