WHEN I recently went to talk to some school children about the nature of money, I brought props: a cowrie shell, a piece of play paper and a small handful of shredded dollar bills. Which of these, I asked, is money?
The point I wanted to make: It is all about belief. If everyone agrees something is money, it is indeed money. One particularly engaged child interrupted me just as I was getting going on the rai stones of Yap to ask: Can fiat currencies really survive? Not what you might expect from an 11-year-old.
The answer, of course, was that it depends what one means by survive. Carry on for many more decades under the same names of dollars, pounds, euros, etc.? Sure. Do so without losing purchasing power? Not a hope. Even inflation at 2% each year halves the value of your money in 36 years. And inflation at 2% for the long-term is something of a distant dream at the moment. CPI is down to 6.5% in the US and it will fall further from here, but it is very unlikely to settle at 2%, where most central banks still have their targets set.
We live in a world of very big government — one in which the answer to anything is more state spending (the UK’s response to rising energy bills, for example, is to have the state cover much of the cost) and in which governments have taken on vast investment responsibilities (in green energy, for instance). Deficits and borrowing will rise as a result. At the same time, the effort to build resilient supply chains and to reshore manufacturing will make everything more expensive, as will rising labor costs around the world. The disinflationary effects of China entering the global workforce are long gone (see Larry Summers on this).
So inflation is with us for the long haul. If you are holding cash, know that it is only a temporary king.
This all led the children and me to a discussion of whether there is anything that stays money forever. Enter physical gold, the only thing that has been considered real money by most people and that has maintained its purchasing power for nearly 3,000 years. This isn’t a particularly interesting conversation if there is no inflation: If a pound or a dollar holds its purchasing power, who needs gold? It is heavy, you have to store it, it has no yield. When inflation is on the table, things get more interesting.
With this in mind, you might have expected gold to be all the rage last year. It was not. Instead, even as inflation hit close to 10% pretty much everywhere, the gold price (in dollars at least) did nothing. Gold mining shares, a good way to get leveraged exposure to gold, fell more than 8% and demand for gold ETFs fell for the second year in a row. Exasperating stuff.
Still, things did pick up toward the end of the year. The gold price (in dollars) is up some 15% since the beginning of last November and the miners have begun to come good too: The GDX gold miners index outperformed the S&P 500 by 14.9% in November and 4.6% in December, say the analysts at Stifel. The outflows from gold ETFs also slowed for the third month in a row in December — with the US even seeing mildly positive demand, to the tune of around $530 million.
This year is looking good too: The gold price is up 7% in the last month in sterling and dollars. The VanEck Junior Gold Miners UCITS ETF (which I hold) is up 10% year to date. Might there be something brewing here? Stifel thinks so. For them, it’s all about the Fed pivot.
Since gold has been allowed to trade freely, there have been 10 periods in which US benchmark rates have peaked. Theoretically, a peak in rates is a positive for gold, which offers no yield so looks less attractive as an investment as interest rates rise and more attractive as they fall. But it works in real life, too. Look at the periods five months before each peak (possibly roughly where we are now given that US CPI has just seen its first monthly drop in more than two years) plus six months, and you see that gold averaged a gain of 18% during these times and also outperformed the S&P 500 by 9.7% through the rate peaks. Good news.
There’s more. Recessions have followed the rate peaks within 18 months 60% of the time (the average being 10 months) and gold has shown a strong tendency to do well in these periods too (beating the S&P500 by 26%) — particularly when recession coincides with a stock market downturn. Regardless of what regulators say about past performance telling us nothing about the future, this does give good reason to think about holding gold in the short-term.
It is also worth thinking about who’s buying gold at the moment. Last year, there was much talk about who the “mystery buyer” in the gold market was. It wasn’t, it turns out, money managers in the US (the ones who should have been looking at the same data as Stifel), but central banks.
Overall, the World Gold Council estimates that central bank buying has lifted gold reserves to their highest level since 1974, with massive purchases from Russia and China being key. The People’s Bank of China bought 62 tons of gold in November and December alone. Why? To build reserve currency status, to hedge against the dollar in the wake of rising sanctions risk, to diversify — all things are possible given the geopolitical environment.
TD Securities are unconvinced on the case for gold. To them, Chinese buying has created a nasty $150 per ounce mispricing in the market — one that will correct if they stop buying.
But you could look at this the other way around and take Chinese buying as a clear reminder that gold is one of the few things that everyone thinks is money — from the precocious 11-year-old I met last month to the heads of every central bank in the world. As Alex Chartres of Ruffer recently said on my podcast, there aren’t many other things you can turn to as a long-term safe haven in today’s markets.
A year ago, some thought Bitcoin might be a rival — a digital gold even. The market has now “kneecapped” that idea. These days, if you want gold you will need to buy, well, gold. That being the case, the question is not have you too much, but have you enough — the very same question the head of the PBoC is clearly asking himself right now.