The catastrophe insurance policy through history
November 5, 2009
By Patrice Rassou
The shift in sentiment away from the US dollar following the credit crisis has pushed the gold price higher. The question now is whether this precious metal, which has played a central role in financial systems for centuries, can reclaim its position as a store of value?
A "fetish" for gold seems to be buried deep in the human psyche. This goes back at least 2 700 years, when coins made of gold and silver alloys were used in the Hellenic city of Efesos. Gold was revered in these ancient societies, as is illustrated by the story of the golden calf that was worshipped by the Israelites while Moses went up Mount Sinai.
Closer to home, the 800-year-old golden rhino of Mapungubwe shows how gold was an important status symbol in the royal courts of the day. Even when central banks came into prominence at the beginning of last century, the global monetary system was linked to gold reserves, further cementing the yellow metal as the backbone of the global economy. Being part of the gold standard was a badge of honour for the 59 countries that bound their currencies to these reserves. However, the discovery of the Witwatersrand gold fields led to an influx of gold in the global monetary system that would be a contributor to its downfall.
Since the 1970s the US dollar has been the reserve currency of choice and gold has lost its place as a common store of value. John Maynard Keynes was one of the economists who constantly berated the use of this "barbarous relic" as a reserve currency. The importance of gold as an anchor of the financial system waned as faith in a monetary system managed by central bankers grew. Gold was dethroned to the secondary role of safe haven asset whose fortunes have been the mirror image of the dollar.
However, the shift in sentiment after the credit crunch towards one of dollar pessimism has driven the gold price to record highs. That said, 63 percent of global currency reserves are still held in dollars - more than double the amount held in euros, the next available alternative.
Gold's status as a store of value has been acquired thanks to its ability to protect against inflation. The hyperinflation episode of the 1920s, when the German government printed money to take care of its war debts, appears to still influence contemporary behaviour: the German central bank still holds almost 70 percent of its reserves in gold. The question of the day, though, remains what the Asian central banks will do with their reserves. China and Japan only hold 2 percent of their reserves in gold and any bid to raise this would cause a sharp hike in demand for gold and further weakness in their current reserve currency of choice, the dollar.
For the man in the street investing in developed markets, the last decade has shaken the traditional belief that stocks are good investments. In the long run, after the US stock markets declined back to 1999 levels and even worse, Japanese investors are on the cusp of a two-decade decline in their equity market.
The Anglo-Saxon world has suffered a double blow: the body bag count has climbed in a pointless search for weapons of mass destruction while Wall Street launched its own weapon of mass financial destruction in the form of the subprime crisis last year. Unemployment is rocketing globally and the UK has suffered 16 quarters of negative economic growth - the longest stretch on record.
With interest rates at record lows, the private investor has sought alternative investment vehicles to protect savings. The rush into gold is no reflection on the current low-inflation environment, but reflects an expectation that the monetary stimulus that the world has received during the current crisis will filter through to inflation over the long term.
The history books remind us how US President Franklin D Roosevelt turned a deflationary environment into an inflationary one by abandoning the gold standard, thereby devaluing the dollar in 1933.
There are concerns that the huge budget deficits - estimated at over $1.5 trillion (R11.8 trillion) for the US - have to be financed and may boost inflation. This is not only a developed world problem, with China seeing money supply growth of over 150 percent in the past year.
Fundamentalists will argue that the price of gold is justified when one looks at the cash costs of production of the global gold mining firms, which has risen to an average of $820 an ounce, justify a much higher spot price in order to make expansions viable. Despite the fundamental case made for the rising gold price, there is a considerable amount of speculative activity driving demand for gold. Gold exchange traded funds account for 6 percent of overall gold holdings with John Paulson, the American hedge fund manager, rumoured to account for almost 10 percent of this. Paulson became a billionaire anticipating the subprime crisis and earlier this year his company bought an 11 percent stake in South African listed gold producer AngloGold Ashanti from Anglo American.
Despite the good news of an expected V-shaped recovery, some investors appear to be buying an insurance policy just in case things do not pan out the way policymakers expect them to go. In 1931, it was the failure of Credit Anstalt, the largest bank in Austria, presided over by a Rothschild, which was one of the triggers of the Great Depression. Now we have had Bear Stearns and Lehman Brothers. History never repeats itself but as Mark Twain said, it often rhymes. Some investors obviously seem to agree with this saying.
Patrice Rassou is a senior portfolio manager at Sanlam Investment Management
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